VII Special Moratorium on Debt Service by Banks Under the Banking Law
- T. Asser
- Published Date:
- April 2001
1. General Observations
Usually, regulatory corrective action cannot be kept secret. When it becomes public knowledge, it may trigger a run on the bank in distress. To reduce the risk that liquidity problems of a bank would balloon into a run on the bank, which could set off runs on other banks, and to buy the bank and the regulators some time to find a solution for the bank’s problems, the banking law of some countries authorizes that a temporary and special payment moratorium for some or all of the bank’s debt be imposed on creditors of a bank in distress.196 These moratoria are special in that they differ from the more common and general moratoria that usually accompany a general insolvency proceeding or a bank receivership.
Debt-service moratoria for the benefit of banks in distress are usually justified by considerations at two levels. At the systemic level, a debt-service moratorium for a bank helps stave off a run on the bank and thereby limits the risk that such a run could lead to a general deterioration of trust in the banking system, precipitating a banking crisis. This means, inter alia, that the moratorium is carefully managed so as to avoid that the implicit weakness of the bank protected by the moratorium be misinterpreted by the public as a sign of more widespread banking problems. At the commercial level, a debt-service moratorium is intended to be used by the bank and the regulator to improve its condition for the benefit of its creditors or to find a suitable takeover partner.
Whatever its justification, a debt-service moratorium is at the expense of the bank’s creditors whose rights are suspended, and is at their risk that, instead of improving, the bank’s financial condition will further deteriorate. Therefore, a moratorium should be declared only if it is justified by systemic considerations197 or if there is a reasonable expectation that the moratorium can and will further the creditors’ interests. In order to ensure that the moratorium is used to achieve its objective and that it does not serve to shield unsafe or unsound banking practices, the law may require for a moratorium that the bank be placed under provisional administration and that the moratorium subject to strict time limits. Preferably, a moratorium should be carried out in accordance with a comprehensive corrective action plan adopted by agreement between the bank regulator and the bank.
Nevertheless, where the objective of the moratorium granted to a bank is to rehabilitate the bank while it continues its operations, or where such rehabilitation requires support from the financial markets in the form of equity capital or credit, a special debt moratorium may present a paradox.
First, it is difficult to see how a bank under a moratorium could continue its operations which is a condition for its rehabilitation: ordinary banking services would normally include incurring new liabilities whose payment would be suspended by the moratorium, unless an exception would be made for new obligations of the bank. Assume that such an exception would be made and that only preexisting liabilities would be covered by the moratorium. Assume further that the bank would continue to transact most of its business with the same clients as before the moratorium. Then, the curious situation would develop where most clients of the bank would have two kinds of claims on the bank: old claims on which debt-service payments by the bank would be suspended by the moratorium and new claims on which debt-service payments would not be suspended. Would there be many clients willing to extend new credit to a bank before payments due on their existing credit would be current?
Second, a moratorium would usually be interpreted as a sign of financial weakness and diminish a bank’s prospects of meeting its funding needs from the markets at a reasonable cost.198 Here, the paradox is that, while the objective of the moratorium is to protect the bank from its creditors, and thereby to keep the bank alive and to enable it to return to viability, the moratorium tends to deny the bank the market funding that it needs to become viable again. Therefore, the more banks rely on financial markets for their funding and the sale of their services, the less effective special moratoria for banks will be, except to gain time needed to engineer a sale or merger of the bank.
These concerns are addressed by the provisions of the banking law of Switzerland that govern the special moratorium for banks that encounter liquidity problems but are not overindebted.199 By limiting the moratorium to cases where the bank concerned is not overindebted, the risk of granting preferential treatment to new creditors over existing creditors is reduced. In contrast, this risk is significantly greater under an otherwise similar provisional administration with moratorium permitted by the banking law of Austria, because it applies especially to banks that are overindebted or insolvent, even though the provisional administration and therefore the moratorium will be granted only if the overindebtedness or insolvency is likely to be cured.200 The banking law of Switzerland contains the following additional safeguards:
- During the moratorium, the bank continues to do business under the supervision and in accordance with the instructions of the administrator; it may not, however, perform legal acts which would prejudice the legitimate interests of creditors or would favor individual creditors at the expense of others. Payments to creditors may be made only with the consent of the administrator. He is authorized to order, at his discretion, payments to creditors with claims that are due and payable up to a specific ceiling; in doing so, it shall be necessary to take proper account of the interests of creditors with claims protected by preferences established by contract or law as well as the interests of small creditors. Such payments may not exceed one half of the amounts for which, according to the administrator’s assessment of the estate, coverage is available.
- During the moratorium, the court may at any time take such additional measures as the circumstances dictate and serve the interests of the bank or the creditors. In particular, the court may require that, to be valid, the conclusion of new transactions, the transfer of real estate, the establishment of liens, or the granting of guarantees shall require the consent of the administrator; such requirements must be published.201
This Swiss moratorium is instituted and supervised by the courts. Such judicial moratoria should be distinguished from extrajudicial moratoria, which are instituted and supervised by another authority such as the government or the bank regulator.
2. Judicial Moratoria
Several countries offer a debt-service moratorium that is instituted by court order and supervised by the court, at the request of the bank concerned,202 at the request of the bank regulator,203 or at the request of a court-appointed administrator.204
Alternatively, the law may ipso facto attach a moratorium to the appointment of a provisional administrator by the court.205
The grounds on which a judicial moratorium may be ordered differ from country to country.
