In response to experiences in the 2008 financial crisis, many states adopted rules and regulations according to which banks
in danger of default can be duly resolved without any contribution by the tax payer being necessary in future.
This leads to shareholders and creditors of banks possibly having to participate in their losses in the event of a bank's resolution.
The objective is to facilitate the resolution or winding-up of a bank without the use of public funding.
The European Union has adopted the following legal acts in this regard:
institutions and certain investment firms in the framework of a Single Resolution Mechanism
and a Single Bank Resolution Fund (the "SRM Regulation").
The BRRD provides, inter alia, for each EU member state to establish a national resolution authority
endowed with certain rights for resolution and recovery of credit institutions. These measures may
have an adverse impact on shareholders and creditors of banks.
The exact design and configuration of measures at national level that may be taken by the resolution
authorities may differ with regard to details. Below we explain the possible resolution actions using
Germany as an example. The resolution processes of other, in particular non-European countries, may
likewise differ and can be even stricter in design.
You can be affected if you are a shareholder or creditor of a bank, i.e. if you hold financial instruments issued by the bank in question (e.g. equities, bonds or certificates) or if you hold any contractual receivables against the bank (e.g. individual transactions under the Master Agreement for Financial Derivatives Transactions). The securities that you as a customer arrange for your bank to keep in a securities account on your behalf and which were not issued by the bank in charge of the securities account are not the subject matter of a resolution action against the bank in question. In the event of resolution of the bank managing the securities account, your ownership rights to such financial instruments in the securities account will remain unaffected.
In order to facilitate due and proper resolution in the event of crises, resolution authorities have been created. The resolution authority responsible for the bank is authorised to order resolution actions to be carried out if certain conditions for resolution are met.
The Single Resolution Board ("SRB") and the Federal Market Stabilisation Authority ("FMSA", German: “Bundesanstalt für Finanzmarktstabilisierung”) are the competent resolution authorities in Germany. For simplification reasons, no distinctions are made between the SRB and the FMSA below.
The resolution authority may order certain resolution actions if the following conditions for resolution are fulfilled:
If all conditions for resolution apply, then the resolution authority can adopt extensive resolution actions – already prior to insolvency – that may have an adverse impact on the bank's shareholders and creditors:
By means of an official order, the resolution authority can adjust the terms and conditions of the financial instruments issued by the bank as well as the existing receivables from it, e.g. the due date or interest rate may be modified at the creditor's expense. In addition, payment and delivery obligations may be modified, e.g. temporarily suspended. Moreover, termination and other contractual rights of the creditors arising from the financial instruments or receivables can likewise be temporarily suspended.
Whether you as a creditor will be affected by the resolution action of the bail-in will depend on the reach of the measure ordered and on the class to which your financial instrument or your debt receivable is to be assigned. Within the scope of a bail-in, financial instruments and receivables are assigned to different classes and drawn on for liability according to a statutory ranking (referred to as a liability cascade).
The following principles apply as to whether the shareholders and creditors of the respective classes are concerned: only if a class of liabilities has been drawn on completely and this is not sufficient to compensate the losses to an adequate degree in order to stabilise the bank can the next class of liabilities in the liability cascade be written down or converted.
Certain types of financial instruments and debts receivables are excepted from bail-in instruments by statute. For instance, these are deposits covered by the statutory deposit guarantee system of up to EUR 100,000 and liabilities secured by assets (such as German mortgage bonds: Pfandbriefe). Liabilities to which the bail-in is applied are also referred to as eligible liabilities.
In the liability cascade of a bank domiciled in Germany, from 1 January 2017 the following classes
will need to be distinguished:
Accordingly, effective as of 1 January 2017 the following simplified liability sequence will be applicable (direction of arrow), with a lower class being drawn on to bear a loss only if its higher classes (beginning with Common Equity Tier 1 capital) are not sufficient to bear the loss in question:
If the resolution authority orders or adopts a measure in accordance with these rules, the creditor is not allowed, on account of this measure alone, to terminate the financial instruments and receivables or to exercise any other contractual rights in this regard. This shall apply as long as the bank meets its primary performance obligations under the terms and conditions of the financial instruments and receivables, including its payment and service obligations. If the resolution authority adopts the measures described above, a total loss of the capital invested by the shareholders and creditors will be possible. Shareholders and creditors of financial instruments and receivables can thus lose the purchase price paid for the acquisition of the financial instruments and receivables in full, plus any costs associated with the purchase. The mere possibility of resolution actions being ordered may render the sale of a financial instrument or receivable more difficult on the secondary market. This can mean that the shareholder and creditor can only sell the financial instrument or receivable subject to considerable discounts or mark-downs. Even in the case of existing repurchase obligations of the issuing bank, a sale of such financial instruments may lead to a substantial markdown. If a bank is liquidated, the shareholders and creditors must not incur greater losses than would have been incurred if the bank in question had been wound up under normal insolvency proceedings . If the liquidation measure nevertheless leads to a shareholder or creditor being in a worse position than would have been the case in regular insolvency proceedings of the bank, this will give rise to a claim for settlement of the shareholder or creditor against the fund set up for resolution purposes (restructuring fund or Single Resolution Fund, "SRF"). Should a claim for settlement arise against the SRF, there is a risk of any payments resulting from such claim being made at a considerably later date than would have been the case in due and proper fulfillment of contractual obligations by the bank.
The German Federal Financial Supervisory Authority (German: “Bundesanstalt für Finanzdienstleistungsaufsicht”, "BaFin"), the FMSA and Deutsche Bundesbank have made information available on the resolution and liquidation rules and regulations applicable in Germany.
Details are available here, for instance:
FMSA, BaFin and Deutsche Bundesbank published a joint interpretation aid containing further notes on how money market instruments are to be determined and what debt instruments fall into the category of structured or non-structured financial instruments / claims in class (5)(a) or (5)(b):
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