Current Framework

4. The BCB is the resolution authority for deposit-taking institutions, although it does not have a formal financial stability mandate. The BCB is responsible for licensing, ongoing supervision and resolution of banks. With respect to the latter, the BCB can intervene in problem institutions, manage a temporary special administration regime, and initiate and lead extra-judicial liquidation proceedings.⁴ However, while the law provides it with functions and powers to fulfill these responsibilities, it does not grant to the BCB an explicit financial stability mandate.

5. The National Monetary Council (“CMN”) has the broader responsibility to ensure the soundness of Brazil’s financial system, including through general rule-making powers. The CMN is established under Law 4,595 of 1964 (“the Banking Law”), with the objective of formulating currency and credit policy—including to ensure the liquidity and solvency of financial institutions—thereby achieving the economic and social progress of the country. Its composition includes the Minister of Finance (acting as Chairperson), the Minister of Planning of Economic Affairs and the BCB Governor.⁵ The BCB provides secretariat services to its functioning. In pursuing its objectives, the CMN issues regulations regarding the operations of financial institutions, such as on modalities of credit, equity ratios and other technical conditions. However, the legal framework does not explicitly grant rule-making powers on resolution matters neither to the CMN nor to the BCB.

6. There is no fixed term for the members of the BCB’s highest decision-making body—its Board. The Constitution provides for the exclusive power of the President of the Republic to appoint the “President and the Directors” (i.e., the Governor and Deputy Governors, forming the Board) of the BCB, upon prior consent of the Senate. The Board is composed of eight deputy governors, with different deputies responsible for supervision and resolution. As there is no fixed term for their positions, the President can dismiss the Governor and Deputy Governor at any time. Nor does the law require that public disclosure is given on the reason for dismissal.

7. The CMN and the MoF exercise administrative power over BCB budgetary and administrative matters, encompassing also its resolution mandate. Under the Banking Law, the CMN approves the bylaws and accounts of the BCB and decides on its budget and accounting system, as well as on the technical and administrative structure of the BCB and its staff.⁶ The BCB bylaws place the BCB under the remit (“autarquia federal vinculada”) of the MoF. The authorities report that the resources allocated to the resolution department of the BCB are determined by an annual decision of the BCB Board, within the budgetary envelope approved by Congress for the organizational expenses of BCB.

8. Inter-institutional arrangements among financial safety net participants are in place with respect to financial regulatory and supervisory matters. Complementary Law 105/2001 authorizes the BCB to enter into agreements with other financial sector supervisors. The BCB has thus entered into cooperation and information exchange arrangements with other financial sector authorities, such as the Securities and Exchange Commission (CVM) and the Private Insurance Superintendence (SUSEP). A committee of Regulation and Supervision of Financial, Securities, Insurance and Complementary Pension Markets (“COREMEC”) has been established under Presidential Decree 5,685 of 2006, with a view to coordinate financial sector regulatory and supervisory activities in Brazil, under the lead of the MoF.

9. In case of resolution of financial conglomerates, the BCB would assume a lead role. Private and non-federal public financial institutions, as well as credit cooperatives, are subject to the intervention and extra-judicial liquidation regimes, conducted by the BCB.⁷ These regimes apply also to brokerage companies, while federal, state-owned public banks are exempted. On a similar vein, the temporary special administration regime applies to private and non-federal public financial institutions. SUSEP is the resolution authority for insurance companies. The BCB can extend the intervention or extra-liquidation framework to legal entities involved in integrated activities (i.e. also defined as debtors of the institutions under intervention or extra-liquidation) or attached by common interests (i.e. when their shareholders participate in their capital with more than 10 percent).⁸

Envisaged Reforms

10. The Draft Law retains the BCB role as the resolution authority for banks, and seeks to grant to it broader rule-making powers. Under the envisaged reform of the resolution regime, the BCB would continue to act as resolution authority, empowered to resolve banks by commencing either a stabilization regime or a compulsory liquidation regime. The Draft Law also seeks to strengthen the rule-making powers of the BCB, which would be authorized to issue a wider range of implementing regulations, within the directives adopted by the CMN.

11. The Draft Law introduces sectoral responsibilities for resolution and provides for a broad scope of the resolution regime. Under the Draft Law, the BCB would be the resolution authority for financial institutions licensed by it and for financial market infrastructures, while the CVM and SUSEP would be empowered, respectively, to resolve securities and insurance companies.⁹ Cooperation and exchange of information between resolution authorities in Brazil is stated as a principle of the resolution regime. BCB would also be able to extend the resolution regime to legal entities that maintain a related interest with the institution subject to such regime (that is, for instance, when they belong to the same economic group or conglomerate), and to their controlling shareholders and managers. Furthermore, the Draft Law seeks to provide resolution powers to the BCB over companies having an ownership stake in the resolved institution and providing services essential for the continuity of the business of such institution.

Assessment

12. While the BCB is effectively in charge of resolution processes, its formal mandate as a resolution authority presents certain limitations. Relevant laws have regulated over time the various proceedings and the role of the BCB in initiating them, but without defining the overarching objective of the BCB in this area. Similarly, the Banking Law sets out a list of responsibilities to be carried out by the BCB and vests to the CMN, rather than to the BCB, the overall competence regarding the soundness of the financial system. While BCB is effectively responsible for the supervision of financial institutions, the absence of a formal financial stability mandate for the BCB is not optimal, as it could complicate the correct understanding by the public, the Congress and the government, of its duties and powers and of its accountability if problems in the financial sector emerge.

13. The limited autonomy enjoyed by the BCB under the law applies also to its role in resolution. International best practices recommend that resolution authorities are, by law and in practice, operationally independent and that arrangements shield against undue political or industry influence. These arrangements should include rules and procedures for the appointment and dismissal of the head of the authority and members of the governing body, as well as statutory constraints on the possible removal from office only for reasons specified in the law.¹⁰ While the mission has not encountered any evidence of an undue political influence in the exercise of the BCB’s resolution mandate, from a strictly legal—as opposed to operational—perspective these arrangements are not in place. Moreover, the fact that the CMN determines the organizational rules on the functioning and resources of the BCB also may infringe on the autonomy of the BCB.

14. Inter-institutional arrangements do not yet include resolution or crisis preparation matters. The cooperation and information exchange arrangements in place between BCB, CVM, and SUSEP are supervisory in nature and do not address issues related to resolution or contingency planning. No similar arrangements exist between the BCB and the FGC although both agencies are working to overcome certain legal impediments—also due to the private law status of the FGC—that are hindering the formal establishment of an MoU. COREMEC is an important forum for the coordination of financial sector activities in Brazil. However, its mandate does not include resolution issues, nor crisis planning and management. It would be important to strengthen inter-institutional cooperation between financial safety net participants, particularly as the resolution reform will be adopted, and a new role will be taken by the CVM and SUSEP as sectoral resolution authorities, as well as by the government as a potential provider of public funds in resolution on an exceptional basis.

