Description
This paper aims to consider whether it is plausible to resolve troubled systemically
important cross-border banks by dividing them so that the component national authorities can resolve
the parts in their jurisdiction separately according to their own priorities.
Journal of Financial Economic Policy
Achieving plausible separability for the resolution of cross-border banks
David Mayes
Article information:
To cite this document:
David Mayes , (2013),"Achieving plausible separability for the resolution of cross-border banks", J ournal of
Financial Economic Policy, Vol. 5 Iss 4 pp. 388 - 404
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J acopo Carmassi, Richard J ohn Herring, (2013),"Living wills and cross-border resolution of systemically
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J FEP-07-2013-0030
Tom Patrik Berglund, (2013),"Optimal jurisdiction of financial supervision", J ournal of Financial Economic
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Harald A. Benink, (2013),"Resolving Europe's banking crisis through market discipline: a note", J ournal of
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Achieving plausible
separability for the resolution
of cross-border banks
David Mayes
Department of Accounting and Finance, University of Auckland,
Auckland, New Zealand
Abstract
Purpose – This paper aims to consider whether it is plausible to resolve troubled systemically
important cross-border banks by dividing them so that the component national authorities can resolve
the parts in their jurisdiction separately according to their own priorities.
Design/methodology/approach – The example of New Zealand is used. This country has chosen
just such a route in its Open Bank Resolution (OBR) policy. The dif?culties and advantages of this
route to resolution are analyzed.
Findings – The paper concludes that the New Zealand route is plausible for systemic subsidiaries,
providing there is deposit insurance. The minimum cost route is likely to be one where the home
authority takes responsibility for the whole group and keeps all systemic operations running.
It remains to be seen what the new EU-level proposals could achieve.
Research limitations/implications – OBR is as yet fortunately untried although there are some
examples from a smaller scheme in Denmark.
Practical implications – These ?ndings have important implications for ?nancial regulators round
the world but especially in the EU as it seeks to ?nd a similar approach in the Recovery and Resolution
Directive.
Originality/value – This topic has not been covered by others and will add ideas of practical value
to the debate. One of the major problems addressed by the Basel Committee in its approach to
supervision and regulation of cross-border banks is to come up with arrangements that allow the
network of national authorities to handle problems in a large cross-border bank quickly, ef?ciently and
preferably pre-emptively without recourse simply to a major taxpayer bailout.
Keywords Financial crises, Cross-border banks, Plausible separability
Paper type Research paper
1. Introduction
One of the major problems addressed by the Basel Committee in the appropriate
supervision and regulation of cross-border banks is to come up with arrangements that
allow the network of national authorities to handle problems in a large cross-border
bank quickly, ef?ciently and preferably pre-emptively without recourse simply to a
major taxpayer bailout. This approach takes it for granted that it is not possible to
create a single legal and practical regime for dealing with such problems, even though
that may be the ideal, especially in a European framework. Colleges of supervisors
and crisis management groups, however well-intentioned, will have dif?culties when
regimes, powers andobjectives con?ict, whatever the prior agreements onhowto proceed.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G01, G21, G28
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 388-404
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-06-2013-0024
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Hence the Basel approach has focused on how the problems can be ring-fenced either
in advance or at the time to enable a solution by national authorities.
This paper focuses on ex ante ring-fencing and considers the ideas that have been
proposed to ensure the minimum levels of separability to have a workable system yet
effective gains fromhaving cross-border banks. There are two main strands to this work.
The ?rst is to look in detail at the systemimplemented by NewZealand for ensuring both
practical and legal separation of its cross-border banks, which represent almost the
entire banking system. No other country has gone as far in trying to achieve real
separation yet allow all of the bene?ts from running systems in more than one country
and gaining the bene?ts of larger scale. The second is to consider whether weaker forms
of such separation including living wills might offer an equally effective route. Much of
the answer depends upon whether the arrangements can handle the appropriate
distribution of the costs of resolution given that one or other authority may be at fault.
The paper concludes with doubts that any of these arrangements will be effective if
the home country is not prepared allow the organisation of the bank in its jurisdiction
to continue in operation.
2. The problem of bank resolution
In the event of serious problems with systemically important banks, the authorities
need to step in quickly and resolve the problems quickly and in a manner which
preferably does not involve taxpayer funds but rather the assignment of losses to
shareholders and then creditors in reverse order of priority (Basel Committee on
Banking Supervision, 2010; FSB, 2011)[1]. If the bank is simply allowed to fail it will
turn a problem into a crisis with possibly severe repercussions on the real economy.
A large number of transactions may fail and a noticeable proportion of people and
business will have their accounts frozen, which will have a knock on effect on their
counterparties in sequence through the ?nancial system. There is also likely to be a
loss of con?dence in the banking system as a whole and withdrawals from other banks.
With a small bank and a limited number of business lines in a single jurisdiction a
managed resolution is a straightforward operation, which has been performed
smoothly in the USA on over 400 occasions in the present crisis. Public funds have not
been needed and since most depositors are fully insured they have not had any
material break in access to their funds. Indeed this approach can be used on large
institutions that are appropriately structured as is shown by the closure of Washington
Mutual (WaMu) in September 2008 and the immediate sale of the banking assets and
most of the liabilities including the deposits to JP Morgan-Chase following a secret
auction by the FDIC. WaMu was the sixth largest bank in the USA at the time[2].
Non-bank activities were only 10 per cent of total assets.
In the case of a complex bank or ?nancial group that runs across jurisdictions the
problem has proved too hard and the only option has been to provide ?nancial
assistance in some form, whether loans, purchase of (preference) shares, or guarantees
for impaired assets[3]. In the main, this assistance has been provided by the authorities
in the home country rather than coordinated across home and host countries. This resort
has all sorts of drawbacks. While it may largely wipe out the shareholders by dilution,
creditors will not be making a contribution to the losses, parts of the group that are
not systemically important will be kept operating and the moral hazard for future
behaviour could be considerable. However, if the degree of insolvency is small and
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a private sector investment cannot be organised in time, a capital injection by the public
sector may be the least cost solution as the bank can rapidly return to pro?tability and
the new shares can be sold to the private sector, quite possibly at a pro?t for the
taxpayer. Relying on this approach poses its own problems, as the authorities may
greatly under-estimate the extent of the insolvency, as in the case of Ireland in 2008
(Honohan, 2010).
A different solution is therefore required where the problem is deeper or more
uncertain and current thinking (Basel Committee on Banking Supervision, 2010) is that
it should involve three main facets:
(1) The banking group should be divisible in such a way that the systemically
essential activities can be separated out and continued.
(2) The banking group should be divisible across jurisdictions so each authority
involved can use its own powers to handle what is systemically essential to it in
a manner that con?icts of interest are eliminated ex ante.
(3) Creditors (and shareholders) are bound into the rescue so that it is possible to
minimise any use of taxpayer funding[4].
This is much easier said than done and involves the construction of plausible living
wills or funeral plans (also labelled as recovery and resolution plans), where the
organisational structure, capabilities and legal powers permit the rapid actions required.
The ability to consult and take all interested parties’ views into account at the time is
very limited. One country, New Zealand[5], feels that it has addressed these issues and
obtained a solution, originally labelled Bank Creditor Recapitalisation (BCR) and now
Open Bank Resolution (OBR)[6], [7]. Between them these labels give the ?avour of the
solution, namely the problem is resolved without the bank stopping operating and the
fundingfor the actions comes fromthe creditors and not the taxpayer. However, it covers
up one essential ingredient, namely that the systemically important activities must be
legally separate and totally controllable by the New Zealand authorities and most
importantly that they are capable of being run as standalone entities within a day
including all the creditor recapitalisation. Since New Zealand has no deposit insurance
scheme, this includes reorganising all depositors’ accounts into accessible and frozen
components within the same day, the frozen component being the contribution to the
recapitalisation. The requirements are thus very considerable.
The purpose of this paper is to explore ?rst whether these arrangements could
actually work even in New Zealand, as there has been no actual bank failure in which to
test the ideas and second to consider whether such arrangements could be translatable
to other countries where the banks are both larger and spread over more jurisdictions.
There is a problem for the EU/European Economic Area in particular where allowing
banks to operate across borders as branches is an integral part of encouraging
integration. The latest proposals for a banking union, including an EU-level resolution
authority, may well offer a way out. The New Zealand arrangements also do not
include any speci?c views on other forms of bail in by creditors or on the form of living
wills so the discussion has to be broadened[8].
3. An outline of OBR
In New Zealand, OBR is only to be applied to banks whose systemic importance is
such that it is not thought possible to allow their banking activities to cease operating
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without causing a serious ?nancial crisis and substantial and unnecessary damage to
the real economy. Just four banks fall into the category: ANZ, ASB, BNZandWestpac, all
of which are Australian owned[9]. Between themthey account for well over 80 per cent of
banking assets. There is only one other bank of any size, KiwiBank, which, as a post
of?ce subsidiary, is effectively owned by the government. Of the 17 other registered
banks in New Zealand only four offer the range of normal retail banking business
(Heartland, Southland Building Society, the Cooperative and TSB Banks) all of whom
are small.
There are thus some very unusual aspects of the structure of the NZ banking
system. However, the dominance of foreign owned banks has meant that problems
with their supervision and resolution have had to be addressed much earlier on than in
some other countries whose banks are primarily domestic owned and therefore under
control of the national authorities.
The ?rst step in the New Zealand regime is that all systemic banks must be not only
separately incorporated and capitalised in New Zealand but that they must be so
structured that they are capable of being run on their own within a value day[10].
Thus, takeover by the authorities must be both legally possible and practicably
achievable[11]. If the bank were to be dependent on the parent or indeed on any other
external provider then the scheme would not work[12].
The process by which the resolution itself takes place is that the Reserve Bank, as
supervisor, would ask the Minister of Finance to petition the Governor-General to
appoint a statutory manager, who would work under the instructions of the Reserve
Bank. The manager would be appointed just after the end of trading on a particular day
and wouldhave until trading resumed to complete the task. Under normal circumstances
this implies appointment on Friday evening with a view to the resumption of trading
early on Monday morning but it could be overnight if required[13]. The statutory
manager would immediately institute a moratorium and make a summary valuation of
the claims on the bank and write them down by a conservative proportion that would
ensure that the bank was again solvent and that assets clearly exceeded liabilities. This
writing down process would start with the shareholders, who are likely to be written
down to zero, followed by the subordinated debtholders and then in increasing order of
priority through the unsecured and ?nally possibly through the secured debtholders
until that degree of writedown could be achieved[14]. Thus, if the whole of subordinated
debt is not large enough to cover the losses, the junior unsecured debtors will have to
meet the remaining shortfall, which will be allocated by a common percentage write
down across all of them[15].
All claims are then divided according to that writedown into a frozen and an
unfrozen part. It depends on the form of the credit as to how long it will be before the
creditor can get access to the unfrozen part of the claim. In the case of a term deposit it
would be when the term expired with equivalent arrangements for wholesale funding.
