Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe

and Germany

Role of Deposit Insurance in Bank Resolution Framework – Lessons from the Financial Crisis

November 13-16, 2011 JODHPUR, INDIA

Dirk Cupei

Director Deposit ProtectionAssociation of German Banks

Vice ChairmanEuropean Forum of Deposit Insurers (EFDI)

Contents

I. E U R O P E

II. Germany- Crisis management - Restructuring fund

Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany

I. E U R O P E

Overview of the EU framework for

cross-border crisis management in the banking

4

October 2009Public Consultation regarding an EU framework

for Cross-Border Crisis Management in the

Banking Sector

May 2010

Communication on bank resolution funds

October 2010

Communication on a new EU framework for crisis management in the financial sector

December 2010/January 2011

End 2011Expected: Com Proposal for a directive on

Crisis Resolution and Bank Resolution FundExpected: Com Proposal for a directive on

Crisis Resolution and Bank Resolution Fund

DeutschlandEuropean Union

Consultation on technical details of a possible European crisis management

framework

Consultation on technical details of a possible European crisis management

framework

Overview of the EU framework for

cross-border crisis management in the banking According to the available working version of the proposal for a directive, the EU framework is currently more or less as follows:

• Scope: (Deposit-taking) credit institutions, investment firms and financial holding companies.

• Resolution authority: Member states will be required to set up a resolution authority that may be part of the banking supervision set-up if arrangements have been made to avoid conflicts of interest.

Recovery plans

• The content of recovery plans will be proportionate to the size and complexity of institutions.

• As part of the risk management process called for in the directive, institutions will be required to draw up recovery plans that have to be updated on at least on annual basis.

• Supervisors will provide institutions with different scenarios, requiring them to draw up a recovery plan for each of these.

• Recovery plans should not assume access to any public financial support.• Detailed requirements for content of recovery plans (e.g. with regard to

preparatory arrangements to facilitate the sale of business lines).• Supervisors will be required to assess the effectiveness of recovery plans

and to request modifications if necessary. They may instruct institutions to remove obstacles to implementation (e.g. by making changes to their business strategy or governance structure).

Intra Group Financial Support

• Parent and subsidiaries may enter into an agreement on financial support arrangements.

• The agreement will be reviewed by supervisors and presented to the shareholders’ meeting for approval.

• The management body will be authorised by the shareholders’ meeting to provide financial support under the agreement, but only if it can be assumed that the support will be repaid and it is justified by a superordinate “common interest of the group” as a whole.

• Financial support must be notified to supervisors, who may prohibit or restrict it within 48 hours after receiving notification.

Resolution plans – Preparatory andpreventative powers

• Resolution authorities will be required to draw up resolution plans, to update these at least on an annual basis and to review them on the basis of predefined criteria.

• Proportionality principle will apply like with recovery plans, but resolution authorities may waive resolution plan requirement if an institution is not considered to be systemically relevant.

• Institutions will be required to provide highly detailed information for development of resolution plans, e.g. to identify major or most “critical” counterparties and analyse the impact of their failure on them (should ultimately be equivalent to workload imposed by recovery plans).

Resolution plans – Preparatory andpreventative powers

• Resolution authorities will assess resolvability of institutions and inform them of any obstacles to implementation of resolution plans they have identified. Institutions must propose measures for removing these obstacles.

• Positive: no justification for intervention if obstacles to resolution lie outside institutions.

• Negative: resolution authority does not share plans with institutions.

• For groups, resolution colleges will be set up. • If necessary, resolution authorities may order measures

themselves, e.g. to make changes to the structure of an institution, restrict business activities, issue CoCos.

Early Intervention

• In cases where there is a significant deterioration in the financial situation of an institution, supervisors may require the institution to, among other things, implement the recovery plan, adopt measures to improve its financial situation or present plans for reaching an agreement with creditors.

• Appointment of a special manager (≈ “special representative” within the meaning of Section 45c of the German Banking Act) for a period of not more than one year.

• Special manager must have same rights as senior management of the institution (e.g. right to convene shareholders’ meeting).

Early Intervention

• Will also be empowered to initiate “rescue measures” against the will of senior management.

