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FinReg > Banks resolution > Flashcards

Banks resolution Flashcards

1
Q

Why banks need resolution

A

Because there is a social impact from bank failure

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2
Q

Inadequacy of insolvency laws and
proceedings to deal with (big) bank
collapses

A
  1. Conducted by a judicial
    authority (too slow - may take years)
  2. May abruptly stop banks’
    provision of critical functions (like payment system)
  3. Destruction of (going concern)
    value
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3
Q

Every system bank has to develop a

A

resolution plan

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4
Q

International standards: FSB Key attributes 2011

A

A) Resolution planning
(preparation for)
B) Resolution scheme

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5
Q

FSB Key attributes 2011: Resolution planning

A
  1. Understanding the bank
  2. Preferred resolution strategy
  3. Financial and operational continuity in
    resolution
  4. Information and communication plan
  5. Resolvability assessment
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6
Q

FSB Key attributes 2011: Resolution scheme

A
  1. Which resolution tool(s)?

2. How to finance resolution action?

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7
Q

What is the time frame for the resolution scheme

A

36 hours, usually starting from Friday when the latest stock market closes, and ends on Monday when the earliest stock market opens

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8
Q

What is the core of any national resolution model now

A

FSB Key attributes 2011

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9
Q

Critical functions of banks include

A

payment system, funding, etc

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10
Q

FSB Key attributes 2011

7 important KAs

A 
KA 1 - Scope
KA 2 - Resolution authority
KA 3 - Resolution powers
KA 5 - Safeguards 
KA 6 - Funding of firms in resolution
KA 10 - Resolvability assessment 
KA 11 - Recovery and resolution planning
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11
Q

KA 1

A

Scope:

All financial institutions that could be systematically significant or critical

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12
Q

KA 2

A

Resolution authority:

• Administrative authority/authorities to exercise resolution powers
• Objectives: (1) safeguard financial stability and continuity of critical functions; (2) protect
depositor/insurance policy holder/investor; (3) avoid unnecessary destruction of value and seek
minimization of resolution costs; (4) consider impact on financial stability in other jurisdictions
• Operational independence, transparent processes, sound governance, adequate resources,
accountability mechanisms, expertise and resources

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13
Q

KA 3

A

Resolution powers:

• Entry into resolution: firm is (likely) no longer viable and no reasonable prospect of becoming so,
but (ideally) not yet insolvent
• General resolution powers: remove/replace management/directors, appoint administrator,
restructure/wind down firm’s operations, override shareholders’ rights…
• Resolution tools: (1) transfer assets and liabilities; (2) establish bridge institution; (3) bail-in within
resolution; (4) establish separate asset management vehicle

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14
Q

Who will bear the losses first in bank failure

A

the shareholders and creditors

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15
Q

the shareholders and creditors don’t like which KA

A

KA 3 Resolution powers,

that’s why KA 5 (Safeguards) is there for

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16
Q

KA 5

A

Safeguards:
• Respect creditor hierarchy (with exceptions) and ‘no creditors worse off than in liquidation’
• Legal remedies and judicial action vs. speed and flexibility required in resolution; only ex post
compensation (no reversal)

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17
Q

KA 6

A

Funding of firms in resolution:

• Availability of temporary sources of funding to maintain essential functions: DepositGuaranteeScheme, resolution fund
or other funding mechanism
• Strict conditions to minimize the risk of moral hazard: last resort, strictly necessary to achieve
resolution objectives, allocation of losses to equity holders
• Recovery of any losses from uninsured creditors and, if necessary, from the industry

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18
Q

KA 10

A

Resolvability assessments:

• Regular evaluation of feasibility and credibility of resolution strategies
• Group resolvability assessments conducted by home authority in coordination with host
authorities
• Measures to reduce complexity and costliness of resolution (as a going concern)

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19
Q

KA 10 (10.5)