This will obviously reduce liquidity if the instrument would otherwise have been
tradeable. All unfrozen claims would then be subject to a government guarantee
against further loss.
The most important category of creditor is the depositors. They will get access to
their unfrozen deposits as soon as business opens, when the moratorium will be lifted
and all outstanding transactions settled. However, since there is no deposit insurance
in New Zealand, this means that depositors will be written down if shareholder funds
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and subordinated debt are insuf?cient to meet the losses assessed. As junior unsecured
creditors they are next in line for a writedown. Clearly this then is a major task as all
deposits have to be identi?ed and divided appropriately overnight. This will require
extensive pre-positioning by the banks and careful adaptation of their computer
systems. The same will apply to the other written down creditors but there the speed
may not have to be so great.
The Reserve Bank suggests (Hoskin and Woolford, 2011) that a de minimis rule will
be applied and small deposits will not be written down. This means that a proportion
of deposits will not be affected, easing the burden of the computer adjustment required
over night. Of course leaving some creditors out of the calculation will increase
the burden on the remainder. If the cutoff point is small this has relatively limited
implications but if it were to be as large as $20,000 per account holder then, while this
would have an effect for those covered similar to insurance, it would result in a very
noticeable increase in the burden on the remaining depositors and creditors. Clearly
this is a departure from equal treatment and one would expect this to be litigated by the
losers unless it can be justi?ed on the grounds of a reduction in transactions costs.
The example shown in the proposal (RBNZ, 2013) is for a $500 limit, so, if this were
applied, the number of accounts that would remain whole might be quite large but the
magnitude of the burden transferred to the other creditors may be relatively small[16].
The process however is still incomplete as the bank needs recapitalising and the
frozen parts of the claims need to be dealt with. Most of the normal options remain for
this second step but now the bank is operating again under the statutory management
and the guarantee there is time available to work this out carefully. The normal
expectation would be that the bank would be taken over by another provider. However,
these are large banks so there would be competition issues to address. One option is
that the parent could recapitalise it, if it has itself been able to work through the crisis
and resume business in Australia. Final payout, if any, on the frozen claims would
depend upon the proper valuation of the various assets, which may take some time if
they are not included in the sale to a new owner[17]. Even if they are one could expect
the claimants to contest the value of the sale in the courts if the payout were less than
100 per cent.
There are various drawbacks to these arrangements which need to be mentioned
before going back to consider the implications for the division of the business[18].
First of all this is not really “open bank” resolution in the technical sense of the word.
The bank is taken away from the shareholders and claims are altered. However, it has
the practical result that the banking business continues. Clearly there has to be some
sort of moratorium overnight while the bank is being resolved and the nature of the
credit event has to be deemed insuf?cient to trigger any closeout clauses. With the
government guarantee it is unlikely that credit ratings will fall indeed they are likely to
rise so this too should prevent any triggering of default-like clauses. All collateralised
transactions would presumably be exempt from the writedown, including covered
bonds, other asset backed securities and repos. Since all the four main banks have high
deposit funding – at least 50 per cent of the total it is very unlikely that the bank could
be so insolvent that a writedown of depositors is insuf?cient to cover a conservative
valuation of the losses.
By not using the writedown to turn debt into equity and recapitalise the bank, OBR
avoids some of the problems relating to how market prices might behave if a large
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number of unwilling new equity holders wish to sell their claims (Mayes et al., 2001).
Such an arrangement could also cause problems if the new owners have different views
about how the bank should now be run from those of the resolution authority.
However, this debt to equity conversion is what characterises most bail in proposals
(Zhou et al., 2012). With a compulsory bail in organised by the authorities the bank
immediately returns to adequate capitalisation (assuming there is enough unsecured
debt to bail in). Once again the key point that needs to be established is that the
instruments used are known to be susceptible to a bail in and hence the bail in does not
constitute a default[19]. However, bailing in debt holders to become shareholders in a
parent that is listed on the stock exchange is conceptually easier than bailing into a
wholly owned subsidiary[20].
The most serious ?aw in the New Zealand is in the treatment of depositors. One of
the main functions of deposit insurance is to discourage a run. If people do not expect
to suffer either credit or liquidity losses in the event of failure then they have no
incentive to remove their money – although nevertheless this can happen. However, in
this case, the appropriate strategy for them if there were any sniff of doubt about the
viability of a bank would be to remove their deposits or at least remove them down
below the de minimis level (assuming that is stated in advance, which it has not been).
Thus, whereas elsewhere deposits are a stabilising force for troubled banks this would
not be the case in New Zealand. Funding problems for troubled banks occur in
wholesale markets as informed counterparties ?rst of all demand a premium and then
refuse to lend at all as dif?culties mount. This inability to borrow in wholesale markets
then causes banks to approach the central bank as lender of last resort. If they are
thought solvent the central bank will step into the place of the market or if they are
thought likely to be insolvent, the process of resolution will start.
To organise resolution well, the authorities require quite a long lead time, perhaps
as much as two to three months if US and UK experience is anything to go by.
However, good living wills and resolution plans might shorten this, although we are
yet to ?nd out how well such plans may work. Depositors help provide that breathing
space because, since their credit to the bank is not under threat, they continue to
maintain their loans and the bank can meet its cash?ow demands. If the depositors
follow on the wholesale funders quite quickly this grace period will not be possible and
the resolution will be messier and more inequitable as some will have been able to
withdraw their deposits and others not.
Since OBR relates to the large banks, unless there is very clear evidence that
problems are related to a speci?c bank, the chances are that there will be a general loss
of con?dence and larger depositors will start removing the money from all banks as a
precaution. Thus, a manageable problem is turned into a full blown ?nancial crisis.
Almost certainly the government would need to renege on its commitment not to use
taxpayer funding in an effort to stabilise the system. Hence, instead of having the
desirable feature that those who knowingly took the risks by investing in and lending
to the bank suffer losses, it will be spread across the population at large.
Thus, not only is OBR likely to be destabilising but it is simply unlikely to ever to be
exercised as the authorities are likely to have to offer a blanket guarantee to depositors
to prevent a general crisis. Having deposit insurance with a fairly high coverage ratio
would address this problem, although in the event of a large bank failing the resources
required may exceed those held by the deposit insurer. In that case temporary
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government funding would be required if the fund is not to default. One might read
into the fact that the Reserve Bank (Hoskin and Javier, 2013) makes it clear that OBR is
there as part of the tool kit and that a decision on which resolution method to use at the
time, that they also feel that OBR presents problems. Unfortunately, starting with this
ambiguity increases the moral hazard from the resolution regime as banks may gamble
that despite what is said in advance they will be bailed out if the severe problem
actually arises.
It is worth noting that the Reserve Bank’s arguments against deposit insurance are
based on moral hazard and the costs of funds to banks:
The New Zealand Government has looked hard at deposit insurance schemes and concluded
that they blunt the incentives for investors and banks to properly manage risks, and may
even increase the chance of bank failure[21].
If the likely outcome for large banks is thought by their owners and managers to be
some form of bail out because OBR is unlikely to be applied, then deposit insurance
will not have an impact on moral hazard. Furthermore, if depositors’ funds are at risk
banks will have to pay more for their funding, obviating the small costs of a pay-box
deposit insurance scheme, even if it is pre-funded.
4. Jurisdictional separation of the bank
The legal separation of systemically important banks in New Zealand from their
parents re?ects the need for the New Zealand authorities to be able to maintain their
?nancial stability. The home country (Australian) authorities do not have any such
duty to look after New Zealand interests, although according to the terms of the
Trans-Tasman agreement, they have to bear regard for the impact their actions will
have on the other country[22]. The New Zealanders have a reciprocal obligation:
[. . .] the participants in responding to bank distress or failure situations, will, to the extent
reasonably practicable, avoid any actions that are likely to have a detrimental effect on the
stability of the other country’s ?nancial system (Memorandum, p. 3)[23].
Since these “Trans-Tasman banks” are systemically important banks in both
countries, some of the con?icts of interest that have been pointed out previously
(Mayes and Vesala, 1998; Eisenbeis and Kaufman, 2008; D’Hulster, 2012) do not apply.
Both countries will want to keep the bank operating in their own jurisdictions. Indeed
the Memorandum of Cooperation (p. 4) states “the participants will explore options for
an open resolution of the parent and subsidiary banks”. Without any separation of the
bank, the New Zealand authorities would have to rely on the gamble that reputation
risk would suggest that since the operations in their country represent around
15 per cent of the group’s activities this activity could not simply be shut down without
bringing the viability of the bank as a whole into question. Hence the Australian
authorities would be likely to save the whole bank even if their only obligation is to
Australians.
Since the New Zealand operations are so much smaller than those in Australia, it
would a reasonable judgement to say that whatever the consultation involved, the
practice of any resolution would be dictated by the Australians, if New Zealand
operations were through a branch. The New Zealanders would have one bargaining
card, that since the main ?nancing would come directly through the parent, saving the
group would involve primarily fund raising or loss allocation in Australia. While the
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Australians might well want the New Zealanders to contribute on some proportionate
basis, say share of assets, they would have some ability to refuse, especially if the
source of the problems lay in Australia and the New Zealand branch had remained
pro?table. Goodhart and Schoenmaker (2009) suggests a number of bases on which a
“fair” allocation might be assessed but largely ignores the issue that what will appear
fair at the time will depend upon the apportionment of blame for the problem. If it
is a regulatory failure in one of the countries then the other will be disinclined to
pay[24].
The key question, however, is whether legal separation is suf?cient to make
resolution practical, even given all the requirements for being able to stand alone,
which are discussed in the next section. Clearly the subsidiary could have substantial
exposures to the parent, some of which may have been contracted in the last few days
before failure as the bank tried to do everything possible to avert the event. This would
have the effect of transferring losses from one part of the group to another. Separation
increases the ability to ring fence assets but does not ensure it. Bertram and Tripe
(2012) point out, for example, that the parent could effectively securitise its
New Zealand lending, so that all the funding coming from the parent was secured and
hence not open to be written down in the resolution of the New Zealand subsidiary.
The smaller the unencumbered assets, the greater the potential burden on the
depositors – or on the deposit insurance funds if they are insured[25]. Several countries
have limited the extent to which assets can be encumbered (Zhou et al., 2012) simply to
ensure that there are enough unsecured creditors to facilitate the resolution.
While the Australian authorities may have kept their New Zealand counterparts
informed of the problems the group was facing, nevertheless they would knowless than
if the group had been entirely within their jurisdiction. There are thus two issues here.
The absolute one of whether even with separation the New Zealand authorities can
achieve what they wish to achieve and the relative one of whether these arrangements
would be better than the alternative. Clearly from the Australian point of view, being
able to control not just the group but the New Zealand branch would be advantageous
but then the burden could be greater in the event of dif?culty.
