Class 20 - Resolution

What economic concept earned Ben Bernanke, Douglas Diamond, and Philip Dybvig the 2022 Nobel Prize?

Research on banks and financial crises, including the role of banks in maturity transformation and the causes of bank runs.

What is the fundamental purpose of a bank according to the Nobel Prize insights?

To act as an intermediary that channels short-term deposits into long-term investments (maturity transformation).

What was a key outcome of the 2008 Global Financial Crisis regarding bank crisis management?

It revealed insufficient crisis management arrangements worldwide, leading to the creation of new resolution frameworks to allow authorities to intervene swiftly.

What is the FSB's "Key Attributes of Effective Resolution Regimes" and when was it published?

It is the international standard for best practices in bank resolution, published by the Financial Stability Board in October 2011.

What is the main EU legislative act that established the bank resolution framework?

The Banking Recovery and Resolution Directive (BRRD) - Directive 2014/59/EU.

What are the three main blocks of the BRRD?

1) Recovery and resolution planning. 2) New powers and tools for authorities to deal with crises. 3) Creation of resolution financing mechanisms (Resolution Funds).

What is the difference between Recovery and Resolution?

Recovery involves voluntary, private measures taken by a bank in distress based on its recovery plan. Resolution involves mandatory measures imposed by the resolution authority when a bank is failing or likely to fail.

What triggers the move from Supervisory Early Intervention to Resolution?

When a bank is assessed as "failing or likely to fail," no alternative private measures can prevent failure within a reasonable timeframe, and resolution is necessary in the public interest.

What are the three cumulative CONDITIONS that must be met to enter resolution?

1) The institution is failing or likely to fail (FOLTF). 2) No reasonable prospect that alternative private measures would prevent failure. 3) A resolution action is necessary in the public interest (assessed against resolution objectives).

List the five main OBJECTIVES of bank resolution.

1) Ensure continuity of critical functions. 2) Avoid significant adverse effect on financial stability. 3) Protect public funds and taxpayers. 4) Protect client funds and assets. 5) Protect covered deposits and investor compensation schemes.

What are the three guiding PRINCIPLES for allocating losses in resolution (the hierarchy of losses)?

1) Shareholders bear losses first. 2) Creditors bear losses after shareholders, in order of priority under normal insolvency. 3) No creditor shall incur greater losses than in liquidation (No Creditor Worse Off - NCWO).

What is the "No Creditor Worse Off" (NCWO) principle?

A guarantee that no creditor will incur greater losses in resolution than they would have if the bank had entered ordinary liquidation proceedings.

What are the four main resolution TOOLS available to authorities?

1) Bail-in. 2) Sale of Business. 3) Bridge Institution. 4) Asset Separation.

Describe the Bail-in tool.

Shareholders and creditors are written down or their claims are converted to equity to recapitalize the bank and restore its ability to operate.

Describe the Sale of Business tool.

The sale of all or part of the failing bank (or its business) to a private purchaser.

Describe the Bridge Institution tool.

The transfer of all or part of the failing bank's business to a temporary, publicly-controlled entity (a bridge bank) to maintain critical functions.

Describe the Asset Separation tool.

The transfer of impaired or troubled assets to a separate asset management vehicle (a "bad bank") to be wound down. This can only be used in combination with another resolution tool.

What is the second pillar of the Banking Union?

The Single Resolution Mechanism (SRM).

What are the two main components of the Single Resolution Mechanism (SRM)?

1) The Single Resolution Board (SRB). 2) The Single Resolution Fund (SRF).

What is the role of the Single Resolution Board (SRB)?

It is responsible for the effective and consistent functioning of the SRM, including resolution planning and decisions for significant institutions (SIs) and cross-border less significant institutions (LSIs).

What is the role of National Resolution Authorities (NRAs) in the SRM?

They are responsible for resolution plans and decisions for non-cross-border LSIs and for executing the SRB's decisions in their jurisdictions.

What is the Single Resolution Fund (SRF) and how is it financed?

A fund to provide financial support for resolution in the Banking Union. It is financed by annual contributions from credit institutions and some investment firms.

What was the SRF's target size and by when was it to be reached?

At least 1% of covered deposits in the Banking Union (approx. €80 billion), built up over an 8-year period from 2016 to 2023.

What are the permitted uses of the Single Resolution Fund?

To make loans or contributions, provide guarantees, purchase assets, or compensate shareholders/creditors under the NCWO principle to support resolution actions.

What is the difference between a Single Point of Entry (SPE) and a Multiple Point of Entry (MPE) resolution strategy?

SPE applies resolution measures at the parent company level, which then absorbs subsidiary losses. MPE applies resolution measures at multiple entities (parent and subsidiaries) independently, with losses absorbed locally.

What type of banking group structure is best suited for an SPE strategy?

Groups with a centralized structure and operating model, where financing and loss absorption are centralized at the parent level.

What type of banking group structure is best suited for an MPE strategy?

Groups where entities operate and obtain financing independently, with sufficient loss absorption capacity at the level of each resolution entity.

What does MREL stand for and what is its purpose?

Minimum Requirement for Own Funds and Eligible Liabilities. Its purpose is to ensure a bank has sufficient loss-absorbing capacity to be resolvable without costs falling on taxpayers or the resolution fund.

What are the three main components of the MREL calculation?

1) Loss Absorption Amount (LAA). 2) Recapitalisation Amount (RCA). 3) Market Confidence Charge (MCC).

What is the Loss Absorption Amount (LAA)?

The amount of MREL intended to absorb losses, covering Pillar 1, Pillar 2 capital requirements, and the leverage ratio requirement.

What is the Recapitalisation Amount (RCA)?

The amount of MREL intended to recapitalize the resolved institution after losses, to meet post-resolution capital requirements.

What is the Market Confidence Charge (MCC)?

An additional MREL amount to ensure market confidence in the institution following resolution, typically covering the Combined Buffer Requirement (CBR) minus 1.25%.

What is the general hierarchy (order) of loss absorption in a bail-in?

1) Common Equity Tier 1 (CET1). 2) Additional Tier 1 (AT1) instruments. 3) Tier 2 capital. 4) Other subordinated claims. 5) Senior Non-Preferred (SNP) debt. 6) Senior Preferred debt. 7) Other preferred claims (e.g., covered deposits).

What is "Senior Non-Preferred" (SNP) debt?

A class of senior debt created specifically to fulfill MREL requirements

List some liabilities that are EXEMPT from bail-in.

Deposits covered by the Deposit Guarantee Scheme (DGS)

According to the "prisoner's dilemma" example of bank failure, what is the suboptimal outcome for two depositors?

Both depositors "run" on the bank, forcing a fire sale of assets and resulting in a lower total payout for both (35 each) compared to if both stayed (45 each).

What is a common mechanism that can turn a liquidity problem into a solvency problem?

A bank run or fire sale of assets. Forced asset sales at depressed prices ("fire sale prices") can erode capital, making an illiquid bank insolvent.

List four usual practices that can lead to bank failure.

Poor lending practices

What is the "flight to quality" and how does it spread a crisis?

Investors sell risky assets and buy safe assets (like government bonds) during fear. This triggers a market downturn, reduces asset values used as collateral, leads to margin calls, and forces further fire sales, spreading losses.