In Switzerland, the law provides for three different moratoria that may apply to banks.206 These are a judicial moratorium under the banking law designed to provide some breathing room for the benefit of a bank that is illiquid but not overindebted;207 a judicial moratorium for banks that may be overindebted, as part of a composition procedure under the general insolvency law that applies to banks;208 and a rarely used extrajudicial moratorium providing for the rescheduling of debt of otherwise sound banks that face a liquidity crisis.209
In Luxembourg, a moratorium may be granted:
…if the creditworthiness of the institution in question is impaired or if it is experiencing liquidity difficulties, whether or not it has ceased payments; if there is a danger that the institution will not be able to fulfill its obligations completely; or
if the authorization of the institution has been withdrawn but the relevant decision is not yet final.210
Generally, the law does not explicitly require for a debt-service moratorium to a bank that the moratorium be justified either by systemic considerations or by a reasonable expectation that the bank’s difficulties will be corrected.211 Such requirement may be implicit in a statutory provision that the moratorium be terminated if it appears that the moratorium will not cure the bank’s financial difficulties,212 or where it becomes evident during the moratorium that the bank has become insolvent.213
In order to mitigate the risk that, under cover of the moratorium, the bank would engage in unsafe or unsound banking activities that would worsen its condition, the law sometimes requires the written authorization of the bank’s supervisory auditors for all acts and decisions of the bank,214 or provides for the appointment of a provisional administrator from the time that the petition for a moratorium is filed with the court.215
3. Extrajudicial Moratoria
Extrajudicial moratoria are characterized by the fact that they do not require a court order for their institution and that they are not subject to court supervision. The moratorium may be declared by the bank regulator,216 or by the provisional administrator with the approval of the bank regulator.217 Not all countries where the moratorium is authorized require that the moratorium be administered by a provisional administrator or receiver.218
The grounds on which an extrajudicial moratorium may be declared vary. Some laws specifically refer to the need to protect the interests of bank depositors219 or bank creditors in general.220 The law may prescribe that the moratorium is mandated by exceptional circumstances221 or that the moratorium is needed to stave off bankruptcy.222
Sometimes the law provides for two different kinds of special moratoria, one for incidental banking problems and one to prevent or to resolve systemic banking crises. This is the case in Germany where the banking law both empowers the bank regulator to grant a moratorium in response to incidental banking problems223 and authorizes the federal government by regulation to establish a special moratorium for any bank when a banking crisis threatens, namely, if there is reason to fear that banks may encounter financial difficulties that warrant expectations of grave danger to the national economy and particularly to the orderly functioning of general payments.224
During the moratorium, the law may permit the bank to complete transactions in progress and to enter into new transactions needed to complete transactions in progress.225 As is usually the case for court-administered moratoria, the law may provide that no execution, attachment, or foreclosure can be carried out or completed concerning bank assets protected by the moratorium.226
In Switzerland, the extrajudicial moratorium is instituted by the government and is limited to a rescheduling of repayments on bank debt if the bank is exposed to continuing and excessive withdrawals, and then only if it is established by a special audit report that the affected claims are fully covered and that during the postponement payments of interest can be maintained.227
4. Entry into Force and Termination of Moratoria
The time at which a debt-service moratorium for a bank enters into force is of crucial importance to net settlement systems for payments and securities transfers. Often, when a moratorium is granted, payment orders issued by the bank are being processed by a net settlement system at home or abroad without knowledge of the moratorium. Following the traditional rule that gives effect to the moratorium at the beginning of the day on which it is granted may require the clearinghouses concerned to reverse their transactions for that day, which could cause them to suspend operations until the administrative backlog has been cleared; this could create considerable systemic risks for the economies of the countries concerned and the international monetary system as a whole. The issue is discussed more fully below.228
A debt-service moratorium for a bank should terminate when it is no longer needed because its objectives have been achieved,229 or when there is no longer a reasonable expectation that the bank will avoid insolvency.230 In addition, the law may limit the duration of the moratorium to an overall time limit, which may be subject to extension.231
If the moratorium is terminated because bank restructuring is deemed to fail, the bank should be closed and be turned over to a regulatory bank receiver or to the bankruptcy court.232
The law should prescribe a graduated corrective response to noncompliance with prudential requirements only where the levels of noncompliance can be hierarchically ranked; otherwise, the extent of corrective action should be controlled by the need to achieve success tempered by administrative law principles, such as the principle of proportionality.
The authority for taking corrective action should be clearly circumscribed by law. Statutory grounds for taking corrective action should grant the bank regulator sufficient discretion to counter unforeseen conditions with a prompt and adequate regulatory response; in particular, such grounds should not be so narrowly prescribed that they would preclude proper or timely corrective action.
Where the bank regulator has identified a significant deficiency in compliance by a bank with prudential requirements, the banking law should require that, whenever in the judgment of the bank regulator conditions permit, the bank submit to the bank regulator for its acceptance a plan consisting of one or more specific corrective measures to be executed by the bank in order to correct that deficiency.
The law should require that exceptional financial support to rescue the business of an otherwise failing bank should be provided only when justified by systemic considerations, and that, to the extent possible, the costs of bank rescue operations should be borne by the banks’ owners, even where this means depriving them of their economic interest in the banks.
A debt-service moratorium should be granted to a bank only if it is justified by systemic considerations or if there is a reasonable expectation that the bank’s difficulties will be corrected. It should be carried out in accordance with a comprehensive corrective action plan. Granting a debt-service moratorium to a bank may adversely affect its position in the financial markets and therefore its ability to obtain funding at costs that are compatible with its restructuring plan. Therefore, in assessing the likelihood that the bank’s difficulties will be corrected, the financial market effects of the moratorium should be taken into account.