II General Legal Considerations

T. Asser
Published Date:
April 2001
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1. The Law Governing Banking Activities

Banks require a strong legal framework providing certainty concerning their rights and obligations under the law and permitting them to enforce their financial claims expeditiously and effectively against counterparties in default. Conversely, weaknesses in the legal system that create uncertainties concerning the existence and enforceability of property rights increase the risk that, as debtors hiding behind such weaknesses default on their obligations, banks will not be able to collect on their claims. Inefficiencies in the judicial processing of financial claims by banks may inhibit the marketing of financial assets and reduce their value; this often results in unhealthy accumulations of nonperforming assets on banks’ balance sheets, weakening the banking system as a whole. Meanwhile, banks will cover these risks and market inefficiencies in the form of higher charges, creating upward pressure on transaction costs throughout the economy.

Not only do weaknesses in the law tend to weaken banks by reducing the value of their financial assets, but systemic legal deficiencies stand in the way of successful corrective action aimed at restoring financial health in banks; and, for banks in liquidation, these deficiencies impede the marketing of financial assets against reasonable prices.

Even seemingly minor procedural weaknesses in a legal system can have far-reaching economic consequences. For instance, in one country, where the law requires creditors to process foreclosure auctions of real estate mortgages through the courts, delays in court proceedings and in the payment of the auction proceeds to creditor-mortgagees effectively blocked the development of a real estate loan market.32

Although there is a good deal of international uniformity of banking law and regulations governing the legal status, organization, and operations of banks, there is less agreement in the area of banking law governing regulatory corrective action and bank receivership. There are considerable differences in national regimes where it concerns the treatment of banks that do not respond to corrective measures ordered by the regulator and which are brought under the regulator’s control, in order to save part or all of a bank’s business, or to merge it with another institution, or to close the bank. As was noted before, one of the issues for which these differences are most pronounced concerns the extent of judicial control over the treatment of banks in distress.33

Among the areas of the law that are particularly important for banking activities and therefore deserve special attention are the following:

  • Central bank law and banking law, as well as payment systems law, are essential to establish adequate institutional and legal frameworks for domestic monetary and financial systems, including, in particular, the prudential regulation of banks.

  • Good governance of banks is often addressed in provisions of the banking law that recognize the special status and needs of banks. Thus, for instance, the banking law often includes requirements concerning the corporate form that banks must take and the experience and other qualifications of bank managers. Logically, these provisions should not extend beyond what is necessary to serve the systemic interests by which they are inspired. What this means in practice depends largely on the traditions of each country and its experience with systemic banking problems.

  • The law of property and the law of contract govern most aspects of banking activities. Although most countries have an adequate system of contract law, some emerging market economies and especially countries in transition to a market economy have inadequate systems of property law. For banks, such inadequacies are particularly troublesome in activities involving book-entry securities or collateral property.

  • The law of negotiable instruments and letters of credit is of special importance to banks, as they are at the heart of most banking activities in international trade. The instruments include in particular bills of lading,34 bills of exchange, and promissory notes. Because bills of lading serve as documents of title to the goods specified on them, they are often used to secure obligations to pay for the goods. In many countries, the domestic law of negotiable instruments is dominated by uniform law established by international conventions.

  • Securities law, both commercial and regulatory, is required to govern securities and related financial products, as well as their transfer, public issue, and trading, to regulate the exchanges where securities are listed, and to provide oversight of broker-dealers and other members of the securities industry. The expanding use by banks of publicly traded securities and financial derivatives, inter alia, to meet their funding needs, to market their loan assets, and to hedge financial risks, and the constant development of novel securities’ products, requires frequent adaptations in this part of the law, often to “codify” internationally established contract practices.

  • The law of secured transactions is indispensable for an efficient financial sector. The perfection of mortgages, liens, and other collateral rights requires title registers for real estate and various categories of movable property (cars, trucks, ships, and airplanes) and an extensive administration system.

  • The law of enforcement of financial claims is of key importance for banks. Although, quite appropriately, much attention has been devoted to adequate insolvency procedures, many insolvencies, including bank insolvencies, can be avoided if the legal framework supports creditors in the enforcement of their money claims with proper procedures for conservatory attachment of, and execution of judgments against, assets of the debtor. Fast-track judicial proceedings should be available for collection on negotiable instruments, such as bills of exchange and promissory notes.

  • Bank insolvency law providing for a regulatory bank administration regime in the banking law or making general insolvency law applicable to banks is an essential component of an effective system of financial law.

A legal system is an organism whose parts are interrelated and dependent on each other. Therefore, reform of part of a legal system cannot be productive without covering the other interrelated parts. Generally, to be successful, legal system reform must follow a holistic approach.

To be effective in a democratic society, law must be largely accepted and complied with by the people on a voluntary basis. Just as bank regulation cannot succeed without voluntary compliance by the banks, so a legal system cannot succeed without voluntary respect for and compliance with the rule of law by the population as a whole.

