On Friday, The Federal Reserve finalized a new rule that would make it easier to unwind important U.S. banks by creating a safe harbor for financial contracts after a firm defaults. This decision was unanimously approved by Federal board members and forms part of the global post crisis efforts to end big institutions that are very complex which could endanger the entire financial system if fallen into bankruptcy.
This rule would required global systematically important banks (GSIBs) to adjust the language in common financial contracts so it wouldn’t be immediately cancelled if entered into bankruptcy. When new legal protections are imposed, regulators have a goal to prevent a run on a GSIB’s subsidiaries that could be brought if a large number of counterparties rush to end their contracts. The new rules would apply to 8 GSIBs which include Citigroup Inc (NYSE: C), JPMorgan Chase & Co. (NYSE: JPM), and Goldman Sachs Group Inc (NYSE: GS).
GSIBs sign a great number of deals which are worth hundreds of billions of dollars, which if cancelled, can bring down other institutions. This rule will help manage the risk to the financial system if and when a GSIB fails. It would apply to a variety of products such as short tern funding agreements, derivatives, and securities lending deals. Banks are given more time to comply and it would also reduce the number of contracts covered by the new rule to be finalized on Friday.