Clearly the very speci?c nature of the arrangement makes the resolution of these
banks rather easier than in many other cases, where separate incorporation and
different rules make it hard to achieve a least cost resolution. The case of Lehman
Brothers is a good example, where the placing of the UK subsidiary in bankruptcy
contributed to a disorderly resolution, which might have been lessened had all
activities been subject to US law, particularly if Lehman Brothers could have been
dealt with by the special insolvency regime no enabled under the Dodd-Frank Act.
Finally despite the legal separation it is likely that the resolution will proceed rather
better if the New Zealand and Australian authorities work together – not just during
the resolution of the bank but in the run up to its demise. This will give a better lead
time for the preparations if nothing else. A joint resolution can be least cost for the
banking group as a whole. While this might not be quite as low a cost for one of
the jurisdictions as it would be under separate resolution, a payment could in theory be
made to this jurisdiction fromthe other to make the outcome the same as under separate
resolution while still giving a better outcome for the other jurisdiction. However, both
countries operate under discretion for remedial action and not with a harmonised
mandatory prompt corrective action.
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The EUis facing just the same dilemma. One route which could work is to ensure that
any systemically important operation lies squarely within the jurisdiction for which it
is systemic and hence is resolved by the host country. The group as a whole and its
branches in other countries would then be handled by the home country (Wihlborg,
2012). The chances are therefore that the home operations and the branches are of small
enough size that the home country can manage their resolution. The alternative,
addressed in the proposed Recovery and Resolution Directive[26], is to appoint an EU
level resolution authority that can act in all jurisdictions and has the resources to ensure
that systemic functions continue smoothly wherever they are. In the ?rst case practical
separation of the bank is also required, whereas in the second it may not be necessary.
5. Practical separation of the bank
It is the practical separation and the preparation for resolution which is the strength of
the New Zealand arrangements. Since the banking business is relatively
straight-forward, although large relative to GDP, the idea that the arrangements can
be pushed through quickly is plausible. Unlike the US system, it is not necessary to
?nd a buyer in advance, which will be dif?cult for a large bank in a concentrated
market, and statutory management is in many ways similar to the bridge bank
arrangements which exist in the USA and the UK among others. Indeed the Danish
arrangements (Poulsen and Andreasen, 2011) also have strong similarities, although
these are designed for small banks and have a Financial Stability Company in place
that would handle any bank that needed to be resolved in an orderly manner. However,
with a small bank the ability to sell the banking business after the impaired assets are
written down will be much greater. The important issue in both cases is that it is not
necessary to try to conduct a secret bidding process, while maintaining a con?dent
front in order to dissuade the depositors and other creditors from running on the bank
and advancing the date of failure. As with a large bank, such as WaMu in the USA, it is
very dif?cult to do anything relatively anonymous in a small economy.
It is not necessary for a practical successful resolution to take place that absolutely
every issue be sorted out at the time. The key requirements include:
.
All the computer and related systems continue to function.
.
All customers can access ATMs and their accounts for inward and outward
transactions.
.
Access to the payment system is maintained and that payments in progress on
the day of closure are completed as soon as the bank reopens.
.
No close-out clauses are triggered nor other contract terms that depend on failure
or default. (This may present a problem if a number of instruments have been
written down).
.
Successful ring-fencing can be applied to prevent exit of assets to the parent.
(One can expect that the parent will try to collateralise the maximum of its claims
on the subsidiary to avoid losses beyond equity).
.
That the resolution cannot be reversed – although a court might require
compensation payments after judicial review of the authorities’ actions.
If all of these aspects are not under the control of the subsidiary directly there could be
problems. In the UK Banking Act 2009, for example, there is provision that essential
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services have to be provided by the “residual bank”, i.e. the part which is left in the
insolvency, if required by the new, surviving bank. This is likely to work if the
provider is in the same jurisdiction but if such services are provided by the parent
direct then they can only be enforced by the other jurisdiction[27]. However, unless the
various parts of the group are physically separated there are likely to be several
problems, such as joint occupancy of buildings or ownership of the premises by a
different part of the group, the parent may have property rights over the computer
software, to say nothing of the brand name. Normally the brand is left intact in a
resolution if it is thought to be valuable and only phased out after the assets
(and liabilities) are purchased by another provider with a better brand.
What the RBNZ requires for OBR is “An Implementation Plan” that explains how
all of the steps of OBR will be applied during the overnight or over weekend period
(RBNZ, 2013; Hoskin and Javier, 2013). The plans need to be regularly tested and kept
up to date as new products and systems are introduced, all subject to approval by the
Reserve Bank. OBR follows a straightforward pattern, which can readily be tested,
but it is much more debatable how this might be mapped into a living will or a funeral
plan. Some facets of OBR can only be simulated as, for example, a bank would not
want to test whether it can close itself to new transactions in order to see if it can
organise the moratorium hours.
Thus, far the discussion has effectively assumed that the “bank” in question is a
simple retail operation, which is the case in New Zealand, or that the other entities in
the group are clearly separable. If it were decided to treat non-retail activities, trading
and investment banking activities for example, differently the resolution becomes
more complex even without the worries of cross-border resolution. Simply placing
them in the insolvency presents a problem. Indeed if they are the source of the losses it
might be dif?cult to resolve the bank without doing so. This concern leads to
suggestions, such as in the Vickers and Liikanen Reports[28], that maybe the best way
to proceed is to have ex ante separation of the activities that have to be kept operating
from those where different solutions are possible. This concern to be able to save
“functions” that the banking group performs rather than simply the entire organisation
is long-standing (Hupkes, 2004) and applies not just to cross-border arrangements but
within countries as well.
The problem with any such arrangements is cost. Failure of major banks is a rare
event despite the experience in the global ?nancial crisis and failure avoidance
mechanisms impose ongoing compliance costs, both in terms of the processes that need
to be in place and in the extra capital that needs to be held[29]. The costs of requiring a
stand alone subsidiary in New Zealand does not appear to have been large. Three out
of the four main banks had judicial separation voluntarily before the Reserve Bank
compelled it and there was no great outcry when the “Outsourcing Policy” (RBNZ,
2006) was introduced compelling the practical separability as well. The cost of the ?nal
measures to ensure compliance with OBR is estimated to be $20 million per bank for
the set up and $1 million per bank each year thereafter (RBNZ, 2012). Since they mainly
involve computer software changes that are a one-off cost, they do not represent a
major cost from having to alter the structure of the business.
Clearly there are compliance costs from the fact that Australia and New Zealand
chose to run different supervisory regimes but these are not an aspect of the costs of
separability from the point of view of ease and cost of resolution. The two countries
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could run the same regulatory and supervisory regime yet still handle resolution
separately because the impact on ?nancial stability may vary or because they wish to
allocate the costs differently. Having a single ?nancial regulatory regime would make a
lot of sense given the objectives of closer economic relations between the two countries
(Leslie and Elijah, 2012). Indeed this emphasises a further point about the choices over
separability in resolution. At least four institutions are involved in each country:
the supervisor, the resolution authority, the deposit insurer and the treasury. There
may be a further resolution fund, as is planned in the European Union. The ?rst three
and the ?fth institutions can all be separate or joint and this will affect the costs and
their distribution. (If the fourth is joint then the problem largely disappears as we
would not be discussing separate countries.) Some combinations make more sense than
others (Wall et al., 2011) but those who pay normally want to control the risks through
supervision and the decision over when and how to resolve.
There is a second element to cost, which is simply that resolutions are also
expensive, hence the temptation to lend to or invest in an institution that is only
slightly insolvent in order to let it trade its way out of dif?culty without implementing
anything more than a more prudent future lending policy and probably a number of
cost cutting measures and resignation of the staff responsible for the errors. OBR
scores quite well from this perspective, although the statutory manager and the careful
audit of the bank to determine the value of the claims will be expensive. Because the
subsidiary is already largely free-standing there are no great costs in altering systems,
or indeed in the process of freezing and unfreezing claims, although all those affected
will have to be informed. It avoids ?re sale prices and enables not simply the
authorities to exit at a point that is ?nancially favourable but seeks to ensure that the
creditors receive the best value they can[30].
6. Concluding remarks
Providing deposit insurance is introduced, the New Zealand arrangements for OBR
offer a workable way forward for small countries with systemically important
foreign owned banks to control their own ?nancial stability at a limited cost in the
event of the failure of one or more of those banks. It is not necessarily the minimum
cost route nor the best one in the circumstances that may prevail but it does offer a
certain way out. Minimum cost to the host country will be achieved where the home
country organises the resolution of the entire group without adversely affecting
operations in the host country – and does not expect the host to pay a proportion of
the bill. Indeed, the presumption by the UK and US authorities as suggested in FDIC
and Bank of England (2012) is that the home country would indeed normally take on
the task.
Relying on that mechanism would be a mistake unless there were extremely strong
guarantees that it would happen, because the failure of such a bank would tend to have
serious consequences and hence potential costs for the home country (assuming the
bank was also of systemic importance there). In such a crisis, countries take rapid
emergency measures and, as illustrated by Iceland and Cyprus (and Ireland in the
opposite direction), can make decisions, given the need to save the country, that alter
existing property rights and impose burdens on others. As soon as there is any question
of burden sharing then blame for the circumstances becomes an issue as does any
con?ict of interest, where the ?nancial and real costs for one country are affected by the
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nature of the resolution in another. There is a trade off between the ability to address the
problem swiftly and effectively and the possible ?nancial bene?ts from joint action.
While the procedures laid down under OBR have not as yet been applied,
fortunately, similar mechanisms have been used in Denmark (Poulsen and Andreasen,
2011) and elsewhere successfully. So the chances are that it will work. Because of the
swiftness of the action entailed and the lack of the need to ?nd a buyer or other
long term solution until later, the authorities can step in early and cause minimum
disruption to the payment system, ?nancial transactions and public con?dence. Some
jurisdictions might prefer to see a bail in as then it would be possible to institute a debt
for equity swap such that the bank was adequately capitalised again, without the need
to raise new capital at some stage to enable the public sector to exit from the resolution.
There will, however, be consequences for both the parent bank and the authorities in
the home country, as separate proceedings are not necessarily lowest cost. If the
European countries implement all aspects of the single supervisory mechanism and
the single resolution mechanism with adequate procedures for funding where needed,
then this could provide a viable alternative. Halfway houses, even among countries that
have genuine wish to work together well in normal times, face considerable risks of
con?icts of interest in a crisis when large and unpleasant losses are expected. With a lack
of judicial and practical separation the host country will have little control and the
consequence may well be that a bail out rather than a compulsory bail in becomes
the only solution[31].
OBR has the advantage that it applies the losses in the same sequence as would
occur in an insolvency, starting with the shareholders and moving on through
subordinated debtholders to unsecured creditors and on up the ladder of seniority.
Public funds are not required unless the running of the resolved bank by the statutory
manager results in further losses or the writedown of creditors to achieve the resolution
turns out to be insuf?cient. However, it is a tool in the armoury and not the sole
mechanism available to the authorities.