A

Resolvability assessment Improved resolution through ring-fencing (structural regulation (KA 10.5))
‘To improve a firm’s resolvability, supervisory authorities or resolution authorities should have powers to require, where necessary, the adoption
of appropriate measures, such as changes to a firm’s business practices, structure or organisation (…). To enable the continued operations of
systemically important functions, authorities should evaluate whether to require that these functions be segregated in legally and operationally
independent entities that are shielded from group problems.’
- UK Banking Reform Act (Vickers): ring-fencing of deposits and SME activity from rest of the group
- Liikanen Report (2012) ➜ Commission proposal withdrawn in 2018
- Volcker Rule on proprietary trading (s. 619 Dodd-Frank Act

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20
Q

KA 11

A

Recovery and resolution planning:

• Recovery plans (responsibility of management and supervisory authority): identifies options to
restore financial strength and viability when firm comes under severe stress
• Resolution plans (responsibility of resolution authority): includes a substantive resolution strategy
and an operational plan for its implementation
• Regular updates and review: at least annually and if material changes

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21
Q

home authority is

A

the authority where the banks HQ are located in

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22
Q

International standards: Strategies of group resolution (2)

A
  1. Single Point of Entry - SPE

2. Multiple Point of Entry - MPE

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23
Q

Single point of entry SPE

A

• All resolution action applies to a single entity
at the top of the banking group (holding
company)
• Group’s home authority is responsible for
executing resolution strategy
• Host authorities are expected to recognize
resolution action within their jurisdictions
• Possibility to avoid resolution for operating
subsidiaries

24
Q

Multiple point of entry MPE

A

• Resolution measures are implemented at
various operating entities or subsidiaries
• Group structure is broken along operational
and/or jurisdictional lines
• Multiple resolution authorities are in charge of
executing resolution
• Risk of subsidiaries suffering losses
• Risk of competitive resolution/insolvency, ringfencin

25
Q

SPE is preferred by home countries to

A

large global banking groups / G-SIBs

e.g. the US, the UK, Swiss authorities

26
Q

International standards: Total loss-absorbing capacity (TLAC)

A

Set out in FSB principles and term sheet (2015)
• Applies to G-SIBs only, and is an addition to Basel III capital requirements
• G-SIBs must have financial instruments available to absorb losses in resolution and recapitalize
‘from within’
• Eligible instruments: minimum regulatory capital, subordinated debt liabilities that meet certain
other criteria (contractual, statutory, structural subordination)

27
Q

TLAC requirement

A
  • 16% of RWAs and 6% of leverage exposure measure as of January 2019 (phase 1)
    − 18% of RWAs and 6.75% of leverage exposure measure as of January 2022 (phase 2)
28
Q

Implementation in the EU through the Bank Recovery and Resolution Directive (BRRD)

A

• Scope identical to the CRD: credit institutions, financial groups and conglomerates, certain
investment firms.
• Member States must designate a resolution authority with a set of ‘minimum’ resolution tools
• Sale of business tool
• Asset separation tool
• Bridge institution tool
• Bail-in tool
• Minimum harmonization: discretion of Member States to adopt stricter recovery and resolution
tools

Important: the SRMR (Single Resolution Mechanism Regulation) introduced a uniform institutional resolution regime for the euro area, but
powers conferred upon the NRAs by the BRRD continue to apply!

29
Q

BRRD/SRMR: Resolution planning and resolvability assessment

A

• A main innovation of the resolution framework is the planning for the event of bank failure.

• Why plan for resolution?
• to obtain a comprehensive understanding of the banks and their critical functions;
• to identify and address impediments to their resolvability; and
• to be prepared for the ‘resolution weekend’, if needed.
• Comprehensive exercise, responsibility of resolution authority, but close involvement of the bank
concerned.
• Individual elements set out in Article 10(7) BRRD and Article 8(9) SRMR as well as Commission
Delegated Regulation 2016/1075.
• Review/updates: at least annually and after any material changes

30
Q

Resolution planning process in practice (6 steps)

