Introduction

20. The Key Attributes, the international standard for recovery and resolution regimes, requires that any bank that could have an impact on financial stability in the event of its failure should be required to prepare a recovery plan.²¹ Recovery plans should: (i) define measures the institution would employ to address shocks to capital or liquidity; (ii) set out credible recovery options to deal with a range of stress scenarios covering both idiosyncratic and market-wide stress; and (iii) define clear backstops and escalation procedures, identifying the quantitative and qualitative criteria that would trigger implementation of the plan by the institution.²² To ensure the quality and effectiveness of recovery plans, supervisors should have the power to require improvements in the plan and, if deemed necessary, to require implementation of recovery options.

21. The Key Attributes advocate for timely intervention to deal with failing banks. Resolution should be initiated when a bank is no longer viable or likely to be no longer viable and has no reasonable prospect of becoming so.²³ The authorities should act early, before a bank has incurred losses exceeding its equity capital. There should be clear standards or indicators of nonviability to help guide decisions.

Recovery Planning

22. The 2019 amendments to the Banking Law include provisions requiring banks to prepare recovery plans²⁴ and the NBG has published an implementing rule.²⁵ Under the law, plans must be prepared byall banks including branches of foreign banks. Plans must be approved by supervisory boards and updated annually or when changes material to the plans occur. The NBG is to review the plans and is authorized to require banks to makes specific changes to the plans. Banks and banking group entities are obliged to cooperate and supply any information required. The Recovery Plan Rule is comprehensive and adheres closely to internationally adopted guidance. It sets out the factors that the NBG will consider in assessing the completeness and quality of recovery plans. The NBG is to provide the conclusions of its assessment to the bank within three months of receiving the plan,²⁶ and the bank is to revise the plan within two months. The NBG may take any supervisory enforcement action necessary to ensure compliance with the recovery planning requirements. All banks are required to submit comprehensive recovery plans by May 31, 2022. In the interim, transitional provisions required SIBs to submit plans addressing one stress scenario²⁷ by January 1, 2021 and plans addressing additional stress scenarios by July 1, 2021. Other banks are to submit plans addressing one stress scenario byJune 30, 2021 and plans addressing an additional stress scenario by December 31, 2021. The first submission by the three SIBs were delayed due to pandemic but were received in the first quarter of 2021. All banks are expected to adhere to the other transitional deadlines.

23. As a component of its recovery plan a bank must prepare a self-assessment of the critical functions it provides and here too the NBG has issued an implementing rule.²⁸ The Critical Functions Rule also adheres closely to internationally adopted guidance. It provides detailed criteria that banks are to use for identification and assessment of critical functions and shared critical services. In brief, critical functions are those that are important to the economy or financial system stability, while critical shared services are those essential to the provision of critical functions.²⁹ Banks must update the self-assessment annually in the context of updating their recovery plans. The rule specifies the process for NBG review of the self-assessments which is essentially the same as for recovery plans described above, although in the case that a bank’s self-assessment, after instructions from the NBG, is not completed in a satisfactory manner, the NBG may make its own assessment where there are any concerns regarding possible economic or financial system impacts.

24. The triggers for assessing whether recovery options should be implemented should be set well above regulatory minimums. The Recovery Plan Rule provides guidance on setting triggers for assessing whether recovery options should be considered by bank management for implementation but does not indicate the relationship between those thresholds and the minimum prudential regulatory requirements. The NBG should amend the rule to make clear that the thresholds for triggering escalation within management and a decision on whether to implement one or more recovery option should be set sufficiently above the regulatory minimums to preclude any breach of those minimums.

25. The NBG is working with banks and has made internal preparations to review and comment upon recovery plans. As set out in the Recovery Planning Rule, the NBG is to assess whether each recovery plan is compatible with and satisfies all the requirements laid down in the rule and is to evaluate its completeness, quality and efficiency³⁰ The NBG has held a series of meetings with the banks to clarify expectations for recovery plans and critical function self-assessments. The Bank Supervision Department will lead the review of recovery plans and will obtain inputs from the Supervisory Policy Department, the Specialized Risks Department and the RLD. To promote improvement in the quality of recovery plans over time, the NBG should consider formally seeking feedback from banks to determine scope for clarifying and perhaps simplifying the Recovery Plan and Critical Functions Rules. The Bank Supervision Department needs to be alert to bank management viewing recovery planning as a compliance exercise rather than a means to improve bank risk management. Ensuring the rules are practically suitable for that purpose in smaller banks will be important.

26. At present there is no role envisioned for the MoF in evaluating the banks’ critical function self-assessments. While the MoF should not be involved in evaluating an individual bank’s self-assessment, it should be informed of banks’assessment of functions deemed critical to the economy and provided the opportunity to periodically present its views. The NBG should seek input from MoF in assessing the adequacy of banks’ self-assessment of critical functions, either directly or through the forum of the IFSC.

27. At present recovery plans are required at bank level but consideration could be given to eventually requiring plans at group level, where relevant. Group level plans would address the recovery of sister entities (financial subsidiaries of the parent entity that are not subsidiaries of the bank itself). Certain of these entities are significant participants in certain sectors, such as the insurance industry. Group level recovery plans would also serve as a useful input to resolution plans (addressed below).

Early Intervention

28. The Banking Law provides the NBG wide-ranging supervisory corrective action powers.³¹ These powers can be used with respect to banks and their managers as well as to controlling persons³² and maybe imposed in case of problems with a bank that might jeopardize the stable and efficient operation of financial sector or the interests of depositors and other creditors.³³ The 2019 amendments to the law incorporated explicit authority forthe NBG to require a bank to implement one or more measures set out in its recovery plan, including restructuring debt and obtaining additional capital from significant shareholders as envisioned in the plan.

29. In the event that supervisory corrective actions do not or are likely to not prove effective, the NBG may appoint a Temporary Administrator (TeA) for the bank. The NBG will issue a formal legal act imposing the TeA and specifying its roles, duties and powers with the goal to rectify the bank’s problems. In general, key decisions taken by management will require the consent of the TeA or the TeA may take such decisions directly. As noted in the Institutional Arrangements section of this Note, the capacity of the TeA to function as the General Meeting of Shareholders was revoked in the 2019 amendments to the Banking Law, and this was appropriate given the role of the TeA as a tool for supervisory intervention and the creation of the Special Manager regime with the power to function as the General Meeting of Shareholders.

