How should a government manage a bank failure, responsibly? This question is at the heart of bank resolution. A failing commercial business will enter classic bankruptcy, and a small bank will have its assets liquidated in a similar fashion. However, simply liquidating a large, systemic bank risks disrupting vital economic functions and spreading panic across the financial system. Bank resolution preserves failing banks’ critical functions temporarily in order to avoid these near-term harms while orderly unwinding the failing bank to promote a viable long-term solution.
Our latest research paper, published by the Bank for International Settlements (BIS), analyzes the role of public support in funding bank resolution. Resolutions always incur costs, typically to fund a bank’s operations or support a purchase of the failing bank. A key goal of bank resolution policies developed after the Global Financial Crisis was to minimize taxpayers’ exposure to loss. Resolution policies, therefore, specify sources to fund the resolution, typically from the bail-in of creditors’ claims that the bank is required to hold or from funds to which the industry contributes, such as deposit insurance funds or dedicated resolution funds. Such measures aim to strengthen banks’ loss-absorbing capacity and avoid charging the taxpayer for a resolution.
However, sometimes public resources must supplement a bank’s internal resources and funds to which industry firms—typically banks—contribute. The bank failures in the spring of 2023 evince that significant amounts of funding may be required to support resolutions. In the U.S., for example, the Federal Deposit Insurance Corporation (FDIC) provided more than USD 20 billion in temporary funding for the resolution of Silicon Valley Bank (SVB) alone, in addition to expenses related to Signature Bank and First Republic. In Switzerland, the Swiss treasury provided a CHF 9 billion guarantee to UBS for its acquisition of Credit Suisse.
And yet—public funding for resolution seems to contravene the objective to minimize taxpayer’s exposure to loss. It also risks diverting scarce public resources from other priorities, encouraging excessive risk-taking by banks through moral hazard, and eroding public confidence. Our paper compares how ten jurisdictions around the world resolve these predicaments inherent in resolution policy. We contrast institutional frameworks, conditionalities, terms and provisions and, importantly, recoupment mechanisms. The paper observes a trend towards the treasury or central bank providing support indirectly: by lending to a deposit insurance or resolution fund to augment its resolution funding capacity. Such a structure facilitates deployment, recoupment, and burden-sharing. All jurisdictions studied also allow public funds to be deployed for resolution only when a systemic risk is present and when a bank’s shareholders and creditors share the costs, but the paper finds significant differences in how these conditions are articulated and operationalized. There are also differences in terms of whether and how the amount of public support available for bank resolution is capped. Finally, jurisdictions typically recoup public support for resolution over time. Public supplements to industry-sourced funds are usually recouped through levies paid by banks, thus containing the cost of resolution within, and mutualizing it across, the banking sector.
We argue resolution frameworks that integrate well-defined public support arrangements help enhance financial stability and contain adverse social costs. Our paper offers four key policy reflections to support this. First, public support arrangements are a last resort; they do not specify the exact circumstances under which public funds will be used, let alone that public support should be guaranteed up front. Rather, they define factors for policymakers to consider in weighing their deployment, such as financial stability, processes to be followed, and control mechanisms to be applied. Second, jurisdictions should codify policies and procedures to recoup the public support used to finance a resolution to contain the cost of resolution within the banking sector. Third, adequate governance arrangements are key to preserve the social legitimacy of the public intervention. Fourth, while public support needs to be subject to safeguards, flexibility to provide requisite support to quell a systemic risk remains crucial.
Although Atticus Finch tells us “it’s a sin to kill a mockingbird,” it is sometimes essential for policymakers to help a failing bank to exit the market. When a bank is failing and its unorganized liquidation would sow financial chaos and incur wide social costs, it is natural for public support to play an important role. However, it is essential for policymakers to weigh the tradeoffs between different financial arrangements and understand the best practices for public support of bank resolution.
Featured Authors:
Jay Rappaport was recently an Associate at the Bank for International Settlements. He is a 2024 graduate of Georgetown University Law Center and Harvard Kennedy School.
Rastko Vrbaski is a a Senior Advisor at the Bank for International Settlements: Financial Stability Institute (FSI).
All views expressed by members are their own and not reflective of the views of the Bretton Woods Committee or the views of their employers.