How does Europe deal with problem banks?

In 2010, former Governor of the Bank of England, Mervin King, said that “large, complex financial institutions are global — at least in life if not in death.” He highlighted the lack of an international framework for bank crisis management and underlined the responsibility of individual countries in dealing with bank failures.
How does Europe deal with problem banks?

(401(K) 2012, CC BY-SA)

This responsibility usually assumes a financial dimension: during the last financial crisis, state aid to EU banks amounted to over EUR4.3 trillion. The main beneficiaries were the largest banks, for which individual aid sometimes exceeded EUR100bn (e.g. Dexia) and usually took the form of government guarantees or recapitalization of banks using public funds.

This experience has led to changes in the legal framework, the essence of which was to implement the resolution procedure and to establish restrictive rules for the provision of state aid to banks. Within the new EU regulations, such aid is not only the use of budgetary resources, but also of the resolution fund and the deposit guarantee fund (for purposes other than the pay-out of covered deposits). However, the prerequisite for the European Commission (EC) to accept the use of such measures is the adequate participation of the bank’s shareholders and creditors in covering losses and capital injection, which in the case of the resolution process should amount to at least 8 per cent of total liabilities (including own funds) of the bank.

Since the implementation of the BRR Directive (Bank Resolution and Recovery Directive), i.e. from mid-2014 to the end of January 2019, the resolution procedure was applied to 13 banks in 8 EU countries. In most of the cases analysed, the initiation of resolution involved the simultaneous implementation of several tools, the most popular was the redemption or conversion of equity instruments (12 cases) or debt instruments (11 cases). In addition, the M&A transactions were used (8 cases), as well as the bridge bank institution (7 cases) and the separation of assets (so-called bad bank, 7 cases).

However, as the Chair of the Single Resolution Board (the resolution body for the Banking Union), Elke König said, “Resolution is for the few, not the many.” The idea is to use this process to address problems of banks fulfilling critical functions whose failure may have negative consequences for financial stability. The remaining banks should be liquidated according to national bankruptcy law. At least 12 examples of such measures were identified during the aforementioned period.

The financial safety net institutions are also responsible for other management tools. They include: government financial stabilization tools (triggered in a systemic crisis when the resolution proves ineffective), government actions other than those triggering the resolution (to address a serious disturbance and not triggering the resolution), assistance from the Deposit Guarantee Fund to prevent a bank failure and emergency liquidity assistance from the central bank.

It should be noted that the adoption of resolution rules and state aid rules has not resulted in a complete elimination of the use of budgetary resources. Examples include interventions, for example, in Banca Popolare di Vicenza, Veneto Banca (liquidation with the use of budgetary funds through the support of the takeover), Monte Paschi dei Siena (prudential recapitalization), Banca Carige (government guarantees on the bank’s newly issued liabilities), Banif (liquidation with the use of budgetary funds consisting in the support of the takeover of the bank following the resolution process from the state budget) or Banco Espirito Santo (liquidation with the use of budgetary funds through government’s support in the takeover of a bridge institution created for the bank).Crisis experience has also shown that there are numerous problems in the application of crisis management tools, such as:

  • inaccurate definition of the circumstances determining undertaking measures towards the bank, i.e.:
    • when intervention should be initiated (which is related to the assessment of whether the bank is at risk of bankruptcy),
    • which tool should be applied in a particular case (which is related, among others, to the assessment of the systemic importance of the bank);
  • the valuation of the bank’s assets for the purposes of the resolution process — it was usually challenged by affected stakeholders;
  • the involvement of retail investors in covering losses or recapitalising of banks — the process usually sought to minimise losses for retail investors by introducing compensation schemes.

This shows that the planning and implementation of resolution activities may still require further work on the applicable legal provisions. It seems that Sebastiano Laviola, a member of the Single Resolution Board, well-summarized it by saying that “resolution planning is a marathon, not a sprint.”

It is worth adding that in the spirit of post-crisis changes aimed at increasing the private sector’s involvement in covering bank losses, in the face of the threat of bank failure, an important element of the measures was the participation of other banks from the market in mitigating the effects of the crisis. The measures involved:

  • taking over problem banks (e.g. Banco Popular Espanol);
  • providing financial support for conducted activities (e.g. the resolution of four small Italian banks with a loan granted by three large Italian banks to the resolution fund in order to finance the creation of bridge institutions); or
  • organizing and financing retail investor compensation schemes (e.g. Veneto Banca, Banca Popolare di Vicenza and the resolution of four small Italian banks in 2015, while the remaining Italian banks participated in financing the compensation scheme organised through a deposit guarantor).

How does Poland compare to Europe? It has a relatively wide range of available crisis management tools for the banking sector which are consistent with the direction of post-crisis reforms at the EU level. One of them is the resolution described in Poland as forced restructuring. Quite recently this procedure was used for the first time — in January 2020 — in Podkarpacki Bank Spółdzielczy (PBS) in Sanok. Under the PBS resolution, the Bank Guarantee Fund (BFG) decided to suspend PBS operations (customers’ funds were not available for 4 days), to redeem its equity instruments and to use a bridge institution instrument. The bridge bank created by BFG — Bank Nowy BFG S.A. — to which selected assets and liabilities of PBS were transferred, and was used to perform forced restructuring. The remaining assets and liabilities were left in the residual entity in order to cover losses and enable forced restructuring in line with the EU State aid framework. Ultimately, the bridge institution will be sold to another bank or a group of banks.

Other Polish experience in applying the current crisis management rules included liquidation of an entity combined with the payout of guaranteed deposits (bankruptcy) and liquidation with alternative use of deposit guarantee funds (acquisition). Most of these activities focused on the credit union (SKOK) sector.

The authors are employees of the Financial Stability Department of Poland’s central bank, NBP.

The views expressed in this article are the private views of the authors and are not an expression of the official position of the NBP.

(401(K) 2012, CC BY-SA)

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