Recovery and resolution

The US  recently issued a statement suggesting a general broadening of their resolution framework to cover a wider population of regulated firms. This article compares the approach to recovery and resolution planning between US and UK and discusses the key takeaways.

Recovery and resolution interventions take place at different stages of a bank’s lifetime. While recovery relates to the measures taken by a bank to avoid bankruptcy, resolution is the process by which financial authorities deal with a failed bank. The border between the two is essentially determined by the point on the spectrum of bank deterioration at which the resolution authority would intervene. The authority would evaluate if any recovery options could be taken. If these fail, the bank would be resolved in an orderly manner.

Recovery Planning

Recovery planning aims to prepare banks for periods of financial stress, and restore their viability in a timely manner (going concern) requiring banks to establish a strategy for dealing with a potential stress well in advance of it occurring. The bank can start by identifying intragroup dependencies and systemic interconnectedness to determine which business units to prioritise for protection.

Recovery planning in the UK applies to banks, building societies and Prudential Regulation Authority (‘PRA’) designated investment firms across the country regardless of their size or complexity. The American recovery plan handbook is prepared for use by the Office of the Comptroller of the Currency (‘OCC’) and only applies to banks with average total consolidated assets equal to or greater than $250 billion. Despite this difference in eligibility, both recovery regimes cover similar topics:

-        Recovery options available to the firm

-        Indicators/triggers

-        Scenario testing

-        Live simulation

-        Playbook structure of the plan

-        Governance

Nevertheless, the methodology used by regulators is different. The OCC provides more detailed guidance whereas the PRA tends to be more generic. Regarding the indicator framework for alerting an oncoming stress, the OCC provides a full list of different type of triggers/indicators to follow such as profitability, revenue, liquidity and capital metrics. The US handbook also provides implementation examples, checklists and FAQs to illustrate and clarify some of the guidelines. Additionally, The US regulators do not require banks to conduct live simulations whereas UK regulators require firms to take part in “fire drills” once every three years.

Overall, the UK recovery plan provides a general framework for designated investment firms to follow but does not include practical details or tools..

Resolution Planning

On the other hand, Resolution planning is a comprehensive tool used to deal with a bank that has failed (gone concern). The purpose is to identify the institution’s characteristics and consequently outline the preferred resolution strategy that would be applied in the event of a collapse. It concludes with a resolvability assessment of the bank to identify and address capital and liquidity requirements. The objectives of a resolution regime are threefold:

-         First, it ensures the continuity of critical functions without harming public interests and causing financial instability.

-        Second, it protects public funds and taxpayers by minimising reliance on extraordinary public financial support.

-        Third, it protects depositors, investors and client funds and assets.

When it comes to resolution, the two countries also have a different approach. In the UK, all banks must comply with the Resolvability Assessment Framework (‘RAF’) set out by the Bank of England. The RAF requires firms to self-assess their own resolvability under a number of pillars. This includes identification and holding of bail in capital (‘MREL’) and identification of critical services (‘OCIR’). The RAF is a requirement for all banks, although the regime is proportional with more strenuous requirements on systemically important firms.

In the US, similarly  to recovery planning, enhanced prudential standards apply to banks based on their asset size and complexity of each organisation. US Banks with total consolidated assets of greater than $100 billion must comply with the Prudential Oversight and Resolution Plan (‘Title 1’) and the Orderly Resolution Authorities (‘Title 2’) set out by the Federal Deposit Insurance Corporation (‘FDIC’). US authorities consider that mid-size banks (<$100bn) perform less complex operations and are therefore not as exposed to systemic risks. US agencies usually recommend Title 1 resolution plans implying that the preferred resolution framework for a failing bank is a rapid and controlled bankruptcy (Wigand, J. and Osterman, R. (2013)).

In the UK the most appropriate exit strategy for firms with significant amount of transaction banking services is considered to be the ‘partial transfer approach’. A partial transfer consists of transferring the healthy part of the bank into a new entity (e.g. bridge bank) while the unhealthy part is resolved. Equally, US authorities disclose the following transfer options for large failing banks: Basic purchase and assumption (P&A) transaction, Whole bank P&A, Loss share P&A or P&A with loan pools. In other words, a healthy bank or group of investors purchases some or all the assets of the failed banks and assumes some or all of the liabilities. However, there may be no bidder or viable bid, and in either of those scenarios, the FDIC will liquidate the bank.

To conclude, both UK and US jurisdiction have developed a conceptual framework for both recovery and resolution. They have specified the information required for performing valuations, stress/scenario testing while ensuring financial stability through developed prudential strategies and loss-absorbing capacity requirements. While both jurisdictions have used similar factors for defining systemic importance of an institution in failure, the US authorities do not currently provide proportionate application of certain requirements for small to medium banks, which is the UK model. Finally, by favouring bank liquidation (Title 1) over transferring bank holdings to healthy acquirers (Title 2), the US model undermines the concept of bridge bank, used by the PRA as their primary resolution option.

References

Wigand, J. and Osterman, R. (2013) Examining the application of title I of the dodd-frank act, The Harvard Law School Forum on Corporate Governance. Available at: https://corpgov.law.harvard.edu/2013/05/15/examining-the-application-of-title-i-of-the-dodd-frank-act/ (Accessed: November 24, 2022).