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Bank Bail-in: Between Liquidity and Solvency.

I. INTRODUCTION

During the recent global financial crisis, the phrase "too big to fail" surfaced as a description of financial institutions that are so large and so interconnected with other financial institutions that their failure would threaten the very fabric of the financial markets. To avoid the demise of these institutions and the corresponding fall-out in the marketplace, many governmental regulators implemented "bailout" plans, using public funds to relieve these institutions of their financial troubles. A bailout, however, not only shifts the risk to taxpayers but it incentivizes risk-taking behavior by the private sector, a phenomenon known as "moral hazard."

Following the crisis, regulators and public policy makers worldwide have embraced, to a greater or lesser extent, the concept of "bail-in," where the institution's losses are not passed to taxpayers but to the institution's investors, depositors, and creditors, often through the restructuring of the institution's balance sheet by eliminating or converting debt. First articulated by Paul Calello and Wilson Ervin in 2010, (1) the concept of "bail-in" is the most significant regulatory achievement in the post-crisis efforts to end the problem of "too big to fail." Bail-in is the modern alternative to the traditional crisis-fighting tools described by 19th century economist Walter Bagehot. In his influential book Lombard Street, Bagehot identified two alternatives: (i) providing central bank liquidity for banks that are illiquid, and (ii) winding down insolvent ones. (2) Bail-in is the "third way" to handle a failing institution by seeking to restructure and/or self-insure banks so that a rescue with public money becomes unnecessary.

It has been eight years since the first conception of the bail-in approach. Yet it remains largely undefined. Uncertainty remains as to the scope of its regulatory objectives. There are ill-defined "triggers," establishing guidelines for when regulators should implement a bail-in. The powers of the regulators remain partial and fragmentary. The effort to find a coordinated approach among multiple nations faced with a failing global institution is nascent. Added to these uncertainties is the broad skepticism that regulators will act timely and decisively in using their bail-in powers or whether institutional reticence will rob this approach of its effectiveness. In short, serious doubts persist as to the viability of this concept.

Rather than arguing for the abandonment of the concept, this article advocates for its enhanced definition in several respects. It argues that the objective of a bail-in has evolved and should continue to evolve. Originally, it sought only to right the institution's balance sheet by shedding debt. We refer to this as the "redistributory" goal (shifting losses from taxpayers to investors and creditors). The prevailing thought at the time was that, once the institution regained solvency, it would be able to attract the necessary funds for its liquidity needs. That has not always been the case and, therefore, the goal of a bail-in should include a market stabilization purpose (to stem a panic and its attendant value-destroying runs on the institution). Thus, a bail-in can and should be applied to both insolvent and illiquid financial institutions. To meet both goals, a regulatory framework that encourages early intervention is crucial. A robust lender of last resort is also essential to provide liquidity to the restructured institution.

The remainder of this paper is structured as follows. Section II introduces the emergence and development of the bail-in concept in post-crisis regulatory thinking. Section III contrasts the bail-in approach with other resolution alternatives. It demonstrates the importance of using a bail-in to enhance market stability. This shift in focus has important ramifications for both the appropriate triggers for implementation of a bail-in and the challenge of incentivizing resolution authorities to intervene in a timely manner. Section IV makes the case for enhanced central bank involvement in the post-resolution phase to restore the institution's viability through greater liquidity.

II. RESOLUTION, BAIL-IN, AND SINGLE POINT OF ENTRY

To date, the post-crisis learning process on how to handle distressed "systemically important financial institutions" ("SIFIs") has been a play in four acts. First, the immediate post-crisis experience showed that special powers were required to orderly wind down large financial institutions because existing insolvency (or bankruptcy) laws were not adequate to the task. This was the impetus for developing "resolution" powers for state regulators, as a de facto specific bankruptcy regime for banks. (3) The second step was to equip resolution authorities with bail-in powers, enabling them to force creditors to absorb the failing institution's losses by eliminating or recharacterizing the debts as equity. The driving force behind granting regulators these powers had little to do with the specific nature of banks or the banking business. It stemmed from the political desire to end taxpayer-funded bailouts. The third phase in the post-crisis agenda was the gradual emergence of a strategy for coordinated efforts among nations using bail-in powers in a global context. International consensus has been growing in support of a "single point of entry" ("SPOE") approach, meaning that the institution's home regulator should be responsible for an international banking group at the group's holding company level. Based on this approach, the fourth phase involved the adoption of rules that guarantee the availability of sufficient "bail-in-able debt" at the holding company level. In other words, the future financial structure of these global enterprises must shift the debt to the holding company's level so that the restructuring may occur at this level and leave the more market-sensitive subsidiaries insulated from the process. Toward these ends, the Financial Stability Board ("FSB") published its final minimum total loss-absorbing capacity ("TLAC") standard for thirty banks identified as global systemically important banks ("G-Sibs") on November 9, 2015. (4) This standard will be implemented in the years 2019-2022.

A. STEP 1: RESOLUTION INSTEAD OF BANKRUPTCY

At the outset, it is important to consider why it is necessary to implement a "resolution" process instead of applying a more traditional bankruptcy alternative for banks and other financial institutions. (5) It is fair to say that a post-crisis consensus has emerged that traditional bankruptcy does not offer an appropriate legal framework for dealing with failing global financial institutions.

Bankruptcy has turned out to be too complicated and, in the context of a failing SIFI, too time consuming. In practice, this has proven to undermine market confidence and risks destabilizing the financial system. SIFIs are typically comprised of a myriad of different entities, including subsidiaries with different roles, such as retail banking units, broker dealers, asset management funds, money market funds, insurance companies, and the like. Using a traditional framework for such insolvencies would be far too complex, costly, and time-consuming. Quick, decisive action must be taken to avoid undermining market confidence, which would run the risk of destabilizing the financial system. (6)

Bankruptcy entails a court-supervised process that is designed to protect the substantive and procedural rights of all creditors, generally without regard for broader public interests. While it might stay collection and contract termination at the holding company level when the holding company files bankruptcy, it generally will not provide the same relief to the myriad of subsidiaries, many of whom are so market-sensitive that they cannot risk their own bankruptcy filings. Thus, the holding company's bankruptcy will likely trigger default provisions at the subsidiary level in various counterparty credit agreements that may permit creditors to seize collateral and may also allow non-debtor contracting parties to terminate relationships. It will also bring an abrupt halt to the trading in financial claims which are the lifeblood of a financial firm.

Because of the nature of assets and relationships in the financial sector, in the absence of immediate debtor-in-possession financing that would keep the firm afloat and guarantee its undertakings while a reorganization is negotiated, bankruptcy intervention will produce severe erosion in the franchise value of a failed financial firm and will deepen the losses for creditors. (7) The financial sector conditions that produce the bankruptcy of a large firm also make it unlikely that other financial institutions could provide such large-scale financing and guarantees; instead, they will hoard liquidity. The consequence of bankruptcy, then, is likely to be disorderly liquidation, meaning the disposition of assets at fire-sale values and a value-destructive disassembly of the firm's business. (8) If the firm is systemically important, particularly if the firm is highly interconnected with other financial firms, the abrupt cessation of counterparty relationships, the expectation of large losses, and the gyrations in asset values will likely produce widespread systemic distress, magnifying the losses that would otherwise occur. (9)

In contrast, "resolution" is an administrative process in which the goal is to protect the liquidity needs of short-term creditors, especially depositors, and to manage financial assets in a way that preserves both asset value and the franchise value of the failing institution. (10) A major objective of resolution is to avoid systemic distress in the financial sector, a social good that may not coincide with the private objective of protecting the equal treatment or absolute priority of creditor claims. (11) Along with the goal of making financial institutions more resilient is the objective of also making them resolvable without taxpayer support. This two-sided approach has been dubbed a "bookends strategy." (12)

"Resolution" itself is an umbrella term that describes the process of handling a distressed bank. Under this generic term, regulators usually employ several different tools, which vary depending on the jurisdiction. Their precise availability, scope, and triggering requirements also vary, arguably producing slightly different outcomes. Typically, resolution powers include the authority to sell or merge the bank's business with another bank, to set up a new or bridge bank to operate critical functions of the failing institution, and to separate good assets from bad ones by moving them into different institutions.

One critical element of resolution is the capacity of the administrator to offer liquidity to maintain the critical functions of the financial institution. (13) This is operationally equivalent to debtor-in-possession financing but has the advantage of assured availability in sufficient amounts at a time of systemic distress. In comparing resolution under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act" (14) with the outcome of bankruptcy, the Federal Deposit Insurance Corporation ("FDIC") projected that in the case of Lehman Brothers, a resolution would have produced losses of only three cents on the dollar versus bankruptcy losses of seventy-nine cents on the dollar. (15) While a bankruptcy filing may be "fast tracked" to move quickly, it still requires due process and the right to evidentiary hearings. While those proceedings take place, the SIFI falls into disarray in the marketplace. In a resolution process, the administrator may move immediately to right the ship.

Their precise availability, scope, and triggering requirements also vary, arguably producing slightly different outcomes. Typically, resolution powers include the authority to sell or merge the bank's business with another bank, to set up a new or bridge bank to operate critical functions of the failing institution, and to separate good assets from bad ones by moving them into different institutions.

B. STEP 2: BAIL-IN AS A TOOL IN THE RESOLUTION TOOLBOX

The most important resolution power is the authority to write down the debt of a failing institution or to convert it to equity, the so-called "bail-in" tool. The corresponding rules entitle the resolution authority to cancel or reduce liabilities to long-term creditors or to convert such liabilities partially or fully into debt or equity securities of the institution or of another entity. Such measures aim at ensuring that the shareholders and unsecured creditors of a failing financial institution are bearing the losses and are ultimately responsible for the costs of the failure--shifting the taxpayer's responsibility to the firm's investors.

Bail-in powers differ in two respects from the resolution mechanisms that were designed immediately after the crisis. First, they seek a different allocation of the financial institution's losses, protecting the taxpayer and avoiding unpopular bailouts. (16) Second, in conceptual terms, the bail-in tool is a type of reorganization procedure, as opposed to liquidation. (17) That is, its primary purpose is to keep the vital parts of a large banking group alive and running; the institution's debts are, however, markedly restructured. (18) Many positive side effects flow from this double objective. For example, the allocation of losses to creditors is said to reinvigorate regular market forces to a bank's success and failure, and to encourage greater monitoring by its creditors. (19)

Relying on this theoretical groundwork, the de facto policy starting point for baihin was the adoption of the concept in the seminal 2011 publication Key Attributes of Effective Resolution Regimes for Financial Institutions, developed by the FSB, an international institution that coordinates regulatory responses to the challenges of global financial markets. (20) The FSB has become the de facto pacemaker for international coordination in financial markets reform post crisis, and the Key Attributes publication provided the blueprint for international best practices.