It is difficult to establish such respect and compliance in societies where they are wanting; often, this will require major social changes that take considerable time to develop. This is confirmed by experience in societies emerging from a repressive dictatorship or from chaos, where law reform fails to take root until a minimum of social cohesion, based on morality or enlightened self-interest, begins to foster voluntary compliance with the rule of law for the sake of an emerging democratic socioeconomic order. This process may be accelerated somewhat by appropriate economic incentives and disincentives, by ensuring that law reform reflects social reality, by making the people stake holders in compliance with the law, and by offering alternative procedures and institutions for dispute resolution based on commercial arbitration.

Especially, to promote voluntary compliance, the law must be rooted in the law-consciousness of the people. In particular, law reform should not outpace social growth; where it does, it is often ineffective and its nonenforcement tends to reinforce disrespect for the rule of law. In essence, law must be grown at home, even though importing foreign legislation may have some success in technical areas of the law. And, foreign law so imported must take root to be fruitful. All this takes time. In some countries, the completion of law reform may take several generations.

2. International Aspects

With the expansion of international financial markets, banks increasingly become parties to transactions governed by unfamiliar foreign law. Considerable progress has been made in reducing differences between national legal systems by harmonizing commercial law through international conventions, especially in international sales, payments, and payment arrangements, as well as in negotiable instruments, such as bills of exchange, bills of lading, and promissory notes. In addition, international financial transactions benefit from a growing global uniformity of commercial practices and contract documentation.35

Notwithstanding these advances, banks are exposed to the risk that, in the event of a contractual default by a foreign party, claims may have to be pursued in foreign jurisdictions. Creditor banks try to avoid this complication by including in their financial contracts covenants permitting them to bring claims before their own courts; however, judgments supporting claims so adjudicated at home must often be executed against assets abroad, requiring cooperation from foreign courts in aid of execution of those judgments in their jurisdictions. A global convention on the recognition and enforcement of foreign money judgments is urgently needed to support the growing volume and importance of international financial transactions.

3. General Protection for Banks: Principles of Administrative Law

In most democratic market-based societies, the state is the servant of the people. From this principle, administrative law has distilled the rule that individual rights may be restricted by the state only if such restriction serves a public interest that is so strong as to justify the restriction and if the restriction does not extend beyond what is necessary to serve that public interest. For banks, these individual rights include, in particular, the right to freedom of economic activity. Consequently, for banks in democratic market-based societies, individual freedom of economic decision making is the rule and the licensing or regulation of that freedom by the state is the exception.

In most countries, to be effective, bank regulation by the state or a state agency such as the bank regulator must be authorized by statute. This means that there must be a proper banking law governing the licensing and prudential supervision of banks, establishing a bank regulator, and providing sufficient and clearly defined powers to the bank regulator to do all that is required of him in granting and revoking banking licenses, in issuing and enforcing prudential regulations, and in taking corrective action. It means that, in using its authority, the bank regulator must stay within the scope of the law.

Most countries also have a branch of the law called administrative law, which generally regulates state authority in order to protect the rights of the people against the improper exercise of power by the state.36 Over the years, their courts and legislatures have developed principles and rules of administrative law that set standards of good administration. Thus, administrative law requires the state to exercise only powers granted to it by law and not to abuse or misuse those powers. Administrative law also requires that administrative acts are transparent and impartial, and that they do not result from arbitrary and capricious decision making. For instance, the requirement of transparency is generally understood to mean that regulations must include an introductory explanation of their objectives and the legal authority for their issue, that they are published, that they take effect only after a reasonable notice period following their publication, and that they do not operate retroactively. In addition, the law may prescribe participation of interested parties in regulatory decisions by providing that their comments on draft regulations be solicited or that they be invited to attend regulatory hearings of immediate concern to them. In many countries, the law requires that regulatory decisions are published or otherwise notified to all parties whose interests are directly affected by them. In most countries, bank regulators are regarded as agents of the state that are subject to these principles of administrative law.37 Regulatory acts constituting an abuse or misuse of authority pursuant to principles of administrative law would be characterized as ultra vires rendering the acts ineffective under the law.

Often, the law grants the regulator a degree of discretion in exercising its power so as to permit a flexible response to changing circumstances.38 In judging what is a proper exercise of discretionary powers by the state, administrative law has developed legal principles to arrive at a proper balance between public and private interests.

Under administrative law, it is generally accepted that prudential regulation curtailing the freedom of economic activity of banks requires careful justification. Less well understood is that the mere fact that a prudential regulation would serve some public interest is not enough to justify that regulation. When a proposed regulation or prudential measure would restrict banking activities, the question is not only whether there are public interests that would be served by such regulation or measure but also and especially whether those interests are so strong and compelling that they outweigh the right to freedom of economic activity that the regulation or measure would restrict. The greater the restriction is expected to be, the stronger the interests served by the prudential regulation or measure should be. For banking regulation this means that, if society attaches great weight to the freedom of economic activity of banks, any restriction of that freedom will require a justification with an even greater counterweight. These considerations apply in particular to determining the limits of regulatory power to intervene in the affairs of banks in distress, because there state intervention is often at its most forceful and intrusive.