30. The legal triggers for the NBG to act in a timely manner in response to deteriorating financial conditions are adequate but a written policy to guide when and how to use the specific powers should be adopted. The triggers in the Banking Law³⁴ are broad and provide sufficient basis for the NBG to act before an institution has incurred losses exceeding its equity capital. But there is no explicit written policy guidance indicating which powers to use in which situations. The NBG should develop detailed policy guidance geared to ensuring that timely action, including the initiation of license revocation or alternative failure resolution action, is taken promptly in response to financial deterioration in all banks. One explicit goal of such a policy should be to mitigate the risk that the NBG forbears on action until failure is imminent.

31. Summary of recommendations:

• Amend the Recovery Planning Rule to ensure thresholds for triggering escalation within management and decisions on whether to implement recovery option are set sufficiently above minimum prudential regulatory requirements.

• Seek feedback from banks to determine scope for clarifying and perhaps simplifying the Recovery Plan and Critical Functions Rules.

• NBG should seek input from MoF in assessing the adequacy of banks’ self-assessment of critical functions.

• Consider requiring recovery plans to be prepared at group level so as to address sister entities that are important participants in sectors other than banking in the financial system.

• Develop detailed policy guidance to ensure that timely action, including the initiation of license revocation or alternative failure resolution action, is taken promptly in response to financial deterioration in any bank.

Introduction

32. With the recent legislative amendments, there are now more clear legal avenues to deal with a bank whose failure might give rise to systemic implications. The NBG can resolve bank failures by means of liquidation with reimbursement by the DIA of insured deposits. The new failure resolution powers offer a range of alternatives to liquidation, substantially enhancing NBG’s capabilities relative to the former regime under which a TeA could assume the powers of the General Meeting of Shareholders in order to affect resolution while avoiding liquidation.

33. Formal resolution planning supports the ability of the authorities to effectively use their new failure resolution powers. Resolution planning, as advocated in the Key Attributes, is intended to facilitate the effective use of resolution powers in order to protect critical functions, with the aim of making the resolution of a systemic bank feasible without severe disruption, and without exposing taxpayers to loss.³⁵ Resolution plans serve as: (i) a mechanism under which to evaluate, in advance, the menu of resolution tools available under the legal framework as they would apply in the case of the specific bank or group; and (ii) based on that evaluation, as the means to articulate both a preferred resolution strategy,³⁶ employing specific resolutions tools, and a backup strategy employing alternative resolution tools.³⁷ Resolution plans should specifically define the means by which to preserve those critical functions in the case of the threatened failure of a bank, and the planning process should identify impediments to implementation of the resolution strategies. In principle, resolution plans should be prepared, at least, for all banks that could be systemically important in failure at the group and significant subsidiary levels.³⁸

Failure Resolution Powers

34. The NBG can initiate liquidation under the provisions of the Banking Law.³⁹ The Banking Law provisions override those in the general Law on Insolvency Proceedings. Bank liquidation is triggered by the NBG by means of license revocation. Only the NBG can declare the insolvency and bankruptcy of a bank.⁴⁰ The 2019 legal amendments clarified that liquidation is to be conducted with a view to preserve financial stability and to protect insured deposits while also maximizing value for creditors. The grounds for license revocation are broad,⁴¹ including when a bank is expected to face significant financial problems or is likely to become insolvent.⁴² The law thus provides the NBG with the discretion necessary to initiate license revocation when in its judgment the bank is likely to fail but before failure is imminent. Decisions in this regard are taken on a case-by-case basis. However, as noted earlier, there is no written policy geared to ensuring that the NBG acts promptly to trigger license withdrawal when a bank is deemed likely to fail, and it is recommended that such a policy be adopted.⁴³

35. The Banking Law sets out the main procedures and timelines for liquidation.⁴⁴ The procedures for liquidation, including the role played by the NBG, have been further elaborated by the NBG in a Liquidation Regulation.⁴⁵ The law and regulation are adequate to guide the efficient liquidation of a bank. Bank liquidations since the prior FSAP were concluded in a relatively short period of time.⁴⁶

36. Under the Banking Law the Liquidator is appointed by, overseen by and accountable to the NBG, and in practice NBG staff are typically appointed to this role. The Liquidator is authorized to transfer the failed bank’s assets to other banks along with some or all of its liabilities.⁴⁷ When transferring assets and liabilities the consent of depositors, creditors or debtors is not required.⁴⁸ In practice, NBG staff typically serve as Liquidators. In this case the salary costs are borne by the NBG while incidental expenses are borne by the liquidation estate. The practice of appointing NBG staff as Liquidator should be phased out. The Liquidation Regulation does not specify the required skill sets of a Liquidator and on the potential for conflicts of interest.⁴⁹ The regulation should be amended to specify the desired professional qualifications and to establish a presumption that NBG staff, as a general principle, have a conflict of interest and should only serve as Liquidator in extraordinary circumstances. These steps would reduce the potential for legal challenge of a Liquidator’s actions. The RLD should identify third party professionals qualified to serve as Liquidators.

37. The Banking Law does not make specific provision for voluntary liquidation or the conversion from one form of regulated entity to another when initiated by shareholders. The legal procedures for winding-up a sound bank upon the decision of its shareholders are the same as those for the NBG-administered liquidation of a failing bank. Similarly, the conversion of a bank branch license or a microfinance organization license to a commercial bank license is not explicitly addressed in the law. In the case of voluntary liquidation, this has given rise to the need for the NBG to appoint a Liquidator to administer the late stages of a voluntary liquidation. As will be noted in the Deposit Insurance System section of this Note, the lack of legal provisions specific to voluntary liquidation might also trigger a deposit insurance payout. The lack of explicit provision addressing conversions means the procedures lack legal certainty, must be handled on case-by-case basis, and give rise to the need for various administrative decision (e.g., with respect to tax consequences). The MoF and the NBG should plan to amend the Banking Law and other relevant legislation to explicitly address these transactions.

