Banking crisis resolution
The permanent failure of a bank or financial institution results in a suspension of payments and court-ordered liquidation i, along with all the harm that that entails: customers’ accounts blocked, service interruption, loss in value of the institution's assets, losses for shareholders and creditors, not to mention possible ripple effects for the rest of the financial and economic sector.
Banking resolution entails the intervention by a “resolution” authority in a bank or financial institution that has failed or is likely to fail in order to restructure it or bring about its orderly liquidation and prevent its failure.
What is banking crisis “resolution”?
“Resolution” is a term of English origin which is similar to the notion of preventive intervention that has existed in French law since the law of 25 June 1999 by which the FGDR was created. In contrast to preventive action, it allows greater coercive powers to be used in relation to the failed institution, its shareholders and its creditors.
Resolution tools for very large banks
The “resolution” powers and tools are outside the scope of ordinary law. The resolution of an institution is undertaken only for reasons of public interest: in practice, in case of difficulties experienced by an institution considered "systemic", i.e. whose failure could have severe repercussions on the rest of the economy.
These resolution powers and tools have been in place since the 2008 financial crisis at European and national levels. They have greatly improved our institutions’ ability to deal with major crises without using government resources, and therefore taxpayers' money.
The resolution tools and measures fall into two categories:
preparation of remediation plans in case of a crisis: institutions must draw up “recovery plans” in order to respond to a significant deterioration in their financial situation; for its part, the European or French resolution authority (depending on the institution) develops “resolution plans” to determine the measures that it should implement for each institution, where necessary;
management of the banking crisis when it occurs: initiation of resolution proceedings and implementation of a series of technical and financial tools to prevent an outright failure.
The four banking crisis resolution tools
The resolution authority can force the troubled entity or its shareholders and creditors to take crisis remediation measures using the following tools:
- Sale of the business:
Transfer of assets and liabilities of the entity subject to resolution proceedings to a third-party operator.
- Asset separation:
The authority may transfer to an asset management vehicle the low-quality assets and liabilities of the entity under resolution which are intended to be sold or liquidated. This vehicle is considered a “bad bank”.
- Bridge institution:
The authority may transfer to a bridge bank the securities or assets and liabilities of the entity under resolution which are intended to be maintained. This institution then handles the activities of what is sometimes called a “good bank”.
- Bail-in tool:
This allows shareholders and creditors to contribute to the loss absorption and recapitalisation of the entity under resolution. It consists of two phases:
- a liabilities reduction phase by order of subordination (shares, other CET1 capital, subordinated debt, etc.) in order to absorb losses and reduce the institution’s net value to zero,
- a conversion phase for the remaining liabilities, by order of subordination, in order to recapitalise the institution or contribute to the capitalisation of the bridge institution.
The FGDR’s role in banking crisis resolution
In 2013, French law pre-empted the European banking crisis resolution scheme and granted resolution powers to the FGDR (Law no. 2013-672 of 26 July 2013 on the separation and regulation of banking activities). Thus, the Chairman of the FGDR Board is one of the six members of the new Collège de Résolution, which was established as the French resolution authority and is assisted through the work of the Prudential Supervision and Resolution Authority (ACPR). At the same time, the Fonds de Garantie des Dépôts (FGD) became the Fonds de Garantie des Dépôts et de Résolution (FGDR).
One authority: the Single Resolution Board (SRB)
The finalisation of the European texts on the Banking Union in 2014, transposed into French law in 2015 (Order No. 2015/24 of 20 August 2015), led to the creation of a resolution authority for the euro zone, the Single Resolution Board (SRB) and the harmonisation of the resolution framework for the entire EU (Directive no. 2014/59/EU of 15 May 2014 on the resolution of large credit institutions, known as “BRRD”).
The SRB’s powers are coordinated with those of the national authorities: if an institution is under severe stress, the SRB determines whether the public interest is at stake and, if necessary, decides on the resolution measures to be taken.
In France, the Collège de Résolution is responsible for taking such measures, with the support of the FGDR, particularly if equity transactions must be implemented. In this way, the FGDR fully plays its role as a banking and financial crisis operator.
Resolution and deposit guarantee are closely linked
- A resolution intervention prior to the failure of a troubled institution makes it possible to avoid the more serious consequences that would certainly result from a failure as well as a compensation process, which is unsuitable for a systemic institution.
Resolution measures and deposit protection
Apart from the resources that may be raised from the resolution funds, and particularly the euro zone’s Single Resolution Fund (SRF), the deposit guarantee schemes' own resources may be used at the time of an institution’s resolution to compensate for the lack of a bail-in on the guaranteed deposits (under €100,000), which must continue to be fully protected.
The deposit guarantee schemes may also be called on to finance other resolution measures (bridge bank, non-performing asset separation tools, good bank) in an amount equal to the cost saved by the deposit guarantee scheme for a liquidation and, therefore, depositor compensation.