Also, in many countries, administrative law requires that restrictions on individual rights do not extend beyond what is necessary to serve the public interest by which they are justified.39 For instance, a bank in distress should not be closed on the ground of insignificant infractions of financial requirements that do not threaten the bank’s liquidity or solvency or the banking system. In some countries this concept is known as “the principle of proportionality”;40 in other countries, the principle of proportionality may be implicitly included under broader norms of administrative law, such as the principle of reasonableness or the prohibition of abuse of discretionary power.41

An example of the application of the principle of proportionality to banks (and other financial institutions) is found in England in the before-mentioned principle of good regulation requiring the Financial Services Authority in discharging its general functions to have regard to:

the principle that a burden or restriction which is imposed on a person, or on the carrying on of an activity, should be proportionate to the benefits, considered in general terms, which are expected to result from the imposition of that burden or restriction.42

The principle of proportionality is not only restrictive but also prescriptive: it not only establishes boundaries to preempt excesses of regulatory authority; it also prohibits regulatory measures that would be too weak to be effective. Thus, the principle of proportionality combats both regulatory abuse and negligent regulatory forbearance.

Owing to the broad and sometimes invasive powers that the law grants to bank regulators, banks are particularly vulnerable to regulatory abuse or misuse of those powers. The broader the grounds on which the law authorizes corrective action against banks, the larger the discretion that the bank regulator may exercise in using such authority, and the greater the role that the administrative law principle of proportionality must play.

Proportionality in bank regulation is required not only on the before-mentioned legal grounds but also because it is sound regulatory practice. Regulatory sanctions that are too severe, if they are published or attract publicity, may adversely affect the bank’s reputation and standing in the financial markets that prudential regulation is designed to help maintain. For banks in distress, disproportionate corrective measures could have the unintended effect of depriving the bank of financing on which its rehabilitation depends. Too much prudential medicine can kill the patient.

Because inequality of regulatory treatment is unfair, administrative law incorporates the principle of equality of treatment. In banking regulation, this principle is supported by an important economic consideration—namely, that it is desirable to maintain a level field of competition for all banks in order to avoid economic distortions. As was noted before, if some banks would be subject to a more lenient regulatory regime than others—for instance, because they would be deemed insignificant from a systemic point of view—such banks would enjoy an unfair competitive advantage through a lower regulatory cost base than other banks that would be subject to stricter regulation.

The foregoing applies in particular to the enforcement of exit policies to failing banks. Generally, transparent exit policies are part of every effective system of bank regulation. Apart from the need for equality of treatment for reasons of equity, there are sound economic reasons why exit policies should be uniformly, consistently, and rigorously enforced with respect to all banks: their function of penalizing bad banking practices and thereby discouraging excessive risk taking on the part of banks would be undermined if some banks would be exempted from these policies, creating a moral hazard. There are therefore good reasons for letting all failing banks fail alike.

Nevertheless, in banking regulation bank regulators and monetary authorities tend to make exceptions to the principle of equality of treatment in order to preserve some banks in distress (while permitting other banks to fail), when this is deemed necessary for the protection and continued operation of the banking system as a whole. A mindless application of the principle of equality of treatment could ultimately lead to the closure of the entire banking system. As such a catastrophic event must be avoided, exceptions must be made. Banks whose failure would inflict intolerable harm on the banking system will be saved or merged with another financial institution, while systemically insignificant banks will be permitted to perish. As a consequence, bank regulators also tend to devote greater preventive attention and resources to banks that are deemed “too big to fail” than to other banks. Of course, bank regulators will avoid a priori decisions about which banks are and which banks are not to be saved, so as to reduce the risk of moral hazard.

How, in practice, the need to protect the banking system from collapse is to be reconciled with the need to ensure equality of regulatory treatment belongs to the art of bank regulation. In any event, no bank may expect to receive exceptional regulatory treatment without systemic reasons that outweigh the need for equality. Generally speaking, the more regulatory action is confined to enforcement action the more weight will be accorded to the principle of equality of treatment; as regulatory action moves from enforcement into corrective action, the weight will shift toward systemic considerations so as to permit the rescue or sale of systemically significant banks.

Bank regulators and their staff will usually follow internal rules and procedures for their regulatory activities that are designed to maintain compliance with the principles of administrative law. However, compliance with administrative law may be problematic for outside experts employed by the bank regulator for special tasks. This may be the case for former bank managers and even for licensed insolvency practitioners employed by the bank regulator as provisional administrators or receivers of banks. Often, such experts are unfamiliar with administrative law and conduct their activities outside the immediate control and supervision of the regulator. Therefore, when they exercise powers that derive from the bank regulator, compliance with administrative law is not always ensured. This argues for restricting the powers of such agents to the powers of the bank’s owners and the bank’s management that they replace. If the exercise of regulatory powers exceeding those of owners and managers is deemed indispensable, it should be accompanied by procedural safeguards ensuring respect for principles of administrative law—for instance, by submitting decisions of a regulatory nature to the prior consent of the regulator.

