signiicantly, but they do retain a chance to recover their money. The
key point is that depositors do not lose under a bailout, but might
under a bail-in.
Following the inancial crisis, central banks established a process
to enable inancial irms to be easily wound down if necessary, ie in
an orderly manner, with continuing provision of inancial services,
minimal impact on other irms and no public money involved.
The process of managing the failure of a inancial irm is called
resolution. )n order to ensure that the principal functions of
a bank can be maintained, a number of stabilisation tools have been
identiied, which can be applied as part of the resolution process:
– the transfer of all or part of a irmǯs
business, which can include either its shares or its property, to
a willing and appropriately authorised private-sector purchaser;
– the transfer of all or part of a irmǯs business to
a bank, which meets the relevant conditions for authorisation,
pending a future sale or share issuance; and
– the claims of shareholders and creditors are written down
and/or converted into equity to restore solvency ȋie they bear the
costȌ. The write-downs are in a strict Ǯwaterfallǯ of priority.
A bail-in, ȋpreviously missing in many jurisdictionsȌ is similar in
efect to a corporate restructuring under Chapter ͝͝ of the United
States Bankruptcy Code. )t is intended to restore solvency and avoid
the disorder that would result from the bank suddenly ceasing to trade
while it is reorganised without calling upon public inances.
The powers set out in the resolution regime are designed to ensure
that shareholders and unsecured creditors meet the cost of irm
failure and that the authorities have suicient lexibility to efect an
orderly resolution as quickly as is necessary.
But safeguards apply, which will ensure that no creditor is left worse
of than they would have been had the whole irm been placed into
insolvency and secured claims are protected.
Bail-in, like the other resolution tools, can only be used when
it is necessary to do so in pursuit of clearly deined public
interest objectives.
Two landmark resolutions in the UK include Northern Rock plc and
Bradford & Bingley plc. There have been two resolutions since ͜͜͞9 in
the UK, namely, the Dunfermline Building Society on ͟͜ March ͜͜͞9,
and the Southsea Mortgage and )nvestment Company Ltd, in June ͜͞͝͝.
What’s this got to do with the treasurer?
The main efect on the treasurer is most likely around how amounts
due from the bank may be afected. Time deposits, certiicates of
deposit and current balances may be bailed in, as may Ǯin the moneyǯ
derivative positions. Donǯt expect that, because you have loans from
the bank ȋbilateral or syndicatedȌ, the balances will be netted. You
may lose money on a deposit and still have to repay the loan. )f you
enjoy letters of credit or guarantees from a bank in resolution, these
may be at risk as well. )f a bank under resolution has issued these on
your behalf, they might need replacing.
Pooling, especially notional pooling where balances are ofset, may
also be afected. Pooling might in any case be more diicult under
Basel ))).
Conclusion
Bank resolution planning seeks to ensure that inancial irms – whether
large or small – can fail without causing disruption to payment systems
and the normal support of trade without requiring a bail-in, thus
exposing taxpayers to losses. Rather, the creditors of the failing banks
should bear any losses, as they would do in insolvency, but without the
inancial instability and disruption to critical functions that the sudden
insolvency of inancial institution would otherwise cause.
By itself bail-in cannot guarantee that the resolution of a failed
irmwill be orderly. (owever, it can be used to stabilise the balance
sheet of a failing irm until it can be restructured and, as such, is an
essential component of a wider framework that, taken together, will
allow authorities to intervene to manage the failure of large, complex
irms in an orderly way. Treasurers must review their counterparty risk
under these regimes.
Glossary
R ng fence
The separation of some aspects of
commercial banking (mostly retail) into
a separate entity to reduce the probability
of failure.
BRRD
Bank Recovery and Resolution Directive
(European law).
TLAC
Total loss-absorbing capital.
Ba l- n
Where losses are absorbed by those investing
in a bank.
Volcker rule
The rule in the US enacted into Dodd-Frank
to prevent banks from engaging in certain
risky activities.
Ba lout
Where losses are absorbed by persons outside
a bank.
Stress test ng
Routine tests on banks to highlight risk
of failure.
H erarchy
The order in which losses are taken by those
investing in a bank.
Resolut on
Resolution is the process by which the
authorities can intervene to manage the
failure of a firm in an orderly fashion.
G-SIB/G-SIFI
Global systemically important bank/global
systemically important financial institution.
V ckers Comm ss on
The report that presaged ring fencing in the UK.
TBTF
Too big to fail.
L kanen report
The report that presaged some separation
of activities in Europe.
Top-down/s ngle
po nt of entry
Resolution starting at bank holding
company level.
Commerc al
bank ng
Deposit taking and lending.
Bottom-up/mult ple
po nt of entry
Resolution starting at a bank operating
company level.
Investment bank ng
Securities trading and proprietary trading.
MREL
Minimum requirement for own funds and
eligible liabilities.
Moral hazard
An example of agency risk where managers
take excessive risks knowing that their
business will be saved by authorities.
Resolut on weekend
The time in which a bank will typically be
resolved, allowing it to open for trading on
the Monday.
Sarah Boyce
is associate director, policy and technical; and
Will Spinney
is associate director of education at the ACT
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