Tom Garske, associate partner at Citihub Consulting, discusses what the benefits of using schemes to abide by the provisions of the EU Bank Recovery and Resolution Directive (BRRD) are to banks.
What are the key provisions of BRRD?
Directive 2014/59/EU (BRRD) sets forth a common framework of recovery tools and crisis management planning for how banks need to cope in times of financial stress.
Banks have long been working on resolution and recovery planning, devising ways in which they can sustain themselves without the use of public funds or government bailouts should they need to proceed towards bankruptcy. These plans are very detailed and scrutinise all aspects of a bank’s business model—measuring risk, limiting investment of their own funds, restructuring business models, understanding how technology is inter-linked, and ultimately ensuring that banks would finally know their entire eco-system. The establishment of BRRD ultimately describes how to avoid failure in a crisis and how to mitigate systematic impact in the event of insolvency.
Some key areas on which banks have focused include:
- total loss absorbing capacity—long-term debt that could be converted into equity to absorb losses and recapitalise the firm’s operating subsidiaries in a resolution
- bail-in funding—restructure the liabilities of a distressed financial institution by writing down its unsecured debt and/or converting it to equity. Done to recapitalise and restructure the distressed institution
- bail-in reporting—deliver reports to regulators that detail current market valuations of anticipated financial support for bail-in
- financial market infrastructure (FMI)—ensure the continuity of key FMI memberships during a recovery and resolution
- key people—identification of living wills critical employees for retention that are needed to support the recovery and resolution plan (RRP)
- system ownership—having documented ownership of systems and applications that would lend to direct support during a transition in a resolution
- critical systems—identification of critical systems and business functions for the purposes of preserving operations in a resolution event
- proper RRP lends itself to early detection of near-term financial issues and a rapid response to its remediation
What were the key practical effects of the two English schemes used by the Co-Operative Bank (Co-Op) to restructure?
The Co-Op’s financial troubles had considered closure or the sale of its operations that were supported by the schemes under BBRD. The bank gave up majority ownership and used the bail-in provision to shore up its financial situation—this pushed bond holders (hedge funds) into new ownership of equity and debt.
Although the hedge funds provided quick relief, the effort to turnaround the operational efficiency of the bank staggered as on-going issues of lawsuits, regulatory fines, and poor business strategies have hampered the turnaround.
Are we likely to see more banks using schemes to comply with BRRD requirements?
Using schemes will most likely be of interest for small to mid-tier banks as a means of working out their troubled assets. Large banks or globally systematic important financial institutions have the required resources and investment means to create elaborate resolution plans and can maintain the necessary capital reserve requirements that are meant to avoid such bailouts needed by the Co-Op.
While the Co-Op’s issues were already rooted as BRRD was being understood and implemented by the industry, it has provided some understanding for how an institution might implement its resolution and recovery plans and the difficulty surrounding the complexity of such an event. We can expect that regulatory scrutiny will continue and the lessons learned from the Co-Op will also drive how the banking industry will look to utilise schemes for effective living will planning in the future.
What other restructuring tools are available under BRRD?
The resolution scheme determines what resolution tools are employed to remedy the financial distress. The options available under the BRRD include:
- the sale of business tool
- the bridge institution tool
- the asset separation tool
- the bail-in tool
What are the key challenges facing banks in the future?
Recovery is never going to be seamless as it is complicated and can take years to show improvements. This will impact future investors and potentially clients’ willingness to stay the course of repositioning.
The publics’ distrust of financial institutions may start to favour or fuel the growth of crypto currencies and internet bank.
Continuous BRRD reform will challenge all financial institutions and the cost to maintain the planning could lead to mergers on the lower tier players as they look to maintain banking services. This could also lead to divestitures where banks look to specialise more in lieu of offering suites of services.
Interviewed by Lucy Trevelyan.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.