By Adam Cull, Rosie Dickinson, Rebecca Hall and Ruth Smith (Resolution Directorate)footnote [1]
- Since the financial crisis, governments and authorities globally have taken steps to make it easier and less costly to manage banks that get into difficulty. In the UK, the Bank of England has powers to manage bank failure in an orderly way, designed to protect financial stability and prevent public money from being used to keep key banking services operating.
- Resolution is when the authoritiesfootnote [2] use those powers in the public interest when a bank is failing.footnote [3] It enables losses to be imposed on a bank’s shareholders and investors outside of insolvency to allow activities, such as access to deposits or payment services, to continue. This stabilises the failing bank in the short term and creates time for the problems that caused its failure to be addressed over a longer period.
- Managing bank failure is unlikely to ever be a smooth process. To reduce the risk of unnecessary disruption we and banks need to put ourselves in the best place to handle the challenges at the point of failure. Confronting, ahead of time, the difficult and complex judgements that would need to be made and having the capabilities and tools to act, will improve the prospect of success.
- With this in mind, in July 2019, we published the last major piece of the UK’s bank resolution regime. The Resolvability Assessment Framework (RAF) introduces a fundamental change in the way banks approach their preparations for the range of unpredictable and challenging issues a resolution involves.
Overview
The RAF builds on the work done since the 2008-09 global financial crisis and sets out the next steps in implementing the resolution regime with the end goal of ensuring that banks are, and can demonstrate that they are, resolvable. Being resolvable is not a binary pass or fail concept; it is about putting banks and the authorities in the best place to handle a bank failure. This goal means banks must prepare systems, processes and people so that they are ready in case of failure. The first section of this article explains the motivations for the RAF.
The second section sets out how the RAF extends our approach to resolution policy. The RAF challenges banks to think about how they would deliver good outcomes during resolution and introduces new ways for major UK banks to be held accountable for their preparations. In particular, every two years major UK banks, those with more than £50 billion of retail deposits, must submit a report on their preparations for resolution to the Prudential Regulation Authority (PRA). These banks must also publish a summary of their resolution report. The Bank of England will also make a public statement on the resolvability of these banks (Figure 1).
In order to prepare successfully, banks must understand what the process of resolution could look like so they can identify and implement the capabilities that would be needed if they were to fail. To help banks prepare, we have published a stylised resolution timeline as part of the RAF. The third section of this article explores how banks can use this timeline to understand the key steps they could need to take during a resolution.
Figure 1: Every two years major UK banks must submit a report on their preparations for resolution to the PRA and publish a summary
Footnotes
Note: In light of Covid-19, the PRA published a Modification by Consent extending the dates for the first cycle.Introduction
The 2008-09 financial crisis taught public authorities around the world a number of lessons. At that time, the UK, like many other countries, had no process tailored to managing the failure of a bank. As the collapse of Lehman Brothers demonstrated, using insolvency for large complex banks would have meant accepting very adverse consequences for financial stability.footnote [4]
With limited options available, the UK authorities resorted to ‘bailouts’. This meant using public money to recapitalise banks in the interests of financial stability. The costsfootnote [5] were therefore imposed on the public rather than on the bank owners and investors who had benefited from banks’ profits prior to the crisis.
Following the crisis, the resolution regime was set up in the UK to give us better options, in good or bad economic situations, when a bank fails. Parliament made the Bank of England responsible for ensuring that banks, building societies and certain investment firms could fail in an orderly way, managing the risks to depositors, the financial system and public finances.footnote [6] For simplicity, this article refers to these firms as banks.footnote [7] The RAF will also support delivery of our commitment to Parliament that major UK banks will be resolvable by 2022.
To explain how we would be likely to implement a resolution, we have published our approach to resolution. In summary, the majority of the banks within the scope of the UK resolution regime are sufficiently small to be resolved using a modified insolvency process,footnote [8] which was developed after the financial crisis. This process is designed to fast-track the payment of compensation to depositors covered by the Financial Services Compensation Scheme, or have their accounts transferred to another firm while the failed bank completes the insolvency (like any other company that fails).