• In the case of groups, joint decision is to be taken by the resolution college within one week; in the absence of a joint decision within 10 days, the consolidating supervisor may take a decision; the EBA will take a conciliatory decision on cases referred to it within 5 days.

Resolution

• Last resort – presupposes, in addition to a situation in which an institution “is failing or likely to fail” (e.g. insufficient own funds), that resolution is in the “public interest”

• General principles include the following: shareholders and creditors must bear an “appropriate” share of losses; senior management must be replaced

• Resolution tools specified in the directive are: - the sale-of-business tool- the bridge institution tool - the asset separation tool (bad bank)- the debt write-down tool (haircut, bail-in) – further details of this are missing in the proposal (Articles 32 – 35)

• Detailed provisions dealing with international cooperation on resolution of groups within the EU and with third countries.

Suspension powers/netting agreements

Resolution authorities will have three different intervention/suspension powers:

• the power to suspend payment or delivery obligations for a period of not more than 48 hours;

• the power to restrict the enforcement of security interests for a period that they may determine;

Suspension powers/netting agreements • the power to suspend close-out and set-off rights under

netting agreements for a period of not more than 48 hours, subject to the following restrictions: - covers only termination rights due to/in relation to prudential reorganisation measures- suspensive effect is removed if no transfer takes place - termination right comes into existence again where transfer takes place if termination right exists in relation to the acquirer- protection of the inseparability of transactions concluded under a netting agreement (no cherry picking – Art. 62)

Suspension powers/netting agreements

• Further definition and requirements/exemptions for:- Restrictions with regard to security interests: exemptions from scope for certain types of security interest and requirements for the period in which restriction applies- Netting agreements: definition of the netting agreements covered and exemptions from the protection provided by Articles 48 and 62

Resolution tool financing arrangements (bank levy)

• e.g. by providing guarantees, purchasing assets or making loans; any losses and costs incurred by the use of financing arrangements must first be borne by shareholders and creditors.

• Arrangements must be financed by domestic credit institutions.• Target level of funds: will be based on whichever amount is higher –

0.6 % of the covered deposits as defined under the Deposit Guarantee Schemes Directive or 0.12% of the non-equity liabilities of all institutions.

• Fund-raising period: target level of funds is to be achieved within a period of no longer than 10 years after the entry into force of the directive. 10% of target level may be made up of payment commitments by institutions.

Resolution tool financing arrangements (bank levy)

• Contributions will be levied annually; assessment must be based on at least one of the seven specified elements (including an institution’s systemic importance, the amount of its liabilities excluding own funds and deposits guaranteed under the deposit guarantee scheme, and the extent to which the institution has previously benefited from state support.

• Extraordinary contributions will be raised where necessary.• Deposit guarantee schemes, provided they are used by

member states for financing resolution measures, will be considered as financing arrangements for the purposes of the directive.

Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany

Germany I. Crisis management

Regulatory consequences of the

financial crisis

The regulatory approach to certain areas has changed, sometimes fundamentally, in response to the financial crisis.

Major changes:

• new capital and liquidity standards (Basel III)• reform of deposit guarantee schemes • new rules on restructuring “systemically important financial institutions”

Restructuring rules are needed because

• entrepreneurial failure should ultimately lead to exit from the market,• state aid to ensure financial market stability should be phased out,• an instrument is needed for the orderly resolution of systemically important

market participants,• competitive distortion must be avoided.

Approach of the German Restructuring Act

Objective Financial market stability: no bank

should be “too big to fail” or “too

connected to fail”

Two-tier restructuring procedure

New rules took effect end of December 2010/ beginning of 2011

Early intervention and crisis management tools for supervisors

Restructuring fund financed by special bank levy

Restructuring procedure crisis management by the bank itself

• Bank deemed in need of restructuring if capital and liquidity position has deteriorated as described in Section 45 (1) of the revised German Banking Act (KWG).

Bank drafts restructuring plan

• May not curtail third-party rights

• But restructuring loans senior to other creditors in the event of insolvency

1st tier: restructuring procedure

• Existence of the bank is threatened (Section 48b (1) KWG) and this could jeopardise the stability of the system (Section 48b (2) KWG).