In the United States, the Dodd-Frank Act granted sweeping powers for resolving SIFIs, effectively creating a separate bankruptcy process for institutions whose resolution under the traditional bankruptcy law would pose systemic concerns. The so-called Orderly Liquidation Authority ("OLA") grants a broad set of powers to the FDIC, with the overarching objective of ending public bailouts. (21) Chief among these powers are discretionary bail-in powers--section 204(a)(1) of the Dodd-Frank Act holds that creditors and shareholders are to bear all the losses of the financial company that has entered OLA. In 2013, the FDIC elaborated on its strategy for the use of these new powers and outlined its SPOE strategy. (22)

The European response appeared in the 2014 Bank Recovery and Resolution Directive ("BRRD"), an instrument seeking to harmonize resolution powers across all twenty-eight European Union ("EU") member states. (23) This is a broad framework law, setting out a common approach for dealing with failing banks, that needs to be implemented and applied by all member states. It includes detailed prescriptions on bail-in authority. (24) Any public support for failing banks is virtually excluded, unless at least a substantial portion of the losses has first been absorbed by the institution's shareholders and bondholders. (25) Specifically, within the Eurozone (those EU countries whose currency is the Euro), resolution authority has been centralized in the hands of the Single Resolution Board ("SRB"), which is responsible for handling large banks on a EU level as part of the project to create a European Banking Union. (26)

C. STEP 3: TOWARDS SINGLE POINT OF ENTRY

Despite these efforts, resolution authorities soon realized that fundamental challenges in resolving SIFIs remained. Even though resolution authors ties were entrusted with wide-ranging resolution tools, the resolution of a global bank involves substantial risks. Applying resolution powers might well disrupt the financial institution's balance sheet, which may lead to its expulsion from payment and clearing systems. Further, financial groups are usually commercially integrated, but their legal and geographical structures may not be. Resolution may thus split up the banking group along artificial lines, depriving it of access to vital resources (such as treasury functions, staff, operations, and central intellectual property and information technology resources that are organized globally). Finally, resolution action in one jurisdiction may not be recognized in another, mostly where resolution powers are applied to debt that is subject to foreign law. These recognition problems may severely hamper successful resolution. In short, the resolution of a global banking group is still perceived as fraught with many uncertainties and legal risks.

Against this backdrop, the FSB strove to develop a common international approach. In its 2013 guidance, the FSB endorsed the SPOE approach to handle global banking groups. (27) At roughly the same time, the FDIC put forward its intellectual framework for applying the new powers granted by the Dodd-Frank Act, which also championed SPOE. (28) According to this approach, the most promising strategy is to resolve the banking group at the level of its ultimate parent, rather than the distressed operating subsidiaries. Resolution powers (and, in particular, bail-in powers) would be applied at the top-tier level of a group's holding company by a single resolution authority.

SPOE has a number of distinct advantages. First, if the bail-in-able debt is at the holding company level, the financial institution, market participants, and the regulator would be aware of the potentially bail-in-able debt, which would enhance transparency and foreseeability of resolution effects. It has the added benefit of making assets across the banking group more valuable for their specific purposes. (29) Second, SPOE works much better in cross-border situations, facilitating an effective regulatory solution by one resolution authority and bundling the responsibility in one center of control. This would mitigate the cross-border recognition problem. Indeed, one of the main points of critique of the alternative "multiple point of entry" approach is that it would empower several regulators in various jurisdictions and, thus, create jurisdictional problems, frictions, and a race to grab assets for the purpose of protecting domestic creditors. (30) Finally, and most importantly, the SPOE approach ensures that the operating subsidiaries can carry on their business without fatal disruptions, destructive runs that can produce fire sale liquidations, negative asset valuation spirals, and other negative effects. Consequently, it is anticipated that a SPOE approach would lead to larger administrative savings that would lessen the overall creditor losses associated with a single resolution than in an uncoordinated resolution. This in turn will reduce the level of bail-in-able debt required to achieve systemic stability.

Given these advantages, regulators around the world have increasingly spoken out in favor of the SPOE approach. It received a major boost with the adoption of a joint-position paper by the FDIC and the Bank of England in December 2012. (31) A May 2013 report by the Bipartisan Policy Center concluded that the SPOE approach is the best strategy for dealing with a failing SIFI "without resorting to taxpayer-funded bailouts or a collapse of the financial system." (32) Since then, regulators worldwide have voiced their support, including the FSB, (33) the European Parliament, (34) regulators in Switzerland (35) and Germany, among others. (36) The strongest endorser is certainly the FDIC, which in 2013 released its substantial roadmap on SPOE within the operation of the Dodd-Frank Act, and in particular in the Title II resolution framework, OLA. (37)

One crucial requirement for SPOE to work is that the financial institutions in question must be organized in such a way as to permit debt conversion without putting core financial constituents through a bankruptcy. (38) This is very important to ensure the ongoing, undisrupted operation of vital financial activity that is organized in legally and contractually complex forms. Avoiding bankruptcy of the operating subsidiaries also facilitates resolution of banks with important cross-border activities; if the subsidiaries are not put into bankruptcy, many difficult cross-border resolution problems can be avoided. After all, the goal in the resolution of a SIFI is to minimize other-firm losses because of systemic distress, and thereby avoiding damage to the real economy. Thus, an effective central resolution mechanism would require banks to adopt these structural characteristics if they have not already done so.

One key problem is that many banking groups outside the United States are organised in a structure that does not lend itself easily to implementing an SPOE strategy. Most large U.S. financial institutions operate in a holding company structure, largely for historical reasons. (39) In contrast, European counterparts are typically organized as "universal banks" and have a complex organizational structure in which various financial services are provided by divisions of the bank or through subsidiaries of the bank. (40)

There is an ongoing debate regarding if and how European banks should be required to adopt a holding company structure to facilitate SPOE. (41) Several European regulators have begun to set incentives for this structural conversion. For example, Swiss rules on banking capital requirements lower those requirements for banks that adjust their organizational structure to make the bank more easily resolvable. This move has prompted the two Swiss SIFIs (UBS and Credit Suisse) to change their structure in a way that is very similar to the United States' holding company structure. (42) Once the new structure is in place, Credit Suisse plans to issue ample bail-in-able debt from its group holding company, in order to facilitate the SPOE approach. (43) Following new regulation in the United Kingdom, British banks are also be' ginning to issue debt at the holding company level. (44) And more recently, the Italian banking group Unicredit as well as Irish banks (Bank of Ireland and Allied Irish Banks) have announced plans to reorganize their operations in a holding structure more amenable to resolution. (45) At least in the case of the Bank of Ireland, this move was apparently required by the SRB to provide a framework for the bail-in of bondholders in the event of another financial crisis. (46)

D. STEP 4: PROVIDING SUFFICIENT BAIL-IN-ABLE DEBT

Logically, the concept of a bail-in requires that banks and other financial institutions have "something to be bailed in." In other words, there must be debts owed by the financial institution that may be cancelled or converted. In the most recent initiatives, regulators have begun to specify an array of standards requiring financial institutions to hold a certain minimum amount of debt that will be subject to bail-in powers. (47)

The European answer to this issue is the new "minimum requirement of own funds and eligible liabilities" ("MREL") for all EU banks in line with the BRRD requirements, further specified by European Banking Authority ("EBA") Regulatory Technical Standards. (48) A rival global approach has been developed by the FSB and is known as the TLAC standard. In November 2015, the FSB published its final Principles on Loss-absorbing and Recapitalisation Capacity of C-SIBs in Resolution and a related term sheet, setting out internationally agreed standards on TLAC for G-SIBs. (49) According to this standard, G-SIBs will be required to meet the TLAC requirement alongside the minimum regulatory requirements set out in the Basel III framework. Specifically, they will be required to meet a Minimum TLAC requirement of at least 16% of the resolution group's risk-weighted assets starting in 2019 and at least 18% in 2022. The firm-specific required level of TLAC will vary, depending on the particular institution, from at least 16% up to 25% of risk-weighted assets. (50) The TLAC principle however only applies to G-SIBs, whereas MREL theoretically covers all EU banks and investment firms. For European G-SIBs, MREL requirements will need to be set consistently with TLAC, and an adjustment of MREL is currently underway. (51) For U.S. financial institutions, the Federal Reserve recently adopted its own version of TLAC, which is broadly consistent with the FSB variant and it will come into force in 2019. (52) Although some differences remain, these three approaches complement one other. (53)

E. OPEN ISSUES

Even though the four steps outlined above evidence a significant intellectual development in the effort to achieve a credible resolution strategy, many issues remain unresolved.

One very problematic concern is that SPOE bail-in depends on a high degree of trust between regulators worldwide, in particular between the resolution authorities of each jurisdiction in which a global banking group has an entity, subsidiary, or assets. Some commentators are skeptical that such trust exists ex ante, and even more so that resolution authorities will honor each other's commitments by respecting their respective decisions and actions ex post. (54) Specifically, there are growing concerns that the United States authorities will respect the resolution power of foreign resolution procedures, in particular where it concerns global banking groups with a United States presence. (55) Continued regulatory dialogue through so-called international crisis management groups, which were instituted by the FSB in 2011, is necessary. (56) Some argue that regulators ultimately need to adopt binding international cooperation agreements. (57)

Some question whether the bail-in concept will work in a global systemic crisis. At best, they think it will only be effective at the individual bank crisis level (58) or in situations where the expected externalities of bank failure would be below a certain threshold. (59) It is true that bail-in will probably work best for individual bank failures, where no serious risk of contagion or sector panic exists. But bail-in should also yield good results in systemic risk scenarios, such as the one we recently experienced with the financial crisis of 2008-09. (60) Bail-in builds on the idea of self-insurance. It makes the bank's failure independent of the strength or viability of the state. The losses are allocated at the creditor level, not the state level, which should ease the need for regulators to deal with the crisis. (61) This is particularly true of the efforts to build a European Banking Union, which was precisely aimed at breaking the state-bank nexus.

A related problem concerns the degree of interconnectedness between financial firms. Traditionally, banks tend to hold a significant portion of each other's debt. Obviously, this poses the threat of rapid contagion, where the bail-in-able debt of one bank is held by another. While this is not a problem for industrial firms, the special character of financial services and interconnectedness in the financial sector means that such cross-participations could be a new source of systemic risk. The FSB identified this problem and now requires resolution authorities to use their prudential tools to restrict large banks' holdings of instruments issued by G-SIBs that are eligible to meet the TLAC requirement. (62) The Basel Committee on Banking Supervision is currently developing a regime that restricts a financial institution's ability to invest in the loss-absorbing capacity of another institution, precisely so that a shock experienced by one firm is not automatically transmitted to the other. (63)

As evidenced by the foregoing, the framework surrounding bail-in is continuously extended and refined--and every regulatory step in one direction appears to require a follow-up step in another area. (64)

III. CREDIBILITY OF THE BAIL-IN CONCEPT

While the theoretical and intellectual underpinnings of the bail-in concept have great merit, its success depends on its practical implementation and the specific design of the bail-in powers. As Mario Draghi famously calmed down the markets with one single sentence on the future strategy of the European Central Bank ("ECB"), the installation of bail-in tools must equally first and foremost send a robust signal to the markets. (65) The credibility of the bail-in strategy is paramount if it is to fulfil its purpose. Yet the legal frameworks presently in place for bail-in raise serious doubts as to whether they can accomplish their envisaged purpose. (66)

Chief among these concerns is whether a bail-in resolution will be triggered by regulators when it is most needed. Answering this question involves two separate, but related problems. First, do the legal requirements for the application of bail-in powers adequately respond to the policy objectives we seek to achieve? Second, even if the answer to the first question is yes, will regulators act on a timely basis to make use of their bail-in powers, or will other influences work against timely intervention? To address both concerns, we must harken back to the role that we envision for a bail-in. Is it merely to address the insolvency of a failing institution? Or will it also include addressing longer term liquidity needs? This and the following sections explore these issues in more detail.

A. BAIL-IN BETWEEN INSOLVENCY AND EARLY INTERVENTION

Conceptually, bail-in has changed its primary objective over the past few years. Early accounts depicted bail-in as a substitute for liquidation, receiver' ship, or bailouts, essentially addressing redistributory concerns. Early commentators characterized the purpose of bail-in as "a mechanism to return an insufficiently solvent bank to balance sheet stability," (67) placing emphasis on achieving recapitalization without recourse to taxpayer money. (68) It has been hailed as "epitomizing] the policy response to the issue of financing of resolu' tion with a view to avoiding or minimizing the problem of social costs." (69) This ex post purpose of avoiding publicly funded rescues is obviously in' tended to produce the ex ante effect of introducing market discipline and reducing the banks' moral hazard. (70)

Early in the debate, some commentators perceived bail-in as something more than just a burden-sharing strategy. Practitioners argued that bail-in is or should be an approach that lies somewhere between an early-intervention measure (such as "recovery plans") and a resolution. (71) As we shall see below, the more recent thinking clearly depicts and designs the bail-in to be an early intervention measure.

