“Taxpayers should not bear the cost” of bank failure says Bank of England as final resolution framework published

Out-Law News | 27 Oct 2014 | 3:34 pm | 3 min. read

The failure of banks should have “the same impact as the failure of any other institution”, with taxpayers spared from having to bear any costs the Bank of England has said. It has published its approach to dealing with lenders in financial difficulty.

The Bank’s final resolution framework (30-page / 1MB PDF) will apply to banks, building societies and investment firms whose failure could have consequences for the wider economy. It has been developed as part of the Bank’s new remit to maintain UK financial stability following the financial crisis of 2008, during which the government had to intervene and provide public funds to recapitalise some struggling lenders.

“This is a significant milestone in our resolution regime,” said Andrew Gracie, the Bank’s executive director of resolution. “It sets out exactly how we would go about resolving a bank, building society or investment firm in practice.”

“The failure of these firms should have the same impact as that of the failure of any other institution i.e. the rest of the system is not impacted and taxpayers do not bear the cost. This is what resolution achieves,” he said.

The plans set out in the framework document will enter into force in January 2015, as part of the EU’s Bank Recovery and Resolution Directive, and update the UK’s existing permanent resolution regime which was put in place in 2009. They are split into three parts: a ‘stabilisation’ phase; a ‘restructuring’ phase; and the institution’s eventual exit from resolution, either because it ceases to exist or because it has been successfully restructured and no longer requires support.

During the initial stabilisation phase, the Bank will take decide on the most appropriate action to take to immediately stabilise the firm over an initial 48 hour period known as the ‘resolution weekend’ – although this period could also occur mid-week. The Bank will also remove senior managers considered responsible for the failure, and appoint new senior management to any continuing parts of the firm not being transferred directly to a purchaser under the next phase of the process.

Resolution tools open to the Bank at this stage include transferring some of the failed bank’s business to a third party, such as a private purchaser or a ‘bridge bank’ ahead of an onward sale; or ‘bailing in’ investors and bondholders in order to recapitalise the firm. Bailing in is far more likely due to the “size and complexity” of most global banks making it difficult to rapidly restructure the firm, according to the document. If bail-in powers are used, the interests of the firm’s shareholders will be cancelled, diluted or transferred, and claims of unsecured creditors written down in order to absorb the firm’s losses. Any shareholders and creditors affected should not be left worse off than if the firm had been placed into insolvency.

Both EU law and the Basel III regulatory reform programme will require leading banks to issue debt that could be bailed in in the event of financial difficulties equivalent to 8% of their assets once the new legal regimes are fully in force. If not enough can be raised from shareholders and creditors, then the Bank will use the proceeds of the annual bank levy to stabilise the firm. It will also have very limited powers of “temporary access to public funds”, for example if the firm needs to make a loan to the Financial Services Compensation Scheme, which protects customer deposits.

As part of the stabilisation phase, the Bank will aim to ensure that the firm’s existing arrangements for accessing payment systems, clearing and settlement systems and central counterparties are preserved. The firm’s core deposit-taking functions should also be able to continue without disruption, with depositors’ and investors’ interests continuing to be protected by the FSCS where appropriate.

Once the firm has been stabilised, it will then enter a longer ‘restructuring’ phase during which it will be expected to take action to address the causes of failure and restore consumer confidence. The extent of restructuring required will depend on the causes and consequences of the failure; and any restructuring plan will need to ensure that “critical economic functions” are maintained.

The final stage of the process will allow the firm to ‘exit’ from resolution; either because it ceases to exist through insolvency, winding down or being absorbed by a new owner; or because it has been successfully restructured. The precise route out of resolution will depend on the nature of the Bank’s intervention, but if the firm is to continue to operate it must be able to show that it has been recapitalised “to a level that is sufficient to restore market confidence and allow the firm to access private funding markets”, according to the framework document.