Directorate Banking Regulation Coordination or Integration of Bank Insolvency in the EU? An Holistic Approach Maria J. Nieto Building a Crisis Management Framework for the Internal Market European Commission 19 March, 2010

Directorate Banking Regulation Coordination or Integration of Bank Insolvency in the EU? An Holistic Approach Maria J. Nieto Building a Crisis Management Framework for the Internal Market European Commission 19 March, 2010

DIRECTORATE BANKING REGULATION These views do not necessarily represent those of Banco de España 3

DIRECTORATE BANKING REGULATION OUTLINE 4 Bank resolution as the fourth arm of the safety net Importance of incentive compatible safety net encompassing resolution/insolvency structures Optimal design resolution/liquidation policies in the EU Conclusions

DIRECTORATE BANKING REGULATION BANK RESOLUTION AS THE FOURTH ARM OF THE SAFETY NET Public policy objective of resolving failed banks should be to permit free entry and exit of failed banks at minimal cost to society Laws and procedures for bank resolution importantly influence the safety net´s ability to succeed 5

DIRECTORATE BANKING REGULATION OUTLINE 6 Bank resolution as the fourth arm of the safety net Importance of incentive compatible safety net encompassing resolution/insolvency structures Optimal design resolution/liquidation policies in the EU Conclusions

DIRECTORATE BANKING REGULATION IMPORTANCE OF INCENTIVE COMPATIBLE SAFETY NET ENCOMPASSING RESOLUTION / INSOLVENCY STRUCTURES If failed banks can be provided liquidity and resolved at no cost, there may be few negative externalities that provide a justification for extensive prudential supervision 7

DIRECTORATE BANKING REGULATION IMPORTANCE OF INCENTIVE COMPATIBLE SAFETY NET THAT ENCOMPASSING RESOLUTION / INSOLVENCY STRUCTURES Resolution rarely starts sufficiently promptly while the bank still has a positive net worth Poorly designed deposit insurance imposes losses on depositors Bank resolution procedures not particularly aimed at preserving financial stability 8

DIRECTORATE BANKING REGULATION OUTLINE Bank resolution as the fourth arm of the safety net Importance of incentive compatible safety net that encompassing resolution/insolvency structures Optimal design resolution/liquidation policies in the EU Conclusions 9

DIRECTORATE BANKING REGULATION OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU 10 Living Wills?

DIRECTORATE BANKING REGULATION OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU Full internalization: Centralization of the EU safety net Absence of a single fiscal authority 11

DIRECTORATE BANKING REGULATION OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU Partial internalization: – Strengthening implicit mechanisms of coordination Further harmonization of the national resolution frameworks »Special Resolution Regime for banking groups – Strengthening explicit mechanisms of coordination Info sharing PS – Resolution authorities (MoU) Colleges (administrative or judicial) resolution authorities: joint resolution measures for the benefit of the group (Mayes, Nieto, Wall, 2008) Delegation »CRD (Art 131) "[u]nder these arrangements additional tasks may be entrusted to the competent authority responsible for supervision on a consolidated basis »Ex ante agreement to make the process of restructuring less cumbersome

DIRECTORATE BANKING REGULATION OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU 13

DIRECTORATE BANKING REGULATION OPTIMAL DESIGN OF RESOLUTION/LIQUIDATION POLICIES IN THE EU Partial internalization (Cont.) - Strengthening explicit mechanisms of coordination – Coordination with prudential supervision ( Hardy and Nieto,2009 ): » First best approach: Highly coordinated PS and Resolution/Liquidation » If Resolution/Liquidation is centralized and not PS, benefits would be limited by PS forbearance » Strengthening explicit mechanism of coordination amongst PS is valuable and reduces the cost of financial crisis...even if coordination amongst resolution/liquidation authorities is limited 14

DIRECTORATE BANKING REGULATION CONCLUSIONS Failed bank resolution processes influence the safety net´s ability to succeed Reforms should aim at strengthening the tools and coordination - Prudential Supervision and Reorganization and Winding up - Deposit Insurance and Reorganization and Winding up Coordination failures may result in negative externalities Lack of centralization of PS and Resolution/Liquidation in an integrated market such as the EU increases forbearance Larger losses of failed banks Centralization of Resolution/Liquidation w/o centralization of PS would limited benefits due to PS forbearance...Further complicating the cost burden sharing: - Private vs Public and Domestic vs Foreign 15

DIRECTORATE BANKING REGULATION Thank you! 16