But if it would be too disruptive to put a failing bank into modified insolvency, we — in co-operation with other UK authorities, such as HM Treasury and the Financial Conduct Authority — can use our powers to impose losses on investors and keep a bank’s key services and core business lines operating so that the business can be restructured in an orderly way or sold. All the larger banks for which we judge this is likely to be the case are within the scope of the RAF policy.footnote [9] Of these, those with more than £50 billion in retail deposits must also produce reports and disclosures assessing their preparations for resolution every two years (Figure 1).
What problem is the RAF trying to solve?
The RAF aims to ensure that larger banks operating in the UK are, and are able to demonstrate that they are, resolvable. The RAF sets out the three outcomes that banks would need to be able to deliver to support a resolution. The RAF is also designed so that, if a bank failed, stakeholders have access to information about how its failure could unfold and what the bank has done to prepare, increasing the overall transparency of the process.
Since the Bank of England was made the UK’s resolution authority,footnote [10] we are now better placed to deal with a bank failure. As well as introducing new policies and requirements for banks, we have also undertaken planning for how we would carry out a resolution for each bank within the scope of the UK resolution regime and assess annually if there are any factors that could prevent us from implementing it. As part of this process, we work with authorities, at home and abroad, so we are ready to co-operate in the event of a bank failure.
But no matter how ready the authorities are, banks must also have systems, processes and people ready in case of failure. Since the financial crisis, banks have been required to remove barriers to resolution in the good times so that, if the need arises, they can be resolved in an orderly manner with minimum disruption to key services or financial stability. The RAF sets out banks’ responsibilities for preparing for resolution in more detail, with reference to the three outcomes banks need to be able to achieve in resolution. Banks must be prepared to:
- Have adequate financial resources to support a resolution.
- Continue to do business through resolution and restructuring.
- Co-ordinate and communicate effectively internally and with the authorities and markets so that resolution and subsequent restructuring are orderly.
Box A explains how the RAF draws together relevant existing rules and policies into a single outcomes-based framework that requires banks to have capabilities to carry out the actions that would be necessary if they failed. To achieve the three outcomes, banks first need to remove any operational or structural barriers to the process of resolution (Figure A). Beyond this, banks will then need to think broadly about how each of the three outcomes can be delivered in the context of their business so they are prepared if the worst happens. We have not been prescriptive about how they should do this because different approaches may be right for different banks, and banks are responsible for their progress towards building and demonstrating their capabilities for resolvability. Banks are best placed to understand how their business works and identify what systems and processes they would need to achieve the three resolvability outcomes in a resolution. This also ensures banks’ resolvability capabilities can be sustained for the long-term.
Some of the capabilities needed by the larger banks in a resolution scenario are not dissimilar to those they would use to execute corporate finance transactions. In particular, there are parallels between recapitalisation in resolution and debt-for-equity swaps and between the sale of a bank in resolution and an accelerated merger and acquisition process. However, given the need for resolution to be implemented quickly by the public authorities, there is a much greater emphasis on preparation in normal times, before any sign of trouble.
Box A: How banks can achieve the three resolvability outcomes
The RAF draws together policy on eight barriers to resolution into three outcomes.
1. Having adequate financial resources to support a resolution
To meet the first outcome, a bank must ensure that it has sufficient financial resources available to absorb losses and to enable recapitalisation during resolution without exposing public funds to loss. This includes meeting our requirements on the quantity and quality of financial resources it needs to hold, such as equity and long-term debt. Banks will also need to be able to support a timely valuation of their assets, as well as be able to forecast what payments they will need make in resolution and how they will meet them.
2. Continuing to do business through resolution and restructuring
To meet the continuity outcome, a bank must ensure that its activities can continue during resolution and any subsequent restructuring. This includes ensuring that the resolution does not result in the bank’s contracts with clients and suppliers being disrupted, and that direct or indirect access to services provided by financial market infrastructures (eg clearing and settlement) are maintained. It also means ensuring that the operational and support services needed for a viable business can be identified, separated, and reorganised to support post-resolution restructuring in a way that minimises disruption.
