Chapter

VIII Taking Control of a Bank Under the Banking Law: Common Issues

Author(s):
T. Asser
Published Date:
April 2001
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1. Survey of Procedures

In most countries, the corrective measures described in the foregoing must be administered to a bank within its existing governance structure. Bank owners retain their rights and bank managers remain in place. However, preserving the corporate structure of a bank imposes limitations on the scope of corrective measures that can be taken without the cooperation of the decision-making organs of the bank. If management or owners do not cooperate with the bank regulator in restructuring their bank, or if they are judged unable to do so, the bank regulator must use stronger medicine and take control of the bank, either directly or through a provisional administrator or receiver.

A comparative analysis of national banking laws produces two general categories of procedures for taking control of a bank in distress, namely:

(a) Bank administration procedures set forth in the banking law. These are discussed in this section of the book; they consist of either:

  • a regime of regulatory administration in which the regulator, either directly or through a provisional administrator or receiver, takes control of a bank without judicial involvement; or

  • a regime of judicial administration, in which control of the bank is taken by a provisional administrator or receiver appointed and supervised by the court, usually in cooperation with the bank regulator; and

(b) Judicial insolvency procedures governed by a general or special insolvency law and carried out under judicial administration. In addition to a formal bankruptcy regime, the law may contain an extensive rehabilitation procedure offering a combination of provisional administration and receivership.233 In countries where the general insolvency law applies to banks, it is common for the law to include special provisions for banks, recognizing their unique position, the role of the bank regulator, and the public interest in a safe and sound banking system; for example, the law may involve the bank regulator in the judicial ruling on a petition for opening insolvency proceedings against a bank.234

In some countries, the law subjects banks to both bank administration procedures under the banking law, and judicial insolvency procedures under the general insolvency law (Australia, Austria, Denmark, France, Netherlands, Switzerland) or under a special insolvency law for financial institutions (Canada).235 In a second group of countries, banks are excluded from judicial insolvency procedures and may be submitted only to regulatory bank administration under the banking law (Italy, Norway, United States) or judicial administration under the banking law (Luxembourg). In a third group of countries, judicial insolvency procedures do apply to banks, to the exclusion of bank administration procedures (Belgium, England, Germany).

Taking control of a bank under bank administration procedures in the banking law, regardless of whether this is done under regulatory administration or under judicial administration, serves one of two immediate objectives, namely: to save the bank as a going concern, or to close the bank.

  • Saving a bank as a going concern, as the term is used in this book, is a broad and complex concept covering several kinds of arrangement that ensure that the bank’s core business continues in operation, within the bank’s preserved corporate structure or as a new corporation or as part of another corporation. Thus, it may involve providing open-bank assistance and managing and operating the bank back to compliance with prudential regulations either through a provisional administrator who takes control of the bank’s management, or through a receiver who usually assumes the powers of all organs of the bank including its owners. Saving the bank as a going concern need not preserve the rights of its owners in the bank’s business. In some cases, it may require the forced purchase of the bank’s outstanding shares from existing owners and the sale of the shares to new owners. In others, it may require the transfer of all or substantially all of the bank’s business, for instance through a purchase and assumption transaction, to another financial institution, moving the bank’s business out of the bank’s corporation and leaving the bank’s former owners with an empty corporate shell. Obviously, it is possible that only part of the bank’s business is saved and that the remainder is liquidated.

  • Closing a bank usually is done in a receivership and consists of the liquidation of at least the bank’s core banking activities and revocation of its banking license.

Like all bank regulation, taking control of a bank serves the general purpose of maintaining a safe and sound banking system and reducing the systemic risks of a bank failure. Just as taking control of a bank serves a systemic purpose, the choice between saving a bank as a going concern and closing a bank should also be made on the basis of systemic considerations. In general, this means that the authorities should be prepared to save a bank as a going concern only if its failure would have significant systemic consequences. This systemic objective should be weighed against the interests of the bank’s creditors, including the deposit insurance agency: generally, bank creditors may expect to be paid as much as they would receive in a traditional liquidation of the bank. In the absence of sufficient systemic justification, banks should be allowed to fail, just like other enterprises.