4. Special Protection for Banks: Provisions of Banking Law

A comparison at the national level of the authority granted by the law to various agencies of the state shows that, in most countries, the powers of the bank regulator go significantly beyond those granted to other public agencies. These greater powers of the bank regulator are justified because they are needed to serve the public interest in a safe and sound banking system. They come at a cost, however: banks are subject to more regulatory interference in their affairs than other types of enterprise.

This does not mean that the authority of the bank regulator would be unfettered. In general, the powers of the bank regulator are restricted in scope by rules of administrative law and by the provisions of banking law granting those powers. These restrictions may take the form of procedures providing for an administrative or judicial review of regulatory decisions and actions at the request of interested parties, subject to the need to exempt from such review emergency intervention when urgently needed. Ultimately, the bank regulator may be condemned to pay damages caused by an unlawful exercise of its powers.

However, general principles of administrative law do not afford greater protection to banks than to others. As the restrictions they impose on regulatory authority are by and large the same for all regulators, they do not neutralize the heavier regulatory burden carried by the banking industry. And banking law, instead of increasing the protection afforded by review procedures in order to compensate for more intrusive banking regulation, often does the opposite by curtailing the use of review procedures for situations that present significant systemic threats and require immediate corrective action lest they spin out of control. The argument is that nature and risks of banking do not always allow time for the deliberate and adversarial decision making and review procedures that generally mark other types of regulation.

This double burden imposed on banks is not inconsistent with administrative law. As was noted before, the principle of proportionality requires not only that restrictions on individual rights do not extend beyond what is necessary to serve the public interest by which they are justified, but also that restrictions are imposed on individual rights when they are needed to serve the public interest by which they are justified. Applied to banking regulation, this generally means that a greater threat posed to the public by banking activities must be met by more intrusive regulation with less protection for the interests of banks.

In different societies the competing interests of the banks and the public are assigned different weights, and consequently, the banking laws of the countries reviewed differ in the protection they afford to interests of banks. The balance between the public interest in swift and effective regulatory action and the interests of banks seems to be largely determined by the legal traditions of each country. In countries whose sociopolitical framework leans toward a command culture, the banking law will tend to grant more freedom of action to the regulator and proportionately less protection to the banks than in countries whose societies prize a consensual approach to decision making.

Several techniques are used in banking laws for calibrating this balance. First and foremost, the powers of the bank regulator should be carefully defined in the law so as to delineate the boundaries of regulatory discretion. Sloppy statutory language as to the authority of the bank regulator creates uncertainty and tends to increase banking transaction costs. Although, ultimately, the boundaries of regulatory authority and the corresponding rights of banks may find ex post clarification in the courts, it is vastly preferable if they are defined ex ante by the law. Moreover, and generally speaking, legal certainty is better served by clear statutory language than by case law born of the idiosyncrasies of fact-oriented judicial decisions.

As stated before, the banking law may protect the interests of banks and their owners by imposing special notice and hearing requirements on bank regulators.43 For example, in Canada, the law prescribes that, before the bank regulator may take control of a bank or its assets, the bank must be given notice of the action proposed to be taken and of the bank’s right to make written representations to the regulator within the time specified in the notice, not exceeding ten days after it receives the notice.44 Exceptionally, the law provides procedural protection to banks by providing that, when taking certain measures, the bank regulator functions as an administrative judicial authority.45

There are matters, however, that do not tolerate the delays inherent in hearings. Some matters are so urgent or serious that they require immediate corrective action on the part of the regulator. Other matters, such as the appointment of a provisional administrator or conservator, may require secrecy, especially if bank owners or managers cannot be trusted. And, where the language of the law is mandatory and requires the regulator to intervene, there is no need to give prior notice of the regulator’s intentions to the bank.46 For such cases, the banking law may exempt the regulator from notice or hearing requirements.47 However, the principle of proportionality demands that such exemptions apply only in the conditions by which they are justified: for instance, and apart from legal principle, the logic is inescapable that the authority of the bank regulator to take swift action without prior hearing in cases of urgency should be limited to cases of urgency.

In England, the banking law provides that the bank regulator need not notify a bank of its intentions in respect of the imposition or variation of a restriction on a banking license in any case in which the bank regulator considers that the restriction should be imposed or varied “as a matter of urgency.” In any such case the regulator may by written notice to the bank impose or vary the restriction, stating the reasons for the action. Thereupon, the bank has fourteen days in which to make representations to the regulator. Within twenty-eight days from when the notice was given, the regulator, taking into account any representations made by the bank, must decide whether to confirm or rescind its original decision or whether to impose a different restriction or to vary the restriction in a different manner, and must give the bank written notice thereof, stating the reasons for the decision unless the original decision is rescinded. This notice takes effect from the date on which it is given.48

The criterion of urgency is not the only standard used to exempt regulatory intervention from notice or hearing requirements.

