Can ‘living wills’ protect the banking system?

Euro banks have been urged to reinforce their balance sheets. AAP

Eurozone leaders have moved to address liquidity fears, with the European Central Bank announcing new measures to head off a credit crunch. Britain has also announced quantitative easing measures.

Outgoing European Central Bank President Jean-Claude Trichet has urged banks “to do all that is necessary to reinforce balance sheets", as efforts continue to rescue Franco-Belgian banking group Dexia, in trouble due to its significant exposure to Greek and Italian debt.

One recent suggestion to prevent contagion among troubled banking institutions has been the concept of banks preparing “living wills” - a basic plan of how a bank could be pulled apart without damaging the broader industry.

The Financial Stability Board has been asked to report a detailed plan to the next G20 meeting in November.

Professor Kevin Davis, Research Director at the Australian Centre for Financial Studies at University of Melbourne explains the concept.

What do living wills mean for banks?

One of the things that came out of the global financial crisis was general recognition that the powers of the regulators to resolve a troubled financial institution are not as good as they should be, so that when large banks get into difficulty we find there are all sorts of problems in them making a smooth and graceful exit from the industry.

Reinforce balance sheets: Jean-Claude Trichet. AAP