Taking control of a bank is intrusive and restricts or eliminates the right of the bank’s owners to exercise control over the bank’s management. Under regulatory administration, the protection of creditor rights is generally inadequate, even though creditors may be able to appeal decisions of the regulator or administrator to the courts. This raises the issue of ex ante judicial involvement. In some countries, provisional administration and receivership are deemed so invasive and their effects on shareholder and creditor rights are considered so serious that the law subjects them to judicial administration.236 With respect to other forms of corrective action the issue hardly arises, and judicial involvement usually does not extend beyond the normal administrative or civil appeals process.

2. Bank Administration Procedures

In most of the countries reviewed, bank administration is carried out by a provisional administrator or a receiver appointed by the bank regulator or by the courts. In some countries, however, the bank regulator may take control of a bank directly.

Taking Direct Control of a Bank

In Australia, at the option of the regulator, provisional administration may be carried out by taking control of the business of a bank either directly by the regulator or through an administrator appointed by the regulator.237 In Canada, the regulator may impose provisional administration on a bank by taking direct control of the assets of the bank and the assets under its administration, or by taking control of the bank;238 although Canadian law does not provide for the appointment of a provisional administrator, one or more persons may be appointed by the regulator to assist the regulator in the management of the bank.239 In the United States, the FDIC may be appointed or appoint itself as conservator or receiver of an insured bank.240

Compared with the appointment of a provisional administrator or a receiver, taking direct control of a bank has distinct advantages. These are chiefly that taking direct control saves time by avoiding an appointment process and avoids the inherent risk of leaks that would tip off the financial markets or bank managers or owners. Taking direct control of a bank allows the regulator to address adequately emergency situations requiring immediate intervention, albeit as a temporary measure; after the bank and its assets have been secured, the regulator may transfer control of the bank to an administrator or receiver. Taking direct control of a bank also has costs, however. The principal disadvantages of direct regulatory control of a bank are that bank regulators are usually not well qualified to manage a bank, and that maintaining an arm’s-length relation to the bank through an independent outsider serving as administrator or receiver permits the regulator to avoid the appearance of a conflict between its responsibilities as bank supervisor and its trustee-like duties as administrator or receiver, especially if there had been deficiencies in supervision.

In the countries where the bank regulator may take direct control of a bank, its powers are generally the same as those of a provisional administrator or receiver. Therefore, and to keep the following discussion simple, the case where the bank regulator may take direct control of a bank or of its business or assets shall generally be subsumed under the appointment of a provisional administrator or a receiver.

Appointment of an Administrator Or Receiver

Bank administration procedures can be distinguished according to their principal objective:

  • Provisional administration consists of the appointment of one or more provisional administrators who take over the management of the bank, with the goal of managing the bank back to compliance with prudential requirements, or to preserve the value of the bank while it is being prepared for transfer to another institution in a sale or merger, or for liquidation.

    In many of the countries where it is offered, provisional administration is a form of regulatory administration (Australia, Canada, Italy, France, Netherlands, United States): provisional administrators are appointed by the bank regulator and their activities are not subject to judicial supervision. There are countries, however, where provisional administration is judicial in nature as it is instituted and supervised by the court (Austria, Luxembourg, Switzerland).

    In countries where the general insolvency law applies to banks, it may include rehabilitation procedures that provide for a judicial form of provisional administration.241

  • Receivership consists of the appointment of a receiver who takes full control of the bank, in order to restructure the bank, pending its transfer to another institution in a sale or merger, or to close and liquidate the bank. The objective is to minimize systemic effects of the bank’s failure while maximizing the value of the bank for its creditors. This may be done by preserving those parts of the bank’s business whose continued operation is important for the banking system, or to liquidate the bank insofar as its continued operation is not needed.

    In several countries, receivership may be carried out under regulatory administration (France, Denmark, Italy, Norway, Spain, United States). In others, it is subject to judicial administration (Luxembourg, Netherlands).

    In several countries (Canada, France, Italy, Luxembourg, Netherlands, United States), the banking law offers both procedures for banks. In others, the banking law offers only provisional administration (Australia, Austria, Portugal, Switzerland) or only receivership (Denmark, Norway).