The banking law of Canada provides that no cease or desist direction shall be issued to a bank unless the bank is provided with a reasonable opportunity to make representations in the matter, but that, where, in the opinion of the bank regulator, the length of time required for such representations might be “prejudicial to the public interest,” the regulator may make a temporary direction with respect to those matters having effect for a period of not more than fifteen days.49

In the United States, the law specifies extensive notice and hearing procedures for the issue of a cease and desist order by the regulator to a bank in response to an unsafe or unsound practice in conducting the bank’s business or a violation of a law, rule, or regulation or a condition imposed by the regulator. The procedure begins with the service of a notice of charges upon the bank, stating the pertinent facts and fixing the time and place for a hearing to determine whether a cease and desist order should issue against the bank. The hearing must take place neither earlier than 30 days nor later than 60 days after service of the notice unless an earlier date is set by the regulator at the bank’s request. If upon the record made at the hearing the regulator finds that any violation or unsafe or unsound practice specified in the notice of charges has been established, the regulator may issue a cease and desist order. Normally, the order becomes effective at the expiration of thirty days after the service of the order upon the bank.50

However, if the regulator determines that the violation or unsafe or unsound practice specified in the notice of charges is “likely to cause insolvency or significant dissipation of assets or earnings of the bank, or is likely to weaken the condition of the bank or otherwise prejudice the interests of its depositors prior to the completion of the administrative proceedings conducted pursuant to the notice of charges,” the regulator may issue a temporary cease and desist order that becomes effective upon service on the bank and, unless set aside, limited, or suspended by a court, remains effective and enforceable pending the completion of the administrative proceedings pursuant to the notice and until the charges are dismissed or until the effective date of a cease and desist order issued pursuant to such proceedings.51

In several countries, the law follows a two-step approach consisting of orders given to a bank to correct a problem, followed by more stringent corrective action if the bank fails to comply.52 Affording a bank a reasonable opportunity to solve its problems on its own accord, and allowing it time to consult thereon with the bank regulator before corrective measures are imposed by the regulator, is an appropriate procedure for safeguarding the bank’s interests.

The foregoing points to the conclusion that some countries use a graduated approach toward the protection of banks and their owners under the banking law: the more intrusive regulatory intervention is, the more protection should be afforded against regulatory abuse. Sometimes, however, this trend runs in the other direction: in the United States, while for cease and desist orders the interests of banks are generally protected by the before-mentioned requirements of advance notices and hearings, the bank regulator may impose the much more invasive measure of appointing a conservator or a receiver for a bank without prior notice or hearing.53

Perhaps the most successful technique used in banking law to protect the interests of banks and their owners is to make them stakeholders in corrective action through their agreement to a corrective action plan.54 These plans are discussed more fully below.55

5. Review of Regulatory Acts

Regulatory acts are reviewed either before they are done (ex ante review) or after they are done (ex post review).

Ex Ante Review of Regulatory Acts56

In several countries, the law submits certain categories of regulatory decisions whose effects on banks are particularly invasive to the ex ante review of a higher administrative authority or the courts for authorizing or taking the proposed decision. Examples are found in the appointment of provisional administrators and receivers in order to take control of a bank.57 As is discussed in greater detail below, the need to protect interested parties is an important argument for submitting the receivership of banks to a court-supervised procedure instead of a regulatory procedure without judicial oversight.58

Countries differ in their judgment as to what rises to the level where ex ante judicial intervention is required. For instance, in some countries, the voting rights of bank shareholders may be suspended only by court order,59 while in other countries this is left to the bank regulator.60

Ex ante review procedures serve a dual purpose. They serve not only the interests of the banks, but also the interests of the bank regulator in that they help ensure that the regulator complies with the rule of law. This enhances public confidence in the bank regulator. In a democratic society, public confidence in the regulator is based on respect for and compliance with the rule of law. Judicial review of regulatory acts, whether in the first instance or on appeal, is a valuable instrument for confirming to the public that the regulator respects the rule of law. Moreover, where compliance with the rule of law on the part of the bank regulator is deficient, voluntary compliance with prudential law on the part of the banking industry will be wanting.

Ex Post Review of Regulatory Acts

For similar reasons, banks should be afforded a reasonable opportunity to complain ex post of alleged abuse or misuse of regulatory power before impartial and qualified administrative tribunals or ad hoc review panels. And, where bank regulatory acts are submitted to an ex ante administrative or judicial review by an authority other than the bank regulator, the law should offer judicial appeal. Accordingly, and apart from the possibility to sue for damages in civil court, many national laws provide for some form of ex post administrative or judicial review and revision of administrative decisions and other acts.

