Crisis Management and Crisis Preparedness
October 22, 2014
Presented at the 13th Annual IADI Conference
Port of Spain, Trinidad
Disclaimer
 The views expressed in this presentation are the speaker’s and
not those of the Federal Reserve Bank of New York and the
Federal Reserve System.
Overview
 Reducing the Too Big to Fail problem and avoiding government
bailouts: a two-pronged strategy.
 Reducing the probability of failure for such firms
 Increasing the ability to put complex firms into resolution
 Increasing the likelihood that firms develop meaningful recovery
plans and activate them early reduces losses and preserves value.
 Breakthroughs have been made in achieving the resolution of a
systemically important financial institution. .
 Publication of the Key Attributes of Effective Resolution Regimes
 Development of the single point of entry resolution strategy
 Emerging thinking on the means for recapitalization and funding
of a financial institution in resolution
 Efforts to improve cross-border recognition of resolution actions
and stays of financial contracts, especially derivatives
 Work remains: progress on resolution is a journey.
Recent Advances—The Key Attributes
 The Key Attributes of Effective Resolution Regimes (November 2011)
 Makes the case for special insolvency regimes for financial
institutions—all financial institutions, large, small, bank, nonbank
 Sets out powers needed by financial resolution authorities
 Recommends that resolution regimes have the ability to use a
“bridge bank” or “bridge institution”
 Introduces the concept of “bail-in within resolution” of at least
some financial liabilities of the firm
 Sets out guidelines for recovery and resolution planning for GSIFIs, systemically important financial institutions designated by
the Financial Stability Board.
 Much progress in major jurisdictions in adopting legislation that
implements the Key Attributes.
 Most notably in 2014, in the European Union,
Recovery and Resolution Planning for G-SIFIs
 The Key Attributes sets out objectives for recovery and
resolution planning for those financial firms designated as GSIFIs.
 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.
 Operational plans for resolution are being developed now.
▫ Likely to be an iterative process.
Status of Recovery and Resolution Planning
 Recovery plans for G-SIFIs are completed and have often been
through a few iterations.
 Resolution strategies have advanced substantially:
 High-level strategies were identified by each CMG last year.
 An operational plan was developed and approved by the
CMG this year.
 CMGs are making a resolvability assessment.
 Cooperative Agreements are being signed by parties within
the CMG and senior-level discussions of the resolution plan
and the resolvability assessment (RAP) for each G-SIFI) are
being discussed. The round of RAP discussions should end
in the first half of next year.
Recovery Planning, a Key Risk Management Activity

Recovery planning by a financial firm identifies possible actions it can take when
problems develop. Those actions are aimed first at stabilizing the firm and then at
working toward a resumption of business health and profitability.
 Historical experience suggests that financial firms minimize financial losses and
other costs by identifying emerging problems early and taking prompt, proactive
steps to address them.

Recovery planning relies on scenario analysis in order to identify stress points and the
rough size of actions that may need to be taken.
 Scenarios need to include both firm-specific and marketwide stresses.

Therefore, firms need to identify quantitative and qualitative triggers for consideration of
options and actions by the firm.
 The triggers are not meant to automatically lead to specific actions, but they must
lead to deliberation within the firm.

After reviewing the initial recovery planning done by G-SIFIs, the CBCM set out in a
paper (July 2013) considerations for sound scenario analysis for recovery planning and
the design and key features of recovery triggers.
Recent Advance on Resolution: Single Point of Entry
 The failure of Lehman Brothers Holdings, Inc., in 2008 and the
commencement of insolvency proceedings in multiple jurisdictions around
the globe exemplified the problem of an uncoordinated resolution.
 The FDIC put forward in its Journal a paper describing how a new
resolution strategy, single point of entry (SPE), could have been used to
resolve Lehman Bros. The FDIC further elaborated in speeches and a
joint paper by the FDIC and Bank of England.
 In the simplest form of single point of entry resolution, the resolution
authority puts only the holding or parent company into resolution, and
continues to operate the parent‘s subsidiaries as going concerns.
 The resolution authority can fund the sole legal entity in resolution
and that entity can fund the subsidiaries. The resolution authority can
then restructure and/or sell the financial company as necessary.
 SPE has been widely adopted by the CMGs for G-SIFIs.
Progress: Single Point of Entry Resolution

The Financial Stability Board published guidance on developing effective
resolution strategies (July 2013). The guidance describes the conditions
leading a resolution authority to choose a single point of entry strategy, a
multiple points of entry strategy, or some combination of both.

Multiple points of entry (MPE) could cover a range of possibilities: regional
breakup, business line breakup, good bank/bad bank, etc. Some
prerequisites for MPE may be a large degree of financial and operational
separation across legal entities/jurisdictions, as well as sufficient independent
funding and loss-absorbing capacity at the potential points of entry.