38. The creditor hierarchy in liquidation was updated as part of the 2019 amendments⁵⁰ but with the adoption of increased deposit insurance coverage on July 1, 2020, should be further updated. Under the current provisions, after secured creditors, unsecured claims of the Resolution Fund (see para below) and the NBG have the highest priority, followed by claims of the DIA subrogated for insured depositors.⁵¹ Thereafter the priority is as follows: i) individuals up to GEL 10,000 in local and foreign currency; ii) legal entities up to GEL 10,000 in local and foreign currency; iii) individuals up to GEL 100,000 in local or foreign currency; iv) individuals in local currency in excess of GEL 100,000; v) individuals in foreign currency in excess of GEL 100,000; vi) legal entities in local currency in excess of GEL 10,000; v) legal entities in foreign currencyin excess of GEL 10,000; vi) loans disbursed by other banks to the liquidation estate; vii) tax liabilities, and; viii) other claims. Thereafter in the order of priority are non-deposit claims of direct and indirect owners, subordinated debt and several tiers for various classes of regulatory capital. The creditor hierarchy needs to be updated to reflect recent and planned changes in deposit insurance coverage and eligibility⁵² When doing so, the hierarchy should be made consistent with deposit insurance coverage and any future coverage changes, and should employ a simplified tiered structure under which insured deposits have priority, followed by eligible uninsured deposits (amounts above the deposit insurance coverage limits at the time), other deposits (those ineligible for deposit insurance), and other unsecured claims.⁵³ In addition, the claims of a bank that lends to a liquidation estate⁵⁴ should be reassigned to have the same priority as NBG unsecured claims.

39. The 2019 amendments provided the NBG with substantial new powers to deal with the failure of a bank whose liquidation could give rise to systemic consequences. The potential systemic consequences might involve impairment to the sound functioning of the banking or financial system or a significant negative effect on the economy. Overall, the amendments to the NBG Law and the Banking Law⁵⁵ provide the NBG with the systemic bank resolution powers and lay the groundwork for the recovery and resolution regimes, envisioned in the Key Attributes. The powers maybe used when the grounds for revoking a bank’s license have been met and when, in addition, the use of the powers is necessary to achieve certain resolution objectives.⁵⁶ The amended NBG Law specifies the resolution objectives and these are consistent with the Key Attributes.⁵⁷ The amended Banking Law sets out appropriate principles to guide resolution action, including that shareholders shall bear losses first, that creditors bear losses after shareholders in order of priority of their ranking in the creditor hierarchy applicable in liquidation, that creditors in the same ranking should be treated equally (with certain limited exceptions cited below), and that insured deposits should be protected.⁵⁸

40. The range of systemic bank resolution powers now available to the NBG are comprehensive. These include: i) the power to write down shares and other regulatory capital instruments or convert regulatory capital instruments into shares or other instruments of ownership;⁵⁹ ii) the power to effect the merger of a bank under resolution with an acquiring bank;⁶⁰ iii) the saie of business tool,⁶¹ the power to effect the sale of the shares or any of the assets and liabilities of a bank under resolution to another bank;⁶² iv) the bridge institution tool, the power to transfer all or any shares, assets and liabilities of a bank under resolution to a bridge bank (see below) established by the MoF;⁶³ v) the bail-in tool, the power to write-down or convert liabilities (in addition to the regulatory capital instruments cited in i) above) in order to recapitalize a bank in resolution or a bridge bank,⁶⁴ and; vi) the power to recapitalize a bank in resolution by causing the issuance of new shares.⁶⁵ The use of these resolution tools is not subject to the approval or consent of shareholders, debtors, creditors or depositors of the bank under resolution. Where other laws applicable to the bank under resolution might interfere with the implementation of these tools, the provisions of those laws do not apply⁶⁶

41. With the sale of business tool, the NBG has the power to transfer the shares or any of the assets and liabilities of a bank under resolution to an acquiring bank or to an asset management company. The remaining assets and liabilities would be dealt with under the Banking Law liquidation provisions. The sale of business provisions can be used to sell the sound operations of a failing bank to an acquiring bank or to sell non-performing loans to an asset management company⁶⁷ Unlike for many of the other powers described in this Note, the NBG has not adopted a rule articulating its policies and procedures for employing these legal provisions but should do so in the context of sales to third parties.⁶⁸ An important matter to address is howto organize competitive and transparent bidding for the assets and/or liabilities of a bank in resolution.

42. The NBG has the power to transfer the shares and/or assets and liabilities of a bank under resolution to a bridge bank established by the MoF, and the NBG has issued an implementing rule. To be prepared for potential use of a bridge bank, the MoF is authorized to establish in advance a joint stock company that can operate as a bridge bank upon NBG granting a license.⁶⁹ The bridge bank is to be managed and operated on a professional and commercial basis,⁷⁰ and the NBG is authorized to prescribe any requirements for its management and operation.⁷¹ The NBG may exempt a bridge bank from certain regulatory requirements for up to six months if required in the interest of financial stability, NBG staff cannot serve as managers, and the bridge bank must be returned to the private sector as soon as feasible and to that end it must prepare an exit plan. The NBG issued a rule applicable to the licensing and operation of a bridge bank.⁷²The rule is comprehensive and addresses the objectives of a bridge bank (to ensure the continuation of critical functions of a bank under resolution); the licensing process; the process for the transfer of shares, assets and liabilities to a bridge bank; rules for the administration of a bridge bank; prudential regulatory requirements;⁷³ and the process for ensuring that the bridge bank is transferred to the private sector (either by means of sale to acquirors or merger with another bank) as expeditiously as possible. Under the rule the supervisory board is to undertake its functions with the agreement of the NBG.

