directorate banking regulation coordination or integration of bank insolvency in the eu? an holistic...

Directorate Banking Regulation

Coordination or Integration of Bank Insolvency in the EU? An Holistic Approach

Maria J. Nieto

Building a Crisis Management Framework for the Internal Market European Commission19 March, 2010

Directorate Banking Regulation

Coordination or Integration of Bank Insolvency in the EU? An Holistic Approach

Maria J. Nieto

Building a Crisis Management Framework for the Internal Market European Commission19 March, 2010

DIRECTORATE BANKING REGULATION

These views do not necessarily represent

those of Banco de España

3

DIRECTORATE BANKING REGULATION

OUTLINE

4

• Bank resolution as the fourth arm of the safety net

• Importance of incentive compatible safety net encompassing resolution/insolvency structures

• Optimal design resolution/liquidation policies in the EU

• Conclusions

DIRECTORATE BANKING REGULATION

BANK RESOLUTION AS THE FOURTH ARM OF THE SAFETY NET

• Public policy objective of resolving failed banks should be to permit free entry and exit of failed banks at minimal cost to society

• Laws and procedures for bank resolution importantly influence the safety net´s ability to succeed

5

DIRECTORATE BANKING REGULATION

OUTLINE

6

• Bank resolution as the fourth arm of the safety net

• Importance of incentive compatible safety net encompassing resolution/insolvency structures

• Optimal design resolution/liquidation policies in the EU

• Conclusions

DIRECTORATE BANKING REGULATION

IMPORTANCE OF INCENTIVE COMPATIBLE SAFETY NET ENCOMPASSING RESOLUTION / INSOLVENCY STRUCTURES

• If failed banks can be provided liquidity and resolved at no cost, there may be few negative externalities that provide a justification for extensive prudential supervision

7

DIRECTORATE BANKING REGULATION

IMPORTANCE OF INCENTIVE COMPATIBLE SAFETY NET THAT ENCOMPASSING RESOLUTION / INSOLVENCY STRUCTURES

• Resolution rarely starts sufficiently promptly while the bank still has a positive net worth

• Poorly designed deposit insurance imposes losses on depositors

• Bank resolution procedures not particularly aimed at preserving financial stability

8

DIRECTORATE BANKING REGULATION

OUTLINE

• Bank resolution as the fourth arm of the safety net

• Importance of incentive compatible safety net that encompassing resolution/insolvency structures

• Optimal design resolution/liquidation policies in the EU

• Conclusions

9

DIRECTORATE BANKING REGULATION

OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU

10

Approach

Safety Net

Centralized Explicit cross country coordination arrangements

DecentralizedImplicit coordination mechanisms

(harmonization)

PrudentialRegulation

- o Lamfalussy architectureoMore homogeneous secondary legislation

oNational legislation subject to therestriction of minimumharmonization

Prudential Supervision

- o European System of Financial Supervisors (ESFS)oCoordination via MoU(PS+LOLR); (PS+LOLR+MF)

o National on site and off sitesupervision

LOLR(Emergency Liquidity)

- o Explicit coordination via MoU (PS+LOLR); (PS+LOLR+MF)o ECB Governing Council

o Implicitly decentralized NCBs

Deposit Insurance - oNational DIsoMinimum harmonization

Reorganization andWinding-Up

- oNational Resolution AuthoritiesoMinimum harmonization (coordination of procedures based on pples home country control, unity and universality)

Living Wills?

DIRECTORATE BANKING REGULATION

OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU

• Full internalization:

•Centralization of the EU safety net

Absence of a single fiscal authority

11

DIRECTORATE BANKING REGULATION

OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU• Partial internalization:– Strengthening “implicit mechanisms” of coordination

• Further harmonization of the national resolution frameworks» Special Resolution Regime for banking groups

– Strengthening “explicit mechanisms” of coordination• Info sharing PS – Resolution authorities (MoU)• Colleges (administrative or judicial) resolution authorities:

joint resolution measures for the benefit of the group (Mayes, Nieto, Wall, 2008)

• Delegation» CRD (Art 131) "[u]nder these arrangements additional tasks may be entrusted to the

competent authority responsible for supervision on a consolidated basis

» Ex ante agreement to make the process of restructuring less cumbersome

12

-

+

DIRECTORATE BANKING REGULATION

OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU

13

Decentralized Centralized Authority Resolution Colleges

(“lead administrator/liquidator”)

Delegation in the

Home country (“Ad hoc”

centralization)

Resolution Authority

Legal Changes Harmonization (min set of harmonized resolution rules –including closure

rules-)

New Charter (contractual agreement)

EU Special Resolution Regime for

resolving cross border banks

Implementation Easy

Relatively easy (relicensing)

Slow

(launching resolution

authority; special charter)

DIRECTORATE BANKING REGULATION

OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU

• Partial internalization (Cont.) - Strengthening “explicit mechanisms” of coordination

– Coordination with prudential supervision (Hardy and Nieto,2009): » First best approach: Highly coordinated PS and

Resolution/Liquidation» If Resolution/Liquidation is centralized and not PS, benefits would

be limited by PS forbearance » Strengthening “explicit mechanism” of coordination amongst PS

is valuable and reduces the cost of financial crisis ...even if coordination amongst resolution/liquidation authorities is limited

14

DIRECTORATE BANKING REGULATION

CONCLUSIONS

• Failed bank resolution processes influence the safety net´s ability to succeed

• Reforms should aim at strengthening the tools and coordination - Prudential Supervision and Reorganization and Winding up - Deposit Insurance and Reorganization and Winding up

• Coordination failures may result in negative externalities• Lack of centralization of PS and Resolution/Liquidation in an

integrated market such as the EU increases forbearance Larger losses of failed banks

• Centralization of Resolution/Liquidation w/o centralization of PS would limited benefits due to PS forbearance

• ...Further complicating the cost burden sharing: - Private vs Public and Domestic vs Foreign

15

DIRECTORATE BANKING REGULATION

Thank you!

16