XI Bank Resolution Procedures Used in a Banking Law Receivership
- T. Asser
- Published Date:
- April 2001
1. Principle Procedures
Bank resolution procedures are used to dispose of a bank. Generally, therefore, they come into play only while the bank is in receivership or when insolvency proceedings have been opened against the bank.345 For the sake of the following discussion, it will be assumed that the bank is in receivership.
From a legal perspective, bank resolution procedures include special financial support; merger; purchase and assumption transactions, including the use of bridge banks; and closure, including forced liquidation and license revocation.
Special financial support includes all forms of official open bank assistance discussed in Chapter VI, above.
Merger of a bank means the sale of the bank’s share capital to another institution.
Purchase and assumption transactions involve the transfer of a whole bank including substantially all of its assets and liabilities, or part of a bank’s assets and liabilities, to another institution. These are discussed in this chapter of the book.
Closure of a bank involves the bank’s forced liquidation and the revocation of its banking license. Forced liquidation is discussed in this chapter of the book, while license revocation is treated in the next chapter.
Dealing with a failing bank requires exceptional speed. After a receiver has taken control of the bank’s assets and its books, and it is decided that the bank cannot be rehabilitated, the first order of business is to try to realize the highest market value for the bank by selling it as a going concern. Generally speaking, if a bank’s business cannot be transferred to another financial institution within a week or so after commencement of the receivership, the bank’s chances of being kept open on a going-concern basis will be slim and in all likelihood the bank will have to be closed. During the liquidation phase, it would still be possible to sell part of the bank’s business under a purchase and assumption transaction.
Ideally, a failing bank is closed on Friday afternoon after close of business, is acquired by another bank over the weekend, and opens its doors early Monday morning under another name. If such a transaction cannot be done for the whole bank, the authorities should at least attempt to engineer a quick transfer of the bank’s insured deposit liabilities to a creditworthy institution so as to minimize the effects of the bank’s failure on its depositors and the attendant systemic risks. An instructive example of this process is the acquisition of Barings by the Dutch ING Group in England, even though the process took a few more days to complete.
Unlike most companies, banks do not respond well to a drawn-out resolution process under the protective umbrella of a moratorium of some sort. Once a bank has been found in need of protection from its creditors, trust in the bank and its ability to attract deposits or capital market funding will often be lost.
The law may require that, in considering the various strategies for bank resolution, the authorities conduct a careful cost-benefit analysis to determine the least-cost solution for winding up a failing bank.346
Although the least-cost test is theoretically attractive, it is difficult to administer in practice, inter alia, for the following reasons. The test requires comparisons between the costs of various resolution scenarios, such as recapitalizing the bank, merging the bank with another institution, or closing the bank. The costs of these different strategies must largely be determined on the basis of estimates based on assumptions supported by hypotheses, not even counting the costs associated with the failure of strategies that aim at saving the bank.
Actually, saving a bank may often be excluded by the least-cost test. If so, special financial support to banks that are deemed too big to fail would be excluded. Logically, the costs to be considered should include not only the financial cost of possible resolution strategies to the bank regulator and the deposit insurance agency but also and especially the economic costs of a bank failure. An option that does not present the least cost to the deposit insurance agency may nevertheless be justified and even indicated by systemic considerations. So as to avoid too rigid an application of the least-cost rule, the banking law may allow exceptions; and, so as to avoid the exception’s becoming the rule, the law may require super majorities for the consent of senior government officials before other than least-cost solutions are adopted.347
As bank owners are entitled to the distribution among them of any positive value that would remain if the bank had been broken up in a traditional liquidation of its assets, they have a residual interest in the resolution strategy to be followed. Therefore, the reasonably estimated liquidation value of the bank could be used as a supplemental benchmark for assessing the appropriateness of other resolution strategies.
2. Bank Merger
In some countries, the rights of shareholders to an insolvent bank are vested in the receiver.348 In others, shareholders of an insolvent bank can be forced by court order to transfer their shares.349 Both permit the authorities to arrange for the merger or sale of the banking corporation in its entirety. Mergers can be voluntary or can be assisted by the government.
The chief advantages of a bank merger include that it builds on the fact that the acquisition of an existing banking franchise is attractive to other banks that wish to expand their operations; that the activities of the failing bank can largely continue, albeit under the corporate roof of another institution, avoiding disruptions in banking services and in payment, clearing, and settlement systems; that the sales price obtained for the bank can include the bank’s franchise value or goodwill, which could not be recovered if the bank were closed; and that the packaged transfer of assets and liabilities is more efficient than a traditional bank liquidation in which assets and liabilities are processed separately and individually. The chief risk of a bank merger is that an otherwise sound bank would be significantly weakened by the purchase of an undercapitalized or insolvent bank.
Alternatively, the authorities may have the power to sell all or part of the business of the bank including its assets and liabilities in a so-called purchase and assumption transaction (see Section 3 below).350 After all assets and liabilities have been removed from a bank, the empty corporate shell remaining may yet have value to a corporate buyer, for instance, when previous losses of the acquired bank may be used as corporate income tax deductions.
3. Purchase and Assumption Transactions
Purchase and assumption transactions represent what possibly is the most common technique for realizing a going-concern value for a bank’s creditors. In such transactions, another bank purchases assets and assumes liabilities of the failing bank, including preferably its goodwill and customer base. The law may contain specific authority for the receiver of a bank to engage in such transactions, sometimes subject to substantive or procedural conditions.351
Ideally, purchase and assumption transactions serve to transfer the entire business of the bank. Such whole-bank transactions include all the assets and liabilities of the failing bank; this has the advantage of moving the burden of collection on nonperforming loans to the purchasing bank. Such whole-bank transactions are similar to bank mergers and have basically the same advantages and risks. The difference between the two types of transaction is chiefly that, whereas a merger is done through a sale of equity shares, a purchase and assumption transaction consists of a sale of bank assets and a transfer and assumption of bank liabilities, each of which may require different legal steps.