Review of the acts of the bank regulator may be either administrative or judicial. Administrative review may be performed by a higher organ of the decision-making agency or by a higher administrative authority. Judicial review may be performed either by administrative courts or tribunals, or by the civil courts.

The review of regulatory acts may concern a review of the legality of the acts or a review of their merits. In this brief discussion, a review of the legality of regulatory acts will be understood to cover only legality in a strict sense—namely, the questions whether the acts were authorized by law, and whether they comply with statutory requirements or violate boundaries set by the law to the discretion of regulators; a review as to the merits will be taken to mean a de novo review of all aspects of regulatory acts, including not only whether the acts are appropriate from a strict legal viewpoint but also whether they are appropriate from a standpoint of public administration. Whereas a review of the legality of an act applies only legal arguments, a review of the merits of an act also includes other considerations, such as economic and political arguments.

A review of the legality of regulatory acts will normally involve a review of the acts in light of the statutory authority for the acts, their compliance with procedural and substantive requirements specified by law, and their consistency with legal standards of good administration such as proportionality and equality of treatment.

Whereas the review of administrative acts as to their legality is not problematic in principle, the broader review of administrative acts as to their merits is, insofar as it requires the reviewing authority to take the seat of the regulator and to examine the decision under review de novo. To be done properly, a review of the merits of an act requires a degree of expertise that is at least equal to that of the agency that acted.

Therefore, a review of the merits of a regulatory act is generally carried out only by a higher organ of the decision-making agency or by a higher administrative authority or by an administrative court or tribunal, and not by the civil courts. Civil courts are often reluctant to extend their review beyond the legality of a regulatory act to its merits, not only because they would lack the necessary expertise to consider nonlegal aspects but sometimes also for reasons related to the constitutional separation between the judiciary and the executive branches of state, particularly where the law grants or leaves the regulator a measure of discretion.61

In civil court, the review of a regulatory act will often identify a certain area of discretion of the regulator, an area of decision making where the law grants the regulator autonomy of judgment. In this area of regulatory autonomy, the civil court will generally refrain from substituting its own judgment for that of the regulator and limit its review to the strictly legal question whether the regulatory act respects the boundaries of the law. Thus, for instance, in applying the principle of proportionality to a regulatory decision, the civil court would not determine what in its judgment would have been a proportional response to the circumstances underlying the decision—reasonable men can differ as to what is proportional—but it would restrict its review to the question whether the response was clearly disproportional to the circumstances. In this sense, the judicial review of regulatory discretion is usually a marginal review that considers only regulatory violations of the boundaries set by the law to administrative discretion. Accordingly, and in contrast with the standards of good administration, which generally are expressed in positive terms, the standards applied by the civil courts in their review of regulatory discretion are often expressed in negative terms, as evidenced by the following words and clauses: discriminatory, excessive, arbitrary and capricious, abuse of discretion, and clearly erroneous.

It is widely accepted that, in principle, measures taken by the bank regulator should be subject to review by a higher administrative authority or by the administrative or civil courts. Article 6 of the European Convention on Human Rights provides that, in the determination of his civil rights and obligations, everyone is entitled to a fair and public hearing within a reasonable time by an independent and impartial tribunal established by law. Accordingly, Article 13 of the First European Banking Directive provides that member states shall ensure that decisions taken in respect of a credit institution in pursuance to laws, regulations, and administrative provisions adopted in accordance with the Directive may be subject to the right to apply to the courts, and that the same shall apply where no decision is taken within six months of its submission in respect of an application for authorization that contains all the information required under the provisions in force.

However, it is equally generally accepted that the bank regulator must have the power to act swiftly and decisively in taking the corrective measures required to protect the banking system or the interests of depositors and other creditors from the consequences of the failure of a bank to comply with prudential standards. The possibility of review of regulatory measures taken by the bank regulator raises difficult questions of balance between these competing interests.

Lest appeals of regulatory decisions would delay urgent regulatory action, the law of some countries provides that decisions of the bank regulator ordering corrective measures or a takeover of a bank are enforceable immediately, notwithstanding their appeal,62 although interested parties may be able to obtain a court order or a decision of the regulator suspending enforcement. In other countries, however, regulatory decisions are suspended pending their appeal, except for decisions that specifically provide otherwise.63

In some countries, appeals from regulatory decisions are brought before the civil courts. For instance, in the United States, a bank may obtain a review of an order served by the bank regulator to cease and desist from an unsafe or unsound practice or violation of law, by filing a petition in a federal court of appeals.64

In other countries, the law may provide for administrative review of regulatory decisions on appeal, either before the general administrative courts or before a special tribunal. Examples are found in the Netherlands where decisions of the bank regulator are subject to review by the administrative courts under the General Administrative Law Act, while the banking law provides also for a special appeal to the Appeals Board for Trade and Industry;65 in Denmark where decisions of the bank regulator are subject to review by a more or less independent Companies Appeals Board established by the Ministry of Industry;66 and in England where appeals can be brought before the Banking Appeal Tribunal.67 In Belgium68 and Spain,69 the Minister of Finance is the authority to review decisions of the bank regulator; while in Italy,70 jurisdiction for review of decisions of the bank regulator is given to the Interministerial Committee of Credit and Savings, consisting of several cabinet members, including the Minister of the Treasury as chairman. Where these authorities are not politically independent, the risk of partiality exists. Yet, that risk is inherent in most administrative review at higher levels of government. In any event, the quasi-judicial tribunals listed might not qualify as courts under Article 13 of the First European Banking Directive or as independent and impartial tribunals under Article 6 of the European Convention on Human Rights.