3. Issues Common to Bank Administration Procedures

The following issues are common to bank administration procedures.

Role of the Deposit Insurance Agency

In some countries, the law provides for the appointment of the deposit insurance agency as provisional administrator or receiver.242 The appointment of the deposit insurance agency as administrator for a bank is problematic, because it is likely to create a conflict of interest between the agency’s duties as a trustee and its own interests as a major creditor of the bank following its subrogation to the rights of depositors after payment by the agency on their deposit claims. The conflict may appear when the deposit insurance agency is presented with a choice between its own short-term financial interests and the long-term interests of the banking system. For instance, there may be situations in which the deposit insurance agency would prefer a certain bank resolution strategy because it carries a lower financial cost than another strategy, even though the latter would produce a significantly stronger banking system whose long-term advantages must be expected to outweigh the difference in current financial outlays.

Also, permitting the deposit insurance agency to take control of a bank may be to the disadvantage of other bank creditors: as a major creditor, the deposit insurance agency would not be expected to offer other creditors the same impartial treatment in the verification or negotiated settlement of their claims as they would receive from an independent judiciary. This would tend to decrease the trust of the general public in the bank resolution system. And, as a practical matter, it would prompt bank creditors to appeal decisions of the administrator in the courts more frequently than otherwise.

Selection of Administrators and Receivers

In most countries, the law provides that provisional administrators and receivers of banks are selected by the bank regulator, even when they are appointed by another authority.

As a rule, provisional administrators and receivers are selected from outside the staff of the bank regulator. There are exceptions, however: in one country, the law expressly permits the bank regulator to appoint one of its own officials to assume the temporary management of a bank,243 while in others the bank regulator may itself take control of a bank.244

Notification and Publicity

To bind the bank, it must be notified of the appointment of a provisional administrator or receiver. To have the desired external legal effect of binding counterparties of the bank, the appointment must be announced to the general public, for instance, in a newspaper of general circulation or in the Official Gazette of the country, or by entering the appointment in the public register of companies or banks. Although the announcement of the appointment of a provisional administrator or a receiver for a troubled bank may have a calming effect on the public, especially if the bank experiences liquidity problems, there is a risk that the appointment and its public announcement would precipitate a run on the bank and worsen the bank’s condition. This risk can be reduced by combining the appointment of a provisional administrator or receiver with a properly structured special moratorium on debt-service payments by the bank.

Plans of Action

As noted for corrective action, a plan of action will greatly contribute to successful regulatory intervention. After an assessment of the bank’s financial condition, the provisional administrator or receiver would prepare and present to the bank regulator or the court a report analyzing the available options. These options would mainly include the restructuring of the bank, transfer of the bank in whole or in part on a going concern basis to another institution in a sale or merger, and closure through liquidation of the bank. The analysis would include for each of the options, a comparative assessment of the probability of success, a cost-benefit calculation, and an estimate of the time required for its execution. The report will need to be discussed with the government if it includes assistance from the state budget.

Thereafter, the bank regulator or the court should decide on a plan of action for the bank, including a business plan, describing the measures to be taken, setting standards by which progress in the plan’s execution is to be measured, and specifying a time period for achieving the goals of the plan. Based on the plan, the bank regulator may impose restrictions on some or all of the bank’s activities.

Preferably, such action plans are established by the bank regulator in close consultation, or better yet in agreement, with the administrator or receiver, with the government to the extent that state funding is required, and also with the bank’s management and owners insofar as these retain authority, in order to ensure “ownership” of the plan by all parties concerned and to reduce uncertainties concerning the objectives of the provisional administration or receivership and the means to achieve them.

Concurrence of Regulatory and Judicial Administration

In countries where during a provisional administration or receivership instituted by the bank regulator another administrator or receiver can be appointed by the courts, or vice versa, questions may arise as to the competing powers of these officials.