The confusion around the proper role of bail-ins originates in traditional beliefs as to how to deal with deteriorating banks. For a long time, our convictions were shaped by the so-called "Bagehot rule," relying on the seminal work by 19th century British economist Walter Bagehot. As the intellectual father of central banking, Bagehot famously instructed central banks to lend to institutions with liquidity problems (provided that they put up good collateral and pay high interest rates), but not to insolvent ones. (72) To this day, the difference between a liquidity crisis and an insolvency crisis is of vital importance to all aspects of a rescue effort. (73) Regulators and central bankers around the globe have subscribed to the policy of providing government funding to banks with perceived short-term liquidity problems, while letting insolvent institutions fail. The main justification for this approach is the risk of moral hazard. Were central banks to print money for the rescue of insolvent institutions, the argument goes, such institutions would be encouraged to take imprudent risks, knowing that the central bank would eventually come to their rescue.

This traditional dichotomy explains the confusion over the proper place for bail-in as an autonomous self-insurance mechanism. The first crisis years were still characterized by classical thinking. Since solvency was associated with taxpayer-funded bailouts, and the bail-in concept was intended to substitute for the bailout, it logically follows that the bail-in concept was associated with insolvent institutions, rather than illiquid ones. (74) According to Bagehot, intervention by the lender of last resort was the way to deal with pure liquidity shocks. (75)

Over time, thinking has shifted on the proper use of a bail-in. There is a growing acceptance that a bail-in can and should help much earlier than the insolvency stage. (76) It is increasingly viewed as a tool to overcome run risks. The recent adoption of statutory frameworks using a SPOE strategy exhibit this intellectual shift from the "redistributory" focus (investors rather than taxpayers) to a "stabilization" function, based on the understanding that a bail-in can be a powerful tool to address investor panic. (77)

The recent innovative designs of bail-in regimes reflect this shift in focus. We need only compare the development from the relatively thin outline of bail-in set forth in the Dodd-Frank Act to the detailed SPOE calibration implemented by the FDIC. (78) Arguably, this additional layer of SPOE strategy is what has made baihin fully operational and credible in the United States. (79) The support of baihin powers by structural subordination of earmarked bail-in-able debt facilitates not only the redistributory goal but is understood as avoiding destructive runs, fire sales, and contagion--in short, any transmission of shock to the real economy. (80) Long-term subordinated debt effectively insures short-term depositors.

In Europe, there is also a growing consensus that regulators need to apply their bail-in powers well in advance of the moment when the bank's problems become pressing, to avoid run risks and investor panics. (81) The initiatives that require banks or bank holding companies to maintain a certain minimum bail-in-able debt reflects this trend, as bail-in operations will be only be successful where sufficient bail-in debt is still available. Hence the international push for global standards on such requirements, culminating in the FSB's agreement on TLAC. (82)

Returning to Bagehot's dichotomy between illiquidity and insolvency, the learning process on how to apply bail-in has arguably moved from the insolvency stage to the (typically earlier) illiquidity stage, if not even earlier (see figure 1). Under Bagehot's framework, stemming the panic was an obligation of the lender of last resort, but this task has now been assigned to resolution authorities. Nowhere better can this connection be seen than in the United States, where the creation of generous bail-in powers under OLA were given to the FDIC. At the same time, legislators severely curtailed the central bank's ability to lend to troubled institutions, culminating in the adoption of new section 13(3) of the Federal Reserve Act. (83) This latter provision makes it exceedingly difficult for institutions to borrow from the Federal Reserve and would have made many actions the Federal Reserve took during the recent crisis illegal, such as the funding it provided to the multi-national insurance corporation, AIG. (84)

The expansion of the bail-in concept to include a panic fighting tool should be welcomed. For one thing, it is often difficult to distinguish a liquidity crisis from an insolvency situation. E xperts assert that insolvency and illiquidity are virtually indistinguishable during crisis times, (85) that this distinction is at least difficult to apply in practice, (86) and that illiquidity is always a manifestation of a lurking insolvency problem. (87) The difficulty in differentiating between the two is exacerbated by the fact that regulators have only limited access to current financial data on the institution. Time pressures also make a comprehensive evaluation unrealistic. (88) Consequently, the line between a temporary liquidity obstacle and a serious solvency problem is often blurred. Some commentators point out that banks typically fail due to liquidity issues, and only very rarely with respect to a full-blown solvency crisis. (89)

B. TRIGGER FOR BAIL-IN

Determining the appropriate triggers for a bail-in needs to be further defined to achieve the twin goals of redistributing losses and preventing market panics and run risks. Those advocating that the trigger should be balance sheet insolvency argue that bail-in power should be initiated at a stage when a financial institution is close to being either balance-sheet or cash-flow insolvent. The principal argument in support of this approach is that bail-in implies such a substantial interference with the rights of stakeholders that it should only be allowed when the bank is insolvent and in danger of liquidation. However, a key disadvantage to this triggering event is that it may be too late to restore the bank to viability.

For this reason, others advocate for earlier intervention, such as the initiation of official administration itself. Official administration is generally triggered by either qualitative (repeated breach of regulatory standards) or quantitative triggers, such as capital adequacy ratios falling below a certain level (e.g., below 50 percent or 75 percent of the norm). In some jurisdictions, a "public interest" finding may also be required. Pre-insolvency triggers would generally allow for a more prompt and effective response to a bank's difficulties, but they suffer from disadvantages as well. In some legal systems, the pre-insolvency triggers could raise legal questions as to the position of senior creditors relative to other stakeholders (including shareholders), official interference with contractual rights, and non-discrimination, which may require compensation to debt holders that are adversely affected.

An influential paper by the staff of the International Monetary Fund ("IMF") has argued that the optimal trigger should be "close to but before balance-sheet insolvency." (90) The trigger could be based on a combination of quantitative and qualitative assessments, such as a combination of a breach of regulatory minima (e.g., minimum capital adequacy ratio) and concerns about the distressed institution's liquidity problems. The triggers, although discretionary, should not be seen as arbitrary, which means that the resolution authority should be able to decide to initiate the process of bail-in only when the trigger criteria are met.

Real world examples of bail-in regimes provide an ambivalent picture. The statutory text appears to be undecided on the exact criteria for triggering bail-in powers, and rather provides for a number of alternatives that may equally be relied on for bail-in intervention. Whether a bank is put into resolution and whether bail-in powers are used remains a discretionary decision for the authorities under most systems. (91)

The definition of a triggering event appears very similar in both the United States and Europe, but both definitions remain vague. (92) Under Section 203(c)(4) of the Dodd-Frank Act, a financial company shall be considered to be "in default or in danger of default" (and, therefore, subject to OLA) if:

(a) a case has been, or likely will promptly be, commenced with respect to the financial company under the Bankruptcy Code;

(b) the financial company has incurred, or is likely to incur, losses that will deplete all or substantially all of its capital, and there is no reasonable prospect for the company to avoid such depletion;

(c) the assets of the financial company are, or are likely to be, less than its obligations to creditors and others; or

(d) the financial company is, or is likely to be, unable to pay its obligations (other than those subject to a bona fide dispute) in the normal course of business.

The European approach is not much different. The BRRD provides its test in article 32(4), which states:

[A]n institution shall be deemed to be failing or lively to fail in one or more of the following circumstances:

(a) the institution infringes or there are objective elements to support a determination that the institution will, in the near future, infringe the requirements for continuing authorisation in a way that would justify the with' drawal of the authorisation by the competent authority including but not limited to because the institution has incurred or is likely to incur losses that will deplete all or a significant amount of its own funds;

(b) the assets of the institution are or there are objective elements to support a determination that the assets of the institution will, in the near future, be less than its liabilities;

(c) the institution is or there are objective elements to sup' port a determination that the institution will, in the near future, be unable to pay its debts or other liabilities as they fall due;

(d) extraordinary public financial support is required except when, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, the extraordinary public financial support takes any of the following forms... (93)

Both tests include a combination of a balance sheet and a cash-flow insolvency test, combined with the careful hint ("in the near future") that ex ante measures would be permissible, without being compulsory. To be sure, the European framework pays lip service to the fact that "[t]he decision to place an entity under resolution should be taken before a financial entity is balance sheet insolvent and before all equity has been fully wiped out." (94) Legal certainty, however, remains elusive. Nor do the additional guidelines provided by EBA add significant clarification. (95) This vague test is echoed in the European Commission's explanations on the first draft of the BRRD in 2012:
   The proposal establishes [a] common parameter for triggering
   the application of resolution tools. The authorities shall
   be able to take an action when an institution is insolvent or
   very close to insolvency to the extent that if no action is
   taken the institution will be insolvent in the near future. At
   the same time, it is necessary to ensure that intrusive measures
   are triggered only when interference with the rights of
   stakeholders is justified. Therefore resolution measures
   should be implemented only if the institution is failing or
   likely to fail, and there is no other solution that would restore
   the institution within an appropriate timeframe. (96)


Reportedly, during the legislative process to draft the BRRD, the issue of the triggering moment had been one of the most controversial topics, requiring prolonged negotiations between the different lawmaking bodies and Member States. (97) A complicating factor was that the BRRD allows resolution authorities to exclude certain liabilities from the scope of baiLin in a number of circumstances, including when they fear the risk of contagion. (98) However, these exceptions might as easily be viewed as excuses for shying away from more decisive and holistic tests.

The academic debate that accompanied these early regulatory attempts weighed more heavily in favor of earlier trigger dates. An IMF team, led by Jianping Zhou, made the case for applying baiLin before balance-sheet insolvency. In 2012, some considered this to be an "extreme version" of bail-in. Other commentators viewed it as innovative. (99)

Since 2012, there is a growing consensus that bail-in powers must be applied earlier than the point of insolvency. This reflects the trend toward viewing a bail-in as a potent tool to stymie investor panics and run risks, rather than merely shifting the financial responsibility for bank failures to bondholders. The working group on bail-in at the International Capital Markets Association summarized the state-of-the-art thinking in 2014, explaining that "[regulators will want to be able to conduct an orderly bail-in or resolution well before investors start the panic." (100) In a similar vein, Larry Wall, Executive Director at the Federal Reserve, stated that timely intervention is paramount to achieve a successful baihin operation. (101)

The growing consensus in favor of earlier intervention recognizes that a bail-in can only work if sufficient bail-in-able debt is available to cover the losses. If instead the triggering moment is set too late, losses may have reached the point where the bail-in-able debt is inadequate, jeopardizing the prospect of a credible resolution. (102) To the extent that bail-in-able debt is long-term and not runnable, sufficient financial liabilities will remain that are runnable. Typically, these are the non-insured financial liabilities. (103) This, in turn, may lead to the acceleration of a downward spiral as creditors and other stakeholders lose faith in the institution and seek to withdraw their exposure, causing further liquidity problems. (104) In contrast, if an institution is resolved in a timely manner, then other investors (who are not at risk of being bailed-in) would be fully protected. In fact, this is the precise goal of the SPOE strategy: intervene at the holding company only, and let critical subsidiaries, transferred to a bridge bank, be unaffected and continue to operate normally. (105) Where this succeeds, most of these regular creditors and other stakeholders will continue normal operations with their subsidiary even if they anticipate that the banking group may soon be put into resolution. The willingness of these parties to continue their business greatly facilitates the reorganization of the failing banking group into a new, viable operation.

Thus, there is a strong case for early intervention to make maximum use of the bail-in's potential. Legislation should reflect this strategy. And the requirements for intervention should be made more concrete, while leaving the regulators with plenty of discretion to initiate resolution sooner.