In England, reviews of decisions of the bank regulator are heard by a specially constituted ad hoc administrative tribunal, the Banking Appeal Tribunal.71 Whenever a request for a review is lodged with the secretary of the Tribunal, the Lord Chancellor and the Chancellor of the Exchequer must appoint the three members of the Tribunal who are to carry out the review. The composition of the Tribunal—an experienced lawyer appointed by the Lord Chancellor as chairman and two members, one an accountant and one a banker—is designed to ensure a professional judgment. The proceedings of the Tribunal are held in camera so as to preserve confidentiality and to help avoid leaks of sensitive information to the financial markets. The review by the Banking Appeal Tribunal is limited by law to the determination of the question: … “whether, for the reasons adduced by the appellant, the decision was unlawful or not justified by the evidence on which it was based.”72 The Tribunal may confirm or reverse the decision of the bank regulator but it does not have the power to vary the decision; it may, however, in certain cases, direct the regulator to vary its decision subject to the power of the regulator to decide how its decision should be varied.73 Both parties may appeal the decision of the Tribunal to the High Court; if the High Court is of the opinion that the decision of the Tribunal was “erroneous in point of law” it must remit the matter to the Tribunal for re-hearing and determination by it;74 thereby, the law limits the scope of review by the civil courts of Tribunal decisions on appeal quite properly to questions of legality and excludes that the courts would submit Tribunal decisions on appeal to a review on the merits.75

The English Banking Appeal Tribunal may serve as a model for other countries, and not only because it meets the criteria of the First European Banking Directive and the European Convention on Human Rights. By its limited scope of review and by bringing a measure of independence and professional expertise to the review process, the tribunal provides safeguards that are missing from review proceedings in other countries. In view of the seriousness of banking regulation, the question must be whether administrative review of decisions of the bank regulator is at all justified in the absence of such safeguards.

Unlike most law governing the review of regulatory acts in the civil courts, the banking law providing for the administrative review of bank regulatory acts often mandates a review on the merits. In banking matters, the authority carrying out the review takes the seat of the bank regulator and must therefore have qualifications worthy of his task. Because of the often highly technical nature of bank regulatory decisions, it cannot be readily assumed that a review panel that is not composed of banking experts—like those serving on an English Banking Appeal Tribunal—will be able to review decisions of the bank regulator with the degree of expertise that such decisions demand.

If the review of bank regulatory decisions must be obtained from a general administrative court instead, it would be appropriate to establish a special division of the court that is qualified to hear banking cases or, alternatively, to require the court to seek advice from one or more independent experts in the field of banking and accountancy and to base its decision on such advice, unless the advice is patently wrong.

To be fair, the review of regulatory acts must be impartial. An essential condition for impartiality is the autonomy of the authority doing the review. This means not only that the authority is functionally and financially independent from the bank regulator in a formal sense but also that the authority is publicly perceived as autonomous and unbiased. The features that help build such perception are generally the same as those of any independent judiciary. In this respect, an administrative court established by law and staffed with judges whose autonomy is ensured by the law has distinct advantages over ad hoc tribunals, especially if their judges are appointed or selected by government officials who may have a political interest in the decision of a particular dispute. However, administrative law courts are sometimes seen as having a pro-government bias; this may require the establishment of permanent review panels enjoying a greater aura of impartiality, possibly with representation of the banking industry. Of course, in building a reputation of impartiality, much will depend on the record of the review authority itself.

In practice, it is difficult for a bank to appeal a decision of its regulator, even under the best of circumstances. The extensive powers of bank regulators make them formidable adversaries and allow them to make life difficult and therefore costly for any bank that dares to question their judgment. It is precisely to protect banks from abuse by the regulator in wielding these powers that the law should give them access to an independent and expert review of regulatory decisions, even though in reality this right would be rarely exercised.

However, there are two important considerations that balance the argument for offering banks and their owners an administrative or judicial review of acts of the bank regulator.

