V Corrective Action: Categories
- T. Asser
- Published Date:
- April 2001
1. Choice of Corrective Action
The same two legislative approaches that were identified with respect to the grounds for corrective action apply to the choice of corrective action.
Some banking laws contain broad provisions that leave the choice of corrective measures largely to the bank regulator. For example, in Australia, the law authorizes the bank regulator to impose on a bank, at any time, by written notice, conditions on the bank’s authority to carry on banking business in Australia; the conditions must relate to matters relating to the conduct by the bank of any of its affairs: (a) in such a way as to keep the bank in a sound financial position and not to cause or promote instability in the Australian financial system; and (b) with integrity, prudence, and financial skill.144 However, the law of Australia also includes narrowly defined corrective measures: when the bank regulator decides to issue a direction to a bank, it must make a choice from among 14 different kinds of direction specified by the law.145
Alternatively, the banking law may grant the bank regulator broad authority to issue orders directing a bank to cease and desist from any unsafe or unsound practice in conducting its business or to take appropriate remedial action.146 In contrast, the banking law may restrict the use of certain corrective measures to certain deficiencies that they are designed to cure.147
Some banking laws combine broad grounds on which corrective action may be taken with a narrow choice of actions enumerated in the law.148 For instance, the banking law of Portugal provides that when a bank is in a “financially unbalanced situation” the bank regulator may chose one or more carefully defined categories of corrective measures, including, inter alia, presentation of a financial reorganization plan and restrictions on the taking of deposits.149
Conversely, other banking laws combine narrowly defined grounds on which corrective action may be taken with a broad choice of actions. For example, in the Netherlands, when a bank fails to comply with any of five requirements specified in the banking law, the regulator may “direct the competent organs of the credit institution to follow a particular course of action in order to achieve compliance….”150
Obviously, the more accurately a corrective measure targets a violation of the banking law, the greater the chance will be that the measure will achieve its objective. However, the law is a crude instrument to accomplish this goal as it is difficult for the legislator to predict all banking problems that may arise. Moreover, to be effective, the regulator must be able to provide a flexible response to the changing nature and circumstances of banking problems. Therefore, even though limiting the grounds for, or the choice of, corrective action in the law provides some legal certainty, its cost in flexibility must be deemed too great.
In addition to the foregoing, the law may require or authorize the bank regulator to order the bank to return to compliance with prudential standards by a certain deadline.151 One banking law even provides that, if the bank fails to heed the order, the regulator may itself take the measure ordered, at the expense of the delinquent bank.152
Corrective action may take the form of a limitation or a condition attached to the banking license. What in some countries would be the authority to order corrective action is in other countries the power of the bank regulator to restrict the banking license, by imposing such limit on its duration as the regulator thinks fit, or by imposing such conditions as it thinks desirable for the protection of the institution’s depositors or potential depositors, or by the imposition of both such a limit and such conditions.153
Is the regulator generally authorized to threaten a bank with license revocation in order to force the bank into compliance? Unless license revocation would be a remedy that would be disproportional to the infraction addressed, threats of such action would seem permissible, especially if in doing so the regulator merely repeats the threat of regulatory action implicit in the law and thereby pursues the compliance goals of the law. The law of England underscores the need for proportionality in wielding this power, by directing the regulator to restrict a banking license instead of revoking the license if it appears to the regulator that there are grounds on which the regulator’s power to revoke the license are exercisable but the circumstances are not such as to justify revocation.154
2. Corrective Agreements, Warnings, and Orders
In carrying out prudential supervision, bank regulators often discover a deficiency in a bank’s operations or financial condition that, if not addressed, could develop into problems. Normally, the bank regulator would inform the bank of the deficiency and may even recommend remedial action to the bank.
Up to this point, the comments of the bank regulator about a bank’s condition and its compliance with prudential banking standards would be regarded as part of ongoing banking supervision and would typically be included in supervision reports, without requiring special authority under the law.
If the bank would not comply with the regulator’s notice of deficiencies or recommendation for remedial action, the regulator may seek a written agreement with the bank that would detail the bank’s infractions of banking law and include a corrective action plan.155 The chief advantages of such agreements are that they form an excellent consensual instrument for recording a bank’s shortcomings in complying with prudential standards and the corrective actions that the bank with the consent of the regulator must take (corrective action plan), and that they provide a firm legal foundation for further corrective action if needed.
