Developing Effective Recovery and
Resolution Plans
Presentation to the 14th Annual Conference
of the International Association of Deposit
Insurers
Kuala Lumpur, Malaysia
28 October 2015
Christine M. Cumming
Visiting Scholar, Rutgers University and Columbia University
Preamble
• Recovery and resolution planning for systemically important
financial institutions involves a journey of learning and
problem-solving.
• The objective of recovery and resolution planning is not to
preserve a failing financial institution “as is” but to
• a) limit spillovers within the financial system and the
economy
• b) preserve critical functions within the financial system; and
• c) impose costs on shareholders, creditors and the financial
(banking) industry rather than the taxpayer.
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Presentation Plan
• Getting started—Crisis Management Groups,
Cooperation Agreements, Recovery Planning
• The Resolution Planning Cycle
• The Components of Resolution Plans: Resolution
Strategy, Recapitalization, Funding, Sale or Relaunch
• Progress to Date
• The Link Between Recovery and Resolution
Planning and Next Steps
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Recovery and Resolution Planning
for G-SIFIs
• The Financial Stability Board designates Globally Systemically Important
Financial Institutions.
• The Key Attributes sets out objectives and requirements for recovery and
resolution planning for those financial firms designated as G-SIFIs.
• Each G-SIFI has a Crisis Management Group (CMG) made up of the lead and
major home authorities and major jurisdictions in which the G-SIFI is active.
• The Cross-Border Crisis Management Group (CBCM) is the forum where the
key jurisdictions can bring forward issues of mutual interest for study and
for coordinating their approaches.
• CBCM reports to the Resolution Steering Group
• Recovery planning was completed for most G-SIFIs in 2011.
• Resolution strategies were chosen for most G-SIFIs in 2012.
• First complete operational plans for resolution developed 2013-5.
• First Resolvability Assessment Process largely completed around mid2015.
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Starting the Recovery and
Resolution Planning Process
• Forming a CMG: the principal supervisors/resolution authorities
for a specific G-SIFI
• Gathering Information with the clear intention to share it with
CMG
• Starting a dialogue with the financial company (bank)
• This dialogue can be uncomfortable; the dialogue
eventually needs to include all the CMG
• Signing a Cooperative Agreement by parties within the
CMG is necessary because it provides an understanding of
obligations to safeguard information
• Information needed to develop the bank’s “Heat Map”
• Business Strategy
• Organizational Structure
• Financial and Risk Information
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Bank Management Develops
the Recovery Plan
• The objective of recovery planning is to identify
possible actions the bank can take first to stabilize the
firm and then to restore its business health and
profitability.
• Historical experience suggests that the earlier the
identification and proactive actions, the better.
• Recovery planning relies on scenario-based stress
tests.
• Scenarios need to include both firm-specific and
marketwide stresses and need to be stringent.
• Banks also need to identify quantitative and
qualitative triggers to begin considering options and
to take action.
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Choosing the Resolution Strategy:
Single or Multiple Point of Entry
• The CMG’s review and discussion with management of
the recovery plan enhances the CMG’s understanding
of the firm’s strategy, structure, finances and risk
profile.
• That understanding helps to inform the key decision
about the resolution planning strategy. The two
principal options are Single Point of Entry (SPE) and
Multiple Points of Entry (MPE).
• Both involve an internationally coordinated
approach to resolution.
• In the simplest form of SPE resolution, the resolution
authority puts only the holding or parent company into
resolution, and continues to operate the parent‘s
subsidiaries as going concerns.
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Why Single Point of Entry?
• SPE has been adopted by most of the CMGs for GSIFIs. It becomes the preferred strategy for GSIFIs when the firm centralizes many or most key
decision processes.
• Prerequisites for SPE:
• sufficient ability to move losses upstream and capital
downstream in the organization; and
• sufficient loss-absorbing capacity at the parent or a
subsidiary that the parent can access.
• Nonetheless, supervisory and resolution
authorities have expressed a strong desire to have
flexibility in choosing the resolution strategy at
the time of failure.
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Why Multiple Point of Entry?
• Multiple points of entry (MPE) could be the
preferred strategy in a range of possible cases:
• A bank with strong regional autonomy
• A bank with very clear business line boundaries
• A bank with the potential for fairly clean good
bank/bad bank separation.
• Prerequisites for MPE:
• a large degree of financial and operational
separation across legal entities/jurisdictions, and
• sufficient independent funding and loss-absorbing
capacity at the potential points of entry
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How will a Bank be Recapitalized in
Resolution? Bail-in Powers
• An important innovation of the Key Attributes is its
requirement that resolution authorities have bail-in powers
and its further clarifying how bail-in should work.
• Bail-in is the power to convert liabilities to equity or write
liabilities down in value; in either case, bailing in
liabilities creates new capital.
• Bail-in strengthens the entity in resolution to continue
and retain business, improves its access to funding
markets while in resolution, and improve its prospects for
sale.
• Bail-in is intended to reduce the permanent
capital/funding need from the public sector to zero—that
is, avoid bailout.
• For bail-in to be effective, market expectations must change
to incorporate the possibility that debt instruments could be
converted to equity. Otherwise, bail-in actions can destabilize.