15. These issues are only partially addressed by the Draft Law, also given that the authorities intend to handle them through separate legal reforms. The Draft Law makes strides toward putting in place a modern resolution regime also from an institutional perspective, including by clarifying the objective of resolution processes and by fostering inter-agency cooperation. However, in a number of areas improvements would be needed. These include:

• (i) Autonomy. The BCB has put forward an ambitious agenda (“BC+”) which also concerns its autonomy, viewed by it as critical and deserving strong support. At the same time, the Draft Law—which is expected to be approved soon—does not address the autonomy of the BCB, leaving this to a separate law. As a new resolution regime will be in place, it is important that the BCB autonomy is also enhanced. While it is legitimate that an inter-ministerial committee such as the CMN—of which BCB is part—is in charge of financial sector policies, the review of the BCB autonomy should also include its role and interaction with the CMN and the MoF.

• (ii) Objectives. The Draft Law includes a set of resolution objectives, which are broadly in line with best international practices. (See Section III.A). However, these appear to be objectives of the regime, while the BCB may have other (not fully consistent) statutory objectives and functions.

• (iii) Rule-making powers. The allocation of responsibilities between the CMN and the BCB on the issuance of regulations that will implement the provisions of the new resolution law is not clear. It would be important to clarify what will be the remit of the CMN in this respect, or the areas where it may exercise rule-making powers.

• (iv) Inter-institutional cooperation. Cooperation and exchange of information between resolution authorities in Brazil is stated as a principle, while it appears to be more appropriate to include a specific provision setting out the duty of the various financial safety net participants to cooperate and exchange information on a regular basis. On the other hand, the Draft Law would remove impediments to share confidential information between the BCB and FGC. While the FGC remains a private institution, safeguards protecting confidential information will have to be included.

• (v) Holding companies and group entities. The Draft Law includes appropriately broad provisions extending the resolution regime to entities that belong to the same economic group or conglomerate. However, the contents of the relevant provisions are not clear. For instance, the BCB would have resolution powers over companies having an ownership stake in the resolved institution and providing services essential for the continuity of the business of such institution. These are two different cases, in that holding companies should be treated separately than other entities (e.g., IT service providers) performing essential services, and not all resolution powers and tools would apply to these entities to an identical extent. If this is not the case, effective implementation of resolution plans may be hindered. Moreover, the draft law extends the resolution regime to certain individuals (e.g., controlling shareholders and managers of the failed institution). This appears to be provided in light of the special liability regime applicable to these individuals under Brazilian law. Care should be taken in the interest of legal certainty and to minimize legal risks to identify the different provisions of the new resolution regime that will apply to holding entities, group companies, directors, and other related parties.

Recommendations

• Provide for a financial stability mandate of the BCB as a resolution authority.

• Strengthen the operational autonomy of the BCB as a resolution authority, by (i) providing for a fixed term of the members of the BCB Board of Governors, statutory constraints for the possible removal from office, and public disclosure over the reasons of any early dismissal, and (ii) clarifying the powers of the CMN and the MoF to regulate BCB administrative and organizational functioning, by ensuring its operational autonomy.

• Clarify the allocation of powers between the CMN and the BCB to issue regulations implementing the provisions of the Draft Law.

• Strengthen the inter-institutional arrangements among financial safety net participants in Brazil to require cooperation and exchange of information among them.

• Formalize, upon adoption of the new resolution regime, arrangements among resolution authorities in charge of different segments of the financial sector, clarifying the leading role and the coordination mechanisms applicable in case of a resolution of financial conglomerates.

• Review the provisions of the Draft Law on the scope of the resolution regime, to ensure that the BCB has clear and strong powers to resolve holding companies of banking groups and to apply the regime to entities providing services that are necessary for the continuity of critical functions of the firm under resolution.

Assessment

24. The early warning framework is effective and identifies banks with emerging financial difficulties, but the process could be tightened by a stronger linkage between a bank’s financial indicator and supervisory action. The offsite monitoring has up-to-date information that is quickly processed and it is shared within supervision. The supervisors have considerable flexibility in determining which actions to take. However, a closer linkage between the build-up of risk and specific actions to mitigate those risks could be warranted. For example, specific actions could be required as a bank’s capital begins to deteriorate or as liquidity stress emerges. Supervisory measures could be implemented, including more formal escalating measures such as enhanced supervision. Such measures do not reduce flexibility in dealing with a distressed institution, particularly when financial stability is at stake, but they do pose a strong bulwark against supervisory forbearance and increasing resolution costs.

25. Banks are currently required to prepare contingency plans for liquidity and capital shortfalls. All banks (including those that are not yet in the watch list) need to prepare contingency plans for liquidity and capital, based on Resolution 4,557. This Resolution requires that the capital management framework of all banks and banking conglomerates must comprise a capital contingency plan, establishing responsibilities, strategies, and procedures to face stress conditions. The same Resolution requires that financial institutions implement a risk management structure, which must include a liquidity contingency plan. The verification of these plans is part of the supervisory process. These plans may be supplemented by the introduction of formal recovery plans (see below Section II.B).

26. The Supervision and Resolution Departments work well but their coordination could be improved and formalized. Preparing for a failure requires considerable preparation. The resolution plans must be updated, the current structure and governance arrangements reviewed and the funding for resolution assured. Under such circumstances, the Resolution Department should receive notification of any supervisory action that affects the solvency (i.e., capital level) or medium-term viability of the institution. Such notification should happen even if the bank is not classified as weak or likely to fail. While a formal communication would be made in a specific BCP committee (COMEF) when issues regarding weak banks are discussed, explicit processes could be put in place to require formal coordination between the Supervision and Resolution Departments.

Recommendations

• Link the early warning indicators to specific supervisory actions, reducing the risk of forbearance or delayed response to risk build-up.

• The Resolution Department should be notified whenever an institution has a correction order affecting capital, liquidity, or viability and its role in the decision-making process leading to the resolution of a bank by the BCB Board should be formalized.

• The FGC should be informed of any bank placed on the watch list. It should be informed whenever supervisory actions are required that affect the solvency of the bank or medium- term viability, even before the bank is classified as weak or about to fail. The FGC, in turn, must establish procedures to ensure that such information remains confidential.

Assessment

38. The RRPs provide important information for the supervisors. The scope for RRPs should be extended to include most banks in the system. However, not all banks need to complete the full RRPs. Small and medium sized banks could provide information on balance sheets items, governance, and basic operations with fewer and simpler stress tests. As the banks become more complex, fuller RRPs could be required.