Single point of entry may have as prerequisite sufficient ability to move
losses upstream and capital downstream in the organization; sufficient lossabsorbing capacity at the parent or a subsidiary that the parent can access,

Supervisory and resolution authorities have expressed a strong desire to have
flexibility in choosing the resolution strategy at the time of failure.
The Innovation of Bail-in Powers
 Key innovation: bail-in powers. Bail-in is intended to
reduce the permanent capital/funding need from the public
sector—to zero.
 Bail-in is the power to convert liabilities to equity or
write them down in value; in either case, bailing in
liabilities creates new capital.
 Bail-in avoids a capital injection by public sector and
strengthens the entity in resolution for sale, and
improves its access to funding markets.
 Bail-in must be credible to not be destabilizing. In the
failure of Washington Mutual, the FDIC wrote down
senior debt, but the market assumed that senior debt
would be protected in a failure.
Why Do We Need Bail-in Now?
 Bail-in is a mechanism to recapitalize a financial institution in
resolution. Why do we need it now?
 Traditional commercial banking involves the taking of deposits
and the lending of funds.
 In concept, traditional commercial banking businesses can
be resolved, in part because the deposits generally have
value, as do the “good” assets.
 To have value, deposits must be “sticky”—not very sensitive
to changes in interest rates or the institution’s health.
 The stickiness comes from the account services (e.g.,
payment and liquidity services) that are intrinsic to the
deposit.
 In contrast, capital market activities and other non-deposit
funding activities have liabilities generally without “stickiness”—
one reason why bail-in is important.
Bail-in and Loss Absorbing Capacity in Resolution
 The equity capital of the firm is meant to absorb losses that
could lead to a firm’s failure and firms have generally depleted
much of their capital as they enter resolution In resolution,
other loss-absorbing liabilities are needed to recapitalize their
firm and support its sale.
 Loss-absorbing capacity (LAC) involves identifying liabilities of
the firm that can be converted into equity or written down in
resolution (bailed-in).
 Liabilities can be rank-ordered by the effectiveness of their
conversion and the absence of inducing further runs.
 Work advancing to the 2014 Brisbane Summit on what qualifies
as LAC, how much is required and where the LAC could be
located in the organization.
What Kind of Liabilities Can be Bailed-in?
 Key features: needs to predictably provide lossabsorbing capacity; needs to avoid triggering runs;
needs to avoid de-stabilizing funding markets.
 Subordinated and senior debt most clearly bail-inable.
Financial institutions may need to issue more.
 Derivatives liabilities and short-term funding seen as
less suitable.
 Agreement that insured deposits should not be bailed
in; also great reluctance to bail in uninsured deposits,
reinforced by the Cyprus experience.
 Some discussion of using or crediting the potential use
of deposit insurance as part of LAC
Funding in Resolution
 Resolution requires funding and liquidity
 Funding is necessary to support the balance sheet and
meet collateral requirements
 Liquidity takes many forms, but a key one is access to
trading markets, necessary in order to manage risk
 What problems can a firm face in funding in resolution?
 History suggests that loss of funding capacity occurs in the
run-up to failure and continues after. What is the potential
gap between the firm’s resources and its funding needs?
 Capital markets activities depend on credit in the settlement
process. When the firm is no longer viewed as creditworthy, it may restrictions on its access to markets.
Recent Work on Funding in Resolution
 The CBCM has begun looking at funding in resolution.
 A review of previous cases of failure or near failure confirms
that funding needs rise in and even after resolution. While
funding eventually is restored, funding needs temporarily
become very large.
 Improving the ability to estimate funding gaps prior to resolution
taking into account bail-in is a clear need.
 Working to develop principles for ways to sustain as much
private sector funding as possible is also a clear imperative.
 Principles to guide public sector funding when it is needed also
look like they would be useful. In addition, much progress was
made in identifying temporary funding approaches that
minimize moral hazard.
 We do not want to be prescriptive as to how countries meet that
need.
Other Noteworthy Areas of Progress
 Cross-border recognition of actions by resolution authorities,
such as temporary stays of derivatives contracts and exercise
of bail-in powers. Discussions with industry and the legal
community have made progress.
 A paper has been written on resolution-related information
sharing between home and host supervisors about financial
firms whose operations in a host jurisdiction are locally
systemic, but small relative to the overall firm’s size and
activities.
 Regional supervisory groups have provided extensive
comments on the paper.
 The next step will be public consultation.
Progressing on the Journey: Future Work
 Considerable progress on resolution plans that do not require
the taxpayer to bear losses, but much remains to be done.
 Ensure continued progress in adopting the insolvency regime
requirements of the Key Attributes.
 With the first round of G-SIFI resolution planning nearing
completion, a good time to assess the process and its
integration into supervisory practice.
 Develop further topics such as operational continuity of critical
operations through the resolution process.
 Further attention to the set of decisions that need to be made
upon entry into resolution: management, valuation, strategies
such as managing problematic assets.
 More detailed planning of roles and responsibilities:
supervisors, resolution authorities, and deposit insurers.