Resolution of cross-border banks

Dirk Schoenmaker (Bruegel, RSM)

FINSAC Bank Resolution ConferenceVienna, 12 December 2016

Outline

• FINSAC Guidebook and Case Studies

• Need for fiscal backstop -> how for cross-border banks?

• Theory: Equilibria of international banking

• EU institutional set-up: Banking Union and beyond

• Policy conclusions – need for burden sharing!

FINSAC Guidebook + Case Studies

FINSAC Guidebook• Very useful translation of legal texts to practical guidelines• Ch 5 + 10 touch on cross-border cooperation:

‘Resolution colleges are expected to reach a joint decision’• But what are the requirements or incentives?

Case Studies• Extremely useful to show that resolution and bail-in is possible• Often combination: SNS in Neth. -> bail-in + nationalisation• Joint-Vienna Initiative case during crisis should be added

4

Reform after crisis

• Much has been done:More capital, including systemic surcharge G-SIBsKey principles for resolution of international banks, but soft lawBail-in: yes for idiosyncratic failures, but for large systemic banks?

• We take the presence of large banks as given Still need for fiscal backstop for (large) banks

• How to solve coordination failure in resolution of cross-border banks? Hard law: ex ante binding ‘burden sharing’ agreement to organise

fiscal backstop

5

Financial trilemma

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Equilibrium A. of financial trilemma

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A. Multinational banks with national subs

• Idea:National subs are separately capitalised and managedNational authorities resolve separately: MPE (multiple point of entry)

• But is this equilibrium viable?Synergies from centralised risk management + 1 brand name Legal firewalls cannot prevent indirect contagionEmpirics: correlation default risk parent and sub is 0.2 / 0.3

• Long run equilibriumTruly stand alone: increasingly high ring-fencing requirements No incentives for national authorities to cooperate

8

Equilibrium B. of financial trilemma

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B. Global banks from large countries

• Fiscal capacity:Small and medium countries cannot support large banks: downsizingOnly large countries can afford and follow SPE (single point of entry)

• But what about foreign retail branches?Home country (and parent bank) may choose to support, or not Incentive host countries to ring-fence -> equilibrium A. (with MPE)

• Long run equilibriumGeopolitics and powerplay: US + China may impose their modelNevertheless, host countries may not accept unilateral approach

10

Equilibrium C. of financial trilemma

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C. Global banks with burden sharing

• Idea:Give up on national policies: joint supervision + burden sharing for

resolution based on hard lawFacilitates SPE (single point of entry)

• Technically easy, but politically difficultTightly connected group of countries: Banking UnionAd hoc (e.g. Joint Vienna) may work if all interests are aligned, but

you cannot count on it

• Long run equilibriumRegional groupings (beyond euro area?)

EU institutional set up

I. Single Resolution Board (SRB) and National Resolution Authorities (NRAs) work together in Banking Union Is resolution supra -national or national? Potential government support and ELA are still national -> conflicts

remain possible ESM as fiscal backstop?

II. EU countries outside euro -area - options Join Banking Union: both supervision and resolution In addition to Intra -Group Financial Support Agreements, burden

sharing between countries in resolution plan (Avgouleas et al, 2013) Or, ring-fencing of national subsidiaries (arms race)

13

ESM as fiscal backstop

Shifting goal posts• In 2012 - direct bank recap to break ‘sovereign nexus’• If bank rescues, then banking supervision needed -> Banking Union• In 2014 - backtracking: one of building blocks• Indirect recapitalisation (Art 15 ESM Treaty) via country not sufficient

ESM Direct Recapitalisation Instrument (DRI) – conditions:• Member’s fiscal sustainability in danger• Own contribution of member• Bail-in of 8% of bank’s total liabilities• Unanimity of votes -> protracted negotiations with uncertain outcome Prohibitive -> no credible fiscal backstop

Conclusions

• International financial stability remains elusive

• Soft law approach (‘expected to reach a joint decision’) will not solve problem

• Burden sharing based on hard law needed to solve coordination failure

• ESM is on its way as fiscal backstop for euro area banksCommon backstop to Single Deposit Insurance and Resolution Fund Improve direct recapitalisation instrumentPart of broader risk sharing and risk reduction agenda

References

• Avgouleas, E., C. Goodhart and D. Schoenmaker (2013), ‘Bank Resolution Plans as a Catalyst for Global Financial Reform’, Journal of Financial Stability, 9, 210-218.

• Schoenmaker, D. (2016), ‘Resolution of International Banks: Can Smaller Countries Cope?’, CEPR Discussion Paper 11600.

• Schoenmaker, D. (2016), ‘The impact of the legal and operational structures of euro-area banks on their resolvability’, Policy Contribution Issue no 23, Bruegel.