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Financial Sector Legal and Regulatory Toolkit : Part Three: Financial Regulation and Supervision : V. Bank Insolvency and Depositor Protection
D. Bank InsolvencyBeyond immediate measures to deal with banking crises, some system needs to be in place to deal with individual situations of bank insolvency. Clearly, however, no system is necessary in jurisdictions which do not intend to allow any banks to become insolvent. Generally speaking, the goals of bank insolvency are threefold:
All three goals are potentially in conflict. Typically, however, the various functions concerned are often embedded in different institutions. The central authorities and their functions can be categorized as follows:
As noted above, the availability of the traditional methods very much depends upon the individual legal system. The organization of a rescue package typically will not require specific authorization. On the other hand, the ability to provide open assistance may be clearly constrained by law. The availability of merger or acquisition, whether public or private, likewise varies, with some jurisdictions having specific legislation addressing financial institution mergers/acquisitions, while in others (especially common law jurisdictions) such issues are primarily dealt with through the relevant company law. In most cases, however, issues will arise under banking law/regulation concerning licenses/authorization. Finally, the availability of liquidation and pay-off varies greatly, with some jurisdictions having completely separate stand-alone systems for bank insolvencies (United States), while in others, bank insolvencies are largely dealt with through the general system of corporate insolvency, although typically modified in some way by banking law/regulation (UK). The greater concern is typically in the latter sorts of jurisdictions where insolvency law and systems may not be overly effective. Significantly, an ineffective system of insolvency may also be a barrier to effective out-of-court workouts. Beyond individual bank insolvencies, measures to address systemic insolvency are typically only developed in the context of an actual situation. Unfortunately, not only can weakness in the overall design of the financial safety net potentially lead to such problems, but weaknesses in supporting legal infrastructure can also make resolution more difficult. For individual countries, the World Bank/IMF Global Bank Insolvency Initiative (GBII) has developed a framework addressing five main elements:
[IMF & World Bank, An Overview of the Legal, Institutional and Regulatory Environment for Bank Insolvency (Apr 2009)] In respect of cross-border financial conglomerates, in their April 2009 meetings, the G20 and FSF have addressed these issues, building upon previous agreements in most cases but in some cases going further, with the G20 leaders stating in their communiqué that “major failures in the financial sector and in financial regulation and supervision were fundamental causes of the crisis”, and committing “to extend regulation and oversight to all systemically important financial institutions, instruments and markets”. In support of these general principles, in an annex to the April London communiqué, the G20, also established the outline of details of approaches going forward, with the FSF renamed and reconstituted as the Financial Stability Board (FSB) and tasked, inter alia, to “set guidelines for, and support the establishment, functioning of, and participation in, supervisory colleges, including through ongoing identification of the most systemically important cross-border firms” and to “support contingency planning for cross-border crisis management, particularly with respect to systemically important firms”, including “to support continued efforts by the IMF, FSB, World Bank, and BCBS to develop an international framework for cross-border bank resolution arrangements”. At the same time, reflecting that such efforts are in reality in most cases still at an early stage, the G20 recognised “the importance of further work and international cooperation on the subject of exit strategies”. In respect of LCGFIs, the G20 confirmed that “large and complex financial institutions require particularly careful oversight given their systemic importance”, reflecting the conclusions of the conclusions of a supporting working group chaired by Canada and India. [G20 Working Group 1 – Enhancing Sound Regulation and Strengthening Transparency: Final Report (Mar. 2009): ] In this respect, the working group concluded in its Recommendation 7 that “large complex financial institutions require particularly robust oversight given their systemic importance, which arises in part from their size and interconnectedness (or correlation) with other institutions, and from their influence on markets” with responsibility assigned to the FSB and prudential supervisors. The working group also identified weaknesses in resolution procedures for financial institutions as a particular weakness in the context of the crisis: “Existing procedures for resolving troubled institutions have been shown to be inadequate when an institution imposes substantial systemic risks. In addition, national resolution mechanisms have not been effective in some cross-border resolutions.” However, the working group did not address related issues, leaving such issues to a second G20 working group. [G20 Working Group on Reinforcing International Cooperation and Promoting Integrity in Financial Markets (WG2): Final Report (Mar 2009) ] G20 working group 2, inter alia, recognised the problems posed especially in the cross-border context and supported on-going work “to develop an international framework for cross-border bank resolutions, and to address the issue of ring-fencing and financial burden-sharing”. In the absence of such arrangements, the working group advocated the development of regional resolution systems in the medium term. In addition, the FSF released the most significant attempt to date to address issues of failure resolution, the FSF Principles for Cross-border Cooperation on Crisis Management. In this short document, the FSF stated “the objective of financial crisis management is to seek to prevent serious domestic or international financial instability that would have an adverse impact on the real economy”. At the same time, the FSF recognised that such financial crisis management “remains a domestic competence”, albeit one requiring cross-border cooperation. In relation to preparation, authorities will “develop common support tools for managing a cross-border financial crisis, including: these principles; a key data list; a common language for assessing systemic implications (drawing on those developed by the European Union and by national authorities); a document that authorities can draw on when considering together the specific issues that may arise in handling severe stress at specific firms; and an experience library, which pools key lessons from different crises.” In addition, supervisors will meet at least annually through the college framework, share a range of information on LCGFIs, and ensure that firms have internal contingency plans in place. In managing financial crises, authorities will “strive to find internationally coordinated solutions that take account of the impact of the crisis on the financial systems and real economies of other countries, drawing on information, arrangements and plans developed ex-ante. These coordinated solutions will most likely be mainly driven by groups of authorities of the most directly involved countries.” Office of the General Counsel
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