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What Kind of Liabilities Should Be
Bailed-in?
• The FSB has proposed a new TLAC (Total Loss-Absorbing
Capacity) requirement to ensure recapitalization of failed firms.
It requires banks to issue some specific bail-inable liabilities.
Which?
• Conceptually, bail-inable liabilities need to:
• Predictably provide loss-absorbing capacity;
• Avoid triggering runs;
• Avoid de-stabilizing funding markets.
• Subordinated and senior debt are most clearly bail-inable. In
order to have enough to recapitalize a firm, G-SIFIs may need to
issue larger amounts of senior debt.
• By the above criteria, derivatives liabilities and short-term
funding instruments seem ill-suited for bail-in.
• Agreement that insured deposits should not be bailed in; also
great reluctance to bail in uninsured deposits.
• Possibility under some circumstances to use ex ante
commitments by deposit insurance or resolution funds to
recapitalize a bank or bear costs of resolution, if pre-funded and
subject to limits.
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Funding in Resolution
• Resolution requires funding and liquidity
• Funding is necessary to support the balance sheet
and meet collateral requirements, but a failing firm’s
funders pull back as the firm’s condition deteriorates
and may be slow to return in a resolution.
• Liquidity takes many forms, but a key form is access
to trading markets, necessary in order to retain
business and manage risk. Capital markets activities
also depend on credit in the settlement process.
• History Suggests Some Kind of Public Sector
Funding May be Necessary
• A review of historical cases of failure or near failure
confirms that funding needs rise into and even after
resolution. While funding eventually is restored,
funding needs temporarily become very large.
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Funding in Resolution on the FSB
Agenda
• How Much Private Sector Funding is Possible? Making
sure there’s enough requires:
• Improving the ability to estimate prior to resolution funding
gaps that could occur in resolution.
• Principles for managing liquidity such that as much private
sector funding as possible can be obtained in resolution. The
recent Basel III agreements on liquidity rules help.
• If temporary public sector funding is necessary, it is
important that:
• Temporary funding be clearly distinguished from capital
injections or other medium-term support (“bailout”) and
designed to minimize moral hazard.
• Principles are developed that recognize the potential need for
temporary public funding. Because institutional
arrangements differ across counties, the challenge is to
develop guidance that is not too prescriptive and still ensures
adequate preparation for a resolution.
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Transforming the Firm in
Resolution
• The last key element involved in a resolution is triage by the
resolution authority of the potential disposition of the failed
financial firm.
• The operational resolution plan will provide a crucial roadmap in making
that triage. The resolution plan will set out:
•
•
•
The organizational structure of the firm
Identification of the firm’s critical functions—a guide to what is most important to preserve
A preferred resolution strategy.
• On entry into resolution, the resolution authority will have additional insight
into the sources and location(s) of recent and future losses.
•
•
•
Are the losses systemic or localized in business lines/subsidiaries?
How much restructuring of the firm is necessary?
Might differ with use of SPE or MPE strategy for resolution.
• The resolution authority needs flexibility to adapt strategy as circumstances
warrant and may need expert help.
• Governance
• Who runs the firm day-to-day in the interim? New management?
• What governance and oversight does the resolution authority provide?
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The Resolvability Assessment
Process (RAP)
• Prerequisites for successful resolution of a G-SIFI is
shared understanding of the resolution plan, a
willingness to act, and trust among the principals
of the key resolution authorities and supervisors.
• Hence the requirement in the Key Attributes that
periodically the principals of the key agencies
review and sign off the resolution plan in a letter
to the Head of the Financial Stability Board.
• That letter cites agreement on a resolution
strategy and a list of major impediments; at this
point, most of them are common to most G-SIFIs.
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Preparing for the Resolvability
Assessment Process
• Staff develops the key documents for use in the
RAP Meeting or Call
• The CMG produces a technical resolvability
assessment
• Details both market-wide and firm-specific impediments
to resolution.
• The findings are a key element of supervisory feedback.
• Signing of the Cooperation Agreement
• In some cases, appending the latest version of the
operational resolution plan to the CoAg
• Drafting the RAP letter
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Completing the Cycle: The Link
Between Recovery and Resolution
• The outcome of the RAP process is a list of
impediments to resolution to be set aside.
• Some might be industry-wide improvement, such as agreeing
to reach a common global approach to a stay on derivatives
exposures when resolution begins.
• Others may be firm-specific, e.g., a need to simplify the
corporate organization, to reduce complex risks, or to
improve liquidity management.
• Addressing these findings make resolution more feasible.
• Many measures have the possibility of making a firm
more “recoverable”.
• A successfully executed recovery plan is always preferable to
resolution.
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Next Phase of Resolution Planning:
Preparing to Execute Resolution
• Most CMGs have developed to date:
• A resolution strategy
• An operational resolution plan with some detail,
although additional work is needed
• CoAgs to govern information-sharing
• A resolvability assessment detailing impediments to
resolution.
• Next Steps
• Follow up to addressing impediments to resolution
• Preparing for the execution of the resolution plan—for
example, to be able to effect a recapitalization
• Valuing the failed organization—i.e., how much capital is
needed
• Exchanging debt into new equity; extinguishing old equity
• Work on restructuring and governance in resolution
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