39. Currently banks are strictly following the structure outlined in the BCB regulations. However, banks have very different structures and different business models. Not all business plans will necessarily fit into the standard framework. More flexibility, together with some proportionality concerning requirements, could make the RRPs more useful.

40. While the RRPs provide insights into the resolvability of the banks, there is a potential for correlation among the measures included in recovery plans. Banks may have similar recovery strategies (selling branches or other assets). If all banks follow the same strategy, however, implementation may be hampered. If all banks have similar strategies, and there is a system-wide disturbance, the plans may not be fully effective. Some analysis would be warranted on the extent to which strategies overlap and, if it were significant, modifications of the plans would be in order.

41. Considerable progress has been made in running crisis simulation and testing of BCB mechanisms. Lessons have been learned and those lessons incorporated in BCB operations. The simulations have focused, however, on the BCB. Such crisis preparedness efforts could be expanded to include inter-agency crisis simulations. Such simulations should include all safety net regulators and the MoF. There is benefit of running such inter-agency simulations on a regular basis as both personnel and operating conditions evolve. Annual tests could be run either on specific operations of the BCB or addressing information sharing and policy development across institutions.

Recommendations

• The regulations requiring RRPs could be expanded to include (notably for recovery planning) all banks in the system. At the same time, for the purposes of resolution planning requirements, the definition of systemic institutions should be interpreted with sufficient flexibility to encompass within such requirements also medium-sized banks, as appropriate.

• The BCB could urge banks to tailor their recovery plans to match more clearly the bank’s structure.

• The BCB should carefully analyse all the recovery plans together looking for correlation among measures.

• The BCB should undertake a formal program for inter-agency crisis simulations and exercises.

Recommendation

• Ensure that the review of the supervisory MoUs, currently underway, include the exchange of information on resolution plans.

Assessment

52. In reviewing specific rules and procedures for ELA, it is important to retain flexibility. Currently, the BCB has wide discretion to give ELA and to determine its rules and conditions. This can give to the central bank adequate assurances that it can perform its lender-of-last resort role as appropriate under the relevant circumstances. Nonetheless, the provision of the Draft Law on the ELA appears very broad as it does not include any general principles (e.g. on collateral or a solvency test) to safeguard the central bank. Specific criteria implementing these safeguards could be spelled out in the BCB regulations.

53. ELA should be subject to a solvency test that is tied to a remedial plan and to restructuring measures. The rules could be revised to specify that the ELA can be provided only to viable but illiquid institutions. At the same time, when a bank receives ELA, it should always be required to submit a remedial action plan and be subject to enhanced supervision. Plans should be revisited on an ongoing basis, with detailed measures and benchmarks. In periods of financial turmoil, medium-term, forward looking viability assessments with agreed restructuring measures might be necessary. Repetitive borrowing from the central bank should represent a red flag and may prompt resolution processes.

54. When systemic circumstances are at stake, the BCB could provide ELA but under adequate safeguards. In these circumstances, assets prices are volatile, collateral values difficult to establish and it may become difficult to distinguish between solvent and insolvent institutions. The BCB may not have sufficient assurances that the potential ELA recipient will be able to repay, but it could view the disbursement as necessary for financial stability reasons. In these cases, the BCB should ensure that there is a time-bound, qualitative restructuring program that results in a solvent institution within a short period of time (3–6 months) and that the institution is viable in the medium run. In addition, in systemic circumstances when solvency or viability is in doubt or the quality of the collateral unclear, the BCB should seek a guarantee from the government, and be indemnified against the losses incurred possibly, this may be provided in the context of the envisaged amendments to the FRL that would be made in the Draft Law. While the authorities believe that the MoF obligation to recapitalize the central bank is an adequate protection, an explicit indemnity for ELA losses allows for faster support for the BCB and enhance its credibility. It also places the decisions making on the possible liquidity support and resolution of institutions in systemic cases in the remit, within their respective responsibilities, of both the BCB and the MoF.

55. The decision-making process should be formalized, by leaving the decision on general ELA policies to the Board. The rules should specify the roles of the various departments (supervision, monetary policy, and resolution) and of the responsible deputy governors in the decision-making process that leads to the disbursement, the procedures to be followed, and the documentation to be examined. Rules and procedures on the decision-making process should aim at reconciling any possible divergent view within the central bank on the condition of the bank and on the merits of disbursing the ELA. For reasons of expediency, consideration could be given to leaving the decision on the specific ELA disbursement to the Governor.

56. Preparedness can be enhanced. As ELA has not been given by the central bank in recent times, it is crucial to review the BCB’s rules and procedures in this area, lest the BCB be unprepared when difficult circumstances materialize. This would entail reviewing templates, processes, standard contracts, as well as collateral requirements and procedures for the prompt assessment of the collateral.

57. The liquidity assistance is a core part of the BCB mandate and it should not be the responsibility of private agencies. As mentioned under Section III.C, the role of the lender-of-last resort function has been performed by the FGC in recent times. While this approach has functioned so far, it poses challenges and sets the wrong incentives. It raises the concern that confidential information could leak to the market. Moreover, the private sector may be unwilling or not able to contribute to resolving liquidity problems in large or systemic institutions. Maintaining this system, therefore, could undermine the functioning of the safety net. The FGC is not equipped to analyze appropriately and monitor its clients and does not have a perspective on the viability of banks. Concerns about the exposure of the BCB to risks and litigation for a decision to give ELA can be addressed by reviewing rules and procedures of the central bank, and ensuring that processes are properly followed when ELA is disbursed. In addition, the strengthening of the legal protection regime will be key, as it can provide reasonable assurances to the BCB when the difficult decision of disbursing ELA has to be made. Returning the ELA function to the BCB should be a high priority. The possible distortion caused by leaving that function in the private sector could undermine the strength of the banking system. Efforts should be made to adopt the necessary policies so that the ELA function shifts back to the BCB.

Recommendations

• Revise the ELA framework to provide for a solvency test that is tied to enhanced supervision, remedial plans, and possibly restructuring measures;

• Allow for the provision of the ELA in systemic circumstances, when the BCB has concerns about the viability of the recipient institution or the quality of the collateral, upon a MoF indemnity;

• Establish the decision-making process for the disbursement, by clarifying the roles of the various BCB departments and deputy governors, through a circular of the Board; and

• Enhance preparedness and test ELA against the BCB’s current rules and procedures.

Current System

58. Currently, Brazil’s resolution framework consists of different proceedings: temporary administration, extra-judicial liquidation, and intervention, while bankruptcy is led by the courts. The main features of these proceedings—as set out under law 6024 of 1974, decree law 2321 of 1987 and law 9447 of 1997—are as follows.