There will no doubt be many loose ends if OBR is actually applied, with problems
over trading names and jointly used facilities. But these are second order issues and
should not inhibit the rapid implementation of the resolution and restoration of stability.
More dif?cult is the issue of whether OBR or similar mechanisms could be readily
applied to more complicated cross-border ?nancial institutions, where activities other
than retail banking are central to the business. Here the same concerns would apply as at
the national level. There is the same debate about whether the retail operations should be
separated out as recommended in the Vickers Report in the UKand the Liikanen Report
for the EU. However, if the retail or other essential operations are systemically important
then there has to be not merely an exact match between the jurisdiction and the
subsidiary but also the ability for the subsidiary to continue in business immediately
irrespective of the resolution applied to the other parts of the banking group. Such banks
will thus be G-SIFIs or R-SIFIs and as such will have complex resolution plans.
The key questions will be whether the supervisors ?nd these plans plausible and
whether they will be operable in practice when a range of jurisdictions have to
cooperate in a hurry. FSB (2011, p. 5) recommends that:
To advance the objective of improving resolvability [. . .] national authorities be equipped with
the powers to require ?nancial institutions to make simplifying changes to their legal and
operational structures and business practices to facilitate recovery and resolvability measures.
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The onus is likely to be very heavily on the home country and the outcome is likely to
be disorderly where the losses are large compared to the GDP of the country concerned.
Some are more optimistic about the ability to organise a joint solution. Avgouleas et al.
(2012) suggest for example that a living will for a cross-border SIFI should set out how
the burden of the resolution should be shared among the participating countries.
However, without an international legal basis it is dif?cult to see how this would be
binding in a crisis.
Notes
1. FSB (2011, p. 1) puts it “implementation should allow authorities to resolve ?nancial
institutions in an orderly manner without taxpayer exposure to loss from solvency support,
while maintaining continuity of their vital economic functions”.
2. WaMu’s holding company was left with $33bn of assets, only some 10 per cent of the total
group, to be unwound in the receivership. In the nine days up to its closure WaMu had lost
10 per cent of its deposits and the authorities stepped in shortly before insolvency was
reached so that the resolution could be orderly. No FDIC funds were therefore required,
although shareholders are still litigating the outcome.
3. Claessens et al. (2011, p. 21) suggests “In the recent crisis, countries had little ability to
orderly wind down large cross-border banks”. This applies not just to the present crisis but
to previous examples such as the Nordic crises (Moe et al., 2004).
4. The Orderly Liquidation Authority in the Dodd-Frank Act of 2010 goes in this direction,
with the expectation that after shareholder funds and subordinated debt are used up
that the resolution of the systemically essential parts of the business should be
continued with the aid of resolution funds raised from the ?nancial sector rather than
the taxpayer.
5. Progress in many other countries has been slow the Basel Committee on Banking
Supervision (2011, p. 5) concluded for example that “There has been no progress towards the
development of a framework for cross-border enforcement of resolution actions, such as a
cross-border mutual recognition and enforcement of resolution powers between home and
host jurisdictions”.
6. The main reason for the relabeling is that while BCR envisaged the creditors recapitalising
the bank to the regulatory minimum, OBR merely writes their claims down enough to ensure
the bank is clearly solvent.
7. Since 2010 Denmark has been applying an insolvency regime that has considerable
similarity in that involves haircuts in order of priority. However, it has only been applied to
two small domestic banks (Poulsen and Andreasen, 2011), the case Amagerbanken being the
better known.
8. Zhou et al. (2012) provides a comprehensive discussion of the factors that need to be borne in
mind for practical bail ins.
9. The size and structure of the New Zealand banking system is set out each six months in the
Reserve Bank’s Financial Stability Review, available on their web site: www.rbnz.govt.nz
10. The requirement to be locally incorporated is set in Chetwin (2006) and the requirements for
structure in order to be resolvable in RBNZ (2006).
11. This means, as suggested by Wihlborg (2012), that there is an exact match between
functional separation and jurisdictional control.
12. Since New Zealand is an earthquake zone there are good practical reasons for insisting that
banks can operate on their own rapidly as key suppliers could easily be incapacitated.
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13. The RBNZ (2013) stresses that a bank must be ready to implement OBR at any time of day
and not just the “convenient” ones, as this is an emergency procedure.
14. However, if there is insuf?cient unsecured debt it is dif?cult to see how a resolution would be
“orderly”.
15. The OBR Proposals (RBNZ, 2013) do not discuss the existence of contractual bail in
arrangements, such as CoCo bonds. Clearly if these exist the infusion of capital could be
suf?cient to avoid triggering OBR.
16. The text is not explicit about whether the ?rst $500 of any deposit would not be touched.
If not someone with just over the cutoff would be worse off than the person just under it –
the point of the de minimis rule being to eliminate a large number of transactions that are
costly compared to their bene?t, not to those with very small deposits.
17. Poulsen and Andreasen (2011), in their description of the new Danish arrangements, set out
the case of Amagerbanken, which failed on Friday 4 February 2011. The summary valuation
of the assets was 18.5bn Dkr but the Financial Stability Company only took 15.2bn Dkr in
liabilities, which represented a 41.2 per cent writedown of nonsubordinated claims.
The independent valuation of the bank, completed in June suggested that the writedown was
too severe and an additional 7.3 percentage points of claims were taken on by the Financial
Stability Company (after the valuation was contested). Subsequently the valuation was
upheld increasing the proportion of claims covered by a further 22 percentage points, some
88 per cent in total as of 25 October 2012.
18. However, on the other side of the account OBRdoes address the ?rst six of the FSB(2011, p. 3) key
attributes for an effective resolution regime: (i) ensure continuity of systemically important
?nancial services, and payment, clearing and settlement functions; (ii) protect, where applicable
and in coordination with the relevant insurance schemes and arrangements such depositors,
insurance policy holders and investors as are covered by such schemes and arrangements, and
ensure the rapidreturnof segregatedclient assets; (iii) allocate losses to?rmowners (shareholders)
and unsecured and uninsured creditors in a manner that respects the hierarchy of claims; (iv) not
rely on public solvency support and not create an expectation that such support will be available;
(v) avoid unnecessary destruction of value, and therefore seek to minimise the overall costs
of resolution in home and host jurisdictions and, where consistent with the other objectives,
losses for creditors; (vi) provide for speedandtransparencyandas muchpredictabilityas possible
through legal and procedural clarity and advanced planning for orderly resolution.
19. FSB (2011) includes this form of compulsory bailing in among the tools that the authorities
could have to hand for an orderly resolution of SIFIs.
20. Clearlyif trigger points for resolutionare different inthe various jurisdictions that a cross-border
institution covers, this will cause serious dif?culties for an orderly result. The Icelandic
authorities for example were very aggrieved when the UK intervened in Icelandic banking
subsidiaries in the UK before similar intervention had taken place in the parent in Iceland. The
UK process effectively forced intervention in Iceland as it stopped the bank from operating a
signi?cant portion of its activities.
21. Reserve Bank News Release on Open Bank Resolution available at: www.rbnz.govt.nz/news/
2013/5191943.html
22. This principle was already incorporated in legislation in Australia (the Australian
Prudential Regulatory Authority Act 1998) and in New Zealand (Reserve Bank Act 1989).
23. The vehicle for co-ordination and, where appropriate, harmonisation is the Trans-Tasman
Banking Council set up in 2005 by the two countries. The “Memorandum of Cooperation on
Trans-Tasman Bank Distress Management” (www.rbnz.govt.nz/?nstab/banking/supervision/
5181778.pdf) is a non-binding agreement “to assist the participants in achieving a coordinated
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response to ?nancial distress in any bank or banking group that has signi?cant operations in
Australia and New Zealand” (p. 1).
24. Attinger (2011) considers a different form of transfer between countries, raised in European
Commission (2011), which suggests that, as part of the resolution, the authorities in one
country might transfer assets or liabilities of the failing group from one jurisdiction to
another. She regards this as impossible in the framework of national law.
25. The arrangement in the USA and some other jurisdictions is that the deposit insurer – and in
some cases, including Australia, the depositor – has preference in the insolvency. Hence,
eventually, they tend to get their funds back. But somebody has to lose. They cannot all
scramble up the ladder of priority. If the depositor insurer ends up paying out major sums,
which are not then recouped from the insolvency, the cost either to the taxpayer or to the
industry, depending on who is the funder, will be considerable.
26. The latest version of the proposals is Council of the European Union, “Proposal for a
Directive of the European Parliament and of The Council establishing a framework for the
recovery and resolution of credit institutions and investment ?rms”, 15 March 2013,
available at:http://register.consilium.europa.eu/pdf/en/13/st07/st07586.en13.pdf
27. If the parent is itself in insolvency, the insolvency law may not permit such an action to be
compelled if it is not in the best interests of the creditors in the home country.
28. Independent Commission on Banking, chaired by Sir John Vickers, Final Report, September
2011, available at:http://ec.europa.eu/internal_market/bank/docs/high-level_expert_group/
report_en.pdf; High-level Expert Group on reforming the structure of the EU banking sector,
chaired by Erkki Liikanen, Final Report, October 2012, available at:http://ec.europa.eu/
internal_market/bank/docs/high-level_expert_group/report_en.pdf
29. As Dewatripont and Freixas (2012, p. 107) point out “A bank resolution regime can be seen
as the result of a constrained cost-bene?t optimisation” where costs on the banking industry
need to be borne against costs from ?nancial instability.
30. Clearly there is no guarantee that the statutory manager, despite his best endeavours, will be
able to make the best choice in the process of sale and recapitalization. Indeed what the best
deal could be is unobservable.
31. Some authors show enthusiasm for intermediate solutions. Claessens et al. (2010), for
example, favour a “modi?ed universal” approach, which involves improved cooperation
rather than a single resolution authority. However, one of the three pillars they feel necessary
for this to work is that the SIFIs are structured more along national lines so that national
authorities can undertake the resolution with existing national tools and a minimum of
cross-border transfers (burden sharing).
References
Attinger, B.J. (2011), “Crisis management and bank resolution: qua vadis Europe?”, Legal
Working Paper Series No. 13, European Central Bank, Frankfurt.
Avgouleas, E., Goodhart, C. and Schoenmaker, D. (2012), “Bank resolution plans as a catalyst for
global ?nancial reform”, Journal of Financial Stability, Vol. 9 No. 2, pp. 210-218.
Basel Committee on Banking Supervision (2010), Report and Recommendations of
the Cross-Border Bank Resolution Group, Bank for International Settlements, Basel,
March.
Basel Committee on Banking Supervision (2011), Resolution Policies and Frameworks – Progress
So Far, Bank for International Settlements, Basel, July.
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Bertram, G. and Tripe, D. (2012), “Covered bonds and bank failure management in New Zealand”,
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Nationalbank Monetary Review, 3rd quarter, part 1, pp. 81-96.