In France, when a provisional administrator has been appointed under Article 44 of the Banking Law (Law No. 84-46), the powers of a judicial administrator appointed under the General Insolvency Law (Law No. 85–98) are limited to supervision of the bank’s operations.245 In Australia, the law provides that the appointment of a provisional administrator by the bank regulator terminates the appointment of an externally appointed liquidator, receiver, or other administrator, and that while a provisional administrator is in control of a bank’s business such external appointment must not be made without the approval of the bank regulator.246

In Canada, an order of the Governor in Council vesting the shares of a bank in the deposit insurance corporation constitutes the latter as the exclusive receiver of the assets and undertaking of the bank or of such part thereof as may be specified in the order,247 until the bank is turned over to the courts for liquidation under the Winding-up and Restructuring Act.

4. Regulatory Administration Versus Judicial Administration

This subsection offers a brief discussion of some comparative advantages and disadvantages of regulatory administration and judicial administration in taking control of banks. The discussion will focus on receivership. Provisional administration is not explicitly covered because, in several countries, it is not instituted and carried out under judicial administration, although many of the arguments advanced may apply where it is. Judicial insolvency procedures are implicitly included in the discussion, as the choice to make banks subject to judicial insolvency procedures in lieu of a special receivership procedure under the banking law will in part be driven by considerations concerning judicial administration.

In several countries, banks may be submitted to a judicial receivership under the banking law or the insolvency law or both (Australia, Austria, Belgium, Canada, Denmark, England, France, Germany, Luxembourg, Netherlands, Switzerland); in some of these, a regulatory receivership under the banking law is also available (Canada, France). In other countries, banks may be submitted only to a regulatory receivership under the banking law (Italy, Norway, United States).

Originally, in many countries, the banking law did not provide for a special bank receivership. Insolvent banks were submitted to general insolvency law and their licenses were revoked. Solvent banks whose licenses were revoked were liquidated in accordance with provisions of company law or continued to carry out nonregulated activities.248 When, in some countries, the liquidation procedures under company law were found to provide insufficient safeguards for depositors and other creditors of banks or for the banking system, a special forced liquidation procedure for banks was adopted and included in the banking law to be administered by the bank regulator or by the courts.

In some countries, the application of the general insolvency law to insolvent banks had become problematic when, as a result of a national banking crisis, court systems were overwhelmed by a large number of bank insolvencies. This was used as justification for exempting banks from court-administered insolvency proceedings and submitting banks instead to an extrajudicial bank receivership.249 The argument was reinforced by several additional considerations, including the following.

Court-administered insolvency proceedings are too time-consuming to permit the expeditious resolution of failing banks, and especially the prompt payment of depositors; both are required to maintain public confidence in the banking system and to avoid contagious runs on other banks. When a bank fails, parts of its business may have to be transferred promptly to a viable institution, in order to minimize the disruption that the failure of a banking institution can cause for the bank’s depositors or in certain areas of the financial system, such as the payment, clearing, and settlement systems for foreign exchange and securities transactions; such prompt action is difficult to achieve under a court-administered general insolvency proceeding. Much of what is called the rehabilitation phase in a general insolvency proceeding consists for banks of corrective action ordered by the bank regulator; corrective action may have been more or less exhausted before a bank would enter a formal insolvency proceeding. Moreover, keeping insolvent banks open during the often lengthy rehabilitation phase of a general insolvency procedure would impair public confidence in the banking system.

A similar argument can be made with regard to judicial receiverships of banks under the banking law. For example, a sudden bank failure demands expeditious action on the part of the bank regulator in its attempt to transfer the business of the bank, including its deposits, to another bank so as to minimize the before-mentioned disruptions. The appointment of a receiver by the regulator pursuant to the banking law should take considerably less time than such appointment would take when it must be made by the courts, including the time required for preparing and presenting a petition, for issuing a notice and conducting a court hearing, and for preparing a court decision.

Prompt closure of insolvent banks helps conserve the value of bank assets for creditors, helps preserve the credibility of the bank regulator, and thereby helps diminish systemic risk. There is a link between prompt closure of insolvent banks and public confidence in the banking system. Prompt closure of insolvent banks is evidence of a decisive bank regulator and bolsters confidence in the banking system as a whole, while keeping insolvent banks open through negligent regulatory forbearance that the public perceives as weak raises doubts about the soundness of all other banks.

These arguments have been answered with counterarguments supporting a court-administered receivership for banks. Some of these are discussed below.