• Temporary special administration (RAET). Upon issuance by the BCB of a temporary special administration decree, the bank’s managers and members of the audit committee are replaced by a directors’ council appointed by the BCB, with full management powers over the ordinary course of business of the institution. The bank under RAET remains operational. Further to a proposal of the directors’ council, the BCB may (i) authorize the merger, spin-off or transfer of the shareholding control of the institution; (ii) propose the expropriation, for reasons of public interest, of the shares of the institution, which would be taken over by the state against a contribution that is determined based on the balance sheet of the institution, prepared by the directors’ council; or (iii) initiate the extra-judicial liquidation of the institution. Under the decree law of 1974, the BCB is authorized to use the monetary reserve fund—which is set up as part of the central bank activity—to remedy the financial condition of the institution. However, this provision has not been used recently.

• Extra-judicial liquidation. The BCB is empowered to conduct an extra-judicial liquidation by appointing a liquidator that will manage the institution, establish the value of creditor’s claims, and sell assets, with BCB authorization, through public auction. Liquidation triggers the payout to insured depositors and will result in the suspension of the enforcement proceedings against the liquidated institution and in the acceleration of its obligations. The acts of the liquidator can be appealed before the BCB. The law also authorizes the liquidator, upon prior authorization of the BCB and for the purposes of protecting the public economy and private savings, to alienate the institution’s properties, settle its liabilities, and assign the assets to a third party, in order to ensure the general or partial continuity of the business of the institution. However, this provision has not been applied, due to, among things, concerns regarding the possible exposure of the BCB and of the liquidator to legal risks.

• Intervention. The BCB can appoint an interventor with full management powers, for a period of six months which can be extended for no longer than six additional months. Intervention triggers depositors’ payouts and the suspension of the enforcement of matured liabilities against the bank. The interventor can dispose of the assets or encumber them upon the BCB’s authorization. However, intervention has not been applied in recent times by the BCB.

59. Court-led bankruptcy and ordinary liquidation are two other frequently used proceedings for banks, often as a subsequent step to extra-judicial liquidation. RAET or intervention may cease if, among other reasons, extra-judicial liquidation is decreed. In turn, the BCB may authorize the liquidator to file for the bankruptcy of the institution, when its assets are not sufficient to cover at least half of the value of the non-privileged credits or when there are indications of bankruptcy crimes. Extra-judicial liquidation or intervention can also be converted into ordinary liquidation, conducted under shareholders’ control, in the existence of assurances to the satisfaction of the General Creditor’s Meeting about the continuity of the institution. This is a route often preferred by the authorities, as it is viewed as an amicable way to settle claims, in contrast to the litigious and resource-intensive process of liquidation.

60. The triggers for RAET, intervention, and extra-judicial liquidation are very broad and qualitative in nature. The BCB can initiate these proceedings under a variety of circumstances, such as repeated infractions to banking legislation, existence of covered liabilities, losses submitted by the entity which put creditors at risk, engendered financial and economic situation.¹³ While these triggers would allow the BCB to step in at an early stage, they are not specifically based on an assessment of non-viability (or likelihood thereof) of a bank, relating to solvency or liquidity grounds.

61. The current framework provides for some general transfer powers. A general provision of law 9447 of 1997 (Article 6) authorizes the temporary special administrator, liquidator and interventor, in order to protect the public economy and the interests of depositors and investors, to: (i) transfer assets, rights and liabilities of the company or of its businesses, individually or together, to other entities; (ii) assign assets and rights to third parties and agree with the assumption of its liabilities by other societies; and (iii) work on the constitution or on the reorganization of an entity or entities to which the assets, rights, and liabilities of the institution submitted to intervention, extra-judicial liquidation, or RAET shall be transferred, partially or as a whole, in order to permit the general or partial continuity of its business. It is not clear, however, if any requirement for creditors or shareholders’ consent to perform these acts is overridden.

62. Other features of modern resolution regimes are not contemplated. The current framework does not provide for a number of features that are recommended by the FSB KAs, such as the “no-creditor worse off than in liquidation” safeguard, stays from early termination rights, and the principle of departure from pari passu treatment of creditors belonging to the same class, under certain circumstances.¹⁴

63. Over the last five years, extra-judicial liquidation has been, out of the three proceedings described above, the only one applied. RAET and intervention have remained unused, except for one bank—Banco Cruzeiro do Sul—which was briefly put under temporary special administration and was then subject to extra-judicial liquidation. On the other hand, the BCB commenced extra-judicial liquidation processes over six institutions, none of which was deemed systemic. While three proceedings are ongoing, the other three liquidations have been converted into either bankruptcy or ordinary liquidations conducted by shareholders. Typically, the overall proceeding is lengthy, with very low asset recovery rates, and litigation protracted. When the liquidator applies for bankruptcy, the relevant proceeding is often left in a limbo, in that the bankruptcy judge may not formally start the review of the file, and the extra-judicial liquidation is not yet formally closed. (See Box 2 on recent cases of bank failures).

64. A strict liability regime over controlling shareholders and management of a failed institution is in force. Persons or legal entities having a control relationship with the institutions subject to RAET, intervention, or extra-judicial liquidation are jointly liable with the managers for the institution’s liabilities. Their property is unalienable and cannot be encumbered until the relevant proceeding is concluded and their responsibility ascertained by the court. This prohibition may be extended to those who have acquired assets from managers when this occurred with the intent of avoiding liability. An objective test for liability applies, whether or not fraud or negligence has been established. Controlling shareholders are liable only for the uncovered liabilities of the institution.

Box 2.

Recent Liquidation Cases

Over the last five years, six banks were subject to liquidation.

¹– BRJ filed for bankruptcy but the liquidation hasn’t been closed by BCB yet.

Name	Initial date	Closing Date	Duration
Banco Cruzeiro do Sul S.A.	04/Jun/2012	03/Sep/2015	39.5 months
Banco Prosper S.A.	14 /Sep/2012	06/Jan/2016	40.3 months
Banco Bva S.A.	19/Oct/2012	15/Oct/2014	24.2 months
Banco Rural S.A. (conglomerate)	02/Aug/2013	Ongoing	Ongoing
Banco Brj S.A.,1	13/Aug/2015	Ongoing	Ongoing
Banco Azteca do Brasil S.A.	08 /Jan/ 20 16	Ongoing	Ongoing

¹– BRJ filed for bankruptcy but the liquidation hasn’t been closed by BCB yet.

View Table

Name	Initial date	Closing Date	Duration
Banco Cruzeiro do Sul S.A.	04/Jun/2012	03/Sep/2015	39.5 months
Banco Prosper S.A.	14 /Sep/2012	06/Jan/2016	40.3 months
Banco Bva S.A.	19/Oct/2012	15/Oct/2014	24.2 months
Banco Rural S.A. (conglomerate)	02/Aug/2013	Ongoing	Ongoing
Banco Brj S.A.,1	13/Aug/2015	Ongoing	Ongoing
Banco Azteca do Brasil S.A.	08 /Jan/ 20 16	Ongoing	Ongoing

¹– BRJ filed for bankruptcy but the liquidation hasn’t been closed by BCB yet.