3. Co-ordinating and communicating effectively internally and with the authorities and markets
A bank must be able to co-ordinate and communicate effectively internally and with the authorities and markets so that resolution and subsequent restructuring are orderly. Effective management and governance arrangements throughout resolution will be important, particularly given the need for the bank’s staff to carry out a large number of actions to support orderly resolution during a period when management deemed responsible for the bank’s failure may need to be replaced. To promote confidence in the continuity of key services, it will also be important that the bank can deliver clear and timely communications to its customers, counterparties, investors and suppliers.
Figure A: The resolvability outcomes and the eight barriers that banks must address to achieve them
The financial crisis taught us that we need to be able to react rapidly and flexibly when a bank gets into trouble. The specific causes of individual bank failures may not be foreseen and the timing of any individual failure will depend on the pace at which the bank is deteriorating. No matter how much preparation is done, neither the public authorities nor banks can count on anticipating all the characteristics of a crisis scenario.
In light of this, the RAF emphasises that banks need to be able to deliver the three resolvability outcomes regardless of why and how quickly they fail. This requires banks to think about the capabilities they would need and how these would interact with one another to allow senior management to make decisions and support actions by the authorities during the preparation for resolution, the execution of the resolution itself and exit from resolution. They will also need to consider how they would interact with relevant third parties during the resolution process, and engage those parties as part of their preparations for resolution.
For example, a bank must be able to adjust projections of the payments it will need to make to clients and counterparties to reflect the different circumstances that it might face in resolution. This will help ensure that in a crisis situation, the authorities are able to use the bank’s analysis to monitor its liquidity position.
To ensure we can take action and respond to different scenarios flexibly, it is also important that banks’ preparations are kept up to date. Banks’ preparations for resolution cannot be drawn up as part of a one-off compliance exercise, allowed to gather dust and then — when they are actually needed — be found to be so out of date that they are redundant. Under the RAF, banks need to embed robust governance and controls, and continually review, assess and test their preparations for resolution and their ability to meet the three resolvability outcomes as their businesses evolve. This will ensure their preparations can be relied upon at any time.
Another key lesson from the financial crisis is the importance of transparency around what is likely to happen if a bank fails. Before the financial crisis, the market’s perception that the biggest banks would be rescued by the Government created an implicit guarantee that acted as a hidden subsidy to these banks.footnote [11] Since the financial crisis, authorities around the world have taken steps to increase transparency about what could happen in a resolution (Box B).
In the UK, the RAF has been designed to increase the public information about banks’ readiness for resolution. Every two years, each of the major UK banks will publish a summary of their assessment of their preparations for resolution and we will make public statements on the resolvability of these banks (Figure 1).
Together with our approach to resolution and the annual publication of the loss-absorbency requirements we set individual banks, the banks’ public summaries of their preparations and our public statement should help investors to better understand the progress banks are making to become more resolvable and what would happen in a resolution. In doing so, these publications should better inform investors and help them to hold banks to account and therefore reduce the risk of failure. Transparency would also have benefits in the case of bank failure itself. Although resolution is unlikely to ever be smooth, the disruption caused is likely to be less severe if depositors and market participants understand that the resolution process is designed to facilitate the continuity of key banking services.
This is why the RAF is designed to increase transparency around preparations for resolution. As stated previously, the resolvability of a bank is a complex judgement and not a binary decision. We will therefore assess banks against the resolvability outcomes and not publish ‘pass’ or ‘fail’ judgements. We will also take care not to disclose proprietary information.
Box B: What are different jurisdictions doing to increase transparency around preparation for resolution?
Efforts to increase transparency around resolution fall into two categories: general disclosures and bank-specific disclosures. In 2019, the Financial Stability Board (FSB) published a discussion paper, which sets out how these two types of disclosure have been used. A number of resolution authorities have published general disclosures on their resolution frameworks and their approach to resolution. Some examples of bank-specific disclosures are outlined below.