At any stage, if a bank would not adequately respond to the regulator’s advice or recommendations, the regulator may issue a warning to the bank that, unless adequate steps are taken by the bank to cure the deficiency, the regulator may have to resort to more invasive corrective action. Whenever the law attaches legal consequences to the failure of a bank to heed a warning by the regulator, explicit statutory authority to give the warning would seem to be required and the grounds on which a warning may be given may have to be specified in the law. Thus, in France, the law authorizes the bank regulator to issue a warning to a bank that has failed to follow sound banking practices, after having afforded the bank’s management an opportunity to provide an explanation; if the warning is not taken into account, the bank regulator may impose a sanction.156
Measures Affecting Rights of Managers and Owners
The banking law may authorize the regulator to order meetings with the bank’s management or owners to agree on corrective measures;157 to direct the bank to remove managers of the bank;158 to prohibit managers to carry out their duties in whole or in part;159 to appoint a manager160 or a substitute manager161 to the bank; to prohibit dividend payments;162 or to order an increase in the bank’s capital.163
If owners, especially those who exercise control over a bank, refuse to cooperate with the bank regulator, the law should permit counter-measures designed to neutralize their power. These measures may include suspension of the voting rights of uncooperative owners by order of the bank regulator;164 the appointment by court order of a trustee to exercise shareholder voting rights;165 and a court order requiring owners to dispose of their shareholdings.166 Ultimately, it may be necessary to place the bank under provisional administration or receivership,167 in order that the provisional administrator or receiver may succeed to the powers of the bank’s owners,168 or may veto decision of owners;169 or may require that the owners exercise their powers only following his prior consent and taking account of his instructions.170
Measures Affecting Bank Operations
This is the category of corrective measures that is most often found in banking law. Typically, the regulator is authorized by law to issue a guideline, direction, or order: to cease and desist from certain banking activities;171 to take any measure required to cure the bank’s condition;172 to prohibit the bank from engaging in certain operations or to impose other restrictions on its business;173 or to order the bank to dispose of shareholdings it owns.174 In some countries, the bank regulator may attach operational restrictions and other conditions to a bank’s operating license.175
The following provisions of the banking law of Australia, reproduced in substance, illustrate the kinds of corrective action that may be ordered by the bank regulator:
(2) The kinds of direction a bank may be given are as follows:
a) a direction to comply with the whole or a part of prudential regulation or a prudential standard;
b) a direction to order an audit of the affairs of the bank, at the expense of the bank, by an auditor chosen by the bank regulator;
c) a direction to do all or any of the following:
i) remove a director, secretary, executive officer or employee of the bank from office;
ii) ensure a director, secretary, executive officer or employee of the bank does not take part in the management or
iii) appoint a person or persons as a director, secretary, executive officer or employee of the bank for such term as the bank regulator directs;
d) a direction to remove any auditor of the bank from office and appoint another auditor to hold office for such term as the bank regulator directs;
e) a direction not to give any financial accommodation to any person;
f) a direction not to accept the deposit of any amount;
g) a direction not to borrow any amount;
h) a direction not to accept any payment on account of share capital, except payments in respect of calls that fell due before the direction was given;
i) a direction not to repay any amount paid on shares;
j) a direction not to pay a dividend on any shares;
k) a direction not to repay any money on deposit or advance;
l) a direction not to pay or transfer any amount to any person, or create an obligation (contingent or otherwise) to do so;
m) a direction not to undertake any financial obligation (contingent or otherwise) on behalf of any other person;
n) any other direction as to the way in which the affairs of the bank are to be conducted or not conducted.
A direction under paragraph (1) not to pay any amount does not apply to the payment or transfer of money pursuant to an order of a court or a process of execution.
(2A) Without limiting the generality of subsection (2), a direction referred to in a paragraph of that subsection may:
a) deal with some only of the matters referred to in that paragraph;
b) deal with a particular class or particular classes of those matters; or
c) make different provision with respect to different matters or different classes of matters.
(3) The direction may deal with the time by which, or period during which, it is to be complied with.
(4) The bank has power to comply with the direction despite anything in its constitution or any contract or arrangement to which it is a party.