Selected issues of interest on these cases include the following.

Banco Cruzeiro do Sul. The BCB initiated a RAET not only with respect to the bank, but also to the holding company and other group companies. During the RAET, the FGC attempted to negotiate a market solution for the sale of the institution, but this was not possible. The bank was put under liquidation due to a number of serious irregularities found in inspecting its books, and investigations have been ongoing with respect to its shareholders and directors.

Banco BVA. Certain depositors have filed a lawsuit claiming that FGC should pay to them a higher coverage based on the new rules on depositor protection which were passed after the commencement of the extra-judicial liquidation (that is, the trigger for depositor payout).

Banco Rural. A regional court suspended payments by FGC in favor of insured depositors for more than two months, claiming that employees should have priority over depositors.

65. The courts provide ex post review over BCB resolution actions. As a resolution decision is taken by the BCB Board, it can be challenged before federal courts, with the superior court of justice being the last instance. Other acts (for instance, of the liquidator) can be challenged before state courts, although in such case the BCB has to be summoned as an interested party and can request that the lawsuit be heard only by the federal courts. Competent courts can, at least in principle, overturn the decision, and may also suspend the resolution action while judicial review is pending. In general, federal courts where a challenge against BCB resolution decisions is filed tend not to enter into the merits of such decisions, as the principle of deference to specialized regulatory agencies is well established in judicial practice and in the literature.

Envisaged Reforms

66. The Draft Law overhauls Brazil’s resolution framework, by introducing two different proceedings: stabilization and compulsory liquidation. The objectives of the new resolution framework are, among others, to preserve the public interest and the continuity of critical functions. If BCB decides to initiate a stabilization regime, it appoints an administrator (a legal entity or a board of officers), with full management powers and responsibility to execute the resolution strategy determined by the BCB. If, on the other hand, the BCB initiates a compulsory liquidation, it appoints a liquidator (an individual or a legal entity) with full powers to manage and liquidate the failed firm. In both cases, shareholders’ rights are suspended and taken over by the BCB as resolution authority. These two regimes would replace the RAET, intervention, and extra-judicial liquidation, but court-led bankruptcy processes for banks would remain in place. The BCB would be authorized to resolve all financial institutions licensed by it, including state-owned banks (see Box 3).

67. As the triggers for stabilization and compulsory liquidation are the same, the BCB has a wide discretion to opt for either regime. Resolution can be activated by the BCB when an institution is not viable, or likely not to be viable, that is, among other things, when it (i) is insolvent; (ii) has insufficient liquidity; (iii) is failing to observe regulatory requirements; and (iv) is exposed to risks, or has incurred in losses that may compromise its regular functioning. Once it determines that any of these triggers are met, the BCB may initiate the proceeding—stabilization or compulsory liquidation—that it considers best suited to the objectives of the resolution regime.

68. Stabilization and compulsory liquidation produce different effects, as the former is aimed at preserving the continuity of the firm under resolution. The approach taken by the authorities in the reform is as follows.

• Stabilization. Stabilization suspends, for two business days, the contractual clauses that provide for the early maturity of the institution’s obligations, the cancellation of its service agreements, or its exclusion from access to in financial market infrastructures. These clauses will no longer be applicable when the institution has been recapitalized (e.g. in a bail-in) or the relevant contracts have been transferred to another firm. The BCB may order the temporary suspension, for up to two business days, of the maturity of the institution’s obligations, including deposits and investment and except in certain cases (obligations with the central bank and financial market infrastructures, “offsetting of derivatives” which shall be called upon). Debts and claims of the institution under stabilization shall be offset, and the trading of its publicly listed securities automatically suspended.

• Compulsory liquidation. The commencement of compulsory liquidation shall produce certain effects that are typical of insolvency proceedings, such as the acceleration of the institution’s obligations and the suspension of enforcement actions by creditors against the institution’s assets.

69. Stabilization measures include a range of options. When a stabilization decree is issued by the BCB, the administrator hires an appraiser to assess the market value of the assets and liabilities of the institution. The BCB may then order the administrator to take any of the following measures: (i) the transfer of assets, entitlements, and obligations of the institution, individually or as a pool; and (ii) the formation of subsidiaries, corporate reorganizations, or the spin-off of the firm under resolution. The transfer shall include only the assets, rights, and obligations specified in the relevant agreements, and shall not automatically entail the assignment or assumption of other assets or liabilities not included therein, such as those deriving from tax or labor laws.¹⁵ The acquiring party shall be entitled to terminate, within twelve months from the transfer, the obligations assumed. In addition, the Draft Law provides that transfer arrangements shall include mechanisms to ensure their “economic and financial equilibrium”, taking into account that certain liabilities would be not transferred. The exact meaning of this provision is, however, unclear.

70. The Draft Law introduces two important tools – bail-in and bridge bank powers. The authorities intend to broaden the resolution toolkit available to them with two important powers.

• Bail-in. The BCB would be empowered to convert certain categories of debt into equity. After full losses are allocated to equity, claims of controlling entities and former directors, and subordinated debt, bail-in would be applied to senior, unsecured debt as well. For the purposes of conversion, the value of the instruments subject to bail-in must be based on their book value. Certain liabilities are automatically excluded from bail-in, including insured deposits, financial instruments held under custody, claims of legal entities under domestic public law, and secured claims. In addition, the BCB can exclude from bail-in other liabilities upon certain grounds (e.g., risks to financial stability).¹⁶

• Bridge banks. The Draft Law provides that assets and liabilities of resolved entities may be transferred to bridge banks (“transitional financial institutions”), which would be owned by the FGC (in its capacity as manager of the resolution fund), with management appointed by the BCB. Bridge banks would be established as shell entities under the private control of the FGC and would not be allowed to engage in any financial activity until they are activated in the context of a resolution process.

71. The Draft Law introduces, although only in the case of bail-in, the “no-creditor worse off than in liquidation” safeguard (NCWOL), while it is not fully clear if it also allows to depart from the pari passu treatment. The BCB shall compensate creditors if the amount they would have received in liquidation is higher than what they have received as a consequence of the conversion of their claim into equity in a bail-in. The compensation will be paid by the resolution fund if the firm under resolution is a member of the resolution fund—which would be always the case in the authorities’ intention. The compensation will be determined based on a report assessing the market value of the institution’s assets and liabilities. The Draft Law also provides that, in the context of a bail-in or for the purposes of other stabilization tools, the contractual clauses that impose to treat creditors of the same class in an equal manner can be disregarded. While this provision may arguably allow to depart from the pari passu treatment, it is not fully clear whether it allows to do so in all relevant circumstances and with adequate legal certainty.

