Resolution strategies in wake of 2008 banking crisis

Introduction

The 2008 banking crisis and its effects caused credit institutions around the world to reflect on the lack of efficient rules, mechanisms and intervention powers for supervisors.

At the EU level, this resulted in the publication of the EU Banking Recovery and Resolution Directive (2014/59/EU), which established a framework for the recovery and resolution of credit institutions and investment firms. The directive aimed to:

• equip national authorities with harmonised tools and powers to tackle crises in banks and certain investment firms at the earliest possible moment; and
• minimise costs for taxpayers.

In Portugal, the EU Banking Recovery and Resolution Directive was transposed into national law by:

• Decree-Law 31-A/2012 of 10 February 2012;
• Decree-Law 114-A/2014 of 1 August 2014; and
• Decree-Law 114-B/2014 of 4 August 2014.

These decree-laws set out the following intervention strategies for credit institutions:

• corrective intervention tools;
• provisory administration tools; and
• resolution tools.

The EU Banking Recovery and Resolution Directive was fully transposed into Portuguese law through Law 23-A/2015, which further amended the General Framework for Credit Institutions and Financial Companies (Decree-Law 298/92) (Banking Law) and transposed the EU Deposit Guarantee Schemes Directive (2014/49/EC), thus protecting depositors of all credit institutions and safeguarding the stability of the EU banking system as a whole.

Resolution tools and financial support

Under the Banking Law, the Bank of Portugal may apply the following resolution measures to failing institutions, which do not involve obtaining prior consent from shareholders or a third party:

• the sale-of-business tool;
• the bridge bank tool;
• the asset separation tool; and
• the bail-in tool.

In a sale-of-business scenario, the Bank of Portugal will decide on the transfer, in whole or in part, of assets, rights or liabilities of the failing credit institution to one or more institutions authorised to pursue the same activity in the Portuguese market.

When deciding on the bridge bank scenario, the Bank of Portugal will approve the transfer, in whole or in part, of assets, rights or liabilities of the failing credit institution to one or more bridge institutions that have been specifically incorporated for such purpose which, in turn, will:

• be sold on the market; or
• transfer their assets and liabilities to one or more institutions authorised to pursue banking activities in the Portuguese market.

The remaining assets and liabilities not transferred to the bridge institution will stay on the failed bank's balance sheet, which will typically enter into winding-up proceedings applicable to credit institutions.

In the asset-separation scenario, the Bank of Portugal may determine the transfer of assets, rights or liabilities of an institution or a bridge institution to one or more asset-management vehicles in order to maximise the respective value in a subsequent alienation or liquidation.

Finally, in a bail-in situation, the Bank of Portugal may decide to apply bail-in measures to a given credit institution in order to reinforce its capital position and funds, so that it can continue to carry out its banking activity while complying with regulatory requirements. In this regard, the Bank of Portugal is empowered to:

• reduce the nominal value of credits that constitute credit institution liabilities; and
• increase share capital by the conversion of eligible liabilities through the issue of ordinary shares.

As a result, losses end up being allocated to shareholders and creditors, thus shifting the burden of bank rescues from taxpayers to bank creditors.

Similar to other jurisdictions, the Portuguese legal framework also allows for the creation of a resolution fund, which aims to provide financial support for the implementation of measures to help failing credit institutions (eg, subscribing the share capital of a bridge bank).

The Banking Law and the Resolution Fund Regulation set out that a resolution fund's financial resources are essentially:

• revenues from banking sector contributions;
• initial and periodic contributions by participant institutions;
• loans preferably granted by participant institutions;
• investment revenues, donations and any other revenue, income or value arising from an institution's activities or attributed to it by law or contract.

Further, should a resolution fund have insufficient financial resources, the participant institutions and/or the state will make additional contributions and the former can also be requested to grant guarantees. Where credit institutions struggle to meet demanding capital requirements and generate liquidity for injection in a weak economy, it is difficult to see under what funding pressure and timeframe the resources needed for a resolution fund could be assembled and maintained. This issue is even more crucial in a bridge bank scenario, where a resolution fund is its sole shareholder. Resolution tools must comply with the guiding principle that:

• shareholders and creditors of failed credit institutions bear first losses, in accordance with the creditors' hierarchy set out in the Insolvency Law (Decree-Law 53/2004); and
• creditors of the same class should be treated in an equitable manner.

Loss-absorbing and recapitalisation capacity of institutions

As regards bail-ins, in order to ensure that there are sufficient financial resources available for the write down of debt or the conversion of liabilities into equity, the EU Banking Recovery and Resolution Directive requires resolution authorities to set minimum requirements for own funds and eligible liabilities that must be met by financial institutions. At the global level, in 2015 the Financial Stability Board and the Basel Committee on Banking Supervision adopted a total loss-absorbing capacity standard, focusing specifically on global systematically important banks and requiring institutions to have an adequate amount of liabilities to ensure the absorption of losses and recapitalisation in the resolution phase. According to the Banking Law, the Bank of Portugal must determine the minimum requirements for own funds and eligible liabilities to be complied with on a case-by-case basis. The ultimate objective is that institutions have sufficient loss-absorbing and recapitalisation capacity to ensure smooth and fast absorption of losses and recapitalisation with a minimum impact on financial stability and taxpayers. The total loss-absorbing capacity minimum requirement will be met with subordinated liabilities that rank below liabilities excluded from such requirement. This can be achieved by:

• contractual subordination (ie, the legal effects of a contract);
• statutory subordination (ie, the laws of a given jurisdiction); or
• structural subordination (ie, a given corporate structure).

In this context, EU Directive 2017/2399 (which will be transposed into national law by 29 December 2018) amends the EU Banking Recovery and Resolution Directive by creating a new asset class of non-preferred senior debt which ranks in insolvency above own-fund instruments and subordinated liabilities that do not qualify as own funds, but below other senior liabilities. The aim is to:

• enable institutions to use the cheaper ordinary senior debt for their funding or other operational reasons; and
• issue new non-preferred debt to obtain funding, while complying with the total loss-absorbing capacity subordination requirement.

Uncovered deposits rank higher than ordinary secured creditors, but below covered deposits.

For more information please contact Benedita Aires, Maria Carrilho or Salvador Luz at VdA by telephone (+351 21 311 3400) or email ([email protected], [email protected] or [email protected]). The VdA website can be accessed at www.vda.pt.

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