ELEMENTS OF A BANK RESOLUTION FRAMEWORK Wouter Bossu IMF Legal Department The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management. Jodhpur, India - 2011
KEY TAKE-AWAYS • Banks are businesses of a very particular nature. . . • . . . which makes it difficult to resolve them under general insolvency law. . . • . . . and requires specific, carefully designed bank resolution frameworks
ROADMAP 1. Specific Nature of Banks 2. Problems with General Insolvency Law 3. Design Features of Bank Resolution Frameworks
1. Specific Nature of Banks are different from ordinary commercial or industrial businesses for the following 4 reasons: 1. Liabilities—may be short-term, to the public, insured (DGS), backstopped by other banks, or guaranteed by State 2. Assets—vulnerable to rapid quality deterioration in case of insolvency of bank 3. Systemic Nature—banks may be systematically relevant; their disorderly failure would cause other banks to fail 4. Official Financial Support—often financial support from central bank and/or Mo. F, possibly combined with explicit or implicit back-up of DGS by the State
2. Problems with General Insolvency Law General insolvency law is ill-suited to deal with ailing banks for the following reasons: • creditor-driven procedures insufficiently internalize financial stability and fiscal cost concerns • the threshold for intervention is too late • bankruptcy trustees have little understanding of nature of banks and connection with financial system • insolvency toolkit is too blunt • automatic and full moratorium rapidly destroys value • lengthy procedures cause public to distrust other banks, which may cause run
3. Design Features of Bank Resolution Frameworks A. Broader Public Policy Objectives Ø Bank resolution frameworks pursue essentially three public policy objectives: • minimizing financial instability • minimizing fiscal cost • satisfying creditors according to their rank ØThe public interest may justify infringing upon shareholder and creditors rights beyond what is typical in general insolvency law
3. Design Features of Bank Resolution Frameworks B. Early Shift toward Official Control Most bank resolution frameworks include mechanism to shift control over troubled bank to (non-judiciary) official sector before insolvency triggers are met Such “official administration” regimes typically feature: ▫ appointment and steering by central bank/supervisory agency ▫ based upon quantitative and/or qualitative triggers ▫ with mandate to assess the bank, restructure when possible, and prepare for liquidation if unavoidable ▫ Replacement of board of directors, and sometimes also general assembly of shareholders
3. Design Features of Bank Resolution Frameworks C. Flexible Resolution Tools Adequate bank resolution frameworks include the following tools to resolve ailing banks: ▫ Transfer of Assets (including systemically relevant activities) and Liabilities ▫ Forced Mergers (“shotgun wedding”) ▫ Mandatory Private and Public Recapitalization ▫ Orderly Liquidation Some countries have also included mandatory debt restructuring in their tool kit
3. Design Features of Bank Resolution Frameworks D. Supportive Mechanisms • Legal underpinnings for official financial support in budget or other laws • Interaction with DGS rules: may DGS “top up” P&A? • Depositor preference • Flexible moratoria/stays • Insolvency protection for new financing • Protection for netting, financial contracts and collateral • Transfer mechanisms for financial contracts
3. Design Features of Bank Resolution Frameworks E. Institutional Aspects • Clear designation and mandates of the bank resolution agency • Interaction with DGS? • Where relevant, adequate coordination mechanisms with micro-prudential supervisor and central bank • Clearly defined role for Mo. F • Coordination with Market and Competition Authorities may also be relevant
Conclusions The orderly resolution of banks requires a specific legal framework that: • balances private and public policy objectives • provides a well-calibrated institutional set-up • allows to restructure banks rapidly and flexibly • comprises robust supportive mechanisms that go beyond insolvency
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