LONDON, July 10 (IFR) - Banks should have to hold more common equity as recent bailouts of banks in Europe show that "too big to fail" is alive and well, according to Neel Kashkari, president of the Federal Reserve Bank of Minneapolis.
Kashkari said the recent rescue of three Italian banks showed that bondholders are often not called on to rescue banks, despite rules put in place for that to happen.
"There’s no need for more evidence: 'bail-in debt' doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity," Kashkari said in an opinion piece in The Wall Street Journal.
Being able to bail-in debt was seen as the solution to "too big to fail". The plan is that when a bank runs into trouble, regulators trigger a conversion of debt to equity and bondholders would take the losses. The bank would be recapitalised and taxpayers would be spared.
But Kashkari said the bailouts of Italy's Banca Monte dei Paschi di Siena, Banca Popolare di Vicenza and Veneto Banca in recent weeks proved it doesn't work. The only recent case in which taxpayers were spared was the failure last month of Banco Popular in Spain.
Kashkari, who has previously worked at Goldman Sachs, Pimco and held senior positions in the US Treasury, has for some time called for banks to hold more capital.
He said bailing in bondholders rarely works in real life. In Italy, that was because bondholders were retail investors. "Regulators claimed that this was a unique circumstance, but there always seem to be unique circumstances when bailouts are concerned," Kashkari said.
He added: "If bail-in debt couldn’t protect taxpayers from a midsize bank failure when the global economy is stable, what are the odds it will work if a Wall Street giant runs into trouble when the economy looks shaky?
"This is one more reminder that only equity can be counted on to protect taxpayers - and it needs to be raised in advance of economic distress."
He said large banks need to be able to withstand losses of around 20%, according to a 2015 analysis by the Federal Reserve. Although banks have increased capital buffers, they still only have about half that amount in equity because regulators assume bondholders will take losses.
"Italy demonstrates that this is wishful thinking. Too big to fail is alive and well, and taxpayers are on the hook," Kashkari said. (Reporting by Steve Slater)