- US resolution plans and assessments: in the US, large banks must submit resolution plans to the authorities and publish sections of these. These documents include information on the bank’s resolution strategy as well as assets, liabilities, capital and funding sources. The authorities publish feedback on bank-specific resolution plans.
- Loss-absorbing capacity disclosures: under the Basel Committee on Banking Supervision’s (BCBS’s) disclosure requirements, global systemically-important banks (GSIBs) must make disclosures on their total loss-absorbing capacity (TLAC). Like the UK, the Swedish authorities have also disclosed bank-specific loss-absorbing capacity requirements. And in Switzerland, the authorities’ assessment of the Swiss GSIBs’ resolvability is implicitly disclosed through the granting of ‘rebates’ on loss-absorbing capacity requirements. Such rebates are granted if overall recoverability and resolvability is improved beyond the minimum standard.
In 2020, the FSB published a consultation report evaluating the impact of too-big-to-fail reforms on GSIBs. This noted many improvements made as well as areas where further progress could still be made to improve resolvability. The FSB highlighted that greater transparency, including through the full implementation of the BCBS’s TLAC disclosure standards, would support credibility of the reforms already made. It also suggested there may be further opportunities to increase provision and availability of data, including around the resolvability of GSIBs.
The FSB has stated that it will continue to encourage appropriate levels of disclosures and, in 2022, it will revisit the question of whether further guidance is needed.
How is the RAF a new type of solution?
In addressing these problems, the RAF requires a change of approach from banks in how they prepare for resolution. It requires banks to think holistically about their resolvability and introduces new ways they can be held accountable for their preparations.
The three resolvability outcomes (Box A) require banks to think about more than complying with individual policies or submitting data to the authorities. They challenge banks to think broadly about how their resolution could unfold and what they would need to do.
In particular, the outcomes mean banks should tailor their preparations for resolution. There is no one-size-fits-all solution to the problem of preparing for resolution. Larger, more complex banks are likely to require more sophisticated systems and analysis than smaller, less complex banks. The arrangements put in place also need to be able to work together effectively to deliver resolution.
It may also be the case that some banks need to undertake additional preparations, beyond those set out in published policy, to allow them to achieve the resolvability outcomes in the context of their business. For example, some banks have a resolution strategy that could involve multiple authorities separating the bank into parts. These banks will need to consider the consequences of this separation.
The RAF also introduces new ways for major UK banks and their management to be held accountable for their preparations for resolution. These mechanisms create additional incentives for banks to take responsibility for their preparations for resolution.
- First, each of the major UK banks must undertake a forward-looking, realistic assessment of how its preparations for resolution would enable it to achieve the outcomes for resolvability and produce a report for the PRA.
- As previously explained, major UK banks must publish a summary of their report. The public will be able to use banks’ disclosures and our public statements to understand banks’ preparations and hold banks to account.
- Third, we have made individual senior managers in each of the major UK banks responsible for carrying out resolution assessments and the banks’ related obligations.footnote [12]
Ensuring there are credible and effective preparations for resolution also has near-term benefits for banks. For example, in 2019, the Financial Policy Committee reconfirmed that effective resolution arrangements reduce the appropriate equity requirement for the banking system by about 5 percentage points of risk-weighted assets.
Imagining the worst
For banks to prepare successfully, they should understand what the process of resolution could look like and how they would need to act. Confronting failure may be challenging for banks, particularly when the risk of failure feels remote. The stylised timeline of how a resolution could unfoldfootnote [13] should help banks think through what their own failure could look like and the actions and decisions they would need to take. It should help make ‘the unimaginable’ imaginable and prepare banks to use their capabilities flexibly in different scenarios.
The timeline has three phases (Figure 2): the pre-resolution contingency planning period, the ‘resolution weekend’ and preparing to exit resolution.footnote [14] In each of these periods, the timeline provides an illustration of what the main steps for the resolution of one of the largest banks might be. It includes the actions required from the failing bank and explains how a bank’s systems and people might be relied upon.