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of New Zealand, available at: www.rbnz.govt.nz/?nstab/banking/regulation/bs11.pdf
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bail-in: mandatory debt restructuring of systemic ?nancial institutions”, IMF Staff
Discussion Note, SDN/12/03.
Further reading
Harrison, I., Anderson, S. and Twaddle, J. (2007), “Pre-positioning for effective resolution of bank
failures”, Journal of Financial Stability, Vol. 3 No. 4, pp. 324-341.
Corresponding author
David Mayes can be contacted at: [email protected]
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This article has been cited by:
1. Jacopo Carmassi, Richard John Herring. 2013. Living wills and cross-border resolution of systemically
important banks. Journal of Financial Economic Policy 5:4, 361-387. [Abstract] [Full Text] [PDF]
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doc_241475902.pdf
This paper aims to consider whether it is plausible to resolve troubled systemically
important cross-border banks by dividing them so that the component national authorities can resolve
the parts in their jurisdiction separately according to their own priorities.
Journal of Financial Economic Policy
Achieving plausible separability for the resolution of cross-border banks
David Mayes
Article information:
To cite this document:
David Mayes , (2013),"Achieving plausible separability for the resolution of cross-border banks", J ournal of
Financial Economic Policy, Vol. 5 Iss 4 pp. 388 - 404
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J FEP-07-2013-0030
Tom Patrik Berglund, (2013),"Optimal jurisdiction of financial supervision", J ournal of Financial Economic
Policy, Vol. 5 Iss 4 pp. 405-412http://dx.doi.org/10.1108/J FEP-07-2013-0029
Harald A. Benink, (2013),"Resolving Europe's banking crisis through market discipline: a note", J ournal of
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Achieving plausible
separability for the resolution
of cross-border banks
David Mayes
Department of Accounting and Finance, University of Auckland,
Auckland, New Zealand
Abstract
Purpose – This paper aims to consider whether it is plausible to resolve troubled systemically
important cross-border banks by dividing them so that the component national authorities can resolve
the parts in their jurisdiction separately according to their own priorities.
Design/methodology/approach – The example of New Zealand is used. This country has chosen
just such a route in its Open Bank Resolution (OBR) policy. The dif?culties and advantages of this
route to resolution are analyzed.
Findings – The paper concludes that the New Zealand route is plausible for systemic subsidiaries,
providing there is deposit insurance. The minimum cost route is likely to be one where the home
authority takes responsibility for the whole group and keeps all systemic operations running.
It remains to be seen what the new EU-level proposals could achieve.
Research limitations/implications – OBR is as yet fortunately untried although there are some
examples from a smaller scheme in Denmark.
Practical implications – These ?ndings have important implications for ?nancial regulators round
the world but especially in the EU as it seeks to ?nd a similar approach in the Recovery and Resolution
Directive.
Originality/value – This topic has not been covered by others and will add ideas of practical value
to the debate. One of the major problems addressed by the Basel Committee in its approach to
supervision and regulation of cross-border banks is to come up with arrangements that allow the
network of national authorities to handle problems in a large cross-border bank quickly, ef?ciently and
preferably pre-emptively without recourse simply to a major taxpayer bailout.
Keywords Financial crises, Cross-border banks, Plausible separability
Paper type Research paper
1. Introduction
One of the major problems addressed by the Basel Committee in the appropriate
supervision and regulation of cross-border banks is to come up with arrangements that
allow the network of national authorities to handle problems in a large cross-border
bank quickly, ef?ciently and preferably pre-emptively without recourse simply to a
major taxpayer bailout. This approach takes it for granted that it is not possible to
create a single legal and practical regime for dealing with such problems, even though
that may be the ideal, especially in a European framework. Colleges of supervisors
and crisis management groups, however well-intentioned, will have dif?culties when
regimes, powers andobjectives con?ict, whatever the prior agreements onhowto proceed.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G01, G21, G28
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 388-404
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-06-2013-0024
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Hence the Basel approach has focused on how the problems can be ring-fenced either
in advance or at the time to enable a solution by national authorities.
This paper focuses on ex ante ring-fencing and considers the ideas that have been
proposed to ensure the minimum levels of separability to have a workable system yet
effective gains fromhaving cross-border banks. There are two main strands to this work.
The ?rst is to look in detail at the systemimplemented by NewZealand for ensuring both
practical and legal separation of its cross-border banks, which represent almost the
entire banking system. No other country has gone as far in trying to achieve real
separation yet allow all of the bene?ts from running systems in more than one country
and gaining the bene?ts of larger scale. The second is to consider whether weaker forms
of such separation including living wills might offer an equally effective route. Much of
the answer depends upon whether the arrangements can handle the appropriate
distribution of the costs of resolution given that one or other authority may be at fault.
The paper concludes with doubts that any of these arrangements will be effective if
the home country is not prepared allow the organisation of the bank in its jurisdiction
to continue in operation.
2. The problem of bank resolution
In the event of serious problems with systemically important banks, the authorities
need to step in quickly and resolve the problems quickly and in a manner which
preferably does not involve taxpayer funds but rather the assignment of losses to
shareholders and then creditors in reverse order of priority (Basel Committee on
Banking Supervision, 2010; FSB, 2011)[1]. If the bank is simply allowed to fail it will
turn a problem into a crisis with possibly severe repercussions on the real economy.
A large number of transactions may fail and a noticeable proportion of people and
business will have their accounts frozen, which will have a knock on effect on their
counterparties in sequence through the ?nancial system. There is also likely to be a
loss of con?dence in the banking system as a whole and withdrawals from other banks.
With a small bank and a limited number of business lines in a single jurisdiction a
managed resolution is a straightforward operation, which has been performed
smoothly in the USA on over 400 occasions in the present crisis. Public funds have not
been needed and since most depositors are fully insured they have not had any
material break in access to their funds. Indeed this approach can be used on large
institutions that are appropriately structured as is shown by the closure of Washington
Mutual (WaMu) in September 2008 and the immediate sale of the banking assets and
most of the liabilities including the deposits to JP Morgan-Chase following a secret
auction by the FDIC. WaMu was the sixth largest bank in the USA at the time[2].
Non-bank activities were only 10 per cent of total assets.
In the case of a complex bank or ?nancial group that runs across jurisdictions the
problem has proved too hard and the only option has been to provide ?nancial
assistance in some form, whether loans, purchase of (preference) shares, or guarantees
for impaired assets[3]. In the main, this assistance has been provided by the authorities
in the home country rather than coordinated across home and host countries. This resort
has all sorts of drawbacks. While it may largely wipe out the shareholders by dilution,
creditors will not be making a contribution to the losses, parts of the group that are
not systemically important will be kept operating and the moral hazard for future
behaviour could be considerable. However, if the degree of insolvency is small and
Achieving
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a private sector investment cannot be organised in time, a capital injection by the public
sector may be the least cost solution as the bank can rapidly return to pro?tability and
the new shares can be sold to the private sector, quite possibly at a pro?t for the
taxpayer. Relying on this approach poses its own problems, as the authorities may
greatly under-estimate the extent of the insolvency, as in the case of Ireland in 2008
(Honohan, 2010).
A different solution is therefore required where the problem is deeper or more
uncertain and current thinking (Basel Committee on Banking Supervision, 2010) is that
it should involve three main facets:
(1) The banking group should be divisible in such a way that the systemically
essential activities can be separated out and continued.
(2) The banking group should be divisible across jurisdictions so each authority
involved can use its own powers to handle what is systemically essential to it in
a manner that con?icts of interest are eliminated ex ante.
(3) Creditors (and shareholders) are bound into the rescue so that it is possible to
minimise any use of taxpayer funding[4].
This is much easier said than done and involves the construction of plausible living
wills or funeral plans (also labelled as recovery and resolution plans), where the
organisational structure, capabilities and legal powers permit the rapid actions required.
The ability to consult and take all interested parties’ views into account at the time is
very limited. One country, New Zealand[5], feels that it has addressed these issues and
obtained a solution, originally labelled Bank Creditor Recapitalisation (BCR) and now
Open Bank Resolution (OBR)[6], [7]. Between them these labels give the ?avour of the
solution, namely the problem is resolved without the bank stopping operating and the
fundingfor the actions comes fromthe creditors and not the taxpayer. However, it covers
up one essential ingredient, namely that the systemically important activities must be
legally separate and totally controllable by the New Zealand authorities and most
importantly that they are capable of being run as standalone entities within a day
including all the creditor recapitalisation. Since New Zealand has no deposit insurance
scheme, this includes reorganising all depositors’ accounts into accessible and frozen
components within the same day, the frozen component being the contribution to the
recapitalisation. The requirements are thus very considerable.
The purpose of this paper is to explore ?rst whether these arrangements could
actually work even in New Zealand, as there has been no actual bank failure in which to
test the ideas and second to consider whether such arrangements could be translatable
to other countries where the banks are both larger and spread over more jurisdictions.
There is a problem for the EU/European Economic Area in particular where allowing
banks to operate across borders as branches is an integral part of encouraging
integration. The latest proposals for a banking union, including an EU-level resolution
authority, may well offer a way out. The New Zealand arrangements also do not
include any speci?c views on other forms of bail in by creditors or on the form of living
wills so the discussion has to be broadened[8].
3. An outline of OBR
In New Zealand, OBR is only to be applied to banks whose systemic importance is
such that it is not thought possible to allow their banking activities to cease operating
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without causing a serious ?nancial crisis and substantial and unnecessary damage to
the real economy. Just four banks fall into the category: ANZ, ASB, BNZandWestpac, all
of which are Australian owned[9]. Between themthey account for well over 80 per cent of
banking assets. There is only one other bank of any size, KiwiBank, which, as a post
of?ce subsidiary, is effectively owned by the government. Of the 17 other registered
banks in New Zealand only four offer the range of normal retail banking business
(Heartland, Southland Building Society, the Cooperative and TSB Banks) all of whom
are small.
There are thus some very unusual aspects of the structure of the NZ banking
system. However, the dominance of foreign owned banks has meant that problems
with their supervision and resolution have had to be addressed much earlier on than in
some other countries whose banks are primarily domestic owned and therefore under
control of the national authorities.
The ?rst step in the New Zealand regime is that all systemic banks must be not only
separately incorporated and capitalised in New Zealand but that they must be so
structured that they are capable of being run on their own within a value day[10].
Thus, takeover by the authorities must be both legally possible and practicably
achievable[11]. If the bank were to be dependent on the parent or indeed on any other
external provider then the scheme would not work[12].
