By Jacqui Hatfield, Partner, and Elizabeth McGovern, Associate, from global law firm, Reed Smith
Following the collapse of Lehman Brothers and the resultant financial crisis, the Bank of England (BOE) was given responsibility for the resolution of a failing bank, building society or investment firm (firms) pursuant to the Banking Act 2009 (the Banking Act). The EU Bank Recovery and Resolution Directive (BRRD) further extended the BOE’s responsibility to branches of firms from outside the European Economic Area.
What is Resolution?
The BOE’s resolution powers allow it – subject to making certain determinations about the solvency of a firm and the impact the insolvency could have on the financial system- to take “early and pre-emptive action” to address the potential insolvency of a firm and protect financial stability. In addition to their pre-emptive nature, the extent of these powers is also noteworthy. Failure to understand the nature and scope of the BOE’s resolution powers could catch many relevant parties off-guard and out of luck.
How is a Resolution Triggered?
Underscored by certain listed objectives, the BOE may put a firm into resolution if:
- The firm is failing or likely to fail
- It is not reasonably likely that action (other than the resolution regime) will be taken that will change this
- A resolution is in the public interest.
The European Banking Authority issued guidelines clarifying what elements should be considered when making the first determination. Itcites the following as indicative:
- Current or likely infringement of the requirements necessary for continuing authorisation by the applicable authority
- Assets are less than (or likely to be less than) liabilities
- Currently (or will likely to be) unable to pay debts and liabilities as they fall due
- A need for extraordinary public financial support.
Although (ii) and (iii) will undoubtedly be familiar to those who practice in the field of insolvency, there is an important distinction in that, unlike in the standard test for insolvency, resolution is a pre-emptive tool in the BOE’s armoury and there is no requirement that the firm be insolvent – that they are likely to be insolvent in the future is sufficient.
Another important distinction from traditional insolvency law is that (similar to Investment Bank Special Administration Regulations) the BOE has no obligation to seek consent from shareholders, creditors or existing management. Unlike administration, where some parties are notified as a matter of course before an administration is commenced, one of the keys to a successful resolution from the BOE’s perspective may be that the resolution itself comes as a surprise to those closest to the firm.
How is a Firm Resolved?
Generally speaking, a resolution is split into 3 phases: (1) stabilisation, (2) restructuring, and (3) exit, with the stabilisation phase having the biggest ramifications for all interested parties.
PHASE 1: STABILISATION
It is important to remember that financial stability underscores the BOE’s entire approach to resolution. Unlike administration, the objective is not to rescue the firm as a going-concern or ensure the best interests of the creditors are protected, although both of those may occur. The BOE’s initial focus is on avoiding excessive disruption to the wider financial system and ensuring that a firm’s existing arrangements for accessing payment systems, clearing and settlement systems and central counterparties remain intact.
Whether during a “resolution weekend” or some longer period of time, the resolution process triggers the BOE’s right (although not obligation) to use any or all of five ‘stabilisation tools’. Practically speaking, it is difficult to envisage a situation where a firm is placed into resolution without the stabilisation tools being utilised.
Notwithstanding which stabilisation tools are used, in all cases ipso facto clauses are not enforceable. Generally speaking, ipso facto clauses allow a party to a contract to call an event of default and terminate a contract upon the insolvency of its counterparty. Under the BRRD, counterparties to contracts with the firm in resolution cannot exercise contractual rights they may have to terminate their contracts early as a result of the firm going into a resolution process. To allow otherwise, according to the BOE, could result in instability. The resolution regime does recognise, however, that financial stability would be harmed if contracts that rely on netting and set-off, collateral and other capital market conditions are not protected, and those contracts should be respected within the resolution.
Of the five stabilisation tools given to the BOE, the first two involve the transfer of some or all of a firm’s critical functions, and the third involves the firm staying whole, but with new shareholders and decreased liabilities.
The three stabilisations tools which can be used in isolation or combination are:
- Sale to a private sector purchaser
- Establishment of a bridge bank with all or part of a firm’s business transferred to a subsidiary of the BOE, pending a future sale, with liabilities staying with the firm as a ‘bad bank’, to be liquidated
- A ‘bail-in’ of shareholders and unsecured creditors, where the claims of shareholders and unsecured creditors are written down and/or converted to equity in a manner that respects the priority of claims in insolvency so that the firm is balance sheet solvent.
The first two tools focus on a transfer of some or part of the firm, preferably to a third party purchaser. If a third party purchaser cannot be obtained, a bridge bank may be utilised to maintain critical economic functions. In both scenarios, certain poor quality assets and loss-bearing liabilities will likely be left with the firm in resolution (the ‘bad bank’) and dealt with through an insolvency process.
The final (and most controversial) of the three primary tools is the bail-in, whereby creditors’ claims are converted into equity as a means of recapitalising the firm and restoring it to balance sheet solvency. The interests of existing shareholders are cancelled, diluted or transferred, and the claims of unsecured creditors are written down by an amount sufficient to absorb the losses incurred with the firm in resolution continuing.
