The Group of Thirty (G30) published a report on the 2023 banking crisis, Bank Failures and Contagion: Lender of Last Resort, Liquidity, and Risk Management. The study, chaired by William Dudley, former President of the Federal Reserve Bank of New York, analyzes the bank failures of March 2023, dissects the causes behind the collapses, and proposes reforms designed to minimize the contagion risks in the future and increase the resilience of banks and the banking system.
Events in March 2023 shook up the banking systems in the United States and Europe. Risky funding structures, large unrealized losses, and declining profit margins at several US banks, and one large Swiss bank, triggered rapid deposit runs that precipitated the banks’ failures. The failures were triggered by a combination of poor business models, weak risk management, and a rapidly shifting macroeconomic environment.
The report proposes reforms to limit contagion when bank failures occur and mitigate broader economic consequences. These include enhanced liquidity support mechanisms, notably a much-improved lender-of-last-resort (LoLR) regime, possible changes to deposit insurance, and a truly workable scheme for resolving large banks. The key goal of the reforms is to reduce the risks of liquidity and other stresses from spilling over to other banks and the system at large. The report also stresses that reforms are needed to reduce the likelihood of banks failing.
These reforms include better bank governance; improved accounting standards and financial reporting; changes to prudential regulations; and much better supervision, including more comprehensive stress tests. Most of these reforms, many advocated for some time, do not impose large costs, if any, on those banks that are already well run and transparent, and they will both force and incentivize banks that are poorly run to improve their performance.
William Dudley, chair of the G30 Working Group on the 2023 Banking Crisis, said in a statement: “We propose strengthened lender-of-last-resort (LoLR) mechanisms: we would require banks to pre-position enough collateral at the discount window to cover, after the normal haircutting for credit risks, all runnable liabilities — that is, all liabilities excluding capital, long-term debt, swap liabilities, and insured deposits. This more robust LoLR system would enable banks to obtain immediate liquidity in times of stress and avoid fire-selling assets.”
“By requiring pre-positioning, we will reduce the risk that uninsured depositors and other short-term claimholders run for the exits during periods of panic.”
Stijn Claessens, project director of the G30 Working Group on the 2023 Banking Crisis and former head of Financial Stability Policy at the Bank for International Settlements, said in a statement: “The study takes a holistic perspective. We recognize the need for a balance between market discipline and public support. We crafted the reforms mindful of minimizing the impact of reforms on the overall financial system. We concluded that a reformed LoLR system is the most important, most feasible, and lowest-cost reform.”
Darrell Duffie, project advisor to the G30 Working Group on the 2023 Banking Crisis and Adams Distinguished Professor of Management at Stanford University, said in a statement: “These LoLR changes can be undertaken by the central bank and regulatory authorities now, without the need for new legislation. In the case of the United States, we do not need to wait for Congress to act. Policymakers and regulators can strengthen the system quickly and effectively.”
Patricia Mosser, project advisor to the G30 Working Group on the 2023 Banking Crisis and Director of the MPA Program in Economic Policy Management at the School of International and Public Affairs, Columbia University, said in a statement: “We are clear that in normal times, banks need to conduct their own prudent risk management, including by holding enough liquid assets, except in the most extreme scenarios that cause a need for an LoLR. Robust norms of good governance, risk management, conduct, and culture will always be necessary for strong and stable banking—as the G30 has stressed in the past. Prepositioning is not a substitute for good risk management.”
The G30 Working Group on the 2023 Banking Crisis included eleven members: Mohamed El-Erian, Jason Furman, John Heimann, Gail Kelly, Mervyn King, Helene Rey, William Rhodes, Masaaki Shirakawa, Tidjane Thiam, Axel Weber, and Zhou Xiaochuan. We extend our gratitude to the Working Group members for their support, input, and dedication throughout the project.