Bank resolution backstops are a governance test emerging markets cannot defer

This is an Opinion piece from Plumb Line, EM Governance Review's analysis, explainer and opinion column. It argues for a position on a live regulatory debate; the facts it rests on are linked.

When a large bank fails, the question that decides whether the failure is orderly is rarely capital. It is cash: who lends to the bank in resolution, how fast, against what, and who pays if the loan is not repaid. The Financial Stability Board's latest peer review says most of its member jurisdictions still cannot answer that question fully. Emerging-market governments, whose banks are often large relative to the state's balance sheet, have the most to lose from leaving it open.

What the review found

The FSB's thematic review of public sector backstop funding mechanisms, published on 9 October, found that "incomplete implementation of Key Attribute 6 in most jurisdictions remains a material gap that weakens authorities' ability to resolve systemic banks and could impact global financial stability", the report page says. Fifteen years after the FSB issued its recommendations on designing such a backstop, "approximately half of jurisdictions still have material gaps", its press release says.

The review tested three things: whether a credible mechanism exists and can deliver temporary liquidity "at the scale and speed likely to be needed for an orderly bank resolution"; whether tools are in place for taxpayer losses to be recovered; and whether safeguards contain moral hazard and keep the mechanism a last resort. It makes six recommendations to jurisdictions and asks them to ensure that arrangements are in place before a crisis, "rather than improvised under pressure". It also finds "there are multiple ways to design a PBF that can fully meet the FSB's high standards".

The scope is deliberately narrow. The review did not assess the full range of resolution powers and tools, only public liquidity as a last resort, and it asks the FSB itself to support members by sharing good practices, building on existing implementation materials and "closely monitoring progress" on Key Attribute 6, the release says. Monitoring will show who moves.

Soledad Núñez, deputy governor of the Banco de España, who chaired the review, said "further work is urgently needed to complete implementation of the FSB's recommendation on public sector backstops". The review grew out of work begun after the 2023 bank failures, which, the FSB says, "demonstrated how quickly a bank can experience acute liquidity stress".

Why emerging markets should move first

The standard dates from the FSB's Key Attributes of Effective Resolution Regimes, adopted in 2011 to make it possible to resolve a failing institution "without severe systemic disruption or taxpayer losses", the FSB notes. The logic of a pre-arranged backstop is that liquidity is lent to a bank in resolution and recovered afterwards from the bank or the industry, so that the alternative, public ownership or an open-ended bailout, is not needed. The FSB puts it plainly: "a credible mechanism can mean failing banks don't have to be taken into public ownership".

That trade-off weighs more heavily in emerging markets for three reasons, in Plumb Line's view. First, the sovereign and the banks are closely tied. Where banks hold large amounts of government debt and the state is the implicit guarantor of the largest lenders, an improvised rescue moves risk from bank balance sheets to the public one at the worst moment. The FSB chair's letter to G20 finance ministers this month pointed to "heightened volatility in sovereign bond markets", the FSB said; that is the environment in which an unplanned bailout is most expensive.

Second, speed and currency. A backstop has to deliver liquidity fast, and where deposits are partly held in foreign currency, a run on a large bank can be partly a run on dollars. A mechanism that can lend only in local currency, or only after a political decision, is not the credible last resort the review is testing for.

Third, credibility with investors. A pre-agreed mechanism with a defined route to recover losses from the industry is a signal that the authorities will not socialise bank losses. That signal lowers the premium investors demand on bank debt and, over time, on the sovereign.

What a good design looks like

The review's three tests translate into a short checklist that finance ministries, central banks and deposit insurers can apply now. The legal basis for lending to a bank in resolution should be in statute, with the provider named in advance, whether the central bank, the treasury or a resolution fund. The scale should be set against the funding needs of the largest banks in stress, not their average needs. Recovery of any loss should be written in as an ex post levy on the banking sector, so that the taxpayer is repaid. And the safeguards that keep the mechanism exceptional, including conditions on the bank in resolution and senior management changes, should be published.

The recommendations are addressed to FSB member jurisdictions, but the FSB also reaches roughly 70 other jurisdictions through its regional consultative groups, and the logic holds for them. Plumb Line's view is that every emerging-market authority with a systemically important bank should publish, within the next year, how it would fund that bank in resolution and how it would recover the cost. A backstop that exists only in a crisis is not a backstop.