C. WILL THEY INTERVENE?

Even if the standards are revised along these lines, the issue remains as to whether regulars will take timely actions to initiate resolution. Regulators have powerful incentives to delay intervention due to behavioral biases. For example, Anat Admati and Martin Hellwig assert that regulators are reticent to undertake their duties with complex international banking groups. (106) Thomas Hoenig, now vice chairman of the FDIC, stated in 2011:
   [T]here are important weaknesses with this framework. In
   particular, the final decision on solvency is not market driven but
   rests with different regulatory agencies and finally with the
   Secretary of the Treasury, which will bring political
   considerations into what should be a financial determination. (107)


While this comment was made regarding the system in the United States, it could also be used to describe the even more complicated and opaque decision-making process in Europe. (108)

Drawing from the behavioral insights offered by psychology, we can de' scribe the behavior of public authorities faced with a failing giant banking group as alternating between stages of denial and superficial bargaining, rather than decisive action. (109) Behavioral research confirms that civil servants, faced with complex decisions and unknown risks, are highly risk averse and tend to underestimate the risks. (110) Regulatory capture and cognitive biases aggravate this problem further. Following the recent crisis, the threats and risks of banking failure are still very much present, but institutional memories are already beginning to fade. The longer the time lag between the actual need to deal with a failing global SIFI and the last banking crisis, the more difficult it will be for the official in question to properly estimate the potential costs of the SIFI's failure. (111)

Early experiences under the new European framework for bank bail-ins, set forth in the BRRD, confirm a reluctance of regulators to apply the new rules. This is particularly troubling in Italy, where confidence in the strength of the banking sector has deteriorated. A number of smaller banks have been facing serious financial difficulties. Instead of applying the bail-in rules mandated by BRRD, the government designed alternative ways of dealing with them. First, the regulators placed four local lenders into resolution in November 2015, (112) before the tougher BRRD bail-in rules came in effect on January 1, 2016. (113) The regulators then relied on substantial state guarantees, rather than bail-in measures. Similarly, the Portuguese regulators forced Novo Banco, the "good bank" created out of failed lender Banco Espirito Santo, into resolution on December 29, 2015. (114) During 2016 and 2017, the high volume of non-performing loans on their balance sheets put many Italian banks under serious stress. Despite the bail-in rules now applicable, the Italian government found ways of bypassing them. It first "encouraged" a private solution, namely the creation of At las, a private bank rescue fund, which was to underwrite the capital increases of Banca Popolare di Vicenza and Veneto Banca. (115) Despite this, both banks had to be bailed out by the Italian government in 2017, after the SRB had concluded that resolution action was not warranted "in the public interest." (116) It also rescued Banca Monte dei Paschi di Siena in late 2016 via a "precautionary recapitalization," relying on a loophole in BRRD. (117) Experts were skeptical whether the requirements for recapitalization were actually carried out. (118) In sum, these few examples demonstrate the reluctance of regulators to actually apply bail-in rules over fear of imposing losses on retail investors.

There are powerful incentives that push regulators toward slow action or inaction. (119) In a complex world with many uncertainties and imponderable risks, nobody wants to be the one "beginning the war" or, more to the point, pulling the plug on a huge banking group. If the decision later turns out to have been premature, the civil servant may face liability or at least public condemnation due to hindsight. Moreover, links between powerful banks and the state are legendary: preserving banks means keeping a strong business factor, employment, and a source of local finance. (120) Where retail investors would be affected by bail-in, politicians fear public anger and backlash. (121)

All of this may account for the fact that, in the past, states have invariably resorted to bailouts rather than bail-ins, which do not involve the creditors. (122) Looking at previous banking crises, David Skeel observed that "regulators have rarely if ever intervened in a timely fashion." (123) In fact, he points out that the lack of public authority decisiveness exhibited itself as far back as the savings and loan crisis in the United States in the 1980s. (124) Consequently, lawmakers enacted the so-called "prompt corrective action" rules, requiring early regulatory intervention, precisely to solve this problem. Despite these rules, there is a great deal of room left for regulatory discretion and, therefore, the added rules did not produce a satisfactory regulatory response. (125)

In the case of bail-ins, much has been done to address these problems. The Dodd-Frank Act and the SPOE approach provide for a much more credible and realistic prospect of timely intervention than before, and international agreements on coordinated approaches are currently being developed. (126) In Europe, the emergence of the Banking Union and its federalized "Single Resolution Mechanism" have taken the decision to resolve the largest banks out of the hands of the EU Member States, hopefully overcoming most national biases and any potential for regulatory forbearance. The risk of contagion is currently being addressed with new rules that will restrict the possibility of banks holding each other's bail-in-able debt. (127)

Nevertheless, one way that lawmakers could contribute to ensure that resolution authorities intervene timely would be to clarify the bail-in triggering conditions, to make them mandatory at a certain point (while maintaining flexibility to utilize them even earlier), and to restrict any potential loopholes that remain. At present, the conditions for bail-in are all relatively vague and discretionary. More specific detail is required to reduce regulatory discretion. (128) Another avenue for improvement would be to reduce the number of regulatory agencies or bodies that are involved in the process. These steps are currently underway.

IV. PROVIDING LIQUIDITY DURING AND AFTER RESOLUTION

As we have discussed, the goals of bail-in have expanded over time. The metamorphosis is one from a purely redistributory tool that shifts the bank's loss allocation from the taxpayer to the investors, towards a solution that is capable of addressing additional goals in resolution, mostly the avoidance of market panics and run risks. The growing consensus is thus that it should not be limited to eliminating debts from the bank's balance sheet but should also include assistance with liquidity needs to prevent market panics and run risks. The argument so far has been that this refined objective of the bail-in strategy should be accompanied by earlier intervention triggers and clearer and less discretionary intervention instructions.

Although the objectives have expanded, legislators and regulators have not yet made changes to reflect this additional goal. This section considers what the changed role of bail-in means for the role of liquidity provision by the lender of last resort during and after resolution. The main argument developed here is that the re-defined objective of the bail-in strategy requires extended liquidity provision powers for lenders of last resort during and after resolution. This relies on the insight that, for bail-in to effectively address market panics, resolution authorities require significant amounts of funding at their disposal. The design of bail-in may have changed in its objective, but the possibility or the mandate of providing liquidity has not kept pace with the redefined objective.

To unpack this argument, I will first discuss the current status of liquidity provision during and post resolution. Subsequently, I will make suggestions as to how this could be improved in order for bail-in to live up to its redefined objectives.

A. EXISTING SOURCES OF FUNDING FOR LIQUIDITY PURPOSES

Liquidity is not a key priority for bail-in at present, at least not under its original design. Remember that bail-in was originally conceived as a redistribution tool that would shift the loss allocation to the bank's creditors in order to avoid taxpayer rescues.

All that bail-in accomplishes, technically, is the writing down of the firm's losses, and the conversion of long-term unsecured claims of the failed SIFI into equity in the new institution, via administrative action under law. (129) The basic philosophy of bail-in is thus that the financial firm is being recapitalized, but crucially not reliquidized. A sufficiently recapitalized firm, so the theory goes, will be able to access funding on the market. This is very much the thinking of the FDIC, which noted in its 2013 concept release on SPOE that:
   It is anticipated that funding the bridge financial company would
   initially be the top priority for its new management. In raising
   new funds the bridge would have some substantial advantages over
   its predecessor. The bridge financial company would have a strong
   balance sheet with assets significantly greater than liabilities
   since unsecured debt obligations would be left as claims in the
   receivership while all assets will be transferred. As a result, the
   FDIC expects the bridge financial company and its subsidiaries to
   be in a position to borrow from customary sources in the private
   markets in order to meet liquidity needs. (130)


In addition, the FDIC provided that a limited amount of funding would be available through the Orderly Liquidation Fund ("OLF"), if necessary, for the brief transitional period of reorganization. The FDIC can supply this temporary liquidity through: (1) a direct cash infusion from the OLF, (2) a drawdown on a Treasury line of credit, or (3) the guarantee of new debt obligations issued by the bank. (131) The FDIC has repeatedly stressed that such funding would not be loss-absorbing. In other words, it may not be used to provide capital support to the institution, but only for liquidity purposes. (132)

This liquidity could come from the central bank's published schemes, or be provided on a bilateral, individually tailored basis.

Within the EU, the issue of liquidity through a lender of last resort has not been addressed at all. Any liquidity provided from public sources would need to comply with the EU state aid framework so that any distorting of the Internal Market can be avoided. And the financial firm would be expected to make a gradual return to using private sector sources of funding, as soon as private market confidence returns.

B. THE CASE FOR LENDER OF LAST RESORT FUNDING

Theoretically, after a successful reorganization following resolution, the bank should be fully capitalized and, thus, solvent. However, there is a difference between capital and liquidity. Assets need to have real and measurable value to provide capital, but they do not have to be liquid. In other words, both liquid and illiquid assets may count as capital. Consequently, a recapitalization operation does not necessarily ensure that the institution has access to liquid assets. A recapitalized bank needs to announce a credible liquidity program by "Sunday night" of the crucial resolution weekend before markets open again on Monday morning.

Theoretically, if the market players have sufficient trust in the newly capitalized bank, the solvent institution should be able to convert any illiquid assets into cash and, thus, continue its business unaffected. However, the recent financial crisis proved that this was not a realistic expectation in the face of general market panic. Where markets become dysfunctional, even healthy and solid banks may not have sufficient liquidity from private sector sources. (133) Moreover, empirical research shows that an institution who has recently undergone resolution will still suffer from a lack of investors' short-term confidence in the bank. (134) This leads to significant outflows of deposits. Thus, there is a strong need for a robust lender of last resort to provide emergency liquidity both during and after a bank resolution process. (135)

In the United States, the OLF has access to a credit line at the Treasury, so sufficient liquidity is ensured. In other proceedings, such as under the Bankruptcy Code, the existence of a lender of last resort may prove elusive, and the ability of the Federal Reserve to provide liquidity to individual non-banking institutions has been dramatically curtailed following the implementation of the Dodd-Frank Act. (136) Commentators have severely criticized these restrictions as politically and symbolically motivated (137) and have advocated for the installation of a stronger lender of last resort in such situations. (138)

The BRRD does not mention the issue of liquidity at all, (139) but resolution funding is to be provided in the Eurozone by a Single Resolution Fund ("SRF"), which is financed by annual contributions from the banks protected by it. The SRF will be built up during a transitional period of eight years (2016-2023) and must reach at least one percent of covered deposits of all credit institutions authorized in the participating Member States, currently estimated at roughly EUR 55 billion. (140) The resolution authority would use the SRF to ensure the operation of the failing bank in the short run. The European Commission has emphasized that it is not a bailout fund designed to absorb losses. (141) It is essentially a form of self-insurance. Nevertheless, the creation of the SRF proved to be one of the most politically controversial aspects of building the Banking Union. (142)

The main problem with the SRF is that its target size of only EUR 55 billion is grossly insufficient. (143) This was even noted by the ECB itself. (144) To partially remedy this problem, the European Parliament succeeded in pushing through legislation that allows the SRF to borrow on the capital markets to augment its lending capacity. (145) Further, the Parliament pushed forward the target date for full funding to eight years instead of ten years after the SRM's coming into force by insisting on an earlier date for the mutualization of existing national resolution schemes. Despite these changes, the SRF, as it has been adopted, cannot credibly support the resolution of a SIFI. The capital market borrowing option will not work because the governments will not endorse such loans and the SRF will only be able to tap funds available through the European Stability Mechanism ("ESM") in exceptional circumstances. (146) Finally, the eight-year transition period means that the SRF will not have any clout at all during its first years. This messy arrangement does not provide a reliable lender of last resort. (147)

This is a problem that should be entrusted to the central bank. It should be empowered to provide liquidity to a bank both during and after resolution. However, driven by the desire to reduce public support for profligate banks, the Dodd-Frank Act severely curtailed the ability of the Federal Reserve to provide liquidity assistance to non-banking institutions. It imposed new restrictions in section 13(3) of the Federal Reserve Act. But this lack of flexibility for central bank funding should be reconsidered. (148) Former Federal Reserve Chairman Ben Bernanke maintains that flexibility in addressing liquidity needs was a crucial component in the successful restoration of market confidence during the recent financial crisis. (149) Moreover, the identity of a lender of last resort for financial institutions that have been recapitalized under Title I of the Dodd-Frank Act is unclear. Both issues should be ad' dressed to make the framework for failing financial institutions more robust and coherent in the United States.

