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The Federal Reserve finalised a new rule that should make it easier to wind down systematically important US banks by creating a safe harbor for financial contracts after a firm defaults.
The decision, unanimously approved by Fed board members, forms part of global post-crisis efforts to end 'too big to fail' institutions that are so large and complex they could endanger the entire financial system if they fall into bankruptcy.
The rule requires global systematically important banks (GSIBs) to amend the language in common financial contracts so they cannot be immediately canceled if the firm enters bankruptcy.
By imposing new legal protections, regulators aim to prevent a run on a GSIB's subsidiaries that could be triggered if a large number of counterparties rush to terminate their contracts, as occurred in the case of Lehman Brothers in 2008. The new rules would apply to eight GSIBs, including JPMorgan Chase, Goldman Sachs and Citigroup.
As GSIBs sign a huge number of such deals, typically worth hundreds of billions of dollars, a market panic to terminate them could potentially drag down other institutions.
"The financial crisis showed that when a large financial institution gets into trouble, its failure can destabilise other firms and the broader financial system," Fed Chair Janet Yellen said in prepared remarks at an open hearing.
"This requirement will help manage the risk to the financial system when a GSIB fails."
The rule applies to a range of products, including derivatives, securities lending deals, and short-term funding agreements, that are privately negotiated rather than processed through a central clearing house.
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