Andrew Gracie of the Special Resolution Unit of the Bank of England presented on Monday at the British Bankers Association. His speech, “A practical process for implementing a bail-in resolution power,” had some points that overlapped and some that differed from the US Orderly Liquidation Authority. We are in particular concerned with how regulators would separate out “good” assets from “bad”, meaning that the bad would be left to fail with no recourse for counterparties. This speech provides some good starts but as Mr. Gracie notes, more details are needed. Excerpts from the speech follow.
In November 2011, the leaders of the G20 endorsed the Financial Stability Board’s international standards for resolution regimes, the Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes). These standards form part of a global solution to a global problem—that of “too-big-to fail” and the avoidance of state-sponsored bail-out of the biggest international banks – or G-SIFIs1 in the parlance of the FSB. They mandate the introduction of a set of resolution tools that should be available to all national authorities—tools that are expressly designed in the resolution of a G-SIFI to achieve the continuity of its critical economic functions, thereby avoiding systemic disruption, and in the process ensuring that public funds are not exposed to loss. The tools include the ability to transfer or sell assets and liabilities of G-SIFIs and to carry out a bail-in of creditors within resolution.
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But bail-in cannot, and should not, be used in isolation from other tools and powers. Writing down and converting debt into equity may help to restore solvency, but on its own it cannot restore viability. And it cannot and should not be used simply to keep a loss-making business artificially alive. Rather, its role, similar to that of a corporate restructuring under Chapter 11 of the US Bankruptcy Code, is to help keep a bank’s vital operations functioning, and avoid the disorder that would result from the bank suddenly ceasing to trade, whilst it is reorganised, replacing management and restructuring the business as necessary. A credible bail-in, including the necessary restructuring, should enable the firm to access market liquidity.
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Well in advance of resolution, it will be necessary, to ensure that G-SIFIs have appropriate loss absorbency2. This would ensure that the G-SIFI has sufficient liabilities that could bear losses within resolution. Both the RRD and the UK’s Independent Commission on Banking (ICB) recommend that such firms be required to hold loss absorbing capacity beyond their Basel 3 capital requirements. This is a regulatory requirement, nothing to do with the bail-in power itself.
Any loss absorbency requirement would need to take account of cross-border enforceability. Hence the desirability of including some form of minimum requirement within the RRD. But any requirement would need to ensure that the relevant non-EEA liabilities of an EU bank could also be subject to bail-in.
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Immediately following the resolution weekend, an intensive valuation period would commence in order to determine the extent of losses incurred or likely to be incurred by the firm and therefore the appropriate terms of the bail-in. This process would build on preliminary valuation work conducted prior to the resolution.
The creditors identified in the announcement at the resolution weekend would be subject to write-downs which in aggregate covered all of the firm’s losses. These write-downs would be determined in a manner that: first, respects the creditor hierarchy; second, stands up to proportionality requirements in order to minimise the risk of compensation claims; and third, is clear and transparent to creditors9. These are all requirements of the RRD which we support.
The obligation that creditors are treated equally within classes we do not. It is important for the resolution authority in deciding which liabilities to include within the scope of the bail-in to retain some discretion, especially within the senior creditor class, to take account of any potential adverse impact on system stability of bailing in particular liabilities or types of liability.
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In fact there may be cases where losses and problems in a firm are so thorough-going that a bail-in is not viable and a firm needs to be wound down instead, bridging the systemic functions that need to be preserved. The ring fencing of particular functions provided by the ICB may be helpful in such cases.