Practically speaking, in the weeks prior to the resolution weekend, the BOE would identify liabilities of the firm that would fall within the scope of its bail-in powers. During the resolution weekend, the BOE will confirm which liabilities are suitable for bail-in, and only at that time may the FCA suspend trading of those instruments. The exact value of the shares would be subject to the BOE completing a valuation to determine the final terms of the write-down.
While there are limited protections for shareholders and unsecured creditors subject to a bail-in, there is a requirement that none be in a worse position after use of the resolutions tools than if the firm had been placed into an insolvency proceeding. As such, an independent valuation of the firm will be done at the point of resolution. If this valuation shows that there is a shortfall, shareholders and/or creditors are entitled to compensation for the difference, with the payment being financed by the industry.
There are also two additional tools available to the BOE that can only be used in conjunction with one or more other stabilisation tools.
The first is the asset separation tool, which gives the BOE the right to transfer assets, rights and liabilities of a firm to an asset management vehicle (AMV). The AMV must be wholly or partially owned by the authorities and would manage the assets, with a view to maximising their value through a sale or orderly wind-down. It is only available if liquidation through a normal insolvency proceeding would adversely effect financial markets.
Finally, a firm could be put into a bank (or building society) administration procedure, after which administration would occur in the normal manner.
The Story Continues…
This legislation is new and untested. While the goal of resolution to ensure stability in the wider financial markets is commendable, it is clear that its impact will be felt beyond the firm itself and on an individual level by its management, shareholders and unsecured creditors. These parties (and those who act on their behalf) must appreciate the nature and extent of these ramifications, and should actively consider what steps they can take to mitigate or protect against these risks. Unfortunately, this may be a situation where the true implications of a resolution cannot be known until the first firm goes through it. That said, a clear understanding of the scope of the BOE’s resolution powers is essential, or relevant parties run the risk of a very unpleasant post-resolution weekend Monday morning phone call …
 The Bank of England’s approach to resolution at pg. 8, October 2014.
A quarter of banking customers noted an improvement in customer service over lockdown, research shows
SAS research reveals that banks offered an improved customer experience during lockdown
This represents some good news for banks in an extremely challenging time, with 59% of customers also saying they’d pay more to buy or use products and services from any company that provided them with a good customer experience over lockdown.
The improvement in customer experience also coincides with a rise in the number of digital customers. Since the pandemic started, the number of banking customers using a digital service or app has grown by 11%, adding to an existing 58% who were already digital customers. Over half (53%) of new users plan to continue using these digital services permanently moving forward.
Brian Holden, Director, Financial Services at SAS UK & Ireland, said:
“It’s notable that in times of need customers value being able to communicate with their bank and place an even higher value on good customer service. A rise in the number of digital customers means banks can now reach a wider audience online, leveraging AI and analytics to offer a more personalised experience.
“There is work to be done, though. Even greater personalisation is needed if banks are to win over the 12% of customers who felt banking services deteriorated over lockdown. And this personalisation will need to get right down to a segment of one to properly reflect the unique circumstances some individuals now find themselves in due to the pandemic.”
While the number of digital users grew over lockdown, there is still a quarter (24%) of the banking customer base that have chosen not to make the switch to digital services.
Meanwhile, failure to offer a consistently satisfactory customer experience could prove costly for banks, with a third (33%) of customers claiming that they would ditch a company after just one poor experience. This number jumps to 90% for between one and five poor examples of customer service, so this just underlines how much retail banks can win or lose in these difficult times.
For more insight into how other industries across EMEA performed during lockdown, download the full report: Experience 2030: Has COVID-19 created a new kind of customer?
Swedish Bank Stress Tests in Line with Recent Rating Actions
The Swedish Financial Supervisory Authority’s (FSA) latest stress test results show major Swedish banks’ robust ability to absorb credit losses. The results support Fitch Ratings’ view that short-term risks have abated in recent months, and are in line with Fitch’s assessment of major Swedish banks’ capitalisation at ‘aa-‘, which was a factor when Fitch removed the ratings of Handelsbanken, Nordea (not covered by the FSA’s stress test) and SEB from Rating Watch Negative in September.
The FSA estimated about SEK130 billion of credit losses over 2020-2022 for the three largest banks (Swedbank, Handelsbanken and SEB) under its stress test. This represents about 220bp of their loans, or about 70bp annually. However, the banks’ pre-impairment profitability in the stress test could absorb credit losses of up to about 110bp of loans annually. Fitch’s baseline expectation is for credit losses below 20bp of loans in 2020 and 8bp-12bp in 2021.
Capital remained strong under the stress test. The average common equity Tier 1 (CET1) ratio fell by only 2.8pp (1.9pp if banks did not pay dividends) from 17.6% at end-June 2020. The capital decline was not driven by credit losses, which could be absorbed by pre-impairment profitability, but by risk-weighted asset inflation.
