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Resolution of SIFIs

2013 Financial Markets Conference

April 2013

An interview with Kenneth E. Scott, the Ralph M. Parsons Professor of Law and Business Emeritus, Stanford University

Larry Wall: I'm Larry Wall and I'm here at the Financial Markets Conference with Ken Scott. And Professor Scott, you've been advocating a change in the bankruptcy code to allow banks, to allow systemically important firms, to be resolved through the bankruptcy code. Why that rather than to go through the FDIC [Federal Deposit Insurance Corporation] resolution that was set up in Dodd-Frank?

Kenneth E. Scott: Well, first of all, the FDIC resolution applies only to a very small number of financial companies, bank holding companies, investment banks, whatever. They have to be systemically important financial institutions, that is, defined as if they went into default it might threaten the financial stability of the United States.

So how many institutions are we talking about? If you try to approximate it, the Financial Stability Board has said worldwide there are about 28 institutions that it regards as systemically important. Eight of those are in the U.S. In doing various stress test exercises, the Fed limited it to some 19 banks.

So, in any event, you're talking about a relative handful of bank holding companies and other financial institutions that can be considered for and put through Title II of Dodd-Frank. There are hundreds and hundreds of financial companies out there, the group that I'm associated with [Stanford's Hoover Institution Working Group on Economic Policy] was formed to consider those issues and to try to develop some reforms, some changes to the bankruptcy code to make it better adapted to handle the failure of financial companies in particular, and large financial companies as a part of that group.

Wall: As you say, you're part of a group and you're advocating a new Chapter 14. What sort of changes need to be made to the bankruptcy code to make it better at resolving financial firms?

Scott: Well, our group consists of about a dozen people of various backgrounds, finance professors, bankruptcy professors, practitioners, former regulators, [and] has been working at developing a new template, a set of changes to the bankruptcy code that we believe would make it more efficient and more able to efficiently handle the failure of financial institutions.

First of all, we're designing it to be the new Chapter 14 exclusively for financial companies. The bankruptcy code provisions on reorganization and liquidation are designed to handle all kinds of companies in any line of business, large and small. Here we're talking about a rather specialized group of companies, none of them necessarily very small, many of them very large. So how are you going to deal with these kinds of institutions?

Partly we change the definition of what Chapter 14 will apply to, and it's financial companies with over $100 billion in assets. Then we talk about some of the provisions that go into effect upon filing for bankruptcy. We talk about who can file a petition for bankruptcy. We make changes to the bankruptcy code in these areas. For example, the provision would permit a primary federal supervisor of a financial institution, financial company, to file a petition for bankruptcy. At present, under the bankruptcy code, it is done by three creditors filing a petition because they haven't been paid, or the firm filing a so-called voluntary petition because it recognizes that it's in financial difficulty and needs to reorganize. So we're trying to adapt that procedure to the realities of highly regulated financial institutions.

Wall: Thank you very much, Professor Scott.