The Single Resolution Mechanism: Requirements, Instruments, and Experiences

12 November 2015

On 9 November, Ulf Bachmann from the First Winding-up Agency (Erste Abwicklungsanstalt) and Karsten Paetzmann from BDO gave a talk at the CFS lecture series “Risk and Regulation”. They talked about the Single Resolution Mechanism (SRM) which is part of the European Banking Union and will be responsible for restructuring and resolution of large European banks from the beginning of 2016.

The objective of the SRM is to reduce the probability that public money has to be spent for future bank resolutions, Paetzmann explained. This aim has already partly been achieved with the Bank Recovery and Resolution Directive (BRRD) which came into force in 2014. The directive harmonized the instruments for bank restructuring and resolution within the EU. It is based on the bail-in principle and provides for the establishment of national resolution funds. According to Paetzmann, the SRM goes beyond the BRRD. It wants to secure an effective cross-border resolution of financial institutions in the EU and aims at establishing a joint Single Resolution Fund (SRF).

According to the BRRD, three conditions must be satisfied in order to initiate a winding-up procedure: the institution is failing or likely to fail; there is no reasonable prospect that any alternative private sector or supervisory action would prevent the failure of the institution within a reasonable timeframe; and the resolution is in the public interest, i.e. no creditor will be worse off than under normal insolvency proceedings. There are different ways to implement a bank resolution, Paetzmann said. For example, shares, assets, rights, or liabilities from a bank under resolution can be transferred to a purchaser on commercial terms; or can temporarily be transferred to a bridge institution which is publicly owned and controlled by the resolution authority; or can be transferred to a bad bank in order to ultimately sale or wind-down the shares, assets, rights, and liabilities.

Ulf Bachmann explained that the establishment of an external bad bank has many advantages. For example, the financial institution under resolution can increase its profitability if it separates from certain assets and, thus, regains the trust of investors, rating agencies and regulatory authorities. However, Bachmann also mentioned some disadvantages of this solution. He pointed to the fact that the establishment of a bad bank is very costly, for instance because assets have to be transferred to the new institution and new employees have to be hired. Besides, the valuation of the assets to be transferred is often difficult and, in certain cases, customers have to agree that their assets will be transferred to another entity.