In most countries, judicial receivership is the rule for corporations. Therefore, moving bank receivership out of the courts and under the administration of the bank regulator is an exception that requires adequate justification.

One of the arguments used to justify regulatory bank receivership procedures is the need for prompt payment of deposits, which allegedly cannot be assured in a judicial receivership. It can be admitted that the prompt payment of depositors is an important objective in limiting depositor runs on banks, as this can undermine the banking system as a whole. However, it is in order to reduce these systemic risks that many countries protect bank deposits through deposit insurance or a special statutory preference.250 Deposit insurance has therefore diminished the need for prompt payment of depositors by using a regulatory bank receivership.

This raises the question whether deposit insurance reduces the risk of depositor runs on banks sufficiently, i.e., to a point where this risk can no longer be used as an argument to exempt banks from judicial receivership. In several countries, there is anecdotal evidence that it does not and that the availability of deposit insurance does not prevent runs by insured depositors on banks, even though such runs may be less frequent or intense than they otherwise might be. There are several reasons for this phenomenon, depending in part on local conditions. Although deposit insurance may guarantee the eventual return of deposits, it may take a long time before insurance payments on deposits are made, and most depositors cannot wait. Meanwhile, the government may flood the economy with liquidity, driving down the real value of the unpaid deposits. Finally, there always is a risk that the state will renege on its deposit insurance obligations.

The argument that regulatory bank receivership is necessary to produce a prompt closure of banks so as to promote confidence in the banking system, although theoretically true, has little practical significance. Moving bank receivership out of the courts does little to advance payments to depositors and other creditors of banks. In practice, the liquidation of a bank can rarely be fast. Bank creditors can rarely be paid in full before a comprehensive bank audit has been completed, all claims on the bank have been verified, and the aggregate value of all assets of the bank available for payment has been determined. Because of the volume, variety, and complexity of banking transactions and the large numbers of counterparties (creditors and debtors), the liquidation of a bank, even a small one, will nearly always take considerable time, regardless of whether it is carried out under an extrajudicial bank receivership or under a court-administered receivership under the banking law or under the insolvency law.

Some serious legal disadvantages attach to regulatory receiverships for banks. These include that regulatory bank receivership denies bank creditors the procedural and substantive protection afforded by a proper judicial administration. If a regulatory bank receivership procedure is somewhat faster than a court-administered receivership, that is so because an extrajudicial procedure avoids the inevitable procedural delays of a judicial proceeding. Usually, it is characteristic of a receivership carried out under judicial administration that important decisions and actions of the receiver are subject to the prior approval of the court. This requires an ex ante review by the court. It is this ex ante character of judicial administration that affords protection to creditors.251

The principal disadvantage of an extrajudicial regulatory receivership is therefore that it provides no effective legal safeguards. Although the availability of an ex post review process may afford creditors in a regulatory receivership some protection against improper regulatory action, it generally does not present a real deterrent but only grants a right to compensation for losses suffered as a result of regulatory abuse. This disadvantage is even greater when the deposit insurance agency is appointed as receiver of an insolvent bank, because its interests as one of the bank’s principal creditors raises doubts about its impartiality as receiver in administering the claims of competing creditors, undermining their confidence in the receivership process.

At this point in the argument, it should be noted that placing bank receivership under judicial administration is not without benefit for the bank regulator: a court-administered bank receivership lessens the regulator’s responsibilities and potential liabilities and thereby deflects political pressure and reduces the risk of successful litigation against it.

Sometimes, a case is made for avoiding judicial administration in countries with a weak or corrupt judicial system. Indeed, it is not illogical to argue that receivership and liquidation of banks should not be administered by a judiciary that aggravates the problems of a bank insolvency, especially where it can be shown that the sloppy treatment of bank insolvencies harbors increased risks to the financial system. Nevertheless, although avoiding the judiciary might produce short-term gains in efficiency and might even reduce systemic risks, its long-term costs could be substantial. Apart from the fact that court avoidance would diminish what little respect remains for the judiciary and thereby weaken the rule of law, it would place banks and their creditors at the mercy of the bank regulator and its receivers, which—and this is the point—should not be expected to treat bank owners and creditors with greater equity and fairness than the judiciary. Generally, a weak judiciary is a product of a culture of disrespect for the rule of law, which is not limited to the legal community but is shared by the public at large. In extreme cases, a compromise might be found in submitting an otherwise regulatory bank receivership to the supervision of an independent judicial review panel, staffed with unbiased external accountants and other financial experts.