43. The NBG has issued a rule addressing its use of the bail-in tool.⁷⁴ The Bail-in Rule defines in detail the manner in which bail-in (the write-off of liabilities or their conversion into shares) is to be affected. The rule envisions the tool being used in the context of the recapitalization of a stand-alone bank in resolution and the capitalization of a bridge bank. The bail-in rule defines the nature of an action plan setting out the post bail-in restructuring to be developed and executed by the Special Manager and the bank management team. The action plan is to be submitted to the RLD and Bank Supervision Department within one month of the bail-in transaction. To promote the ability to affect bail-in, the NBG has the power to require banks to issue a specific volume of debt instruments that can be readily bailed-in,⁷⁵ referred to as MREL (Minimum Required Eligible Liabilities) but has not yet done so. The NBG’s current regulations do not require that debt issuances legally subject to bail-in contain contractual clauses highlighting that they might potentially be written-off or converted into equity⁷⁶

44. The NBG should take steps to enhance legal certainty regarding the effectiveness of bail-in as a resolution tool. The three SIBs (as well as some other banks) have issued a significant volume of senior debt and subordinated debt, all of which is subject to bail-in in principle. Much of the existing debt is issued in foreign jurisdictions and is subject to foreign law. The NBG should adopt a regulation to require all new debt issuances to include contractual clauses recognizing that the instrument is subject to bail-in by the NBG. In its Bail-in Rule, the NBG requires that banks individually certify that a bail-in decision with respect to each debt instrument is enforceable under foreign law. Where banks cannot provide the certification, the instrument will not count toward the bank’s eventual MREL. To complement this requirement, the NBG should commission its own legal analysis in each relevant jurisdiction of the likely outcomes of investor challenges to potential NBG bail-in decisions. This analysis may inform steps the NBG can take to increase legal certainty regarding the extraterritorial effectiveness of its bail-in decisions. It should also inform an analysis of the practicality of bailing-in existing and new debt issuances in different jurisdictions, which in turn, may guide the NBG in further defining and setting bank’s MREL (See the Resolution Planning section of this note for related recommendations.)

45. The NBG issued a rule addressing its power to recapitalize a bank in resolution by issuing new shares.⁷⁷ This power is seen as one that would be used subsequent to use of the bail-in tool. The rule envisions the potential acquisition of new shares by existing or new shareholders. However, there are no mechanisms in place to require existing or new shareholders to subscribe new shares. The rule should be amended to make clear that this power is to be used subsequent to the full write-off of the pre-resolution shareholders as part of the implementation of bail-in of creditors, such that the existing shareholders referred to in the rule are bailed-in creditors and not pre-resolution shareholders.⁷⁸

46. To facilitate rapid execution of resolution decisions the NBG issued a rule defining simplified procedures for acquiring a significant share of a bank in resolution.⁷⁹ The use of most resolution tools likely will result in a change in ownership of a bank in resolution. The Banking Law requires NBG authorization of acquisitions of direct and/or indirect holdings at thresholds of 10 percent, 25 percent and 50 percent. To enable rapid decision-making and execution, the rule sets out streamlined documentation requirements and review procedures for evaluating the suitability of potential acquirers. The procedures envision possible conditional consent being granted, subject to further assessment based on more complete documentation, and that conditional consent might involve a suspension of the acquirer’s voting rights or a decision that the NBG will exercise the voting rights until complete information is submitted and a final decision is made.

47. The NBG has extensive powers to stay actions by shareholder, creditors and other third parties. Among these, the NBG can impose a moratorium of up to 90 days to suspend payments due by a bank in resolution, except payments for insured deposit claims and claims associated with the bank’s involvement in payment and settlement systems.⁸⁰ It can apply to the court to suspend for up to 90 days legal proceedings against a bank in resolution.⁸¹ The law provides that no right or obligation under any contract to which the bank in resolution is a party may be terminated, accelerated, or modified by the bank’s counterparties solely due to the initiation of resolution or any resolution action taken by the N BG.⁸² The N BG may impose a stay of up to two days on the early termination rights arising with respect to financial collateral arrangements and netting arrangements/contracts of a bank.⁸³

48. The 2019 Banking Law amendments specify the role of valuations in the resolution process.⁸⁴ To support a decision as to whether the conditions for license revocation exist, the NBG is to commission a valuation by an independent valuer using regulatory accounting standards, though in case of urgency the NBG can take a decision to trigger resolution action based on its own valuation.⁸⁵ To support decisions on the specific resolution tool(s) to be applied and the terms and conditions associated with the chosen tool(s), the NBG is to commission an independent valuation using more conservative valuation principles, including an assessment of value should the bank be liquidated, but again in case of urgency may conduct its own valuation for this purpose. If it applies resolution tools based on its own valuation, the NBG is to commission the independent valuation as soon as practical thereafter, and on the basis of that valuation, may make adjustments to the terms associated with the resolution tool(s) applied. In addition, a post-resolution independent valuation is required to determine whether creditors have been left worse-off under resolution than they would have been had the bank been liquidated (see more below.)

49. The NBG has issued a rule and further guidance addressing valuations.⁸⁶ The rule provides comprehensive guidance on rules, procedures and methodologies for valuations prepared by independent valuers as well as for provisional valuations that might be prepared by the NBG. The rule specifies the content of the reports that are to be prepared by independent valuers. It sets out qualification requirements and criteria for selection of independent valuers. The rule is supported by a guideline that further elaborates on valuation methodologies. The rule does not address in detail the NBG’s expectations for the information that banks have to make available in order to enable the valuations and this should be specified and promulgated.

50. The creditor hierarchy applicable in liquidation applies in resolution and creditor safeguards are in place. In applying the resolution tools, and in particular when imposing losses on creditors, the NBG must respect the creditor hierarchy. Consistent with the resolution principles, creditors in the same class are to be treated equally, except in certain circumstances set out in the law.⁸⁷ No creditor should incur a loss under resolution actions in an amount greater than they would have incurred had a bank been liquidated, the No-Creditor-Worse-Off (NCWO) principle.⁸⁸ If, based on the independent valuation described above, it is determined that creditors did incur losses greater than in liquidation, they are entitled to compensation from the new Resolution Fund (described in the Temporary Public Funding section of this Note).⁸⁹ The recommendations for revisions to the creditor hierarchy cited earlier in this section would contribute to reducing the risk of successful NCWO claims.⁹⁰

51. While the legislative amendments provide the NBG broad administrative resolution powers, the Court continues to play several roles during resolution and the legal framework includes useful provisions to clarify the interaction between the Court and the NBG.⁹¹ Court approval is required for the NBG to exercise its power to suspend legal proceedings against the bank in resolution.⁹² As per good practices, recent legal amendments require the Court to issue its decision within a day⁹³ The Court can confirm or declare the NBG resolution action as illegal, although appropriate provisions exist to ensure that judicial actions do not impede resolution implementation. During appeal the NBG’s actions will continue in force. In its deliberations the Court is to defer to the quantitative and qualitative assessments of the facts as presented by the NBG unless there is manifest error. In the event that the Court finds resolution action as illegal, the legal effects of resolution actions are preserved, and there is no returning to the pre-resolution status quo ante. Rather, the NBG is financially liable for any proven actual damages as determined by the Court. While useful, these provisions are not yet tested, and therefore it is prudent to rely on robust resolution decision-making to ensure that the NBG’s resolution actions are upheld. To that end, while the current legal framework is appropriate, the NBG should analyze and take any indicated operational steps to minimize legal uncertainty as to whether its resolution decisions will be sustained by the Court.⁹⁴