The timeline should help banks contextualise the three resolvability outcomes. They should use it to help decide what preparations they need to undertake — including the development of systems and processes not covered by any of the eight barriers to resolution. To illustrate the importance of developing all capabilities, the next section explains how, for example, a bank’s valuations systems, communications and planning capabilities could be needed at different stages.
Of course, each resolution will be unique and will not necessarily conform to this stylised timeline in practice; some phases may be accelerated and others take much longer to complete.
Figure 2: Our stylised resolution timeline outlines the three key phases of resolution
Valuations in the contingency planning period
The first phase in the timeline covers the pre-resolution contingency planning period. During this period, alongside efforts to recover from the stress, a bank and the public authorities will also need to prepare for resolution.
Supporting valuations is one example of the many things a bank may need to do in this contingency planning period. Ahead of a resolution we will require valuations of the bank’s balance sheet to inform our decisions including:
- whether the bank is failing (or likely to fail)
- the extent of any write-down or bail-in that may be required
- the recapitalisation needs of the bailed-in bank
- the long-term viability of the bailed-in bank
The valuation process is likely to be iterative, taking into account rapidly evolving information on the resolution, the restructuring options envisaged following resolution, funding requirements and market conditions more broadly. As such, banks will need to prepare their systems in normal times so that they would be able to provide timely access to relevant data and information, as well as the personnel needed to support the required valuations and analysis.
Valuations are a good example of how the preparations required will depend on the bank in question. For smaller and less complex banks it may not be necessary for them to develop internal models although they should then build capabilities to provide relevant data for an independent valuer to produce timely and robust resolution valuations using its own models. However, for larger, more complex banks, valuation models should be available for all material asset and liability classes, where it is not reasonable to expect an independent valuerfootnote [15] could suitably develop and deploy a robust valuation model on a timely basis in the lead up to resolution. Banks should ask themselves how they can be confident their processes will work as expected, and are adequate to support the work of an independent valuer as part of any resolution.
Communications during the ‘resolution weekend’
The second indicative phase begins at the point that the authorities determine that the bank should go into resolution and ends the next business day. Ideally we would want to ensure that this phase takes place over a weekend. This may not always be possible and so the resolution may need to take place mid-week, as happened in 2017 when Banco Popular failed in Spain.
Once we have decided to carry out a resolution, we will exercise our powers and announce this to the public as soon as practicable after doing so. We may also appoint an administrator to control the bank and oversee the management of the bank.
It will be important that communications about the resolution are effective, delivered on a timely basis and contain relevant information. To promote confidence that its key services will continue operating, the failing bank will need to communicate with its stakeholders, including counterparties, investors, customers and suppliers. As an example, Box C sets out some of the key messages about continuity of services that we published after the resolution of Dunfermline Building Society in 2009.footnote [16]
Restructuring planning when preparing to exit resolution
The third and final phase covers the period between the ‘resolution weekend’ and when the bank returns to private control. We aim for this period to last no more than three to six months. In practice, however, this period would last as long as necessary until we could safely return the bank to private control and could be significantly longer for more complex banks. It is possible that restructuring could continue once a bank is returned to private control.
To return a bank to private control, we would need to be content that the bank has a credible restructuring plan to restore long-term viability. The bank would need to undertake the analysis necessary to produce, or support the production of, this plan, within a month of the resolution weekend. Banks should ask themselves in advance what factors would constitute an actionable restructuring plan, and therefore ensure that they have the ability to credibly evaluate and execute restructuring options. This will require banks to draw upon a wide-range of capabilities, such as valuations and funding. Banks should consider possible restructuring options in advance, but also have the capabilities to extend these options to respond to specific scenarios.