72. In compulsory liquidation, the liquidator conducts the activities typical of liquidation processes, although its powers to transfer assets and liabilities are not fully clear. The liquidator overseen by the BCB disposes of the assets of the failed institution and verifies and satisfies liabilities. A council of creditors provide its opinions on proposed settlements and debt reliefs, oversees the activities of the liquidator, and examine its accounts. The BCB may order the liquidator to transfer assets of the liquidated institution to an investment fund, for the purposes of managing the portfolio of assets and refunding the proceeds to the shareholders. The BCB, as resolution authority, can advance funds to the liquidated institution, to cover essential expenditures. While it is understood that compulsory liquidation would trigger depositors’ payouts by the FGC, it is not fully clear if under the Draft Law the liquidator can transfer assets and liabilities (other than insured deposits) in bulk, and if so, whether any procedural step is required.¹⁷ When the BCB detects liabilities not covered by the assets of the institution subject to compulsory liquidation, it may require the liquidator to file for bankruptcy.

73. The Draft Law does not change creditor hierarchy rules, although the authorities’ position does not seem to have been yet settled. As mentioned above, the Draft Law exempts insured deposits and FGC claims from bail-in. However, it does not introduce any change to the general creditor hierarchy rules in insolvency, by retaining insured depositors under the same status as unsecured creditors. It is worth noting though that in a previous version of the Draft Law depositor preference was explicitly provided for.

74. Under the Draft Law, judicial powers to suspend resolution actions would be significantly curtailed. The Draft Law prohibits that the decision to adopt a resolution be suspended or that a provisional measure be granted by the court. Moreover, judicial decisions of first instance (i.e., where cases are heard for the first time) affecting acts undertaken by the BCB shall have effect only after being confirmed by a court of second instance (where cases are heard in case of appeal). It is understood that this provision refers to the case where the court rules that the act of the resolution authority is not valid. The authorities consider that a provision stating that the court may not reverse resolution measures but only award damages would be legally problematic, and point out that, in any event, the possibility of reversal would be remote.¹⁸

Assessment

75. There is recognition that the existing resolution framework is not in line with international standards and must be revised. The current framework cannot ensure the exercise of speedy and effective resolution powers, posing the authorities with the alternative between a temporary administration, which does not clearly impose losses on shareholders, and a liquidation proceeding, which can be lengthy and costly. Nor does it seem that the general resolution powers available to the authorities can be promptly operationalized—as a matter of fact, they have not been applied in recent times. These shortcomings are broadly acknowledged by the BCB, whose efforts to vigorously move forward the resolution agenda over the last years, in spite of the challenges faced by the country, must be commended and deserve full support. For these reasons, the assessment and recommendations made in this section focus on the new resolution regime contemplated under the Draft Law, rather than on the features of the existing framework.

76. The resolution regime envisaged in the Draft Law represents a major improvement. The Draft Law provides a comprehensive framework, giving options to restore the financial strength and viability of troubled institutions, plan for their orderly failure, and apply a broad toolkit of resolution powers, including bail-in and bridge bank schemes. It also thoughtfully strikes to achieve a delicate balance between the preservation of public interest, by providing for the allocation of losses of failed banks to shareholders and creditors, and the objective of financial stability, by allowing for government support in exceptional circumstances. (See Section III.B and IV).

77. At the same time, the Draft Law presents issues that warrant close attention. While conceptually the features of the Draft Law are comprehensive and go in the right direction, the legal drafting is not always very clear and in certain areas is not specific or defined enough. This understandably reflects the fact that discussions on the policy design of the reform have been thorough and protracted over time. Nonetheless, uncertainties in the interpretation of the law may increase legal risks and hinder prompt resolution action of the authorities, once the BCB determines to activate the framework. Technical improvements can be made on a number of issues, to allow the authorities to act quickly and effectively. Given the importance of this reform, it is recommended that the Draft Law be closely reviewed to remove any ambiguity and to provide the authorities with a framework that is as efficient and cost-effective as possible. More specific rules could then be added in regulations or other secondary legislation.

78. There is scope for improving the design of the various proceedings for failed banks, and to ensure that the authorities are able to apply resolution powers to medium and small-sized banks, as appropriate under the circumstances. It is not fully clear when the BCB would opt for stabilization or compulsory liquidation, given that the triggers are identical. At the same time, while bankruptcy can only be activated when the BCB decides so, the existence of such an additional process may create uncertainties, particularly as it seems to overlap with extra-judicial liquidation. Nevertheless, it is understood that the BCB views extra-judicial liquidation (or, under the reform, compulsory liquidation) as a mechanism to control the orderly wind-down of a firm—something that court bankruptcy cannot be relied upon. In the design of the resolution regime, it is crucial to clarify the resolution strategy which would guide BCB action in initiating either stabilization or compulsory liquidation. The tools are very different in either case, with compulsory liquidation leading to an orderly wind-down and stabilization to some form of resolution. It is important to retain flexibility, to ensure that stabilization can apply, if appropriate, to small and medium-sized banks (e.g. through a purchase and assumption or a bridge transaction).

79. While the triggers for entry into resolution are adequately broad, they can be improved by providing for forward-looking criteria and by requiring action when the BCB determines that the relevant trigger (e.g., solvency) is met. The Draft Law refers to a number of conditions evidencing the lack of viability (or likelihood thereof) of a bank. However, these conditions do not include prospective assessments on a “likely default” or “likely breach” of a bank, which would provide greater flexibility to intervene at an earlier stage. This kind of assessment could be provided for, to support the test on the non-viability or likely non-viability of a bank. Moreover, the Draft Law allows, but does not require the BCB to begin intervention once it determines that the triggers are met. It is important to maintain a certain degree of discretion to determine whether the triggers for resolution have been met. However, to minimize the risk of forbearance, consideration could be given to whether the provisions of the Draft Law should state that the resolution regime will be triggered automatically upon a determination that its conditions have been fulfilled. Even if the Draft Law includes such a requirement, the BCB will also have the option to adopt appropriate strategy. The selection of that strategy would have to entail, inter alia, the systemic impact of any resolution option.

80. Some specifics regarding the bail-in technique should be reviewed, to improve its effectiveness. It is worth noting the following.

• Haircuts and other loss-absorption tools. The Draft Law contemplates bail-in only in the form of a conversion of debt into equity and does not seem to allow the authorities to terminate or write down debt instruments (e.g., by reducing principal and/or interest amounts due on unsecured creditor claims). Nor does it seem possible to perform other actions that might also be typically included in the bail-in toolkit (e.g., overriding pre-emption rights, exchanging different types of equity and debt instruments, and issuing warrants).

