Resolving a bank crisis
In an earlier post we explained that Spain has two national resolution authorities: the Banco de España, which prepares Spanish banks for resolution when faced with a potential crisis situation (the “preventive phase”), and the FROB, the Spanish executive resolution authority, which takes control if a bank is declared to be failing (the “executive phase”).
Let’s see what these phases involve.
The preventive phase covers a bank’s entire life and seeks to prepare it for situations in which it might fail. The aim is to ensure that a bank’s resources are managed appropriately, so that if it becomes distressed and has to be resolved, this may be done without jeopardising financial stability, the economy or other financial institutions, and especially without putting its customer deposits and public funds at risk. In this phase, the Banco de España is responsible for drawing up resolution plans for the Spanish banks under its remit. It also cooperates with the Single Resolution Board (SRB) to draw up resolution plans for banks under the SRB’s remit. These plans include the measures that the FROB, the Spanish executive resolution authority, could apply if the bank were to fail.
A bank will be resolved if it is declared to be failing, or if it faces such serious difficulties as to be considered likely to fail in the near future. However, resolution proceedings will only start when it is understood that the distressed bank must be refloated in order to maintain confidence in the banking sector and prevent systemic risk in the economy.
In the resolution process the bank will be restructured, through an agile administrative process headed by the competent Resolution Authority that has the power to guarantee the continuity of a bank’s most critical functions, safeguarding financial stability and minimising the impact on the taxpayer. In short, the aim is to protect the public interest in the event of a bank failure, including, in particular, protecting bank deposits. For this purpose, the resolution authorities have tools that allow them to sell all or part of the banking business to a private buyer, to create a new bank, temporarily controlled by the resolution authorities, or to recapitalise the bank, transforming its creditors into shareholders.
The resolution regulations mean that shareholders and creditors know in advance that they will have to bear the impact of a possible bank failure. In any event, bank deposits will be the last to be affected. In this respect, it is important to bear in mind that, in the event of resolution, the Deposit Guarantee Scheme will reimburse depositors up to the amount of covered deposits pursuant to the regulations in force at the time.
The resolution cost could also be borne, not only by the shareholders and creditors of the distressed bank, but also, under certain conditions, by a European Resolution Fund. This Fund, which is financed through mandatory annual contributions by banks, may be used to grant more flexibility to the process or to make up the losses of the shareholders and creditors of the failed bank. Accordingly, the cost of bank resolution is borne, first by the owners of the bank concerned, second by its creditors, and subsequently by other banks (through their contributions to the Resolution Fund), it being understood that the orderly resolution of a failed bank is also in their interest, as it mitigates the possibility of contagion and financial instability.