The first consideration is that the right to review should not be abused to frustrate proper regulatory intervention. This is particularly important where it concerns regulatory action whose suspension or repeal would be damaging to the banking system, and hence would undermine the authority and credibility of the bank regulator and diminish confidence in the banking system. Some protection against undesirable effects of appeals could be granted by stipulating in the law that some critical decisions are enforceable pending appeal.76 Or, the law may mandate specific regulatory action in certain narrowly defined circumstances, leaving no room for regulatory discretion and little room for appeal.77 Alternatively, there are countries where appeals against certain regulatory measures are simply excluded by law;78 there is a risk, however, that the legality of such exclusions would successfully be challenged on constitutional grounds or pursuant to provisions of international human rights agreements.79

The second consideration is that the bank regulator and its staff must be protected against frivolous damage claims brought by bank owners and managers and other interested parties in the civil courts. This need is expressed in the first of the Basle Core Principles, which argues for “[A] suitable legal framework for banking supervision … including … legal protection for supervisors.”80 A distinction must be drawn between, on the one hand, suits brought against the bank regulating agency (or the state if the agency has no legal personality), including its staff in their official capacity, and, on the other hand, claims brought against individual members of the agency’s staff on a personal basis on account of their official acts or omissions. Claims of the second category should be ruled out by the law, except perhaps in cases of willful personal misconduct not ordered by a superior officer of the agency.

In many countries, the bank regulator enjoys a measure of immunity from suit. Such immunity is bolstered if the law provides for review procedures administered by experts and designed to provide relief to injured parties while protecting the regulator from unreasonable claims. In determining the scope of the immunity of the bank regulator, special consideration should be given to the need to provide a suitable deterrent against gross negligence and willful abuse of power on the part of the bank regulator or its staff.

Although there are good reasons why the law should discourage frivolous claims for damages resulting from regulatory action, there are equally good reasons why the law should support justified tort claims against the bank regulating agency. Regulators are only human, even bank regulators, and mistakes are made. However, these should not be at the risk or for the expense of the bank. The improper character of unlawful activity by the state or its agents can and should be cured by prompt and adequate compensation of damages suffered as a result of such activity, and this not only to establish a more equitable distribution of the costs of regulatory abuse but also to strengthen the justification for permitting urgent regulatory action to proceed pending its review. Thus, for example, in France, the state is responsible for deficiencies in prudential supervision by the Banking Commission, which lacks legal personality and capital, but the state is liable for damages only in the relatively rare cases where such deficiencies rise to the level of gross negligence.81 In countries where the law continues to afford an unreasonable degree of governmental immunity from liability suits, the law should be changed accordingly.82

Principal Objectives To Be Pursued by Law

All banks should be submitted to adequate prudential regulation that submits similar banking activities to similar prudential requirements and regulatory costs.

Prudential banking regulation should be assigned to a single financially and operationally autonomous bank regulator, accountable to the public and staffed with sufficient qualified and experienced personnel.

The bank regulator should promote fair competition between banks, foster innovation, and educate the public in financial matters; it should generally constrain the corrective effects of market forces on banks only if required by overriding systemic considerations.

Official liquidity support to banks should be limited in amount and time and should be based on a careful cost-benefit analysis, weighing the cost of moral hazard against the benefit of systemic risk reduction. In the event of a rescue operation, bank owners should be made to pay for the operation’s cost. Bank regulators should combat moral hazard that may result from guarantees of official financial assistance to failing banks or their customers, regardless of whether these are implicit or explicit (deposit insurance), by normally permitting bank failures to occur through strict enforcement of explicit exit policies for banks.

In order to help prevent banking problems the law should promote conditions conducive to sound banking systems, including especially an adequate legal framework for banking activities. Countries should accede to the international conventions governing banking activities and should cause their banks to use where possible internationally accepted uniform standards and procedures in their international transactions. A global convention on the recognition and enforcement of foreign money judgments is urgently needed.

Bank regulators and their agents are subject to the rules of administrative law. Prudential law should be written and enforced so that the regulatory measures taken pursuant to the law present a proportional response to the banking deficiencies addressed by the measures. Prudential law should be enforced equally toward all banks, so as to avoid unfair competition between banks. However, in derogation of the principle of equality of regulatory treatment, exceptional regulatory intervention to save some banks while others are permitted to fail may be justified by overriding systemic considerations.

Noncompliance with administrative law by external agents of bank regulators assigned to banks in distress, such as inspectors, provisional administrators, and receivers, may be limited by providing that the powers of inspectors and provisional administrators shall not exceed those of bank managers, and by submitting important decisions of receivers to an ex ante review by the regulator or the court under whose authority they operate.

The law should provide banks, and their owners and creditors, protection from regulatory abuse by affording them a reasonable opportunity to make representations before a regulatory decision affecting their rights is taken, subject to the need for immediate regulatory action if urgently required by overriding interests.

Interested parties should be afforded a reasonable opportunity to have decisions of bank regulators or their agents affecting their rights reviewed by an impartial tribunal, established by or pursuant to law and staffed with judges having sufficient expertise or being assisted by independent experts. As a rule, regulatory decisions under review by a tribunal should remain in effect pending their review, except as the tribunal may otherwise decide.

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