Bank resolution frameworks risk being “for the last war instead of the one that’s coming”

By Rebekah Tunstead | 16 April 2019

Bank resolution frameworks are so focused on past lessons they are failing to prepare for potential future events, according to the acting head of department of financial stability and consumer protection at the Swedish National debt office.

“To compare it to the military, there is always a risk that you are planning for the last war instead of the one that might be coming,” says Pär Holmbäck, current head of the department. “There are a number of challenges in the sense that this is a new framework. The resolution framework has only been here a few years. It is a new perspective which hadn’t been thought of previously, which requires certain things which weren’t done before in terms of extra reporting to authorities.”

“It is still rather early days some would argue. We might come out of this a few years down the line in terms of possible requirements on how banks should adapt, how they should do things in a different way? It is a bit premature to say that we know already what that might be, because the analysis is ongoing and as you know banks and financial markets are very dynamic atmosphere. The current case might not be relevant a few years down the line,” he says.

On April 15, Fernando Restoy, chairman of the financial stability institute at the Bank of International settlement told an Institute of International Finance market fragmentation roundtable in the US that “there is little international guidance” on what criteria supervisors should follow to determine Pillar 2 capital add-ons, or how these add-ons “if imposed, should interact with the new buffer requirements introduced under Basel III.”

Pillar 2 is to address any specific risks firms may have that are not adequately covered by the standardized capital requirements for banks under Pillar 1.

“While Basel III establishes uniform minimum Pillar 1 capital requirements, these are not the binding constraint for effectively required capital in most jurisdictions,” said Restoy. “Actual capital requirements are typically established by Pillar 2 capital add-ons derived from Supervisory Review and Evaluation Process analysis and/or supervisory stress tests.”

“The disparity of the criteria followed to supplement the harmonised Pillar 1 requirements implies that Basel III cannot, by itself, guarantee a complete harmonisation of actual capital obligations across jurisdictions,” he said.

On April 2, Elke Konig, chair of the Single Resolution Board told a hearing at the Economic and Monetary Affairs (ECON) committee of the European Parliament, that “where banks are not cooperating as they should, I have a clear message: the SRB will intervene if it has to. No one can avoid the task of making their bank resolvable, postponing is not an option.”

Effective resolution planning requires a change “that will be carried through forcefully by authorities and politicians alike,” says Holmbäck.

“While there are a lot of very positive upsides to this journey, it requires both politicians and policy makers to have the strength to uphold change and make sure that banks are being made resolvable, it will require adjustment of banks’ balance sheets. It will require banks to replace rather significant amounts of their senior unsecured funding with subordinated debt instead,” he says.

In April, the International Monetary Fund’s global outlook paper for 2019 stated that “regarding financial sector policies, the current risk-based approach to regulation, supervision, and resolution should be preserved (and strengthen in the case of nonbank financial institutions) to counteract vulnerabilities from weaker corporate credit underwriting standards, rising corporate leverage, and emerging cybersecurity threats.”

For Holmbäck, there are difficulties for firms regarding the level of data required under the current resolution frameworks.  

“My impression is that the granularity of data required by the resolution authority on the liability side of the bank is slightly more granular than what has been previously been collected.  Obviously, that entails some practical issues. Regarding reporting – you need to make sure the banks know what data they should be reporting, and in what format etc,” says Holmbäck.

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