• Valuation. The legislation should provide for a mechanism to override the book value where the BCB considers it necessary, e.g., if the BCB or an independent valuation determines that liability instruments have been incorrectly recorded on the books. Otherwise, the risk is that not sufficient losses may be absorbed, and public funds may be needed.

• Voting rights. It is not clear why the suspension of voting rights in case of debt-for-equity conversion until the transfer is approved by the supervisory authority would apply only for a controlling interest, and not to any significant holding (e.g. 10 percent, 20 percent of shares). Moreover, it would be appropriate to specify who would exercise voting rights (e.g. the resolution authority) and how.

81. There are limited rules on the establishment, governance, and operations of bridge banks. The Draft Law sets out the regime for bridge banks before their effective operationalization, rather than for their functioning after the transfer of assets and liabilities is made. We understand that further detail will be set out in the regulations or other secondary legislation. However, while the desire for flexibility is fully warranted, at least certain general rules should be spelled out in the primary law in the interest of legal certainty. This is even more important given that bridge banks would be owned by the FGC, that is a private association in turn owned by the banks. These rules should include general principles on the governance of the bridge banks and on the role of the authorities over its strategy and risk profile.

82. It is unclear if the resolution toolkit includes the power to establish an asset management company (AMCs). Typically, AMCs would purchase assets of the troubled bank such as non-performing loans, while the bank is restructured. A provision in the Draft Law allows the authorities to operate a spin-off, but it is not fully clear whether this would provide the legal basis to establish an AMC. As in the case of bridge banks, more specific provisions on the setup, governance and strategy of the AMC could be added in the law, while reserving details to implementing regulations.

83. It should be clarified whether the BCB would be allowed to depart from the general principle of equal treatment of creditors of the same class. In a bail-in and in other stabilization tools, the authorities can disregard the contractual clauses imposing that creditors of the same class be treated in an equal manner. This seems equivalent to a power to depart from the pari passu treatment, although in a limited range of cases. Consideration should be given to clarifying in the Draft Law the relevant circumstances whereby the BCB could depart from the pari passu treatment of creditors of the same class.¹⁹

84. The possibility for the acquirer of assets and liabilities to terminate, within 12 months from the acquisition, the obligations assumed in the transfer should be revisited. Leaving this power in the hands of a private sector acquirer risks leaving in a limbo the transfer of assets and liabilities, potentially severely undermining the resolution objectives. It is critical that the BCB has the authority to arrange for a transfer, whereby certain liabilities would be left behind in the shell of the liquidated institution. Mechanisms for returning assets and liabilities to the failed bank could be envisaged, but under precisely defined circumstances, a short timeframe, and the close control of the resolution authority.

85. The NCWOL safeguard should also be extended to the other resolution tools. Tools such as transfers of assets and liabilities can be used to achieve the same economic effect as bail-in (e.g., by leaving some creditors behind facing losses after transferring others of the same rank to a healthy bank or bridge institution). There is therefore no reason to apply the NCWOL only to a bail-in, and not when other tools are used.

86. It is recommended to introduce tiered depositor preference. Having general depositor preference—with insured depositors and the FGC, subrogating to their claims, ranking in the first tier, and uninsured depositors ranking in the second tier, higher than other unsecured creditors—can produce several benefits. First, it fosters financial stability as it facilitates the transfer of deposits to a healthier institution, in the context of a purchase and assumption technique or a bridge bank. Second, it may allow the FGC to obtain higher recovery rates over the estate of the failed institution. Third, by preserving the financial condition of the FGC it protects the public purse, as it seeks to avoid a depletion of deposit insurance funds, which would likely need to be replenished by the state in case of systemic crises.

87. The provisions on the evaluation over the failed bank’s assets and liabilities could be improved. Requirements regarding the eligibility criteria of the evaluator (e.g., concerning its independence) and the main principles to be adopted in the evaluation could be introduced. The BCB could ensure that there is an adequate list of available evaluators who meet specific requirements and can be called upon quickly. Where appropriate to allow for swift actions, mechanisms for preliminary evaluations, with ex post final opinions, should be in place. More specific rules could also be adopted in implementing regulations.

88. Certain effects of the stabilization regime could be clarified. A more precise distinction could be made on the various effects triggered by the stabilization regime. For instance, it should be provided that the commencement of a stabilization regime does not entitle a counterparty to terminate a bond early. The moratorium powers to suspend payments should also be distinguished from the power to temporarily stay certain specific contracts (e.g., derivatives), and the latter power could be usefully clarified under the Draft Law. Lastly, consideration should be given to making the power to suspend the trading of the securities issued by firm under stabilization discretionary rather than automatic, and providing for adequate forms of coordination between the resolution authority and the securities regulator.

Recommendations

• Ensure that the new resolution framework—and its stabilization tools—can apply also to medium and small-sized banks, as appropriate under circumstances.

• Upon introduction of the new resolution regime, adopt a resolution strategy that would also inform the authorities’ approach toward stabilization and compulsory liquidation.

• Provide for forward-looking criteria, based on the non-viability of a bank, that allow for an early and timely entry into resolution.

• Revise the provisions on the resolution toolkit available to the authorities, by broadening the options for bail-in, specifying the rules applicable for bridge bank transactions, clarifying the availability of powers to establish an AMC, and facilitating a transfer of assets and liabilities to a healthier purchaser.

• Introduce tiered depositor preference, with the first tier of preference applicable to the claims of insured depositors and of the FGC.

• Clarify safeguards available to creditors under the resolution regime and the effects of the stabilization and compulsory liquidation regime, and strengthen the rules regarding the independent evaluation of the failed bank.

Assessment

97. Currently, the funding arrangements for resolution are limited. The Fiscal Responsibility Law limits government support for resolution and the BCB is restricted in its ability to finance resolution. As a result, the financing of bank restructuring has shifted to the private sector. The FGC receives premiums from the industry and uses those resources both for the deposit guarantee and for open bank assistance.

98. The use of private institution to finance resolution raises a number of important concerns that could potentially undermine financial stability. The lack of access to information raises the possibility that weak or insolvent institutions will continue to operate without a restructuring plan guided by the BCB. In addition, while the FGC has limited information, there is a risk that whatever warnings it may receive in terms of preparing for a closure could leak to the market. As the FGC takes on more responsibility for resolution under the Draft Law, it will need timely and accurate information on the conditions of the banks. Subject to confidentiality safeguards, it should receive early warning indicators, information on any substantial supervisory enforcement measure, and early financial data on filing or likely to fail banks.

