Recovery and resolution: banks need to be prepared
The European recovery and resolution regime was set up to strengthen confidence in the banking system and ensure long-term financial and economic stability even if banks are forced to exit the market, without exposing taxpayers’ money to losses. Under the Bank Recovery and Resolution Directive (BRRD), crisis prevention and preparation are important aspects of the regime. Institutions prepare and regularly update recovery plans that set out the measures they would take to restore their financial position following a significant deterioration.
The BRRD also requires resolution authorities to plan for effective resolution of an institution in the event of future failure. Credible resolution plans are thus intended to ensure that resolution objectives are achieved. These include ensuring the continuity of critical functions, avoiding significant adverse effects on the financial system and protecting public funds. To ensure an effective recovery and resolution regime, European Banking Supervision and the Single Resolution Board (SRB) cooperate closely in implementing the first two pillars of the Banking Union – the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).
Banks are required to draft recovery plans to prepare for possible financial difficulties and restore their viability in a timely manner during periods of financial distress. Recovery plans should be fully aligned with banks’ risk management framework. In broad lines, banks are expected to set up a governance framework that promptly detects a stress situation and operates swiftly and smoothly in a crisis. The core of the recovery plan outlines a wide range of credible and feasible recovery options to restore viability, for example to improve the capital or liquidity situation. To identify and react to critical situations, banks should monitor a range of indicators reflecting at least their capital, liquidity, asset quality and profitability situation. The plans should also include a timely escalation process to the management body for implementation if one or more of these indicators is breached. Finally, the set-up should be tested under theoretical scenarios and the institution should include in the plan its communications strategy for addressing the crisis. Banks’ management bodies are responsible for preparing and maintaining recovery plans and ensuring that they are kept up-to-date and fit for use in crisis situations.
At least annually, institutions must submit their recovery plans to their supervisor, who performs a complete assessment of the usability of their plans and provides them with feedback. As the supervisory authority of significant institutions, ECB Banking Supervision receives around 110 recovery plans for review each year. When assessing the plans, the ECB checks if they comply with the regulatory requirements and standards set by the European Banking Authority (EBA). It assesses whether the plans would be operational in a crisis, taking into account (i) the variety of recovery options proposed and whether they would work in crisis scenarios; (ii) evidence that the options could be executed in a reasonable timeframe without legal and operational obstacles; and (iii) the internal escalation mechanism to ensure that the management body is informed of a crisis situation in a timely manner, how it would react and what crisis policy would be implemented.
ECB Banking Supervision also carries out benchmarking analyses to obtain a harmonised view of the full scope of its supervised entities. It uses these analyses to recognise improvements with respect to previous versions, identify best and weak practices, and assess trends in recovery plans, such as the types and amount of recovery options available. The ECB and national competent authorities share the institutions’ recovery plans with the SRB and national resolution authorities with the aim of providing banks with feedback from a resolvability perspective and informing their resolution planning. The feedback provided to institutions following the ECB’s assessment provides a key input for improvements to their recovery plans.
In contrast to recovery plans, resolution plans are not drawn up by the banks but are prepared and regularly updated by the SRB and national resolution authorities.
A resolution plan comprises a comprehensive description of credible and feasible resolution actions which may be implemented under the SRM if a bank meets all the conditions for resolution: (i) the bank is declared failing or likely to fail, (ii) there are no supervisory or private sector measures that can restore the bank to viability within a short time frame (for example, by taking actions set out in its recovery plan), and (iii) resolution is necessary in the public interest. If the two first conditions are met, but the public interest criterion is not satisfied, the bank has to be wound up under normal insolvency proceedings in accordance with the relevant national law.
Resolution plans prepare the measures and the process for the potential orderly resolution of a bank by ensuring the continuity of its critical functions. The plans identify these functions and the bank’s core business lines and establish a preferred resolution approach tailored to its specificities and business model, so as to achieve the resolution objectives as fully and as well as possible. Resolution plans also set appropriate levels of minimum requirements for own funds and eligible liabilities (MREL), which are necessary resources to fund resolution without recourse to public funds.
In drawing up the resolution plan, the resolution authorities identify and address potential impediments to institutions’ resolvability and may ask the institutions to address any impediments they detect. This may, among other consequences, imply changes to the business model, funding structure or organisational model of the institution concerned.
Before it approves the resolution plans for significant institutions, the SRB consults the ECB on the content of the plans, the MREL level and any measures identified to address the impediments to resolvability. The ECB’s supervisory insights and input in this consultation process ensure that there is no disproportionate tension in resolution plans between a bank’s going concern business perspective and its gone concern perspective. For example, the measures taken by the institution in accordance with the resolution plan should be the ones that, while having the lowest impact on its current business model, still adequately ensure the resolvability of the bank and thus safeguard financial stability.