In the European context, all eyes should be on the ECB to fill the gap and provide liquidity with the objective of ensuring a smooth transition of the recovered bank. (150) The ECB is the only player in the European context with access to unlimited resources and, thus, the only credible provider of a liquidity backstop. At the same time, the ECB must be prohibited from absorbing losses; what is required is quick access to liquidity without any loss-bearing obligations. The ECB should demand that the institution pledge any unencumbered assets it may have. Further, to ensure that the ECB does not incur any losses, the SRF could be redesigned to provide additional collateral to the ECB, if needed. (151) The SRF might also guarantee privately sourced provisions of liquidity.

If this is not politically feasible, another alternative would be to use the ESM as a backstop, as proposed by the French government (152) and by the IMF. (153) Originally set up as the European bailout fund to provide financial assistance in Eurozone, it responded to the sovereign debt crisis. After completion of the Banking Union, the ESM's mandate was expanded by the "Direct Recapitalisation Instrument," which allows direct lending to SIFIs under certain circumstances. (154) In this way, the ESM already plays the role of a backstop. (155) Nevertheless, ECB funding would be preferable. ESM funds are limited. The ECB's maximum lending capacity amounts to EUR 500 billion. While that is substantially more reassuring than the funding available through the SRF, it is still insufficient in a time of systemic crisis where not one but several SIFIs may be at risk simultaneously. In addition, funding from the ECB is easier to deploy than the politically-controlled ESM.

V. CONCLUSION

This article does not intend to flesh out all the necessary details for changes to the bail-in concept. Its more modest intention is to raise awareness to the need to redefine its goals and to implement changes that will make a successful resolution more feasible. As we have discussed, the goals of a bail-in have evolved over the few years since it was implemented, moving from only a "redistributory" purpose of sparing taxpayers the need to rescue banks, to include a "market stabilizing" function of stemming panics and avoiding run risks.

While this trend is to be welcomed, this new function requires a number of significant changes to the present legal frameworks that are in place in many jurisdictions. The issues to be addressed include, inter alia, formulating appropriate criteria to trigger bail-in measures and to overcome the natural reluctance by of resolution authorities to intervene and apply their bail-in powers. There is a strong case for early intervention triggers. Further, liquidity provision during and after resolution is crucial to make bail-in credible and should be provided by a robust lender of last resort.

Glossary

BRRD: The 2014 Bank Recovery and Resolution Directive of the Dodd'

Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act

EBA: European Banking Authority

ECB: The European Central Bank

ESM: European Stability Mechanism

EU: European Union

FDIC: The Federal Deposit Insurance Corporation

FSB: The Financial Stability Board

G-Sibs: Global systemically important banks

IMF: International Monetary Fund

MREL: minimum requirement of own funds and eligible liabilities

OLA: The Orderly Liquidation Authority

SIFI: systemically important financial institutions

SPOE: Single point of entry approach

SRB: Single Resolution Board

SRF: Single Resolution Fund

TLAC: total loss-absorbing capacity standard

Wolf-Georg Ringe, Professor of Law and Director of the Institute of Law & Economics, University of Hamburg, Germany; Visiting Professor, University of Oxford, UK. I am grateful for comments by Martin Oebmke, Henrik Bjerre-Nielsen, Avinash Persaud, Tim Skeet, Jeff Gordon, Martin Hellwig, Nicholas Dorn, John Crawford, Martin Brown, and participants at a Law & Finance conference at Goethe University Frankfurt, a workshop of Finance Watch in Brussels, a conference at Christ Church, Oxford University, and a Seminar on Bank Resolution at the University of Oslo.

(1) Paul Calello & Wilson Ervin, From Bail-out to Bail-in, The Economist, Jan. 28, 2010.

(2) Walter Bagehot, Lombard Street: A Description of the Money Market (1873).

(3) See Robert R. Bliss & George G. Kaufman, Resolving Insolvent Large Complex Financial Institutions: A Better Way, 128 Banking L. J. 339 (2011); Ending Government Bailouts as We Know Them (Kenneth E. Scott, George P. Shultz & John B. Taylor, eds., Hoover Press 2010); Bankruptcy Not Bailout: a Special Chapter 14 (Kenneth Scott & John B. Taylor, eds., Hoover Press 2012).

(4) See Financial Stability Board, Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution--Total Loss-absorbing Capacity (TLAC) Term Sheet (Nov. 9, 2015), http://www.fsb.org/2015/11 /total-loss-absorbing-capacity-tlac-principles-and-term-sheet/.

(5) On the difference between the SPOE strategy and bankruptcy, see Douglas G. Baird & Edward R. Morrison, Dodd-Frank for Bankruptcy Lawyers, 19 Am. Bankr. Inst. L. Rev. 287, 299-302 (2011) (comparing the chapter 11 bankruptcy process with Title II receivership under the Dodd-Frank Act); David A. Skeel, Jr., Single Point of Entry and the Bankruptcy Alternative, in Across the Great Divide: New Perspectives on the Financial Crisis 311, 321-26, 329-33 (Martin Neil Baily & John B. Taylor eds., 2014).

(6) Gary Gorton & Andrew Metrick, Regulating the Shadow Banking System, 41 Brookings Papers on Econ. Activity 261 (2010); Andrei Shleifer & Robert Vishny, Fire Sales in Finance and Macroeconomics, 25(1) J. Econ. Persp. 29 (2011).

(7) See Randall D. Guynn, Are Bailouts Inevitable?, 29 Yale J. on Reg. 121, 137-40 (2012) ("[B]ankruptcy is a slow and deliberate process that is not designed for preserving systemically important operations critical to the functioning of the economy as a whole.").

(8) The value loss includes significant social value, not just private value, because the assets commonly end up in the hands of parties who are not well positioned to maximize their value. For example, a loan officer with knowledge of the borrowers will be better positioned to manage the credit relationships than a hedge fund manager who has purchased a loan book. See Andrei Shleifer & Robert Vishny, Fire Sales in Finance and Macroeconomics, 25 J. Econ. Persp. 29, 41-43 (2011) (surveying economics literature).

(9) See Heidi Schooner & Michael W. Taylor, Global Bank Regulation: Principles and Policies 243 (2010) (noting placing large banks into an ordinary liquidation process would cause "very real economic damage").

(10) See John Armour, Maying Ban\ Resolution Credible, in Oxford Handbook of Financial Regulation 453 (Niamh Moloney et al., eds., 2015).

(11) Guynn, supra note 7, at 141 (noting that the Bankruptcy Code does not have goals of considering "public confidence or systemic risk").

(12) Paul Tucker, Regulatory Reform, Stability, and Central Banking (Hutchins Center of Fiscal and Monetary Policy at Brookings Jan. 16, 2014), http://www.brookings.edU/~/media/Research/ Files/Papers/2014/01/16%20regulatory%20reform%20stability%20central%20banking%20tucker/16%2 0regulatory%20reform%20stability%20central%20banking%20tucker.pdf.

(13) See Guynn, supra note 7, at 144.

(14) Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203,124 Stat. 1376 (2010).

(15) Press Release, Federal Deposit Insurance Corp., FDIC Report Examines How an Orderly Resolution of Lehman Brothers Could Have Been Structured Under the Dodd-Frank Act (April 11, 2011), http:// www.fdic.gov/news/news/press/2011/prl 1076.html. For a detailed analysis of the Lehman Brothers bankruptcy, see generally Michael Fleming and Asani Sarkar, The Failure Resolution of Lehman Brothers, 20 FRBNY Econ. Pol'y Rev. 175 (2014), https://www.newyorkfed.org/medialibrary/media/research/ epr/2014/1412flem.pdf. For a critical perspective, see Nicholas Dorn, Democracy and Diversity in Financial Market Regulation 47 (Abingdon: Routledge 2015).

(16) Emilios Avgouleas & Charles Goodhart, Critical Reflections on Ban\ Bail-ins, 1 J. Fin. Reg. 3, 4 (2015).

(17) Armour, supra note 10, at 471-72.

(18) In the United States, critics have argued that this character of bail-in appeared to conflict with the FDIC's mandate, granted under Title II of the Dodd-Frank Act, which is restricted to liquidation. See Joe Adler, Is the FDIC's 'Single Point' Resolution Plan a Stealth Bailout?, 178 (F348) Am. Banker 13 (Dec. 13, 2013); Who Is Too Big To Fail: Does Title II of the Dodd-Frank Act Enshrine Taxpayer-Funded Bailouts?: Hearing Before the Subcomm. on Oversight and Investigations of the Comm, on H. Financial Services, 113th Cong. 68 (2013) (written statement of David A. Skeel, Jr.), https://www.gpo.gov/fdsys/ pkg/CHRG-113hhrg81754/pdf/CHRG-113hhrg81754.pdf. More recently, see Arthur E. Wilmarth, Jr., SPOE + TLAC = More Bailouts for Wall Street, 35(3) Banking & Fin. Serv. Pol'y Rep. 1, 3 (2016).

(19) John C. Coffee, Systemic Ris\ after Dodd-Franl(: Contingent Capital and the Heed for Strategies Beyond Oversight, 111 Colum. L. Rev. 795 (2011).

(20) Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions (Oct. 2011), http://www.fsb.org/wp-content/uploads/r_111104cc.pdf. An update was published in 2014.

(21) Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corp., Presentation to Peterson Institute for International Economics: A Progress Report on the Resolution of Systemically Important Financial Institutions (May 12, 2015), https://fdic.gov/news/news/speeches/spmayl215.html. For a recent summary, see Richard W. Nelson & George G. Kaufman, Will DFA End TBTF?, 35(4) Banking & Fin. Serv. Pol'y Rep. 1, 6-9 (2016).

(22) The FDIC outlined the SPOE strategy in a request for public comments. See Federal Deposit Insurance Corp., Notice and Request for Comments, Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy, 77 Fed. Reg. 76614, 76615-24 (2013); infra Section H.3.

(23) Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, 2014 O.J. (L173/190) [hereinafter BRRD],

(24) See id., art. 43-58.

(25) See id., art. 44(5)(a). The only exceptions are precautionary recapitalisations for solvent banks, satisfying the requirements laid down in BRRD Article 32(4)(d) and recital 41, that is (a) in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, and (b) the recapitalization takes place "at prices and on terms that do not confer an advantage upon the institution." See Stefano Micossi et al., Fine-tuning the use of bail-in to promote a stronger EU financial system, (CEPS Special Report, No 136, April 2016).

(26) Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010, 2014 O.J. (L225/1) [hereinafter SRM Regulation].

(27) Financial Stability Board, Recovery and Resolution Planning for Systemically Important Financial Institutions: Guidance on Developing Effective Resolution Strategies (July 16, 2013), http://www.fsb.org/wp-content/uploads/r_1307l6b.pdf.