The process by which the resolution itself takes place is that the Reserve Bank, as
supervisor, would ask the Minister of Finance to petition the Governor-General to
appoint a statutory manager, who would work under the instructions of the Reserve
Bank. The manager would be appointed just after the end of trading on a particular day
and wouldhave until trading resumed to complete the task. Under normal circumstances
this implies appointment on Friday evening with a view to the resumption of trading
early on Monday morning but it could be overnight if required[13]. The statutory
manager would immediately institute a moratorium and make a summary valuation of
the claims on the bank and write them down by a conservative proportion that would
ensure that the bank was again solvent and that assets clearly exceeded liabilities. This
writing down process would start with the shareholders, who are likely to be written
down to zero, followed by the subordinated debtholders and then in increasing order of
priority through the unsecured and ?nally possibly through the secured debtholders
until that degree of writedown could be achieved[14]. Thus, if the whole of subordinated
debt is not large enough to cover the losses, the junior unsecured debtors will have to
meet the remaining shortfall, which will be allocated by a common percentage write
down across all of them[15].
All claims are then divided according to that writedown into a frozen and an
unfrozen part. It depends on the form of the credit as to how long it will be before the
creditor can get access to the unfrozen part of the claim. In the case of a term deposit it
would be when the term expired with equivalent arrangements for wholesale funding.
This will obviously reduce liquidity if the instrument would otherwise have been
tradeable. All unfrozen claims would then be subject to a government guarantee
against further loss.
The most important category of creditor is the depositors. They will get access to
their unfrozen deposits as soon as business opens, when the moratorium will be lifted
and all outstanding transactions settled. However, since there is no deposit insurance
in New Zealand, this means that depositors will be written down if shareholder funds
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and subordinated debt are insuf?cient to meet the losses assessed. As junior unsecured
creditors they are next in line for a writedown. Clearly this then is a major task as all
deposits have to be identi?ed and divided appropriately overnight. This will require
extensive pre-positioning by the banks and careful adaptation of their computer
systems. The same will apply to the other written down creditors but there the speed
may not have to be so great.
The Reserve Bank suggests (Hoskin and Woolford, 2011) that a de minimis rule will
be applied and small deposits will not be written down. This means that a proportion
of deposits will not be affected, easing the burden of the computer adjustment required
over night. Of course leaving some creditors out of the calculation will increase
the burden on the remainder. If the cutoff point is small this has relatively limited
implications but if it were to be as large as $20,000 per account holder then, while this
would have an effect for those covered similar to insurance, it would result in a very
noticeable increase in the burden on the remaining depositors and creditors. Clearly
this is a departure from equal treatment and one would expect this to be litigated by the
losers unless it can be justi?ed on the grounds of a reduction in transactions costs.
The example shown in the proposal (RBNZ, 2013) is for a $500 limit, so, if this were
applied, the number of accounts that would remain whole might be quite large but the
magnitude of the burden transferred to the other creditors may be relatively small[16].
The process however is still incomplete as the bank needs recapitalising and the
frozen parts of the claims need to be dealt with. Most of the normal options remain for
this second step but now the bank is operating again under the statutory management
and the guarantee there is time available to work this out carefully. The normal
expectation would be that the bank would be taken over by another provider. However,
these are large banks so there would be competition issues to address. One option is
that the parent could recapitalise it, if it has itself been able to work through the crisis
and resume business in Australia. Final payout, if any, on the frozen claims would
depend upon the proper valuation of the various assets, which may take some time if
they are not included in the sale to a new owner[17]. Even if they are one could expect
the claimants to contest the value of the sale in the courts if the payout were less than
100 per cent.
There are various drawbacks to these arrangements which need to be mentioned
before going back to consider the implications for the division of the business[18].
First of all this is not really “open bank” resolution in the technical sense of the word.
The bank is taken away from the shareholders and claims are altered. However, it has
the practical result that the banking business continues. Clearly there has to be some
sort of moratorium overnight while the bank is being resolved and the nature of the
credit event has to be deemed insuf?cient to trigger any closeout clauses. With the
government guarantee it is unlikely that credit ratings will fall indeed they are likely to
rise so this too should prevent any triggering of default-like clauses. All collateralised
transactions would presumably be exempt from the writedown, including covered
bonds, other asset backed securities and repos. Since all the four main banks have high
deposit funding – at least 50 per cent of the total it is very unlikely that the bank could
be so insolvent that a writedown of depositors is insuf?cient to cover a conservative
valuation of the losses.
By not using the writedown to turn debt into equity and recapitalise the bank, OBR
avoids some of the problems relating to how market prices might behave if a large
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number of unwilling new equity holders wish to sell their claims (Mayes et al., 2001).
Such an arrangement could also cause problems if the new owners have different views
about how the bank should now be run from those of the resolution authority.
However, this debt to equity conversion is what characterises most bail in proposals
(Zhou et al., 2012). With a compulsory bail in organised by the authorities the bank
immediately returns to adequate capitalisation (assuming there is enough unsecured
debt to bail in). Once again the key point that needs to be established is that the
instruments used are known to be susceptible to a bail in and hence the bail in does not
constitute a default[19]. However, bailing in debt holders to become shareholders in a
parent that is listed on the stock exchange is conceptually easier than bailing into a
wholly owned subsidiary[20].
The most serious ?aw in the New Zealand is in the treatment of depositors. One of
the main functions of deposit insurance is to discourage a run. If people do not expect
to suffer either credit or liquidity losses in the event of failure then they have no
incentive to remove their money – although nevertheless this can happen. However, in
this case, the appropriate strategy for them if there were any sniff of doubt about the
viability of a bank would be to remove their deposits or at least remove them down
below the de minimis level (assuming that is stated in advance, which it has not been).
Thus, whereas elsewhere deposits are a stabilising force for troubled banks this would
not be the case in New Zealand. Funding problems for troubled banks occur in
wholesale markets as informed counterparties ?rst of all demand a premium and then
refuse to lend at all as dif?culties mount. This inability to borrow in wholesale markets
then causes banks to approach the central bank as lender of last resort. If they are
thought solvent the central bank will step into the place of the market or if they are
thought likely to be insolvent, the process of resolution will start.
To organise resolution well, the authorities require quite a long lead time, perhaps
as much as two to three months if US and UK experience is anything to go by.
However, good living wills and resolution plans might shorten this, although we are
yet to ?nd out how well such plans may work. Depositors help provide that breathing
space because, since their credit to the bank is not under threat, they continue to
maintain their loans and the bank can meet its cash?ow demands. If the depositors
follow on the wholesale funders quite quickly this grace period will not be possible and
the resolution will be messier and more inequitable as some will have been able to
withdraw their deposits and others not.
Since OBR relates to the large banks, unless there is very clear evidence that
problems are related to a speci?c bank, the chances are that there will be a general loss
of con?dence and larger depositors will start removing the money from all banks as a
precaution. Thus, a manageable problem is turned into a full blown ?nancial crisis.
Almost certainly the government would need to renege on its commitment not to use
taxpayer funding in an effort to stabilise the system. Hence, instead of having the
desirable feature that those who knowingly took the risks by investing in and lending
to the bank suffer losses, it will be spread across the population at large.
Thus, not only is OBR likely to be destabilising but it is simply unlikely to ever to be
exercised as the authorities are likely to have to offer a blanket guarantee to depositors
to prevent a general crisis. Having deposit insurance with a fairly high coverage ratio
would address this problem, although in the event of a large bank failing the resources
required may exceed those held by the deposit insurer. In that case temporary
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government funding would be required if the fund is not to default. One might read
into the fact that the Reserve Bank (Hoskin and Javier, 2013) makes it clear that OBR is
there as part of the tool kit and that a decision on which resolution method to use at the
time, that they also feel that OBR presents problems. Unfortunately, starting with this
ambiguity increases the moral hazard from the resolution regime as banks may gamble
that despite what is said in advance they will be bailed out if the severe problem
actually arises.
It is worth noting that the Reserve Bank’s arguments against deposit insurance are
based on moral hazard and the costs of funds to banks:
The New Zealand Government has looked hard at deposit insurance schemes and concluded
that they blunt the incentives for investors and banks to properly manage risks, and may
even increase the chance of bank failure[21].
If the likely outcome for large banks is thought by their owners and managers to be
some form of bail out because OBR is unlikely to be applied, then deposit insurance
will not have an impact on moral hazard. Furthermore, if depositors’ funds are at risk
banks will have to pay more for their funding, obviating the small costs of a pay-box
deposit insurance scheme, even if it is pre-funded.
4. Jurisdictional separation of the bank
The legal separation of systemically important banks in New Zealand from their
parents re?ects the need for the New Zealand authorities to be able to maintain their
?nancial stability. The home country (Australian) authorities do not have any such
duty to look after New Zealand interests, although according to the terms of the
Trans-Tasman agreement, they have to bear regard for the impact their actions will
have on the other country[22]. The New Zealanders have a reciprocal obligation:
[. . .] the participants in responding to bank distress or failure situations, will, to the extent
reasonably practicable, avoid any actions that are likely to have a detrimental effect on the
stability of the other country’s ?nancial system (Memorandum, p. 3)[23].
Since these “Trans-Tasman banks” are systemically important banks in both
countries, some of the con?icts of interest that have been pointed out previously
(Mayes and Vesala, 1998; Eisenbeis and Kaufman, 2008; D’Hulster, 2012) do not apply.
Both countries will want to keep the bank operating in their own jurisdictions. Indeed
the Memorandum of Cooperation (p. 4) states “the participants will explore options for
an open resolution of the parent and subsidiary banks”. Without any separation of the
bank, the New Zealand authorities would have to rely on the gamble that reputation
risk would suggest that since the operations in their country represent around
15 per cent of the group’s activities this activity could not simply be shut down without
bringing the viability of the bank as a whole into question. Hence the Australian
authorities would be likely to save the whole bank even if their only obligation is to
Australians.
Since the New Zealand operations are so much smaller than those in Australia, it
would a reasonable judgement to say that whatever the consultation involved, the
practice of any resolution would be dictated by the Australians, if New Zealand
operations were through a branch. The New Zealanders would have one bargaining
card, that since the main ?nancing would come directly through the parent, saving the
group would involve primarily fund raising or loss allocation in Australia. While the
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Australians might well want the New Zealanders to contribute on some proportionate
basis, say share of assets, they would have some ability to refuse, especially if the
source of the problems lay in Australia and the New Zealand branch had remained
pro?table. Goodhart and Schoenmaker (2009) suggests a number of bases on which a
“fair” allocation might be assessed but largely ignores the issue that what will appear
fair at the time will depend upon the apportionment of blame for the problem. If it
is a regulatory failure in one of the countries then the other will be disinclined to
pay[24].
The key question, however, is whether legal separation is suf?cient to make
resolution practical, even given all the requirements for being able to stand alone,
which are discussed in the next section. Clearly the subsidiary could have substantial
exposures to the parent, some of which may have been contracted in the last few days
before failure as the bank tried to do everything possible to avert the event. This would
have the effect of transferring losses from one part of the group to another. Separation
increases the ability to ring fence assets but does not ensure it. Bertram and Tripe
(2012) point out, for example, that the parent could effectively securitise its
New Zealand lending, so that all the funding coming from the parent was secured and
hence not open to be written down in the resolution of the New Zealand subsidiary.