The three banks’ 3Q20 results showed that capital has been resilient despite the coronavirus crisis. The banks had a CET1 capital surplus over regulatory minimums, including buffers, of almost SEK100 billion (excluding about SEK33 billion earmarked for dividends). SEB had a CET1 ratio of 19.4% at end-September, Handelsbanken’s was 17.8% and Swedbank’s 16.8%.
The SEK130 billion credit losses under the latest stress test are lower than under the FSA’s spring 2020 stress test (SEK145 billion), which also covered a shorter period of two years. However, they are still larger than the actual losses incurred by the three banks during the 2008-2010 crisis. This is despite tightened underwriting standards by the three banks in recent years, including, in the case of SEB and Swedbank, in the Baltics, the source of most of their loan impairment charges in the previous crisis.
In its baseline economic forecasts, the FSA assumes a harsher shock to Sweden’s GDP in 2020 and 2021 (-6.9% and 1%, respectively) than Fitch’s baseline (-4% and 3.4%), although it assumes a similar recovery by end-2022. It also assumes real estate price corrections, which appears particularly conservative in light of a 11% housing property price increase over January to November 2020.
The ratings of Handelsbanken (AA), Nordea (AA-) and SEB (AA-) are on Negative Outlook due to medium-term risks to our baseline scenario. The rating of Swedbank (A+) is on Stable Outlook, reflecting significant headroom at the current rating level following a one-notch downgrade in April due to shortcomings in anti-money laundering risk controls.
Future success for banks will be driven by balancing physical and digital services
Digital acceleration due to COVID-19 has not eliminated the need for bank branches
Faster service (23%), smaller queues (26%) and longer opening hours (31%) are among customers’ biggest asks of their bank branch, new research from Diebold Nixdorf today reveals. But with 41% consumers saying they would be comfortable to engage with all banking services via an app, it is vital that banks respond to the full spectrum of customer needs – balancing and evolving their offerings on multiple fronts.
A third (35%) of customers say they will always want access to physical, in-branch banking services in some capacity and one in ten (10%) consumers will never bank predominantly online in the future. This demonstrates that there remains an important role for the services a branch provides. This role, however, continues to shift away from purely transactional banking:
A quarter (26%) value face-to-face advice when it comes to their banking needs
One in five (18%) seek advice on different products
17% want to speak to the staff or other customers.
Matt Phillips, Diebold Nixdorf vice president, head of financial services UK & Ireland, said: “The majority of banks have spent the last decade focusing on their digital strategies and investing in improving – or establishing – their online customer experience. However, the data shows that there is still an essential role for physical branches. Banks now increasingly face the challenge of continuing to provide customers with access to a range of physical and as well as digital services, giving them the flexibility to choose the best service for them at any given moment in time.”
When looking beyond the impact of COVID-19, planned branch visits by customers are expected to rebound to 28%, following a dip to 11% during lockdown. And when asked about the new services they’d like to see inside their bank, sixteen percent of respondents said more self-service machines would improve their in-branch experience.
Matt Phillips continues: “In a world that is fast evolving and where the future is digital, there’s no doubt that high street banks must, and are, responding to the needs of highly digital customers. But not every customer requirement is digital. There is still a strong need for physical bank branches and the interaction and services they offer, and striking this balance between physical and digital is where the industry must come together to provide solutions. For example, building a strong, leave-behind strategy is something we’re seeing across the board when banks have to close branches, ensuring customers have access to self-service machines to complete all their transactional needs.”
The Coming AI Revolution
By H.P Bunaes, CEO and founder of AI Powered Banking. There is a revolution in AI coming and it’s going...
Q&A with Joe Steele, Head of Workplace Technology at Starling Bank
In just under a year, many businesses had no choice but to go online and with digital transformation on the rise...
How financial services organisations are using data to underpin future growth
By John O’Keeffe, Director of Looker EMEA at Google Cloud In addition to the turmoil caused by the COVID-19 pandemic, a...
Three questions the financial services industry must answer in 2021
Xformative, a Mastercard Start Path recipient, shares what these questions mean for fintech partners and their innovations This year, fintechs...
A quarter of banking customers noted an improvement in customer service over lockdown, research shows
SAS research reveals that banks offered an improved customer experience during lockdown A quarter (27%) of banking customers noted an...
Is Digital Transformation the Key to Business Survival in the New World?
After a turbulent year, enterprises are returning to the prospect of a new world following an unprecedented pandemic. Around the...
Virtual communications: How to handle difficult workplace conversations online
Have potentially difficult conversation at work, like discussing a pay rise, explaining deadline delays or going through performance reviews are...
Black Friday payment data reveals rapid growth of ‘pay later’ methods like Klarna
Payment processor Mollie reveals the most popular payment methods for Black Friday Mollie, one of the fastest-growing payment service providers,...
Brand guidelines: the antidote to your business’ identity crisis
By Andrew Johnson, Creative Director and Co-Founder. How well do you really know your business? Do you know which derivative of your...
COVID-19 creates long and winding road for startups seeking investment
By Jayne Chan, Head of StartmeupHK, Invest Hong Kong Countless technology and other companies describe themselves as innovators, disruptors or...