(28) On the SPOE approach in detail, see John F. Bovenzi, Randall D. Guynn & Thomas H. Jackson, Too Big to Fail: The Path to a Solution--A Report of the Failure Resolution Task Force of the Financial Regulatory Reform Initiative of the Bipartisan Policy Center 2332 (Bipartisan Policy Center 2013), http://bipartisanpolicy.org/wp-content/uploads/sites/default/files/ TooBigToFail.pdf. For a general account, see Randall D. Guynn, Framing the TBTF Problem: The Path to a Solution, in Across the Great Divide: New Perspectives on the Financial Crisis, Chapter 13, 281-301 (Martin Neil Baily Sc John B. Taylor, eds., 2014), available at http://www.hoover.org/sites/ default/files/across-the-great-divide-ch 13.pdf.

(29) This may be part of the explanation for why the rating of the holding company would normally not be much different from the rating of an integrated banking structure. See Scope Ratings, Holding Companies: The Right Vehicle for European Bank's SPE Resolution? (Sept. 11, 2014), http:// www.scoperatings.com/.

(30) European Parliament, Directorate General for Internal Policies, Single Resolution Mechanism--Note, at 13 (Feb. 2013), http://www.europarl.europa.eu/document/activities/cont/201302/20130214 ATT61105/20130214ATT61105EN.pdf.

(31) Fedbral Deposit Insurance Corp. & Bank of England, Resolving Globally Active, Systemically Important, Financial Institutions (Dec. 10, 2012), http://www.fdic.gov/about/srac/ 2012/gsifi.pdf. For additional United States support, see Martin J. Gruenberg, Remarks to the Volcker Alliance Program Washington, DC (Oct. 13, 2013), https://www.fdic.gov/news/news/speeches/archives / 2013/spoct 1313 .html.

(32) See Bovenzi et al., supra note 28.

(33) See Financial Stability Board, supra note 27.

(34) See European Parliament, supra note 30.

(35) Eidgenossische Finanzmarktaufsicht (FINMA), Resolution of Global Systemically Important Banks--FINMA Position Paper on Resolution of G-SIBs (Aug. 7, 2013), https://www.fin ma.ch/en/~/media/finma/dokumente/dokumentencenter/myfinma/finma-publikationen/diskussion' spapiere/diskussionspapier-20130807-sanierung'abwicklung'global'Systemrelevante'banken.pdf?la=EN.

(36) For a helpful overview, see Scope Ratings, supra note 29.

(37) See Federal Deposit Insurance Corp., supra note 15.

(38) For a more detailed discussion of this argument, see Jeffrey N. Gordon & Wolf-Georg Ringe, Ban\ Resolution in Europe: The Unfinished Agenda of Structural Reform (ECGI Working Paper Series in Law, Paper No. 282, 2015), http://ssrn.com/abstract=2 5482 51.

(39) Jeffrey N. Gordon & Wolf-Georg Ringe, Ban\ Resolution in the European Banking Union: A Transatlantic Perspective on what it Would Tafe, 115 Colum. L. Rev. 1297, 1330 (2015).

(40) On the European universal banking model, see Jordi Canals, Universal Banking: International Comparisons and Theoretical Perspectives 6-11 (1997). The typical United States "holding company" group model is not popular in Europe, see High-Level Expert Group on Reforming the Structure of the EU Banking Sector, Final Report 137 (2012), (the so-called "Liikanen Report"), http://ec.europa.eu/internal_market/bank/docs/high-level_expert_group/report_en.pdf. See also Institute of International Finance, Making Resolution Robust--Completing the Legal and Institutional Frameworks for Effective Cross-Border Resolution of Financial Institutions 52 (2012), https://www.iif.com/file/5160/download?token=TKH8xs-E (noting holding company model "is not uncommon in the United States"); Bob Penn, Single point of entry resolution: a milestone for regulators: a millstone for ban\s?, Allen & Overy, http:// www.allenovery.com/publications/en- gb/lrrfs/uk/Pages/Single-point-of-entry-resolution.aspx (last visited June 28, 2018); James R. Barth et al., Ban\ing Structure, Regulation, and Supervision in 1993 and 2013: Comparisons Across Countries and Over Time, 13 J. Int'l Bus. & L. 231, 251-54 tbl.4 (2014) (illustrating differences in bank structure across jurisdictions); James R. Barth et al., Ban\ing Structure, Regulation, and Supervision in 1993 and 2013: Comparisons Across Countries and Over Time, 13 J. Int'l Bus. & L. 231, 251-54 tbl.4 (2014) (illustrating differences in bank structure across jurisdictions); James R. Barth et al., Commercial Banking Structure, Regulation, and Performance: An International Comparison, tbl.5, 6a, 6b (Office of the Comptroller of the Currency, OCC Working Paper No. 97-6, 1997), www.occ.gov/publications/publicationsby-type/economics-working- papers/1999-1993/working-paper-1997-6.html (reviewing bank regulations across various jurisdictions); Richard J. Herring & Anthony M. Santomero, The Corporate Structure of Financial Conglomerates, 4 J. Fin. Services Res. 471, 481-89 (1990) (comparing various models of corporate structure); Richard Herring & Jacopo Carmassi, The Corporate Structure of International Financial Conglomerates: Complexity and Its Implications for Safety and Soundness, in The Oxford Handbook of Banking 195, 217-21 (Allen N. Berger et al. eds., 1st ed. 2010) (describing implications of banks' complex corporate structures for stability).

(41) See Gordon & Ringe, supra note 38; Jeffrey N. Gordon & Wolf-Georg Ringe, Ban\ Resolution in the European Banking Union: A Transatlantic Perspective on what it Would Ta\e, 115 Colum. L. Rev. 1297, 1365 (2015).

(42) James Shotter, Credit Suisse to Overhaul Structure, Fin. Times, Nov. 21, 2013, http://www.ft.com/ intl/cms/s/0/45d5a706-527d-lle3-8586-00144feabdc0.html; James Shotter, Swiss Ban\ Creditors Face Bail-in Risk, Fin. Times, Aug. 8, 2013, http://www.ft.com/intl/cms/s/0/48ab28a0-ff6e-lle2-919a 00144feab7de.html. According to rating agency Fitch, it is likely that other European banks are under pressure to follow this example. Shotter, Credit Suisse, supra; see also James Shotter, UBS Plans Dividend as Part of Overhaul to Ease a Crisis Breakup, Fin. Times, May 6, 2014, http://www.ft.com/intl/cms/s/ 0/7c5ffa50-d4d8Tle3-8f77'00144feabdc0.html ("UBS is to overhaul its legal structure to make it easier to break up the bank in a crisis, in a move designed to lower its capital requirements and enable it to pay a special dividend.").

(43) Shotter, Credit Suisse, supra note 42.

(44) Sam Fleming, Banins Address "Too Big to Fail" Question with Debt Shift, Fin. Times, Dec. 26, 2013, http://www.ft.com/ems/s/0/df877896-6c7e-1 Ie3-ad36'00144feabdc0.html.

(45) Fitch Ratings, New UniCredit Structure Would Simplify A Resolution (November 20, 2015), https://www.fitchratings.com/site/fitch'home/pressrelease?id=994472; Joe Brennan, Banks advance bond 'bail-in' plans under new European rules, The Irish Times, Feb. 3, 2017, http:// www.irishtimes.com/business/financial'Services/banks'advance'bond'bail'in'plans'Under'new'european rules-1.2962210.

(46) Ciaran Hancock, Ban/(of Ireland gets court approval to set up new holding company, The Irish Times, June 23, 2017, https://www.irishtimes.com/business/financial-services/bank-of-ireland-gets-courtapproval-to-set- up-new-holding-company-1.3131510.

(47) For a recent in-depth examination, see James McAndrews, Donald P. Morgan, Joao A. C. Santos & Tanju Yorulmater, What Maizes Large Bank Failures So Messy and What Should Be Done about It?, 20 FRBNY Econ. Pol'y Rev. 229 (2014).

(48) There is presently disagreement between EBA and the Commission on these Regulatory Technical Standards. See European Banking Authority, Opinion on the Commission's Intention to Amend the Draft Regulatory Technical Standards Specifying Criteria Relating to the Methodology for Setting Minimum Requirement for Own Funds and Eligible Liabilities According to Article 45(2) of Directive 2014/59/EU, EBA/Op/2016/02 (Feb. 9, 2016), https://www.eba.europa.eu/documents/10180/1359456/EBA-Op 2016-02+Opinion+on+RTS+on+MREL.pdf. See Christian M. Stiefmiiller, TLAC/MREL: Maying failure possible?, in FinanceWatch Policy Brief 8-9 (Mar. 2016).

(49) See Financial Stability Board, Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution--Total Loss-absorbing Capacity (TLAC) Term Sheet (Nov. 9, 2015), http://www.fsb.org/wp-content/ uploads/TL AC-Principles-and-Term-Sheet-for-publicationfinal.pdf.

(50) Id. at 13. The threshold limits were based on a calculation of losses during the recent financial crisis in an earlier consultation document. See Financial Stability Board, Memorandum to the Steering Committee, Issues for Consideration in the Development of a Proposal on Adequacy of Loss Absorbing Capacity in Resolution, SC/2013/45 Annex 26-31 (Dec. 18, 2013). Some European countries, such as France and Italy, want to limit TLAC. See Brussels under pressure to soften banrules, Fin. Times, June 2, 2016, at p. 8.

(51) The so-called "banking reform package" was proposed in November 2016. See Upcoming: Planned actions relating to Directive 2014/59/EU on ban\ recovery and resolution, European Commission, https:/ /ec.europa.eu/info/node/7782/.

(52) Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important U.S. Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations, 82 Fed. Reg. 8266 (adopted Jan. 24, 2017) (to be codified 12 C.F.R. pt. 252).

(53) Andrew Gracie, TLAC and MREL: From design to implementation, Speech at BBA loss absorbing capacity forum, London, 17 July 2015, http://www.bankofengland.co.uk/publications/Documents/ speeches/2015/speech834.pdf; see also Stiefmuller, supra note 48.

(54) Patrick Bolton & Martin Oehmke, Bank Resolution and the Structure of Global Banks (Oct. 2015) (Columbia Business School Working Paper); see also Mathias Dewatripont et al., Balancing the Banks: Global Lessons from the Financlal Crisis 122-SO (2010); Federico Lupo-Pasini & Ross P. Buckley, International Coordination in Cross-Border BanBail-ins: Problems and Prospects, 16 European Bus. Org. L. Rev. 203 (2015).

(55) Penn, supra note 40; Paul Kupiec & Peter Wallison, Can the "Single Point of Entry" strategy be used to recapitalize a systemically important failing banlf!, 20 J. Fin. Stability 184 (2015). See also Avgouleas & Goodhart, supra note 16, at 24-5.

(56) Andrew Gracie, Executive Director Resolution, Bank of England, Ending too big to fail: Getting the job done, Speech at Deloitte, London (May 26, 2016), http://www.bankofengland.co.uk/publications/ Pages/speeches/2016/912.aspx.

(57) See generally the accord between FDIC and Bank of England, Federal Deposit Insurance Corp. & Bank of England, Resolving Globally Active, Systemically Important, Financial Institutions (Dec. 10, 2012), http://www.fdic.gov/about/srac/2012/gsifi.pdf. For a skeptical perspective, see Gracie, supra note 56 ("I do not think this is necessary to ensure resolution will work effectively. There is a level of detail and complexity in the resolution plans that does not lend itself to a quasi-legal document like a [Cooperation Agreement].").

(58) Skeel, supra note 5, at 325; see also Neel Kashkari, Lessons from the Crisis: Ending Too Big to Fail, Speech at the Brookings Institution, Washington, DC (Feb. 16, 2016), https://www.minneapolisfed.org/ news-and-events/presidents-speeches/lessons-from-the-crisis-ending-too-big-to-fail; Francesco Guarascio, EU bail-in inappropriate for systemic banking crisis: Junc\er aide, Reuters, Nov. 17, 2016.