(5) The direction has effect until the bank regulator revokes it by notice in writing to the bank. The bank regulator may revoke the direction if, at the time of revocation, it considers that the direction is no longer necessary or appropriate.176
Before issuing such an order, the effects of the order on the bank’s obligations should be carefully considered. In particular, the bank regulator must ensure that the entry into force of an order to a bank does not adversely affect payment instructions or securities transfer orders already given by the bank; this to protect payment and securities transfer systems.177
3. Appointment of Observers and Inspectors
Many banking laws provide for the bank regulator to become involved in the management of a bank that fails to comply with the banking law or fails to carry out corrective measures ordered by the regulator. This category ranges from passive involvement in the management of the bank through the appointment of an observer or inspector to taking active regulatory control of the bank through one or more administrators or receivers.
Observers and inspectors must be distinguished from provisional administrators and receivers.178 Observers and inspectors are agents of the bank regulator and owe their duty entirely to the bank regulator. To the bank concerned, they remain outsiders who are not appointed as bank managers but assigned to the bank as supervisors. Provisional administrators, however, even though they are appointed by or upon the request of the bank regulator, become part of the internal governance structure of the bank.179 Receivers, though outsiders, usually take complete control of the bank, whereas observers and inspectors do not.
Some banking laws authorize the bank regulator to assign an observer to a bank.180 Observers are investigators whose task is generally limited to surveillance of, and reporting to the bank regulator on, the activities of the bank. Normally, an observer may not intervene in the bank’s business and his consent is not required for management and shareholder decisions.181 The observer attends management and shareholder meetings. He may have to be consulted on some or all important business decisions of the bank.
Because the activities of the observer have no external effects, his appointment need not be publicly announced. This has the advantage of protecting the bank from an adverse market reaction to the appointment. However, under the influence of growing demand for greater transparency, this advantage may eventually disappear.
In some countries, an inspector may be appointed whose main task is to supervise banking activities. The law may require prior authorization of the inspector for all legal acts and decisions of the bank, including decisions of the general meeting of shareholders.182 Or the law may charge the inspector with prohibiting the bank to engage in activities that would be detrimental to the bank’s financial condition.183
Often, the banking law fails to attach sanctions to transactions conducted with third parties without the required consent of the inspector. In civil law countries, this omission would usually be cured by the provisions of company law governing external representation of the bank, which would permit the bank to disavow such transactions for lack of authority to conclude them, provided that the restriction on the powers of the bank’s managers had been recorded in the public register of companies before the activity occurred; without such registration, the absence of consent of the inspector could normally not be invoked against counterparties of the bank.
Sometimes, the banking law imposes a two-step procedure, requiring that the appointment of an inspector be preceded by a notice of noncompliance, which may or may not order the bank to take corrective measures; an inspector may then be appointed only if in the opinion of the regulator the bank’s response to the notice is inadequate or the bank fails to comply with the order.184
The control exercised by an inspector falls short of bank management. The inspector’s role is largely a passive one, as he has only the right to give or to withhold his consent and may not initiate acts or decisions. The inspector does not have the power to enforce compliance by the bank with the law or the instructions of the regulator, not even where noncompliance is the principal ground for his appointment. Therefore, if the purpose of the appointment of an inspector is to restore the bank to health, more will be needed than the authority to disallow inappropriate transactions, especially if it concerns a large, modern full-service bank. Restructuring such an institution will require proactive involvement in all departments of the bank—for instance, to cut out waste, to close unprofitable undertakings or excessively leveraged positions, or to improve accounting, auditing, and risk management systems and procedures. It is questionable whether an inspector lacking the right of managerial initiative would be legally permitted or even practically able to leverage his veto powers to such an extent that he could force the bank’s management to initiate actions that he is not authorized to initiate himself. Moreover, if that were the legislative intent behind the appointment of an inspector, it would be more efficient for the law directly to grant managerial authority to the inspector.
Another disadvantage of the appointment of an inspector is that, to give the requirement of his consent external legal effect, the bank must be notified of the appointment and the appointment must be made public. This may trigger an adverse market reaction. Moreover, in some jurisdictions, the appointment of an inspector may make the regulator liable for errors committed by the inspector.
The principal advantage of appointing an inspector is that it affords the bank regulator a close eye on the bank’s operations, providing it with valuable information about the performance of the bank’s managers. As such, it may precede the removal of bank managers by the regulator and their replacement with one or more provisional administrators.