The smaller the unencumbered assets, the greater the potential burden on the
depositors – or on the deposit insurance funds if they are insured[25]. Several countries
have limited the extent to which assets can be encumbered (Zhou et al., 2012) simply to
ensure that there are enough unsecured creditors to facilitate the resolution.
While the Australian authorities may have kept their New Zealand counterparts
informed of the problems the group was facing, nevertheless they would knowless than
if the group had been entirely within their jurisdiction. There are thus two issues here.
The absolute one of whether even with separation the New Zealand authorities can
achieve what they wish to achieve and the relative one of whether these arrangements
would be better than the alternative. Clearly from the Australian point of view, being
able to control not just the group but the New Zealand branch would be advantageous
but then the burden could be greater in the event of dif?culty.
Clearly the very speci?c nature of the arrangement makes the resolution of these
banks rather easier than in many other cases, where separate incorporation and
different rules make it hard to achieve a least cost resolution. The case of Lehman
Brothers is a good example, where the placing of the UK subsidiary in bankruptcy
contributed to a disorderly resolution, which might have been lessened had all
activities been subject to US law, particularly if Lehman Brothers could have been
dealt with by the special insolvency regime no enabled under the Dodd-Frank Act.
Finally despite the legal separation it is likely that the resolution will proceed rather
better if the New Zealand and Australian authorities work together – not just during
the resolution of the bank but in the run up to its demise. This will give a better lead
time for the preparations if nothing else. A joint resolution can be least cost for the
banking group as a whole. While this might not be quite as low a cost for one of
the jurisdictions as it would be under separate resolution, a payment could in theory be
made to this jurisdiction fromthe other to make the outcome the same as under separate
resolution while still giving a better outcome for the other jurisdiction. However, both
countries operate under discretion for remedial action and not with a harmonised
mandatory prompt corrective action.
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The EUis facing just the same dilemma. One route which could work is to ensure that
any systemically important operation lies squarely within the jurisdiction for which it
is systemic and hence is resolved by the host country. The group as a whole and its
branches in other countries would then be handled by the home country (Wihlborg,
2012). The chances are therefore that the home operations and the branches are of small
enough size that the home country can manage their resolution. The alternative,
addressed in the proposed Recovery and Resolution Directive[26], is to appoint an EU
level resolution authority that can act in all jurisdictions and has the resources to ensure
that systemic functions continue smoothly wherever they are. In the ?rst case practical
separation of the bank is also required, whereas in the second it may not be necessary.
5. Practical separation of the bank
It is the practical separation and the preparation for resolution which is the strength of
the New Zealand arrangements. Since the banking business is relatively
straight-forward, although large relative to GDP, the idea that the arrangements can
be pushed through quickly is plausible. Unlike the US system, it is not necessary to
?nd a buyer in advance, which will be dif?cult for a large bank in a concentrated
market, and statutory management is in many ways similar to the bridge bank
arrangements which exist in the USA and the UK among others. Indeed the Danish
arrangements (Poulsen and Andreasen, 2011) also have strong similarities, although
these are designed for small banks and have a Financial Stability Company in place
that would handle any bank that needed to be resolved in an orderly manner. However,
with a small bank the ability to sell the banking business after the impaired assets are
written down will be much greater. The important issue in both cases is that it is not
necessary to try to conduct a secret bidding process, while maintaining a con?dent
front in order to dissuade the depositors and other creditors from running on the bank
and advancing the date of failure. As with a large bank, such as WaMu in the USA, it is
very dif?cult to do anything relatively anonymous in a small economy.
It is not necessary for a practical successful resolution to take place that absolutely
every issue be sorted out at the time. The key requirements include:
.
All the computer and related systems continue to function.
.
All customers can access ATMs and their accounts for inward and outward
transactions.
.
Access to the payment system is maintained and that payments in progress on
the day of closure are completed as soon as the bank reopens.
.
No close-out clauses are triggered nor other contract terms that depend on failure
or default. (This may present a problem if a number of instruments have been
written down).
.
Successful ring-fencing can be applied to prevent exit of assets to the parent.
(One can expect that the parent will try to collateralise the maximum of its claims
on the subsidiary to avoid losses beyond equity).
.
That the resolution cannot be reversed – although a court might require
compensation payments after judicial review of the authorities’ actions.
If all of these aspects are not under the control of the subsidiary directly there could be
problems. In the UK Banking Act 2009, for example, there is provision that essential
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services have to be provided by the “residual bank”, i.e. the part which is left in the
insolvency, if required by the new, surviving bank. This is likely to work if the
provider is in the same jurisdiction but if such services are provided by the parent
direct then they can only be enforced by the other jurisdiction[27]. However, unless the
various parts of the group are physically separated there are likely to be several
problems, such as joint occupancy of buildings or ownership of the premises by a
different part of the group, the parent may have property rights over the computer
software, to say nothing of the brand name. Normally the brand is left intact in a
resolution if it is thought to be valuable and only phased out after the assets
(and liabilities) are purchased by another provider with a better brand.
What the RBNZ requires for OBR is “An Implementation Plan” that explains how
all of the steps of OBR will be applied during the overnight or over weekend period
(RBNZ, 2013; Hoskin and Javier, 2013). The plans need to be regularly tested and kept
up to date as new products and systems are introduced, all subject to approval by the
Reserve Bank. OBR follows a straightforward pattern, which can readily be tested,
but it is much more debatable how this might be mapped into a living will or a funeral
plan. Some facets of OBR can only be simulated as, for example, a bank would not
want to test whether it can close itself to new transactions in order to see if it can
organise the moratorium hours.
Thus, far the discussion has effectively assumed that the “bank” in question is a
simple retail operation, which is the case in New Zealand, or that the other entities in
the group are clearly separable. If it were decided to treat non-retail activities, trading
and investment banking activities for example, differently the resolution becomes
more complex even without the worries of cross-border resolution. Simply placing
them in the insolvency presents a problem. Indeed if they are the source of the losses it
might be dif?cult to resolve the bank without doing so. This concern leads to
suggestions, such as in the Vickers and Liikanen Reports[28], that maybe the best way
to proceed is to have ex ante separation of the activities that have to be kept operating
from those where different solutions are possible. This concern to be able to save
“functions” that the banking group performs rather than simply the entire organisation
is long-standing (Hupkes, 2004) and applies not just to cross-border arrangements but
within countries as well.
The problem with any such arrangements is cost. Failure of major banks is a rare
event despite the experience in the global ?nancial crisis and failure avoidance
mechanisms impose ongoing compliance costs, both in terms of the processes that need
to be in place and in the extra capital that needs to be held[29]. The costs of requiring a
stand alone subsidiary in New Zealand does not appear to have been large. Three out
of the four main banks had judicial separation voluntarily before the Reserve Bank
compelled it and there was no great outcry when the “Outsourcing Policy” (RBNZ,
2006) was introduced compelling the practical separability as well. The cost of the ?nal
measures to ensure compliance with OBR is estimated to be $20 million per bank for
the set up and $1 million per bank each year thereafter (RBNZ, 2012). Since they mainly
involve computer software changes that are a one-off cost, they do not represent a
major cost from having to alter the structure of the business.
Clearly there are compliance costs from the fact that Australia and New Zealand
chose to run different supervisory regimes but these are not an aspect of the costs of
separability from the point of view of ease and cost of resolution. The two countries
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could run the same regulatory and supervisory regime yet still handle resolution
separately because the impact on ?nancial stability may vary or because they wish to
allocate the costs differently. Having a single ?nancial regulatory regime would make a
lot of sense given the objectives of closer economic relations between the two countries
(Leslie and Elijah, 2012). Indeed this emphasises a further point about the choices over
separability in resolution. At least four institutions are involved in each country:
the supervisor, the resolution authority, the deposit insurer and the treasury. There
may be a further resolution fund, as is planned in the European Union. The ?rst three
and the ?fth institutions can all be separate or joint and this will affect the costs and
their distribution. (If the fourth is joint then the problem largely disappears as we
would not be discussing separate countries.) Some combinations make more sense than
others (Wall et al., 2011) but those who pay normally want to control the risks through
supervision and the decision over when and how to resolve.
There is a second element to cost, which is simply that resolutions are also
expensive, hence the temptation to lend to or invest in an institution that is only
slightly insolvent in order to let it trade its way out of dif?culty without implementing
anything more than a more prudent future lending policy and probably a number of
cost cutting measures and resignation of the staff responsible for the errors. OBR
scores quite well from this perspective, although the statutory manager and the careful
audit of the bank to determine the value of the claims will be expensive. Because the
subsidiary is already largely free-standing there are no great costs in altering systems,
or indeed in the process of freezing and unfreezing claims, although all those affected
will have to be informed. It avoids ?re sale prices and enables not simply the
authorities to exit at a point that is ?nancially favourable but seeks to ensure that the
creditors receive the best value they can[30].
6. Concluding remarks
Providing deposit insurance is introduced, the New Zealand arrangements for OBR
offer a workable way forward for small countries with systemically important
foreign owned banks to control their own ?nancial stability at a limited cost in the
event of the failure of one or more of those banks. It is not necessarily the minimum
cost route nor the best one in the circumstances that may prevail but it does offer a
certain way out. Minimum cost to the host country will be achieved where the home
country organises the resolution of the entire group without adversely affecting
operations in the host country – and does not expect the host to pay a proportion of
the bill. Indeed, the presumption by the UK and US authorities as suggested in FDIC
and Bank of England (2012) is that the home country would indeed normally take on
the task.
Relying on that mechanism would be a mistake unless there were extremely strong
guarantees that it would happen, because the failure of such a bank would tend to have
serious consequences and hence potential costs for the home country (assuming the
bank was also of systemic importance there). In such a crisis, countries take rapid
emergency measures and, as illustrated by Iceland and Cyprus (and Ireland in the
opposite direction), can make decisions, given the need to save the country, that alter
existing property rights and impose burdens on others. As soon as there is any question
of burden sharing then blame for the circumstances becomes an issue as does any
con?ict of interest, where the ?nancial and real costs for one country are affected by the
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nature of the resolution in another. There is a trade off between the ability to address the
problem swiftly and effectively and the possible ?nancial bene?ts from joint action.
While the procedures laid down under OBR have not as yet been applied,
fortunately, similar mechanisms have been used in Denmark (Poulsen and Andreasen,
2011) and elsewhere successfully. So the chances are that it will work. Because of the
swiftness of the action entailed and the lack of the need to ?nd a buyer or other
long term solution until later, the authorities can step in early and cause minimum
disruption to the payment system, ?nancial transactions and public con?dence. Some
jurisdictions might prefer to see a bail in as then it would be possible to institute a debt
for equity swap such that the bank was adequately capitalised again, without the need
to raise new capital at some stage to enable the public sector to exit from the resolution.