(59) Benjamin Bernard, Agostino Capponi & Joseph E. Stiglitj, Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability (NBER Working Paper No. 23747, 2017).

(60) See, e.g., Press Release, Federal Deposit Insurance Corp., FDIC Report Examines How an Orderly Resolution of Lehman Brothers Could Have Been Structured Under the Dodd-Frank Act (Apr. 11, 2011), http://www .fdic.gov/news/news/press/2011/pr11076.html.

(61) Joseph H. Sommer, Why Bail-In? And How!, 20 FRBNY Econ. Pol'y Rev. 207, 222 (2014).

(62) Financial Stability Board, supra note 49, at xii.

(63) Lucy Chennells & Venetia Wingfield, Bank failure and bail-in: an introduction, 55 Q. Bull. Bank of Eng. 228, 237 (2015).

(64) For example, once holding company restrictions are implemented, the next question will be who is left to typically hold the bail-in-able debt. Sceptics point out that, realistically, hedge funds and other professional non-bank holders are likely to hold the lion share of bail-in-able debt in the future, a scenario that many policymakers view with serious reservations.

(65) On July 25, 2012, Draghi single-handedly resolved the Eurotone sovereign debt crisis by announcing that, "[wjithin our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." Mario Draghi, President of the European Central Bank, Speech at the Global Investment Conference in London (July 26, 2012), https://www.ecb.europa.eu/press/key/date/2012/ html/spl20726.en.html.

(66) For a critical view, see Tobias Troger, Too Complex to Work: A Critical Assessment of the Bail-in Tool under the European Bank Recovery and Resolution Regime 4 J. Fin. Reg. 35 (2018).

(67) Chris Bates & Simon Gleeson, Legal aspects of banbail-ins, 5 L. & Fin. Mkt. Rev. 264 (2011).

(68) Id.

(69) Anna Gardella, Bail-in and the Financing of Resolution within the SRM Framework, in European Banking Union 373, [paragraph] 11.03 (Danny Busch & Guido Ferrarini, eds., 2015).

(70) Id. [paragraph] 11.33.

(71) Assoc, for Financial Markets in Europe, Prevention and Cure: Securing Financial Stability After the Crisis 30 (2010).

(72) See the explanations by Charles Goodhart, Myths about the lender of last resort, 2 Int'l Fin. 339 (1999).

(73) For example, the difference remains illustrative (and relevant) for exceptional public support under BRRD Article 32(4), which is only permissible when granted to solvent banks. See BRRD, supra note 23.

(74) See infra Section IV.

(75) See infra Section IV.

(76) See Avgouleas & Goodhart, supra note 16, at 10.

(77) To be sure, another aspect of market stabilization is the issue of a potential contagion between financial institutions. See supra Section II.5.

(78) See Skeel, supra note 5.

(79) Id.; see also Gordon & Ringe, supra note 41.

(80) See Gordon & Ringe, supra note 41.

(81) See Tim Skeet, Europe's bank bail-in rules change the game, Fin. Times, Sept. 11, 2014, at 30.

(82) See Financial Stability Board, Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution--Total Loss-absorbing Capacity (TLAC) Term Sheet (Nov. 9 2015), http://www.fsb.org/wp-content/uploads/TLAC-Principles-and-Term-Sheet-for-publicationfinal.pdf.

(83) The "Bailout Prevention Act" proposed in 2015 would have further restricted the Federal Reserve's emergency powers. See Bailout Prevention Act of 2015, S. 1320, 114th Cong. (2015), https:// www.congress.gov/bill/114th-congress/senate-bill/1320/text.

(84) According to Ben Bernanke, the revised section 13(3) was introduced as a quid pro quo for Title II of the Dodd-Frank Act. See Ben S. Bernanke, Warren-Vitter and the lender of last resort, Brookings (May 15, 2015), http://www.brookings.edu/blogs/ben-bernanke/posts/2015/05/15-warren-vitter-proposal.

(85) John H. Cochrane, Toward a Run-Free Financial System, in Across the Great Divide: New Perspectives on the Financial Crisis 197, 205 (Martin Neil Baily & John B. Taylor eds., 2014) ("illiquidity and insolvency are essentially indistinguishable in a crisis"); Donald Kohn, Panel Contribution, as mentioned by Simon Hilpert, Summary of the Commentary, in Across the Great Divide: New Perspectives on the Financial Crisis 370 (Martin Neil Baily & John B. Taylor eds., 2014); see also Paul Davies, Liquidity Safety Nets for BankS, 13 J. Corp. L. Stud. 287, 290-1 (2013) (describing how bank liquidity problems can readily translate into solvency problems).

(86) Xavier Freixas et al., Lender of Last Resort: What Have We Learned Since Bagehotl, 18 J. Fin. Serv. Res. 64 (2000).

(87) Charles W. Calomiris, Liquidity and the Role of the Lender of Last Resort (Brookings Institution, April 30, 2014), https://www.brookings.edu/events/liquidity-and-the-role-of-the-lender-oflast-resort/ ("So, what liquidity crises are, and always have been, is insolvency crises"); see also Joshua Mitts, Systemic Risk and Managerial Incentives in the Dodd-Fran\ Orderly Liquidation Authority, 1 J. Fin. Reg. 51, 52 (2015) (providing three examples where banks that were considered illiquid were in fact insolvent).

(88) Charles Goodhart, Myths about the Lender of Last Resort, 2 Int'l Fin. 339 (1999).

(89) Wilson Ervin, Vice Chairman, Credit Suisse, Presentation, Bail-in: Origins & Implementation (May 2015), https://www.riksgalden.se/Dokument_eng/fsnc/Presentationer/fsnc2015-wilson-ervinpresentation.pdf.

(90) Jianping Zhou, Virginia Rutledge, Wouter Bossu, Marc Dobler, Nadege Jassaud, & Michael Moore, From Bail-out to Bail-in: Mandatory Debt Restructuring of Systemic Financial Institutions, IMF Staff Discussion Note SDN/12/03, at 11 (April 24, 2012).

(91) Simon Gleeson, The Architecture of the BRRD--A UK Perspective, in European Banking Union 408, [paragraph] 12.10 (Danny Busch & Guido Ferrarini, eds., 2015).

(92) Tim Skeet, Who Will bear losses when banks go wrong: 'Bail-in' framework puts investors at risk yet much still unclear, Fin. Times, Mar. 1, 2015, at 30 ("As for the point of non-viability and where this point might be, regulators are not transparent on how they fix this. The complexity and vagueness of current proposed regulations makes its exact position, and identifying what might trigger it, hard to pinpoint. There are risks in all this").

(93) BRRD, supra note 23, at art. 32(4) (emphasis added). BRRD and SRM Regulation, supra note 26, have an almost identical approach. According to article 18 of the SRM Regulation, the conditions for resolvability under the SRM are similar to Article 32 BRRD. According to Article 5(2) and recital 18 of the SRM Regulation, EBA guidelines also apply for the SRM.

(94) SRM Regulation, supra note 26, recital 57.

(95) European Banking Authority, Guidelines on the interpretation of the different circumstances when an institution shall be considered as failing or likely to fail under Article 32(6) of Directive 2014/59/EU, EBA/GL/2015/07 (Aug. 6, 2015).

(96) Commission Proposal for a Directive of the European Parliament and the Council for establishing a framework for the recovery and resolution of credit institutions and investment firms, at 11, COM (2012) 280 final (June 6, 2012) (on article 27 of the draft BRRD, which corresponds to final article 32).

(97) Alex Barker & Peter Spiegel, ECB policy maker calls for currency bloc bank crisis plan, Fin. Times, Mar. 31, 2012, at 6; Brooke Masters, IMF looks at pros and cons of 'bail-in' regimes for banks, Fin. Times, April 25, 2012, at 8.

(98) Recital 72 of the BRRD states that:
   Resolution authorities should be able to exclude or partially
   exclude liabilities in a number of circumstances including where it
   is not possible to bail-in such liabilities within a reasonable
   timeframe, the exclusion is strictly necessary and is proportionate
   to achieving the continuity of critical functions and core business
   lines or the application of the bail-in tool to liabilities would
   cause a destruction in value such that losses borne by other
   creditors would be higher than if those liabilities were not
   excluded from bail-in. Resolution authorities should be able to
   exclude or partially exclude liabilities where necessary to avoid
   the spreading of contagion and financial instability which may
   cause serious disturbance to the economy of a Member State. When
   carrying out those assessments, resolution authorities should give
   consideration to the consequences of a potential bail-in of
   liabilities stemming from eligible deposits held by natural persons
   and micro, small and medium-sited enterprises above the coverage
   level provided for in Directive 2014/49/EU.


(99) Masters, supra note 97, quotes Barney Reynolds, partner at Shearman & Sterling: "In their view governments should step in when a bank fell short of regulatory capital requirements--rather than having to wait until a bank got to the point of actual insolvency. The authors also call for wiping out equity shareholders and limiting the ability of courts to intervene to the question of determining damages after the fact."

(100) Tim Skeet, Europe's bank bail-in rules change the game, Fin. Times, Sept. 11, 2014, at 30.

(101) Larry D. Wall, Bail-in Debt: Will the Supervisors Pull the Trigger in Time?, in Federal Reserve Bank of Atlanta, CenFIS publication (Aug. 2014), https://www.frbatlanta.org/cenfis/publications /notesfromthevault/1408.aspx.

(102) Id.

(103) This point is emphasized by McAndrews et al., supra note 47.

(104) Id.; see also McAndrews et al., supra note 47, at 243 (pointing out the run risk of holders of uninsured financial liabilities in the presence of deposit insurance. "As a result, early intervention by the regulator is even more important.").

(105) Gordon & Ringe, supra notes 38 and 39.

(106) Anat Admati & Martin FIellwig, The Bankers' New Clothes. What's Wrong With Banking and What to Do About It 77 (Princeton Univ. Press, 2013).

(107) Deniz Anginer, Written Testimony for the hearing "Examining the GAO Report on Government Support for Bank Holding Companies" before the Senate Subcommittee on Financial Institutions and Consumer Protection United States Senate (July 31, 2014), http://www.denizanginer.com/wp-content/ uploads/2014/08/Senate-Testimony.pdf; see also Editorial Comment, Still Too Big, Still Can't Fail, Wall Street J. Europe, Mar. 7, 2011, at 11. At the time, Mr Hoenig was chief executive of the Tenth District Federal Reserve Bank in Kansas City, Missouri.

(108) See, eg., Martin Hellwig, Yes Virginia, There is a European Banking Union! But It May J\pt Make Your Wishes Come True, 23 (Aug. 2014) (MPI Collective Goods Preprints No. 2014/12), http:// www.imf.org/~/media/Websites/IMF/imported'full'text'pdf/external/pubs/ft/sdn/2012/_sdnl203. ashx ("[G]iven the uncertainties about how systemically important functions are to be maintained and funded, I expect that, in a clutch, most governments will decide that it is better to avoid a resolution procedure altogether").

(109) Admati & Hellwig, supra note 106 (relying on Edward J. Kane, Missing elements in US financial reform: A Kubler-Ross interpretation of the inadequacy of the Dodd-Frank Act, 36 J. Banking & Fin. 654, 655 (2012), who in turn relies on Swiss psychiatrist Elisabeth Kubler-Ross and her 1969 book, On Death and Dying).

(110) The Behavioral Foundations of Public Policy (Eldar Shafir, ed., Princeton Univ. Press 2012).

(111) David A. Skeel, Jr., Single Point of Entry and the Bankruptcy Alternative, in Across the Great Divide: New Perspectives on the Financial Crisis (Hoover Institution Press, 2014) 311, 323; see also Kenneth Ayotte & David A. Skeel, Jr., Bankruptcy or Bailouts?, 35 J. Corp. L. 469, 497 (2010).