Meanwhile, the argument in favor of placing bank receivership under the control of the courts would not per se be an argument against permitting a bank receivership under the banking law instead of a receivership under general insolvency law. From the perspective of bank regulation, which is the focus of this book, a bank receivership under the banking law has important advantages over a general insolvency procedure because, more easily than a general insolvency law, the banking law can be tailored to meet the special requirements of the banking sector.

There is an even stronger argument for removing bank receivership from the general insolvency law to the banking law. General insolvency proceedings leading to the liquidation of a bank tend to place the fate of the bank into the hands of the judiciary. This raises some difficult legal policy issues. Even though the gravity of the measure may appear to require the high authority of a court, the bank regulator is the only authority technically qualified to determine if the statutory grounds for liquidating the bank concerned have been met. More important, the bank regulator, as the appointed guardian of the safety and soundness of the banking system, should be the only authority qualified to determine whether a liquidation of the bank would or would not have unacceptable adverse consequences for the banking system as a whole. A similar argument could be made for the need to involve other monetary authorities charged with the protection of the broader financial sector, including the capital markets and the payment and securities transfer systems. Allowing the judiciary to make the decision whether a bank should be liquidated, and then not necessarily on financial policy grounds but on grounds derived from general insolvency law, does not afford enough protection against overriding systemic risks.

However, there is another side to this argument. Once it is determined that an insolvent bank should not be rescued or that it cannot benefit from other bank resolution techniques, the bank must be liquidated. If in that event the bank’s depositors are largely protected by deposit insurance, it is difficult to see why the bank regulator should not revoke the banking license and turn the bank over to the bankruptcy court for liquidation like any other insolvent company. Submitting insolvent banks to insolvency proceedings under the general insolvency law needs no justification. Submitting insolvent corporations to general insolvency proceedings is the rule; submitting banks to special insolvency proceedings is the exception that must be justified. If and when it is decided to turn a bank over to liquidation, that must mean that there is no overriding systemic interest in preserving the bank. With respect to a bank whose depositors benefit from deposit insurance, it is difficult to see what significant systemic interests would be adversely affected by the fact that such bank would be wound up in a court-administered general insolvency proceeding rather than in a receivership carried out under banking law.

Notwithstanding this argument, the difference between a judicial receivership under the banking law and a judicial receivership under the general insolvency law need not be so great as to offset the before-mentioned advantages of keeping bank receiverships within the framework of the banking law.

This brings us to the choice between regulatory receivership and judicial receivership under the banking law. The foregoing points to the conclusion that this choice should be driven by the search for a proper balance between concern for the soundness of the banking system and the equally legitimate need to protect the interests of bank creditors. It would appear that regulatory receivership would be justified only if systemic considerations outweigh creditor interests. This will, for instance, nearly always be the case if a bank suddenly and unexpectedly fails and a receivership serves to transfer the bank’s business or at least its depository business quickly to another bank in a sale or merger, preferably over the weekend, because then efficiency and speed are at a premium.252 The same will apply if there are urgent reasons for taking immediate control of a bank in order to stop ongoing criminal activities (money laundering) or to secure its assets for fear of their dissipation by crooked owners or managers. The argument that speed is also of the essence in a bank closure is far less convincing. Therefore, as insolvent banks move closer to liquidation and the chances of a successful restructuring or transfer of their business as a going concern diminish, the balance of the argument begins to shift toward protection of creditor rights under a judicial receivership.

This line of reasoning suggests a regime consisting of two different receivership procedures for banks, both under the banking law: a general receivership under administration of the courts that would be the rule, and a special receivership administered by the bank regulator as the exception allowed on systemic grounds. The law should define the systemic grounds on which the special receivership procedure may be used and should authorize the bank regulator to take control of a bank, subject to ratification or termination of the receivership by the courts within a brief period of time such as one week.

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