99. In the new law, the use of deposit insurance funds to finance resolution may become inefficient. Treating the resolution of systemically important banks separately from the open bank assistance and resolution for non-systemic banks may not be effective. First, continued use of the deposit insurance fund for open bank assistance, without an adequate emergency liquidity back up system, could raise depositor concerns about the solvency of the deposit insurance fund. Open-bank assistance could deplete the fund and lead to uncertainty about the strength of the deposit insurance system. Second, the resolution functions for managing systemically important banks and non-systemic banks are similar. Having the deposit insurance fund and the resolution fund both undertake resolution raises a question of duplication of work. Tools for both could include purchase and assumption transactions, bridge banks, and even AMCs. Third, the resolution fund will be used infrequently for the resolution of systemically important banks. For that reason, the banks will raise concerns about contributing and, as the fund accumulates resources, pressures would develop to use them for other activities. Such pressures will be mitigated if the resolution fund is used for more frequent resolution activities.

100. The FGC could consolidate all resolution funding into the Resolution Fund and reserve the depositor insurance fund for reimbursing deposits either through direct payout or for financing the transfers of depositors to other viable institutions. Public confidence in the deposit insurance system will be strengthened if depositors understand that the deposit insurance fund remains for their protection. Emergency liquidity provision by the FGC should be discontinued once the BCB ELA framework has become fully operational. If solvency support is required in systemic circumstances, it should be provided from the resolution fund (subject to safeguards, such as prior dilution of existing shareholders and subordinated debt) and open bank assistance from the deposit insurance fund should be ruled out.

Recommendations

• The BCB and FGC should strengthen information sharing and related safeguards.

• The remit of the deposit insurance fund should be limited to the payout or the funding of the transfer of insured deposits in resolution processes.

• The FGC should consolidate all resolution funding into the Resolution Fund, including by allowing it to provide solvency support in systemic circumstances, subject to safeguards in the interest of taxpayers.

• Open bank assistance by the deposit insurance fund should be ruled out once the BCB ELA framework has become fully operational

• The FGC should incorporate an analysis of the medium-term viability of an institution borrowing from it.

• Finally, in the interim BCB should have to give a “no objection” to any liquidity support, even DPGE2.

Assessment

113. The FGC has a number of design features that could be strengthened. The activities of the FGC are limited by the design of its operations and the data it receives. Specifically:

• FGC cannot prepare for effective evaluation of banks seeking open bank liquidity assistance because it does not receive timely financial data. Supervisory information and notification of pending supervisory actions that affect bank viability should be immediately given to FGC, subject to confidentiality safeguards

• The FGC cannot prepare for payout because it does not receive adequate deposit information in a timely manner, resulting in slow depositor payout and difficulties in evaluating the strength of borrowers. It should aim, over time, to develop the capacity to payout in 7 days following a bank’s failure.

• The lack of back-up funding is a serious constraint in the ability of the FGC to maintain public confidence in its ability to ensure timely payout. Arrangements should be made with the MoF (or the BCB) for immediate and unambiguous access to emergency liquidity to fulfill its deposit payout obligations.

• Contingency plans and tests of operations are limited and could be enhanced. The lack of information undermines the analysis of risks in the banking system. Once greater information is available, the processing and analysis of such information would be important. The Draft Law should also introduce emergency back-up funding, preferably from the MoF.

• The funding framework is precarious. While the overall fund is adequate by international standards, FGC is responsible for covering a wide range of instruments outside the normal scope of a deposit insurer. In addition, its open bank assistance is set at a maximum of 50 percent of its net assets to a single borrower. Were demands on FGC exceed available resources, it has no access to emergency backup funding and must turn to the industry.

• Overall coverage of deposits is extremely wide and unusual in international comparison. This breadth of coverage increases the work of the FGC as it must monitor and analyze a wide range of deposit-like instruments and the institutions issuing them. The prohibition on covering nonresident deposits is unusual and could create adverse incentives in the financial market.

114. The approach taken in the Draft Law to maintain the FGC as a private sector association owned and managed by the banking industry, rather than converting it into a public-sector agency, raises concerns. As a private institution, the FGC has limited access to bank data and no access to supervisory reports. While there are informal mechanisms of cooperation with the BCB, information sharing faces inherent constraints. As a result, the FGC can neither do an effective analysis of bank risks nor prepare in advance for a bank failure, which may contribute to slow depositor payout. The FGC has few means of countering incentives for supervisory forbearance as it has no formal voice in the review and oversight of weak bank. While certain confidentiality safeguards are in place and the board of the FGC cannot be composed of active bankers, the fact that its shareholders are financial institutions is problematic. Ownership by the banking industry may also not provide the appropriate incentives to act quickly if systemic risks are at hand. This arrangement can limit the effectiveness of the resolution process and lead to higher resolution costs.

115. The FGC’s provision of open bank assistance is a quasi-central bank function but without central bank safeguards. Banks have automatic access to FGC financing if collateral is adequate. Weak or failing banks that might be frozen out of the market will thus be able to obtain liquidity with appropriate collateral. While effective under some circumstances, this private sector arrangement could distort the financial sector by supporting weak institutions without corresponding restructuring plans, delaying resolution and prolonging asset deterioration. The simple provision of liquidity without a solvency test or assessment of medium-term viability misses an important safeguard of such lending and should be ruled out, replaced by properly designed ELA from the central bank, with adequate safeguards. Moving the FGC into the public sector would prevent conflicts of interest, help improve the exchange of confidential information, and allow the FGC to be included in high-level crisis management committees. Even if this reform proves challenging in the short term, the FGC should seek to strengthen its loan approval mechanisms, by expanding its access to financial and supervisory data, adding financial analysis to the approval process, and requiring that the borrowing institution be reviewed in a medium-term context. Moreover, the BCB should be informed of such borrowing and mechanisms put in place to ensure that any FGC lending is not misused or used to support insolvent banks.

Recommendations

• The FGC should have access to timely, direct information for all of FGC’s members, including supervisory data subject to appropriate confidentiality safeguards.

• Banks should be required to provide depositor data in SCV format.

• The FGC should be moved into the public sector—by transforming it into a fully owned public institution, performing a public interest function regulated by law – and included in high-level crisis management committees. Even if this reform proves challenging in the short term, adequate mechanisms should ensure that FGC lending does not artificially maintain the operation of weak banks without restructuring plans (including through a right of “no objection” by the BCB for any liquidity support, and by incorporating an analysis of the medium-term viability of an institution borrowing from the FGC).

• The FGC should develop a time bound plan to reduce the payout period.

• The FGC should have access to emergency liquidity support from the MoF (or the BCB) in case it is unable to meet the demands for deposit payout.

• The FGC should evaluate more completely its revenue base. Given the wide scope of its coverage, consideration could be given to expanding its revenue base.

• The FGC should have contingency plans and procedures for payout, financial assistance, and assistance to systemic banks, also to facilitate prompt transfers of insured deposits in the case of a purchase and assumption transaction. A multi-year plan could be devised outlining payout simulations using de-identified data, failure simulations, and desktop communication exercises with other safety-net organizations.

• The restriction on covering deposits of foreign residents should be removed.