As part of a purchase and assumption transaction, certain incentives may have to be offered to the buyer, such as temporary exemptions from some prudential requirements, while the deposit insurance agency may have to cover deficits between the assets and liabilities of the failing bank, less its franchise value, by a cash transfer to the acquiring bank.
Often, however, no institution can be found to acquire all of a failing bank’s assets and liabilities, because the transaction is done too soon to permit a complete appraisal of those assets and liabilities and banks are understandably loath to acquire open-ended liabilities. To meet such concerns, two techniques have been developed. One is the so-called clean-bank purchase and assumption transaction in which only “clean” assets and “known” liabilities are transferred; “dirty” assets and open-ended liabilities that remain may be transferred to an asset management corporation, also called bad bank, to be processed separately. The other technique has the deposit insurance corporation write a put option to the acquiring bank that entitles the latter to return to the former, within a specified time period, certain assets at an agreed price.
Purchase and assumption transactions include the transfer and assumption of a bank’s liabilities. Generally, the law of obligations provides that the assumption of liabilities by a third party will not bind the creditor without his consent. Obtaining the consent of all of a bank’s creditors under a wholesale purchase and assumption transaction would cause substantial delays before the transaction could be closed. Therefore, the law may provide for a procedure whereby a receiver can transfer a bank’s liabilities without creditor consent after obtaining prior approval from the court or the bank regulator and after publication of the transfer of liabilities. Thus, for example, in the Netherlands, the law provides that an assumption of bank debt in a bank receivership binds bank creditors if the court authorizes the assumption of debt and the receiver publishes the assumption of debt in the Official Gazette.352 In other countries, the law prescribes a similar procedure, except that the assumption of debt may be authorized by the bank regulator.353 Or the law simply provides that liability transfers may be made by the receiver without any approval or consent with respect to such transfer.354
In the United States, the banking regulators have the option of using bridge bank powers as part of the receivership process.355 When one or more banks are insolvent or in danger of becoming insolvent, the Federal Deposit Insurance Corporation (FDIC) may, at its discretion, organize a new national bank that the Comptroller of the Currency is then required to charter (bridge bank). To date, this authority has been used to facilitate sales of large banks that were first closed, for which the FDIC was appointed as receiver. The sales consist of purchase and assumption transactions entered into between the FDIC as receiver and the newly chartered bridge bank. Thereafter, the bridge bank continues to operate the business of the failed bank, while the owners of the failed bank are left with an empty corporate shell.
As far as depositors and other customers of the bank are concerned, there is a seamless transition between the failed bank and the bridge bank, since, as a result of the purchase and assumption transaction, in a practical and economic sense, the doors of the bank never close. The bridge bank is controlled by the FDIC, which appoints its board of directors and may provide operating funds in lieu of capital (no capital is required for a bridge bank by law) or financial assistance, such as grants, loans, or guarantees. The law does not clearly regulate the ownership of a bridge bank. The law provides that no capital stock need be issued on behalf of a bridge bank and that a bridge bank is not an agency, establishment, or instrumentality of the United States; however, as bridge banks are organized by the FDIC and as all their ownership rights, including the issue of capital stock and their sale or merger, are exercised by the FDIC, it may be assumed that the FDIC is the owner of the bridge bank. The duration of the bridge bank is limited to a two-year period followed by no more than three one-year extensions.
The use of bridge bank powers allows the FDIC to stabilize a large bank suffering from a depositor run, clean its balance sheet through the use of a receivership, and then enter into a bidding process by which interested parties can do due diligence prior to making an offer to purchase the bridge bank, either in a whole-bank or clean-bank purchase and assumption transaction, and without interference of owners of the failed bank. The bridge is then closed a second time; if the bridge bank was sold in a clean-bank transaction, the FDIC would administer a second receivership for the unsold assets and liabilities.
4. Forced Bank Liquidation
Generally, the law provides for three categories of bank liquidation: voluntary liquidation, forced liquidation, and liquidation in bankruptcy. Only the second one will be discussed in this section.356
Forced bank liquidation is a procedure for winding up all or part of a bank that cannot be rehabilitated or benefit from one or more of the preceding bank resolution procedures. Forced bank liquidation is generally carried out through the liquidation of assets and the discharge of liabilities. Although forced liquidation is usually applied to insolvent banks, it may also be used to liquidate solvent banks whose banking license is revoked because they failed to comply with nonfinancial requirements of the law, such as prohibitions of money laundering.
If provisional administration or receivership for a bank fails to manage the bank back into compliance with prudential standards, or fails to arrange for a transfer of the bank as a going concern, the bank should generally be liquidated.
Bank liquidation under general or special insolvency law is generally carried out by receivers appointed and supervised by the court. Conversely, bank liquidation under company law will generally not be subject to judicial administration; however, in case bank liquidators appointed under the company law cannot ensure an orderly liquidation, the law may provide for their replacement by court-appointed liquidators upon request of the bank regulator.357 As was noted in the discussion of bank receivership, forced bank liquidation under the banking law will be carried out under a receivership that may or may not be administered by the courts.
If the liquidation is carried out in a regulatory receivership without court supervision, there is less assurance that the legitimate interests of creditors and owners of the bank are taken into account than in a judicial receivership. This is especially the case when the liquidation is administered by the deposit insurance agency (Norway, United States), which may have a conflict of interests between its trustee role as receiver and its position as a major creditor of the bank following subrogation to the rights of depositors after payments out of the deposit insurance fund.