When a bank fails or is likely to fail, regulators have several prudential tools for early and timely intervention to ensure public confidence and financial stability. To maintain the critical functions of the bank and minimize the negative effects to the real economy, the Central Bank can assume control and appoint an external administrator to serve the public interest and protect the position of creditors and other stakeholders. During the process of bank administration, the external administrator can limit customer withdrawals and activate the deposit protection scheme whilst inquiring for the assets and liabilities of the bank.
Financial stability is connected with public confidence in the financial system. Traditionally bank failures were caused by liquidity shortages, and closures such as the Bank of Credit and Commerce International (BCCI) in 1991 for illicit behavior was always considered an incident by the general public. Ever since money laundering received an important position on the global regulatory agenda, financial stability is considered in a broader spectrum and also includes the facilitation of financial crime and money laundering.
Even though the improved capital and liquidity requirements initiated by the Basel Accords reduced the likelihood and impact of a bank failure from the liquidity perspective, there is only limited guidance when banks fail to comply with regulation and are forcefully closed due to such violations. Early intervention by supervisory authorities, such as Central Banks, allow for swift action as soon as financial difficulties arise. To protect the public interest, the bank is placed under administration until a resolution plan is formed and approved for execution.
The EU perspective on bank recovery and resolution differentiates between banks whose existence is crucial for the economy, a systemic bank or SIFI, and financial institutions that should be held accountable for their actions towards their creditors and other stakeholders. The result is that both systemic and non-systemic banks follow a resolution process that includes a write down of assets when liquidity is insufficient to cover the full account balances. Alongside the distribution of assets, the traditional creditor hierarchy as discussed in local insolvency law prevails when the resolution, recovery or liquidation stages commence.
Both (global) systemically important financial institutions and non-systemic banks follow a legal framework where international guidelines, such as the European Bank Recovery and Resolution Directive (BRRD), the Single Resolution Board (SRB), overlap and collaborate with local bankruptcy, insolvency, and banking laws.
Administration is the first stage of the resolution and recovery processes. The administrator is appointed by the regulator and prevents the illicit outflow of suspicious deposits. This is needed to safeguard the deposits of honest customers whilst limiting withdrawals from criminal networks that can ultimately trigger liquidity shortages and a run on the bank. It is critical for creditors who want a maximum return of their assets, to comply with the earliest request of the administrator and benefit from all available recovery options.
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