(112) See Banca d'Italia, Information on resolution of Banca Marche, Banca Popolare dell'Etruria e del Lazio, Cassa di Risparmio di Chieti, and Cassa di Risparmio di Ferrara crises (Nov. 22, 2015), https://www.bancaditalia.it/media/approfondimenti/2015/info-soluzione'crisi/ index.html.

(113) Rachel Sanderson & James Mackintosh, Rome Rushes Through Bank Rescues Before EU Bail-In Rules Start, Fin. Times, Nov. 24, 2015, at 6; James Politi, Bail-in tremors reverberate beyond Italy, Fin. Times, Dec. 23, 2015, at 3; Silvia Merler, Italy's Bail-in Headache, Bruegel, July 19, 2016, http:// bruegel.org/2016/07/italys-bail-in-headache/.

(114) Martin Arnold & Thomas Hale, Bondholders cry foul ova bank bail-ins, Fin. Times, Jan. 8, 2016.

(115) Rachel Sanderson & Martin Arnold, Atlas struggles to support weight of Italy's languid banks, Fin. Times, May 5, 2016, at 6; Tyler Davies, Who's afraid of the big bad bail-in?, in GlobalCapital (May 10, 2016), http://www.globalcapital.com/article/xqrdfvpwljv9/who-is-afraid-of-the-big-bad-bail-in.

(116) Single Resolution Board, The SRB will not take resolution action in relation to Banca Popolare di Vicenza and Veneto Banca (June 23, 2017), https://srb.europa.eu/en/node/341.

(117) BRRD, supra note 23, at art. 32(4)(d).

(118) Francesco Canepa & Andreas Kroner, Europe's bank rescue rule in doubt, even among enforcers, Reuters, Jan. 18, 2017, http://www.reuters.com/article/us-eurozone-banks'bailout-idUSKBNl522V2.

(119) McAndrews et al., supra note 47, at 230 ("plausibly" assume that the resolution authority "is 'slow' in the sense that it will shut down and resolve a firm only once its (book) equity capital is exhausted.").

(120) This problem has been nicely summarized by Mike Mayo, in Exile on Wall Street--One Analyst's Fight to Save the Big Banks from Themselves 148 (John Wiley, 2012) ("The pain of letting one of these institutions go under is almost always too much for politicians and our government to bear").

(121) Reportedly, a pensioner who held subordinated debt in one of the four Italian banks restructured in November 2015 committed suicide in the immediate aftermath. This episode was widely reported and created a downright hostility towards bail-in in Italy. See, e.g., Banca D'Italia, Annual Report 2015 --The Governor's Concluding Remarks 14 (May 31, 2016), https://www.bancaditalia.it/pubblica zioni/interventi-governatore/integov2016/en-cf-2015 .pdf?language_id=1.

(122) Ayotte & Skeel, supra note 111.

(123) David A Skeel, Jr., Single Point of Entry and the Bankruptcy Alternative, in Across the Great Divide: New Perspectives on the Financial Crisis 311, 323 (Martin Neil Baily & John B. Taylor, eds., Hoover Institution Press, 2014).

(124) Id.

(125) See Comments of William Lang, Office of the Comptroller of the Currency, Research Roundtable: What Can an Examination of Savings and Loans Reveal About Financial Institutions, Markets and Regulation, in The Savings and Loan Crisis: Lessons from a Regulatory Failure 340 (James R. Barth, Susanne Trimbath & Glenn Yago, eds., Kluwer Academic Publishers & Milken Institute 2004).

(126) See, for example, the accord between FDIC and Bank of England in Federal Deposit Insurance Corp. & Bank of Enlgand, Resolving Globally Active, Systemically Important, Financial Institutions (Dec. 10, 2012), http://www.fdic.gov/about/srac/2012/gsifi.pdf. The FDIC is currently negotiating with other regulators worldwide. See Bloomberg Business, FDIC's Gruenberg on Resolution Strategy for Banks, Nov. 21, 2013, http://www.bloomberg.com/video/fdic-s-gruenberg-on-resolution-strategy -forbanks-g5YN2PiESFyCrIsIuANWJQ.html (explaining ongoing international negotiations in pursuit of US-UK model).

(127) See Chennells & Wingfield, supra note 63.

(128) This is currently being implemented in Europe by way of delegated lawmaking. See, e.g., Commission Delegated Regulation (EU) 2016/860 of 4 February 2016 specifying further the circumstances where exclusion from the application of write-down or conversion powers is necessary under Article 44(3) of Directive 2014/59/EU of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms, 2016 O.J. (L144/11).

(129) See Federal Deposit Insurance Corp., supra note 22, at 76616 ("[Long-term] debt in the failed company would be converted into equity that would serve to ensure that the new operations would be well-capitalized.")

(130) Id. at 76617.

(131) See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, [section][section] 204(d), 210(n)(8)(B), 124 Stat. 1376, 1455, 1598 (2010) (codified at 12 U.S.C. [section][section] 5384(d), 5390(n)(8)(B) (2012)) (identifying how FDIC may supply "funds for the orderly liquidation of a covered financial company" and noting FDIC may issue contingent liabilities during receivership). As Bridgeco is incorporated and operated by the FDIC, these obligations are full faith and credit obligations of the United States government.

(132) Henry Engler, FDIC adds more flesh to "single point of entry" resolution plans, but questions remain, Reuters Fin. Reg. Forum (Dec. 18, 2013), http://blogs.reuters.com/financial-regulatory-forum/2013/ 12/18/ fdic-adds-more-flesh-to-single-point-of-entry-resolution-plans-but-questions-remain/.

(133) See Lucy Chennells & Venetia Wingfield, Ban\ failure and bail-in: an introduction, 55 Q. Bull. Bank of Eng. 228, 236 (2015) ("[I]t may be the case that, in the short term, a firm requires liquidity as a temporary backstop if market participants are not immediately willing to lend to it."). In fact, the need for lender of last resort functions during normal times and bank financing through discount window (Fed) or Emergency Liquidity Assistance (ECB) is proof for this proposition.

(134) Martin Brown, Ioanna S. Evangelou & Helmut Stix, Banking Crises, Bail-ins and Money Holdings (Central Bank of Cyprus Working Paper 2017-2, 2017), https://ssrn.com/abstract=3102815.

(135) Id.

(136) See Federal Reserve Act, Pub. L. No. 63-43, [section] 13(3) (1913) (codified as amended at 12 U.S.C. [section] 343 (2012)).

(137) See, e.g., Peter R. Fisher, Mistakes Made and Lessons (Being) Learned--implications for the Fed's Mandate, in Across the Great Divide: New Perspectives on the Financial Crisis 127,131 (Martin Neil Baily & John B. Taylor eds., 2014).

(138) Randall D. Guynn, panel contribution to Liquidity and the Role of the Lender of Last Resort, Brookings Institution (April 30, 2014), https://www.brookings.edu/events/liquidity-and-the-role-of-the-lenderof-last-resort/.

(139) Hellwig, supra note 108, at 20.

(140) Press Release, Single Resolution Board, Banking Union--Single Resolution Board fully operational as of 1 Jan. 2016 (Nov. 30, 2015), http://srb.europa.eu/docs/20151130-press-release_en.pdf. On the target level of the SRF, see SRM Regulation, supra note 26, at recital 105. However, the Commission will decide whether a percentage of total liabilities of financial institutions would be "a more appropriate basis." Id.

(141) Commission Proposal for a Regulation of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) Ho. 1093/2010 of the European Parliament and the Council, at 13, COM (2013) 520 final (July 10, 2013).

(142) For more detail, see Gordon & Ringe, supra note 39, at 1347. See, eg., Benjamin Fox, Bntssels on Collision Course with Germany on Banking Union, EU Observer, July 10, 2013, https://euobserver.com/ economic/120822 ("Just as controversial is the concept of a single bank resolution fund ...").

(143) See, e.g., Hellwig, supra note 108, at 19. Mark Wall, Deutsche Bank's chief Eurozone economist, and academic economist Paul De Grauwe have both considered the Fund insufficient. See eg., John O'Donnell & Tom Korkemeier, Europe Strides Deal to Complete Banking Union, Reuters, Mar. 20, 2014, http:// uk.reuters.com/article/2014/03/20/uk-eu-bankingunion-idUKBREA2J0IW20140320. For a more optimistic view, see Thomas Huertas 8c Maria J. Nieto, How much is enough? The case of the Resolution Fund in Europe, Vox CEPR Policy Portal (Mar. 18, 204), http://www.voxeu.org/article/ensuring-europeanresolution-fund-large- enough; Willem Pieter De Groen & Daniel Gros, Estimating the Bridge Financing Heeds of the Single Resolution Fund: How expensive is it to resolve a banfe, CEPS Special Report No. 122 (Nov. 2015).

(144) See John O'Donnell & Tom Korkemeier, Europe Strifes Deal to Complete Banking Union Reuters, Mar. 20, 2014, http://uk.reuters.com/article/2014/03/20/uk-eu-bankingunion-idUK BREA2J0IW20140320 (noting ECB's view).

(145) See SRM Regulation, supra note 26, art. 74, at 79 ("The Board shall contract for the Fund financial arrangements, including, where possible, public financial arrangements ...."); see also European Parliament Press Release 11:12, Parliament Negotiators Rescue Seriously Damaged Bank Resolution System, at 1 (Mar. 20, 2014), http://www.europarl.europa.eu/pdfs/news/expert/infopress/20140319lPR39310/ 20140319lPR39310_en.pdf ("[A] system will be established, before the regulation enters into force, which will enable the bank-financed single resolution fund to borrow.").

(146) See European Council, Statement of Eurogroup and ECOFIN Ministers on the SRM Backstop (Dec. 18, 2013), http://www.eurozone.europa.eu/media/502738/20131218-SRMbackstop-statement.pdf ("In the transition period, bridge financing will be available either from national sources, backed by bank levies, or from the ESM in line with agreed procedures.").

(147) Benjamin Fox, Eurozone ban\fund needs credit line, Draghi says, EU Observer, Sept. 24, 2013, https://euobserver.com/economic/121545.

(148) Kohn, supra note 85.

(149) Bernanke, supra note 84

(150) For a discussion of this argument in a different context, see Gordon & Ringe, supra note 39, at 1354. There is nothing in the BRRD or the SRM Regulation that would rule out provision of liquidity by the central bank in the event of resolution.

(151) See Huertas & Nieto, supra note 143.

(152) Jim Brunsden, A Franco-German Amsterdam clash on banking union music, FT Brussels Blog (Apr. 22, 2016), https://next.ft.com/content/3a8609b2-771b-34d9-b5e3-49f7a42fe41d.

(153) IMF, Euro Area Policies: 2016 Article IV Consultation, IMF Country Report No. 16/219 (July 2016).

(154) Press Release, European Stability Mechanism, ESM direct bank recapitalisation instrument adopted (Dec. 8, 2014), http://www.esm.europa.eu/press/releases/esin-direct-bank-recapitalisation-instrumentadopted.htm? lang=en; see also European Stability Mechanism, FAQ on the ESM direct recapitalisation instrument, http://www.esm.europa.eu/pdf/2014T2'08%20FAQ%20DRI.pdf.

(155) However, at present, DRI funding is subject to a number of requirements, which may need to be reconsidered for the purposes proposed here. See Christos Hadjiemmanuil, Bank Resolution Financing in the Banking Union, at 30 (June 2015) (LSE Law, Society and Economy Working Papers), https:// www.lse.ac.uk/collections/law/wps/WPS2015-06_Hadjiemmanuil.pdf.

Caption: Figure 1. Bail-in in the context of insolvency and illiquidity.
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Author:Ringe, Wolf-Georg
Publication:American Bankruptcy Law Journal
Date:Jun 22, 2018
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