Bank drafts reorganisation plan

• Curtailment of creditors’ rights possible, e.g. by reducing or deferring claims

• But no curtailment of claims covered by deposit guarantee schemes

• Curtailment of shareholders’ rights possible (e.g. by hiving off parts of the company).

• Debt for equity swaps with the approval of creditors

2nd tier: reorganisation procedure

BaFin CourtApplication

Reports need for restructuring

Restructuring plan

Proposes special manager

Impending difficulties:

Restructuring by bank itself

Orders implementat

ion

Appoints

Oversees restructuring Special

manager

RestructuringRestructuring

Reorganisation

German Restructuring Act

Affected Bank

BaFin CourtApplication

Reports need for reorganisation

Reorganisationplan- Curtailment of creditors´ rights- Dept-Equity-Swap

Restructuring has failed or likely to fail:

Bank draws up reorganisation plan

Orders implementat

ion

Appoints

Overses reorganisation Reorganisation

manager

RestructuringRestructuring

Reorganisation

Threat to existence of bank threatens financial market

stability

- Reorganisation/Living Off of units

Acceptance of reorganisation plan requires

- Approval of all creditors and shareholders

- Endorsement by works (courts examine if necessary whether approval of individual groups of creditors may be waived)

German Restructuring Act

Affected Bank

New supervisory tools

Revision of prerequisites for intervention if bank’s capital / liquidity position deteriorates and new powers of intervention Section 45

KWG

Sections 48a – 48s

KWG

Section 45c KWG

Power to appoint a special manager

Introduction of measures in the event of a threat to the stability of the financial system

Early intervention: supervisors will be able to instruct a bank to implement restructuring measures at an early stage.

Crisis management: additional tools with which to restructure and wind up an ailing bank.

Threat to a bank’s existence and the system as a whole

(Section 48b KWG)

Threat to bank’s existence

Threat that the bank will collapse unless corrective action is taken

• Indications of concrete impending default or overindebtedness not necessary.

• Threat is assumed to exist in the event of a qualified breach of capital and liquidity requirements.

threatens

financial market stability

If there is a danger of the threat to the bank’s existence will have a seriously adverse effect on

• other firms in the financial sector,

• the financial markets or

• the confidence of investors and other market .

BaFin FMSAadministers

Affected Bank

e.g.:- Establishment of bridge bank- issues guarantees- recapitalisation measures

Resolution insolvency

RestructuringRestructuring / Resolution

Orders

Restructuring fond

Bridge Bank

Old Bank

Systemically important units

Non-systemically important units

Sale

Regulatory instruments for crisis management

Threat to existence of bank threatens financial market

stability

Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany

GermanyII. Restructuring fund

Restructuring fund (bank levy)

• Objective: to stabilise the financial markets

• Targeted size of fund: 70 billion euros

• Contributors to fund:

– Principle: all domestic banks plus branches of foreign banks headquartered outside EU/EEA

– Exceptions: KfW, Deutsche Bundesbank and regional development banks

• Financing: annual contributions, first contributions due 30 September 2011

• Basis of contribution: amount of bank’s systemic risk

• If additional resources needed: special levy

• Tax implications: annual contributions non tax-deductible

Method of calculating contributions (Section 12 (10) of the Restructuring Fund Act)

Annual contributions depend on bank’s business volume, size and degree of integration in financial market; determined by total liabilities and unsettled derivatives.

Following balance-sheet liabilities will be deducted:

1. liabilities to customers, except for liabilities to legal entities in which thebank holds an interest,

2. participatory capital, except participatory capital with a maturity of under two years,

3. funds for general bank risks and4. regulatory capital.

Progressive scale for annual contributions

German government issued a regulation to clarify details.

Total raised by annual contributions to restructuring fund

Federal Ministry of Finance estimate in 2010*(figures are not actual anymore!)

o Private banks 690 million euros o Landesbanken 319 million euros

o Savings banks 60 million euros

o cooperative banks 27 million euros

Annual total approx. 1.3 billion euros (new estimation total 800 Mio.)

* Source: German Council of Economic Experts, 2010/2011 annual report, published November 2010, p. 168.

Many thanks for your attention!

Dirk Cupei

Director Deposit ProtectionAssociation of German Banks

Vice ChairmanEuropean Forum of Deposit Insurers (EFDI)