There will, however, be consequences for both the parent bank and the authorities in
the home country, as separate proceedings are not necessarily lowest cost. If the
European countries implement all aspects of the single supervisory mechanism and
the single resolution mechanism with adequate procedures for funding where needed,
then this could provide a viable alternative. Halfway houses, even among countries that
have genuine wish to work together well in normal times, face considerable risks of
con?icts of interest in a crisis when large and unpleasant losses are expected. With a lack
of judicial and practical separation the host country will have little control and the
consequence may well be that a bail out rather than a compulsory bail in becomes
the only solution[31].
OBR has the advantage that it applies the losses in the same sequence as would
occur in an insolvency, starting with the shareholders and moving on through
subordinated debtholders to unsecured creditors and on up the ladder of seniority.
Public funds are not required unless the running of the resolved bank by the statutory
manager results in further losses or the writedown of creditors to achieve the resolution
turns out to be insuf?cient. However, it is a tool in the armoury and not the sole
mechanism available to the authorities.
There will no doubt be many loose ends if OBR is actually applied, with problems
over trading names and jointly used facilities. But these are second order issues and
should not inhibit the rapid implementation of the resolution and restoration of stability.
More dif?cult is the issue of whether OBR or similar mechanisms could be readily
applied to more complicated cross-border ?nancial institutions, where activities other
than retail banking are central to the business. Here the same concerns would apply as at
the national level. There is the same debate about whether the retail operations should be
separated out as recommended in the Vickers Report in the UKand the Liikanen Report
for the EU. However, if the retail or other essential operations are systemically important
then there has to be not merely an exact match between the jurisdiction and the
subsidiary but also the ability for the subsidiary to continue in business immediately
irrespective of the resolution applied to the other parts of the banking group. Such banks
will thus be G-SIFIs or R-SIFIs and as such will have complex resolution plans.
The key questions will be whether the supervisors ?nd these plans plausible and
whether they will be operable in practice when a range of jurisdictions have to
cooperate in a hurry. FSB (2011, p. 5) recommends that:
To advance the objective of improving resolvability [. . .] national authorities be equipped with
the powers to require ?nancial institutions to make simplifying changes to their legal and
operational structures and business practices to facilitate recovery and resolvability measures.
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The onus is likely to be very heavily on the home country and the outcome is likely to
be disorderly where the losses are large compared to the GDP of the country concerned.
Some are more optimistic about the ability to organise a joint solution. Avgouleas et al.
(2012) suggest for example that a living will for a cross-border SIFI should set out how
the burden of the resolution should be shared among the participating countries.
However, without an international legal basis it is dif?cult to see how this would be
binding in a crisis.
Notes
1. FSB (2011, p. 1) puts it “implementation should allow authorities to resolve ?nancial
institutions in an orderly manner without taxpayer exposure to loss from solvency support,
while maintaining continuity of their vital economic functions”.
2. WaMu’s holding company was left with $33bn of assets, only some 10 per cent of the total
group, to be unwound in the receivership. In the nine days up to its closure WaMu had lost
10 per cent of its deposits and the authorities stepped in shortly before insolvency was
reached so that the resolution could be orderly. No FDIC funds were therefore required,
although shareholders are still litigating the outcome.
3. Claessens et al. (2011, p. 21) suggests “In the recent crisis, countries had little ability to
orderly wind down large cross-border banks”. This applies not just to the present crisis but
to previous examples such as the Nordic crises (Moe et al., 2004).
4. The Orderly Liquidation Authority in the Dodd-Frank Act of 2010 goes in this direction,
with the expectation that after shareholder funds and subordinated debt are used up
that the resolution of the systemically essential parts of the business should be
continued with the aid of resolution funds raised from the ?nancial sector rather than
the taxpayer.
5. Progress in many other countries has been slow the Basel Committee on Banking
Supervision (2011, p. 5) concluded for example that “There has been no progress towards the
development of a framework for cross-border enforcement of resolution actions, such as a
cross-border mutual recognition and enforcement of resolution powers between home and
host jurisdictions”.
6. The main reason for the relabeling is that while BCR envisaged the creditors recapitalising
the bank to the regulatory minimum, OBR merely writes their claims down enough to ensure
the bank is clearly solvent.
7. Since 2010 Denmark has been applying an insolvency regime that has considerable
similarity in that involves haircuts in order of priority. However, it has only been applied to
two small domestic banks (Poulsen and Andreasen, 2011), the case Amagerbanken being the
better known.
8. Zhou et al. (2012) provides a comprehensive discussion of the factors that need to be borne in
mind for practical bail ins.
9. The size and structure of the New Zealand banking system is set out each six months in the
Reserve Bank’s Financial Stability Review, available on their web site: www.rbnz.govt.nz
10. The requirement to be locally incorporated is set in Chetwin (2006) and the requirements for
structure in order to be resolvable in RBNZ (2006).
11. This means, as suggested by Wihlborg (2012), that there is an exact match between
functional separation and jurisdictional control.
12. Since New Zealand is an earthquake zone there are good practical reasons for insisting that
banks can operate on their own rapidly as key suppliers could easily be incapacitated.
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13. The RBNZ (2013) stresses that a bank must be ready to implement OBR at any time of day
and not just the “convenient” ones, as this is an emergency procedure.
14. However, if there is insuf?cient unsecured debt it is dif?cult to see how a resolution would be
“orderly”.
15. The OBR Proposals (RBNZ, 2013) do not discuss the existence of contractual bail in
arrangements, such as CoCo bonds. Clearly if these exist the infusion of capital could be
suf?cient to avoid triggering OBR.
16. The text is not explicit about whether the ?rst $500 of any deposit would not be touched.
If not someone with just over the cutoff would be worse off than the person just under it –
the point of the de minimis rule being to eliminate a large number of transactions that are
costly compared to their bene?t, not to those with very small deposits.
17. Poulsen and Andreasen (2011), in their description of the new Danish arrangements, set out
the case of Amagerbanken, which failed on Friday 4 February 2011. The summary valuation
of the assets was 18.5bn Dkr but the Financial Stability Company only took 15.2bn Dkr in
liabilities, which represented a 41.2 per cent writedown of nonsubordinated claims.
The independent valuation of the bank, completed in June suggested that the writedown was
too severe and an additional 7.3 percentage points of claims were taken on by the Financial
Stability Company (after the valuation was contested). Subsequently the valuation was
upheld increasing the proportion of claims covered by a further 22 percentage points, some
88 per cent in total as of 25 October 2012.
18. However, on the other side of the account OBRdoes address the ?rst six of the FSB(2011, p. 3) key
attributes for an effective resolution regime: (i) ensure continuity of systemically important
?nancial services, and payment, clearing and settlement functions; (ii) protect, where applicable
and in coordination with the relevant insurance schemes and arrangements such depositors,
insurance policy holders and investors as are covered by such schemes and arrangements, and
ensure the rapidreturnof segregatedclient assets; (iii) allocate losses to?rmowners (shareholders)
and unsecured and uninsured creditors in a manner that respects the hierarchy of claims; (iv) not
rely on public solvency support and not create an expectation that such support will be available;
(v) avoid unnecessary destruction of value, and therefore seek to minimise the overall costs
of resolution in home and host jurisdictions and, where consistent with the other objectives,
losses for creditors; (vi) provide for speedandtransparencyandas muchpredictabilityas possible
through legal and procedural clarity and advanced planning for orderly resolution.
19. FSB (2011) includes this form of compulsory bailing in among the tools that the authorities
could have to hand for an orderly resolution of SIFIs.
20. Clearlyif trigger points for resolutionare different inthe various jurisdictions that a cross-border
institution covers, this will cause serious dif?culties for an orderly result. The Icelandic
authorities for example were very aggrieved when the UK intervened in Icelandic banking
subsidiaries in the UK before similar intervention had taken place in the parent in Iceland. The
UK process effectively forced intervention in Iceland as it stopped the bank from operating a
signi?cant portion of its activities.
21. Reserve Bank News Release on Open Bank Resolution available at: www.rbnz.govt.nz/news/
2013/5191943.html
22. This principle was already incorporated in legislation in Australia (the Australian
Prudential Regulatory Authority Act 1998) and in New Zealand (Reserve Bank Act 1989).
23. The vehicle for co-ordination and, where appropriate, harmonisation is the Trans-Tasman
Banking Council set up in 2005 by the two countries. The “Memorandum of Cooperation on
Trans-Tasman Bank Distress Management” (www.rbnz.govt.nz/?nstab/banking/supervision/
5181778.pdf) is a non-binding agreement “to assist the participants in achieving a coordinated
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response to ?nancial distress in any bank or banking group that has signi?cant operations in
Australia and New Zealand” (p. 1).
24. Attinger (2011) considers a different form of transfer between countries, raised in European
Commission (2011), which suggests that, as part of the resolution, the authorities in one
country might transfer assets or liabilities of the failing group from one jurisdiction to
another. She regards this as impossible in the framework of national law.
25. The arrangement in the USA and some other jurisdictions is that the deposit insurer – and in
some cases, including Australia, the depositor – has preference in the insolvency. Hence,
eventually, they tend to get their funds back. But somebody has to lose. They cannot all
scramble up the ladder of priority. If the depositor insurer ends up paying out major sums,
which are not then recouped from the insolvency, the cost either to the taxpayer or to the
industry, depending on who is the funder, will be considerable.
26. The latest version of the proposals is Council of the European Union, “Proposal for a
Directive of the European Parliament and of The Council establishing a framework for the
recovery and resolution of credit institutions and investment ?rms”, 15 March 2013,
available at:http://register.consilium.europa.eu/pdf/en/13/st07/st07586.en13.pdf
27. If the parent is itself in insolvency, the insolvency law may not permit such an action to be
compelled if it is not in the best interests of the creditors in the home country.
28. Independent Commission on Banking, chaired by Sir John Vickers, Final Report, September
2011, available at:http://ec.europa.eu/internal_market/bank/docs/high-level_expert_group/
report_en.pdf; High-level Expert Group on reforming the structure of the EU banking sector,
chaired by Erkki Liikanen, Final Report, October 2012, available at:http://ec.europa.eu/
internal_market/bank/docs/high-level_expert_group/report_en.pdf
29. As Dewatripont and Freixas (2012, p. 107) point out “A bank resolution regime can be seen
as the result of a constrained cost-bene?t optimisation” where costs on the banking industry
need to be borne against costs from ?nancial instability.
30. Clearly there is no guarantee that the statutory manager, despite his best endeavours, will be
able to make the best choice in the process of sale and recapitalization. Indeed what the best
deal could be is unobservable.
31. Some authors show enthusiasm for intermediate solutions. Claessens et al. (2010), for
example, favour a “modi?ed universal” approach, which involves improved cooperation
rather than a single resolution authority. However, one of the three pillars they feel necessary
for this to work is that the SIFIs are structured more along national lines so that national
authorities can undertake the resolution with existing national tools and a minimum of
cross-border transfers (burden sharing).
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Further reading
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failures”, Journal of Financial Stability, Vol. 3 No. 4, pp. 324-341.
Corresponding author
David Mayes can be contacted at: [email protected]
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