52. The NBG Law addresses resolution action in cooperation with foreign resolution authorities. When the basis for resolution action under the Banking Law exist, the NBG may exercise its resolution powers to support the resolution actions taken by a foreign resolution authority. However, the NBG may refrain from doing so if it would have adverse effects on financial stability or give rise to material fiscal implications in Georgia, or if the creditors of a Georgian bank would not be treated equitably under the foreign resolution proceedings.⁹⁵

Resolution Planning

53. A resolution planning regime is being implemented and the NBG issued a rule to guide the planning process.⁹⁶ The rule is comprehensive, defining, inter alia, the contents of a resolution plan, the procedures for assessing the resolvability of a bank (identifying impediments to the use of resolution tools), and the criteria for selecting a preferred resolution strategy. The rule calls for an initial assessment of the credibility and feasibility of liquidation as a means to deal with any bank’s failure. If the NBG assesses that liquidation would have an adverse impact on the financial system or the economy, a preferred resolution strategy identifying the intended resolution tools is to be developed. The resolution strategy is also to include identification of possible variants to the intended approach in the event the preferred resolution strategy cannot be practically implemented due to circumstances at the time. Plans are to be reviewed annually and updated as necessary.

54. Initial resolution plans are to be developed for the three SIBs, but resolution planning for other banks should be considered. The plans are to be developed by the RLD by year-end 2021 and will need to be approved by the RC. The RLD also will need to develop a process for assessing, with respect to all banks, the credibility and feasibility of liquidation as a means to resolve their failure, a task not envisioned to be initiated until 2022 due to the other priorities facing the RLD. Nonetheless, given the stresses on the banking system arising from the pandemic, the RC should commission a rapid stock-taking based on the NBG’s institution-wide knowledge of the circumstances of all banks with a goal to determine whether banks other than the SIBs, specifically those were there is reasonable doubt the bank could resolved by means of liquidation and insured deposit payout without systemic consequences, should be subject to at least some form of resolution planning in 2021.⁹⁷ If this is the case, the NBG Board should consider bolstering staff resources of the RLD.

55. The NBG should leverage the first round of resolution plans to contribute to setting MRELforat least the SIBs. In the context of undertaking resolvability assessments, the RLD, working with relevant supervisory and legal staff, should analyze the status of banks’ existing debt issuances with respect to the practicality and legal certainty of executing bail-in in the various jurisdictions. This analysis should help guide the NBG in further defining and setting banks’ MREL. A formal policy decision on setting and implementing MREL should be adopted as soon as practical, along with a timeline for phasing-in the requirements.

56. The MoF needs to take steps to be in a position to establish and operate a bridge bank. These efforts should be undertaken in collaboration with the NBG. As noted, the MoF is authorized to establish in advance a joint stock company that can apply for a banking license in time of need. The MoF should set up such an entity as soon as feasible. The NBG and the MoF should work to ensure that the information to be provided by MoF to the NBG in order to support a decision on licensing the entity as a Bridge Bank is prepared in advance. MoF will need to form a Supervisory Board that will meet the approval of the NBG, and a protocol will need to be developed for coordination between the Supervisory Board and the NBG as all Supervisory Board actions must be taken with the agreement of the NBG. The MoFalso will need to make arrangement to be able to capitalize the Bridge Bank and templates for the required submissions to the Cabinet and Parliament should be prepared. The MoF and NBG should consider establishing a joint working group to carry these tasks forward within deadlines agreed by the Minister and the NBG Governor. (Additional recommendations for collaboration between the MoF and the NBG in the context of financing effective resolution action are set out in the NBG Liquidity Support and Temporary Public Funding sections of this Note.)

57. The RLD is planning to contract independent experts to undertake the valuation necessary to support decisions on entry into resolution, the terms of the use of resolution tools, and the adjudication of potential NCWO claims. As noted, the rule on valuations sets out the relevant criteria. To be able to perform the valuations, the RLD should place at least two firms under standby contracts that would enable them to initiate work within a short period of time, such as within a week. In doing so, the RLD should solicit feedback from the providers on the valuation rule, the guideline and the information requirements and make enhancements where indicated.

58. The regional expansion of Georgian financial groups may eventually imply responsibility for the RLD to engage in cross-border analysis and cooperation related to resolution planning. This implies tasks such as understanding the relevant legislation in jurisdictions hosting any significant subsidiaries or branches of local groups and determining whether and how NBG resolution actions can be made effective in the hostjurisdiction, and ensuring adequate cooperation with host resolution authorities, especially where the subsidiary or branch is systemically important in the hostjurisdiction, though this is not situation at present.

59. Summary of recommendations:

• Amend the Liquidation Regulation to specify the desired professional qualifications of a Liquidator and to establish a presumption that NBG staff, as a general principle, have a conflict of interest and should only serve as Liquidator in extraordinary circumstances.

• Identify qualified third parties to serve as Liquidators.

• Amend the Banking Law to include legal provisions specific to voluntary liquidation and conversions of one form of regulated entity to another.

• Amend the Banking Law to update and simplify the creditor hierarchy by adopting a tiered structure that is consistent with deposit insurance coverage and by assigning the claims of a bank that lends to a liquidation estate the same priority as NBG unsecured claims.

• Adopt a rule articulating policies and procedures for use of the sale of business tool with respect to third parties.

• Adopt a regulation to require all new debt issuances to contain contractual clauses recognizing that the instrument is subject to bail-in by the NBG.

• Commission legal analyses of the likely outcomes of investor challenges to NBG bail-in decisions in relevant foreignjurisdictions and take any steps indicated to increase legal certainty.

• Clarify the rule on recapitalization by issuing new shares so it is clear the existing shareholders referred to in the rule are bailed-in creditors and not pre-resolution shareholders.