A
  1. Strategic business analysis: Description of the
    bank’s structure, financial position, business
    model, critical functions, core business lines etc.
  2. Preferred resolution strategy: Normal insolvency
    proceeding or resolution? Which resolution tools
    and powers?
  3. Financial and operational continuity in
    resolution: Assessment of prerequisites to
    continuity in resolution.
  4. Information and communication plan. (communication with the public)
  5. Conclusion of the resolvability assessment:
    Identifies impediments to resolution and
    measures to address them; determines MREL.
  6. Opinion of the bank in relation to the resolution
    plan.
31
Q

BRRD/SRMR: Resolvability assessment

(Articles 15 and 17 BRRD, Article 10 SRMR

A

• Resolvability = Feasibility and credibility of liquidation/resolution without significant adverse
consequences for the financial system and interrupting critical functions.
• Includes the determination of each bank’s/group’s Minimum Requirements for Own Funds and
Eligible Liabilities (MREL) (Article 12 SRMR and Article 45 et seq. BRRD).
• Resolution authorities have far-reaching powers to address identified impediments
• Structural measures: limitation or cessation of specific activities, changes to legal or
operational structures…
• Financial measures: asset divestments, change of intragroup financing agreements…
• Information requirements

32
Q

BRRD/SRMR: Minimum Requirements for Own Funds and Eligible Liabilities (MREL)

A

• applies to all European banks (not only G-SIBs)
• is determined by the responsible NRA/SRB for each bank/group individually (no harmonized minimum level)
Criteria for
determination
(Article 45c(a) BRRD/
Article 12(7) SRMR)
• Ensure that the institution can be resolved
• Ensure losses can be absorbed and CET1 ratio restored
• Size, business model, funding model, risk profile
• Potential contribution of DGS to resolution financing
• Extent of adverse effects on financial stability
• For European G-SIBs, both TLAC and MREL apply.

33
Q

MREL is the European equivalent to the international

A

TLAC

34
Q

BRRD/SRMR: Conditions for resolution

A

Supervisory authority (ECB) + Resolution authority (SRB) + 5 resolution objectives

35
Q 
BRRD/SRMR: Conditions for resolution:
Supervisory authority (ECB)
A 
Determines that bank is ‘failing or 
likely to fail’
• Balance-sheet insolvency
• Cash-flow insolvency
• (Other) requirements for 
authorization are no longer met
• Extraordinary public financial 
support
36
Q 
BRRD/SRMR: Conditions for resolution:
Resolution authority (SRB)
A 
No alternative 
private sector 
measure or 
supervisory action 
(last resort)
37
Q

BRRD/SRMR: Conditions for resolution:

5 resolution objectives

A 
Necessary in the public 
interest
1. Continuity of critical 
functions
2. Avoid contagion
3. Protect public funds
4. Protect depositors
5. Protect client 
assets/funds
38
Q

In case the condition 3 (public interest) is not fulfilled the bank is

A

wound down under normal national insolvency proceedings

39
Q

BRRD/SRMR: Sale of business tool

A

The “good” part of the failed bank (deposits + certain (liquid) assets) is sold to a private buyer (for which usually pays nothing); and the rest is liquidated

40
Q

BRRD/SRMR: Bridge institution tool

A

This is only for a certain time (hence, used to buy time)

The good part goes under the control of the resolution authority for normally 2 years. It aims to continue operating certain critical functions and viable operations of a failed bank’s transferred business

41
Q

BRRD/SRMR: Asset separation tool

A

When bank is under stress, the bad part (certain (illiquid) assets and liabilities) are transferred to Asset management vehicle - under control of the resolution authority and only temporary, then liquidated

It aims to achieve orderly management and run down of non-performing loans or difficult-to-value assets

42
Q

BRRD/SRMR: Bail-in tool

A

the most difficult part of resolution
Losses borne primarily by bank’s shareholders and creditors
• Determination of amount needed to restore bank to viability (meeting regulatory requirements
and enjoying market confidence)
• Insolvency ranking applies (in reverse order), pari passu treatment
• Equity is written off and (subordinated) debt is written down or converted into equit

43
Q

Exemptions from BRRD/SRMR: Bail-in tool

A
  • Deposits up to EUR 100,000
  • Interbank loans (maturity up to 7 days)
  • Salaries/pension benefits
44
Q