Box C: The resolution of Dunfermline Building Society
In March 2009, Dunfermline Building Society, the largest Scottish building society was deemed to be failing or likely to fail. At the time it had more than 350,000 customers, 550 staff and 34 branches across Scotland.footnote [17] Over the weekend of 28–29 March, we conducted a sale to Nationwide Building Society under the Special Resolution Regime provisions of the Banking Act 2009. Immediately after the resolution of Dunfermline Building Society in March 2009, we published a press release, which included the following announcement:
‘It is business as usual for all customers. Dunfermline’s deposit business will continue to operate normally. Branches and telephone banking will continue to open during their normal hours and customers can deposit and withdraw their money in the usual ways. Savers can be assured that their money is safe. Loan and mortgage customers can continue to contact Dunfermline in the usual way and should continue to make repayments as normal. All of Dunfermline’s staff have been transferred to Nationwide.’
Conclusion
Memories of financial crises are always at risk of fading with the passing of time. The challenges and actions needed in severe stress become harder to imagine. The Covid-19 pandemic, live at the time of writing this article, reminds us that unexpected events may be just around the corner. The possibility of new and unpredictable events emphasises the importance of the resolution regime and the need for the financial system, and those who are active in it, to be capable of responding successfully. Through establishing the RAF, we hope to embed the lessons that were so hard-learned and ensure that banks are, and are able to demonstrate that they are, resolvable in a transparent manner. Resolution is unlikely to ever be a smooth process. But the work done by banks under the RAF in its first and future cycles should increase the chances that resolution is conducted in an orderly fashion and disruption to the financial system is minimised.
This article was published outside of the normal Quarterly Bulletin publication schedule.
The Bank of England, in its capacity as UK resolution authority, acting in consultation with HM Treasury and the Prudential Regulation Authority or Financial Conduct Authority, as applicable, has the power to impose losses.
Resolution is just one of the actions we have taken to increase the resilience of the UK banking system since the financial crisis.
For example, the rapid close-out of derivatives contracts during the Lehman Brothers insolvency caused disruption to financial markets and financial stability.
£137 billion in public money was injected to stabilise the financial system in the 2008-09 financial crisis. The overall cost to the public is estimated at £27 billion, though the eventual cost will only be known once all government shares in banks are sold and all loans are repaid. For further details see the ‘Financial sector interventions’ section of the Office for Budget Responsibility’s Economic and fiscal outlook, and the National Audit Office’s FAQ page.
The PRA also discharges its general statutory objective by minimising the adverse effect that the failure of one of the firms we regulate could be expected to have on the stability of the UK financial system.
The UK established a framework for resolution (known as the ‘resolution regime’) in the Banking Act 2009. In 2014, the resolution regime was extended to include central counterparties (CCPs). The approach to a CCP resolution differs to the approach to a firm resolution, reflecting CCPs’ specific characteristics.
Or special administration, depending on the type of firm.
This means they must be able to meet the three resolvability outcomes (Box A). The scope of the RAF policy also includes certain UK subsidiaries of overseas-based banking groups. More details on the scope of the policy are set out in Section 2 of our approach to assessing resolvability.
As part of the Banking Act 2009.
See our 2015 paper on estimating the extent of the ‘too big to fail’ problem.
Under 4.1 (10) of the Allocation of Responsibilities section of the PRA Rulebook, a firm must prescribe responsibility for developing and maintaining the firm’s recovery plan, resolution pack and, where relevant, resolution assessment, and for overseeing the internal processes regarding their governance
Our stylised resolution timeline is available in annex 1 and 2 of the RAF policy statement. Readers can also consult our approach to resolution for further background.
Our stylised resolution timeline refers to the third period as ‘the bail-in period’.
For UK-led resolutions, the Bank of England would be required to appoint an independent valuer responsible for producing the valuations required for resolution. For more information see guidance on valuation capabilities to support resolution.
Additional information about the resolution of Dunfermline Building Society is available on our website. This is the only resolution the Bank of England has carried out (as Southsea Mortgage and Investment Company Limited was placed into modified insolvency). Dunfermline Building Society was substantially smaller in scale than the major UK firms but provides some useful lessons.
Details about Dunfermline Building Society at the time of its resolution are available in the report to the House of Commons Scottish Affairs Committee.