• Expand the valuation rule to make clear NBG’s expectations for the information that banks have to make available in order to enable the valuations.

• Consider the implications for the sequencing of creditor bail-in when revising the creditor hierarchy.

• Analyze and take any indicated steps to minimize uncertainty as to whether NBG’s resolution decisions will be sustained in Court.

• The RC should commission a rapid stock-taking of all banks to determine whether banks other than the SIBs should be subject to at least some form of resolution planning in 2021.

• Set MRELfor SIBs as soon as practical and leverage the first round of resolvability assessments in doing so.

• The MoF should take steps to establish, operationalize and fund a bridge bank in collaboration with the NBG.

• The RLD should place at least two valuation firms under standby contracts to enable them to initiate work within a short period of time.

• In the context of placing independent valuers under contract, solicit their feedback on the valuation rule, the guideline and the to-be-specified information requirements and make enhancements were indicated.

Deposit Insurance System

60. A Deposit Insurance System (DIS) was introduced since the prior FSAP. The Law of Georgia on the Deposit Insurance System (Dl Law), enacted in 2017, established the Deposit Insurance Agency (DIA) and the Deposit Insurance Fund (DIF). The DIA is an independent legal entity under public law that reimburses (pays out) insured deposits in the case of the failure of a bank. It is governed by a five-member Supervisory Board comprising the Minister of Finance, the NBG President, the Minister of Economy and Sustainable Development, and two independent members nominated and selected by the banks.⁹⁸ The chair of the Board rotates between the three ex officio members.⁹⁹ The Board approves the DIA’s annual budget and staffing, its investment policy, the guidelines issued by the DIA and the premium schedule. The DIA is led by the Head of the Agency recruited by the Board who is responsible for day-to-day operations. The current Head has been in their position since the inception of the DIA At present the DIA has a permanent staff complement of six,¹⁰⁰ and in addition employs five part-time specialist contractors.¹⁰¹ The DIA regularly obtains support from NBG staff. The staff of the DIA cannot be held personally liable for any actions or omissions if executed in the course of performing their duties in accordance with the law.¹⁰² The DIA is further governed by a Charter which reflects well the provisions of the Dl Law. As noted, the DIA is one of the four members of the IFSC.¹⁰³

61. Deposit insurance is triggered upon the occurrence of an Insurance Case which is the commencement of liquidation, insolvency or bankruptcy proceedings under the Banking Law.¹⁰⁴ Under the Dl Law, deposit payouts are to commence within 20 days of the occurrence of an Insurance Case.¹⁰⁵ While deposits in local and foreign currency are covered, payouts are only made in local currency¹⁰⁶ In the event of a payout, the DIA becomes the first ranked creditor in liquidation after secured creditors and the unsecured claims of the NBG, the MoF and the Resolution Fund.¹⁰⁷ Depositors have up to three years to make a deposit insurance claim.¹⁰⁸

62. The original coverage offered by the DIS has been and is further being expanded. Originally, only resident and non-resident natural persons were eligible for insurance up to GEL 5,000, covering both local and foreign currency deposits.¹⁰⁹ Coverage was increased to GEL 15,000 on July 1, 2020.¹¹⁰ A legislative amendment is pending in Parliament to extend coverage to legal persons as well.¹¹¹ Under the original arrangements around 7 percent of total deposits were insured. With the increase in coverage to GEL 15,000 around 11 percent became insured, and with the planned expansion of eligibility to legal entities, around 13 percent of total deposits will be insured.¹¹² The deposits of 97 percent of natural persons are fully insured.¹¹³

63. Banks pay regular monthly risk-based insurance premiums into the DIF. Under the Dl Law the regular monthly premium for each bank is capped at 0.067 percent of its insured local currency deposits plus 0.1 percent of its insured foreign currency deposits.¹¹⁴ Banks paid premiums at this rate from the inception of the DIF until the introduction of the higher coverage limit, at which time the premium charged on local currency deposits was reduced to 0.03 percent in order to mitigate the financial impact on banks.¹¹⁵ A risk-based methodology for computing each bank’s regular premium, subject to the cap, was mandated by the law and was implemented. Concurrently, the DIA increased the highest monthly premium for local currency deposits to 0.05 percent,¹¹⁶ though on average banks pay around 75 percent of the highest possible overall premium under the risk-based regime. Thus, there is scope to increase premiums further should, for example, the DIA perceive risks increasing.

64. Banks are potentially liable for extraordinary premiums. Extraordinary premiums may only be assessed in the event of the occurrence of an Insurance Case that causes the resources of the DIF to be insufficient to fully reimburse all insured deposits in the failed bank. Extraordinary premiums are further limited in amount to 1 percent of insured deposits in a calendar year.¹¹⁷ Extraordinary premiums are to be paid within 5 days. Should there remain a deficiency in available resources notwithstanding the aggregate extraordinary premium, the DIA would have to borrowto fund the deficiency.

65. The DIA may borrow and may benefit from a state guarantee in doing so. The DIS Law provides that the DIA may borrowfrom the NBG and MoF, among other sources.¹¹⁸ However, borrowing is authorized only when an Insurance Case causes the resources of the DIF to be insufficient to meet the payouts associated with that Insurance Case. The DIA can enter into a line of credit arrangement in anticipation of a possible need to borrow. The DIA may also borrowfrom the NBG on a fully collateralized basis, which should allow it to quickly liquify (convert to cash) its investment portfolio. The DIA should both secure a back-up funding line of credit with the MoF and enter into a framework agreement with the NBG.

66. The Dl Law establishes a 6 percent of insured deposits DIF target balance. Under the law, regular premiums must be paid until the DIF reaches the 6 percent target.¹¹⁹ There is no provision for the target balance to be adjusted. While the target is reasonable, the DIA and MoF should consider legal amendments to provide that the target balance can be adjusted by the DIA Supervisory Board, for example in case guidance on international best practices is further defined.

67. At year-end 2020 the DIF balance of GEL 60.5 million represented around 1.5 percent of insured deposits. At that level the DIA could payout the insured deposits of any but the seven largest banks (in terms of insured deposits) and could payout the six smallest banks combined. With the pending expansion of coverage eligibility to legal entities, projected total insured deposits by year-end 2021 will be approximatelyGEL4.56 billion, of which GEL466 million will be deposits of legal entities. At the current level of risk-based premiums, projected year-end 2021 DIF resources will approximate GEL 95.6 million, representing 2.1 percent of insured deposits. The DIA projects the DIF will reach the 6 percent target in 2026, assuming no occurrence of an Insurance Case in the interim and that the coverage level remains unchanged.