Discretionary exemptions from BRRD/SRMR: Bail-in tool

A

In pursuance of resolution objectives

➜ ‘no creditor worse off’ principle applies

45
Q

Bail-in tool introduced by the BRRD aims to

A

absorb a bank’s losses from within

46
Q

Resolution action may still involve (additional) financing from external sources, e.g. because

A
  • loss-absorption via bail-in is insufficient (not enough eligible liabilities)
  • of the specific resolution strategy (e.g., guarantee for purchasing competitor)
  • the bank under resolution needs liquidity (not capital)
47
Q

External sources of resolution financing

A
  • Contribution from Deposit Guarantee Scheme(s) (DGSs)
  • Contribution from national resolution funds or the SRF
  • Extraordinary public financial support (national fiscal funds, ESM funds)

Any such aid to banks under resolution is subject to the EU State aid regime (Articles 107-109
TFEU) and needs ex ante approval by the Commission!

48
Q

State aid is prohibited unless and until

A

approved by the Commision

49
Q

The Commission will approve State aid in the context of resolution if certain conditions are met:

A
  1. The aid must be adequately remunerated (interest, fee etc.) to reflect the risk taken by the
    body providing the funds.
  2. Banks must provide a restructuring plan.
50
Q

The reconstructuring plan outlines

A

• how the bank will restore long-term viability without State aid as soon as possible (< 5 years).
Examples: rationalization of branches and employees, reduction of international activities, downsizing of risky business lines.
• how the bank itself (its shareholders and subordinated creditors) contributes to the restructuring
(burden-sharing).
Examples: dilution of shareholders, conversion of subordinated debt into shares.
• measures to limit distortions of competition.
Examples: downsizing of the bank, behavioral constraints (acquisition bank, ban on advertising State support etc.)

51
Q

Main purposes of Deposit Guarantee Schemes (DGS)

A
  • Depositor protection (liquidity risk of depositors)

* Financial stability (disincentivize depositors to run on banks)

52
Q

International standards: IADI Core Principles (2009, revised 2014)

A

• DGS may have a wide range of mandates/powers: from a simple ‘paybox’ that reimburses insured
depositors in the event of a bank failure to full-blown resolution and even supervisory powers.
• Membership should be compulsory for all banks.
• Coverage should be credible and cover the large majority of depositors but leave a substantial
amount of deposits exposed to market discipline.
• Funding through risk-based premia, primarily ex ante.
• Reimbursement of most insured depositors within 7 working days

53
Q

EU: DGS Directive

A

• Each Member State must ensure one or more DGSs within its territory
• Eligible deposits targeted at retailers (excluding deposits by financial institutions and public authorities)
• Coverage level: EUR 100,000 (or equivalent) of the aggregate deposits of each depositor per bank
➜ maximum harmonization: Member States must not go beyond that level.
• Repayment within seven working days of the bank’s determined failure
• Financing of DGSs: Ex ante contributions (risk based) Target level: 0.8% of covered deposits > Ex post contributions (not exceeding 0.5% of bank’s covered deposits per year) > voluntary borrowing between DGSs > Alternative funding means

54
Q

The DGS-Directive allows for different mandates of national DGSs

A

• DGSs should be primarily used in order to repay depositors of an insolvent bank (traditional main
function).
• DGSs can be used in order to finance the resolution of banks in accordance with Article 109
BRRD:
• The DGS essentially contributes up to an amount equaling its hypothetical loss had the bank
entered an insolvency proceeding instead of resolution.
• Any contribution is limited to 50% of the DGS target level.
• Further-reaching mandates / financing of resolution are possible, which creates some tensions
with the resolution framework of the BRRD/SRMR

55
Q

Resolution of banks is necessary if

A

their liquidation under normal insolvency proceedings would

lead to financial instability or fail to meet other resolution objectives

56
Q

Three conditions have to be met for a bank to go into resolution:

A

(1) ‘failing or likely to fail’;
(2) no alternative private sector measures;
(3) warranted in the public interest

FinReg (12 decks)

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