68. The DIA is taking steps to accelerate deposit payouts. Under the DIA Law, deposit payouts are to be made within 20 days.¹²⁰ It is completing implementation of a digital payout system that enable it to commence payouts via one or more agent banks with the seven-day internationally agreed standard.¹²¹ The payout system involves provision by banks of specified data in specified digital formats that then can be processed by the DIAs system. All banks have implemented the system and the DIA is testing the ability of the largest banks to provide accurate data in the required format in collaboration with the NBG. The DIA intends to enter into standby contracts with two agent banks that can be activated in time of need to administer payouts.¹²²

69. The DIA does not have the legal authority to transfer insured deposits to another bank nor to fund such a transfer by the liquidator. Rather, the DIA can only reimburse insured depositors. Having the ability to allow an acquiring bank to purchase the (good) assets and assume the insured deposits of a failing bank (often referred to as a purchase and assumption, or P&A, transaction) offers the benefit of eliminating the demand on DIF resources (or at least greatly reducing the demand¹²³) relative to a payout and simplifying the procedures for depositors whose insured deposits are transferred to another bank without requiring action on their part. As noted in the Failure Resolution Powers section of this Note, the power to transfer assets and liabilities to an acquiring bank is explicitly available under the liquidation legal regime. The authorities should amend the legal regime to enable the DIF to be able to fund P&A transactions in liquidation if lesser cost for the DIF.

70. The current constraints on the ability to preemptively obtain additional resources for the DIF may undermine confidence in the DIS. Under the Dl Law and DIA’s Charter, one goal of the agency is to prevent a significant outflow of deposits from other banks upon the occurrence of an Insurance Case. The inability to replenish the DIF in the absence of an actual deficiency in available resources may conflict with this goal. As noted, the constraints are the inability to require banks to make an extraordinary premium other than in a situation where a single Insurance Case requires a payout in excess of the DIF balance, and the inability to borrow except in the same circumstance. The inability to assess extraordinary premiums in an amount greater the 1 percent of insured deposits in a calendar year is a further constraint. Taken together these constraints mean that subsequent to an Insurance Case that exhausts its resources, there is no mechanism by which to replenish the DIF. A depleted DIF may raise questions regarding the system’s capacity to handle another Insurance Case (bank failure) and might lead to deposit outflows. The MoF and DIA should amend the Dl Law to allow for preemptive replenishment of the DIF.¹²⁴

71. Voluntary liquidation is construed to be an Insurance Case under the Dl Law. This derives from the absence of Banking Law provisions specific to voluntary liquidation. In principle this could allow a bank to force the DIA to initiate a payout insured deposits should the bank take action that triggers license revocation by the NBG prior to completion of a bank-led winding-up and repayment of all insured depositors. It also leads to the DIA playing a role not envisioned in its Charter in acting as an agent in the handling of unclaimed deposits in a voluntary liquidation. The NBG and MoF should amend the Banking Law to adopt provisions specific to voluntary liquidation.

72. The DIA has drafted a Crisis Management Plan. Under the DIA’s Charter it is to adopt crisis management policies, procedures and systems to ensure effective response to risks associated with the occurrence of an Insurance Case. The Crisis Management Plan is to serve that purpose. The plan should be finalized and adopted by the Supervisory Board. The Board should require that DIA management adopt a regular plan testing program in part for the purpose of further elaborating and enhancing the plan overtime. In 2021 the DIA intends to simulate a bank failure to test the functioning of the new payout MIS.

NBG Liquidity Support

73. The NBG provides secured intra-day, overnight and term loans to banks and may provide a “last resort loan.” In addition to the intraday and overnight facilities, the NBG offers standard seven-day and one-month auction-based facilities.¹²⁵ A “last resort loan” is emergency liquidity assistance (ELA).

74. The NBG has published a comprehensive Regulation of Financial Collateral Management. The regulation, last updated in December 2018, specifies the forms of collateral eligible for each of its various facilities, including ELA.¹²⁶ It specifies the means to register the pledge for all forms of assets and the procedures to foreclose upon and liquidate the assets in the event of default. Haircuts for all forms of assets are also published.

75. The 2019 amendments to the NBG Law allow the NBG to provide ELA to a bank whose solvency is in doubt, including a bank in resolution. Previously a bank was required to be solvent to be eligible, and ELA could be granted for a period not exceeding three months at an interest rate higher than the benchmark for the standard facilities.¹²⁷ The law now provides that in exceptional circumstances the NBG may provide ELA to a bank whose solvency may be in doubt, such as a bank pending resolution action or a bank undergoing resolution. The law requires the bank be deemed to be viable under a realistic time-bound restructuring, rehabilitation or resolution plan that is to be accompanied by a funding plan, and that the ELA be secured by an unconditional and irrevocable guarantee issued by the MoF, in addition to any collateral taken by the NBG.¹²⁸ The NBG has published a policies and procedures rule for all forms of ELA (ELA Rule).¹²⁹ The ELA Rule stipulates the purpose of ELA as the prevention of potential systemic problems and financial crises or minimizing their negative impacts in order to ensure financial system stability. By policy all ELA is to be provided in GEL though there is no legal restriction to lending in foreign currency. The duration of ELA to a bank whose solvency is in doubt can be extended by an additional three months. The Vice-Governor responsible to supervision initiates any request for ELA to the NBG Board, which must approve all ELA The rule should be amended to incorporate the role of the RLD and RC in initiating a request for ELA for a bank pending or undergoing resolution.

76. The MoF and the NBG have yet to agree arrangements for the execution of the MoF guarantee for NBG ELA. A formal joint agreement should be pursued. Among policy matters, the agreement should address MoF’s expectations regarding NBG collateral requirements for ELA, and the relationship of ELA financing and potential Resolution Fund liquidity financing (see next section). The agreement should define in detail the procedures for putting in place the guarantee and for calling upon the guarantee in the event of a default on the ELA and a consequent NBG loss, including the roles of both parties.

77. The NBG can lend to DIA under certain conditions.¹³⁰ Under the NBG Law lending is permitted if the DIA is facing a severe liquidity problem. The lending must be fully secured. This provision allows the NBG to liquify (convert to cash) the DIF in time of need, but no arrangements are in place at this time. As recommended above in the Deposit Insurance System section of this Note, the DIA and NBG should enter into a framework agreement for this purpose.

Temporary Public Funding

78. The 2019 amendments provide that the MoF can provide temporary public funding to support implementation of resolution actions either directly or by means of a new Resolution Fund. The MoF can deploy temporary public funding directly by means of: i) capitalizing a bridge bank; ii) acquiring the equity of a bank in resolution and/or purchasing or guaranteeing its regulatory capital instruments; oriii) providing loans, guarantees and/or financing in any other form.¹³¹ Alternatively the MoF can provide funding indirectly via the conduit of the Resolution Fund. The Fund can be used to provide: i) loans to a bank under resolution or to a bridge bank; ii) the guarantee of the liabilities of a bank under resolution or of a bridge bank; iii) contributions to close any difference between the liabilities and the assets transferred to an acquirer under the saie of business tool or a bridge bank too/;¹³² iv) contributions to absorb losses that have not been absorbed by shares or other liabilities in the use of the baii-in too/;¹³³-¹³⁴v) the payment of successful NCWO claims;¹³⁵-¹³⁶ and vi) loans or guarantees to a purchaser in the context of the saie of business tooi (including via merger). A precondition for any temporary public funding is that all shares, other regulatory capital instruments, other subordinated debt, debt with contractual write-down and conversion provisions, and any other claims of direct and indirect owners, should have fully absorbed losses to the extent of such losses.¹³⁷-¹³⁸ Before the use of temporary public funding, the NBG may require any regulatory capital instruments that were not written-off to absorb losses to be converted into common shares under terms and conditions to be determined by the NBG.¹³⁹ A request for the use of temporary public funding is to be submitted by the NBG to the MoF.¹⁴⁰

79. The Resolution Fund is ex post funded and backs topped by the banking industry.¹⁴¹ The Fund is an account at the NBG that will be funded by the MoF, and/or via grants, borrowings, or other sources as provided by the National Budget. The MoF may issue guarantees for the liabilities of the Fund.¹⁴² To the extent they are not recovered from the outcome of resolution action (e.g., from the resolved bank), any losses incurred by the Fund are to be repaid to the MoF by the banking industry, including branches of foreign banks.¹⁴³ The NBG is to manage and reporton any activities of the Fund.

80. The MoF and the NBG published a Joint Regulation guiding the use of temporary public funding and the operation of the Resolution Fund.¹⁴⁴ Although under the law the MoF has wide latitude in providing financing directly, the regulation limits the use of direct funding to the capitalization of bridge bank by policy; all of forms of financing will be channeled through the Fund. The regulation sets out the agreed content of the required written request by the NBG to the MoF for financing, including, inter alia, identification of the resolution tools to be employed, quantification of the nature and volume of necessary financial support, an assessment of the stability implications of using liquidation rather than the resolution tools, and the envisioned means of recouping the temporary public financing.¹⁴⁵ It similarly defines the information requirements necessary for the issuance of a MoF guarantee of Fund liabilities. The procedures set out in the regulation provide adequately for rapid decision making. Under the regulation, consultations to support decisions can be made directly between the MoF and the NBG, or in the forum of the IFSC.

81. The NBG Law and the Joint Regulation provide for a high degree of flexibility in bringing to bear temporary public financing to support effective use of the resolution tools, suggesting the utility of having an internal policy agreed in advance. The flexibility provided in the law is appropriate in enabling the MoF and the NBG to respond as needed to any circumstance. The regulation, which is in the public domain, usefully articulates the policy that limits MoF direct financing to the provision of capital to a bridge bank. Given the substantial latitude in law for other forms of direct financing, the MoF and NBG should consider developing an internal contingency policy framework that will help ensure a shared understanding of situations that might arise that call for possible alternative policy responses. This internal policy framework should also address the potential role of NBG ELA in resolution financing, including expectations and guidance on the use of temporary public financing via the Fund to repayany NBG ELA that might have been granted.¹⁴⁶ Having such a framework in place will help facilitate rapid decision-making in possible extraordinary circumstances.

82. The provision of temporary public funding by the MoF is subject to Parliamentary approval. The funding requires an amendment to the Annual Budget Law. The draft amendments would need to be approved by the Finance Minister, the Cabinet and the Prime Minister and then submitted by the Prime Minister to the Finance and Budgetary Committee of the Parliament. Under expedited procedures provided for in amendments to the Organic Budget Code as an element of introducing the new resolution regime, the committee has two days to discuss the draft amendment, and the full Parliament has five days within which to take a decision. It is expected the timeline can be accelerated in urgent situations. The MoF should prepare in advance templates for the documentation that would need to be provide Parliament to secure approval for the use of public funds. When the fiscal space exists, the MoF should consider providing for an explicit contingency fund for this purpose in the annual budget.

83. Summary of recommendations:

• DIA and NBG should enter into a framework agreement to be able to quickly liquify the DIF investment portfolio;

• Consider amendments to the Dl Law to provide that the DIF target balance can be adjusted by the DIA Supervisory Board.

• Amend the legal regime to provide for P&A transactions in liquidation that are funded by the DIF.

• Amend the Dl Law that allow for preemptive replenishment of the DIF.

• Amend the Banking Law to adopt provisions specific to voluntary liquidation.

• The DIAs Crisis Management Plan should be finalized and adopted by the Supervisory Board and the Board should require that DIA management adopt a regular plan testing program.

• Amend the ELA Rule to incorporate the role of the RLD and RC in initiating a request for ELAfor a bank pending or undergoing resolution.

• The MoF and the NBG should enter into an agreement regarding arrangements for the execution of the MoF guarantee for NBG ELA

• The MoF and NBG should develop a written internal policy framework addressing temporary public funding, including the use of temporary state financing to repay NBG ELA.

• The MoF should prepare in advance templates for the documentation that would need to be provide Parliament to secure approval for the use of public funds.

• The MoF should consider providing for an explicit contingency fund for temporary public funding of bank resolutions in the annual budget.