Recovery in bank failure can be seen from the perspective of the institution that needs to get its financial position above the minimum requirement for own funds and eligible liabilities, or from the perspective of the creditor who wants to secure most of his assets during resolution or liquidation. Recovery planning is done by financial institutions, encouraged by regulators and aim to tackle banking crises at an early stage, whilst promoting financial stability and confidence in the banking sector and at the same time reduce the impact of bank failure on society. For creditors of a failing bank, the objective is to safeguard their position and minimize risk.
Even though the recovery plan by the bank is focused to improve the resilience of the financial institution against a future crisis, there are also non-financial elements that can trigger the downfall of the bank. It is unlikely that a financial institution can address illicit behavior of individual staff members or where the bank is an (unwilling) participant in fraudulent activities addresses such post-hoc. Yet, alternative risk factors can result in even more devastating consequences. Examples are violations of anti-money laundering provisions, and sophisticated scams like the highly contagious Bernie Madoff Ponzi Scheme and the collapse of BCCI Bank.
Crisis management is a joint effort of banks and their regulators to protect financial stability and limit risk for creditors, stakeholders, and society. Recovery planning considers possible future events and therefore simulates unpredictable and uncertain situations. Similar strategies are used in the regulatory stress test as executed by the regulator. The recommendations from a stress test urge the relevant financial institution to act and take consecutive measures.
Creditors of a failing bank have individual motives that are in line with the credible recovery options the bank clarifies in its recovery plan. To ensure maximum recovery, creditors need to follow the different steps in the recovery procedures. During liquidation, the domestic insolvency or creditor hierarchy decides on the position of creditors when assets are realized, and liquidity paid out on a pro prate basis. This pro rata payment applies per stage in the hierarchy and therefore secured creditors are covered in full before unsecured bank deposits and subordinated claims can be paid.
To protect the position of unsecured creditors, including bank deposits, Central Banks administer a deposit guarantee scheme (DGS) protecting qualifying deposits up to 100.000 Euro. Even though the name deposit guarantee scheme assumes that all deposits are covered, there are several exclusions.
Understanding the scope and nature of protected DGS deposits, goes back to European Directives 89/646/EEC on the business of credit institutions, 91/308/EEC on the prevention of the use of the financial system for the purpose of money laundering, and 94/19/EC on deposit guarantee schemes. Following these directives, financial institutions are excluded from DGS coverage. These financial institutions are defined in points 2 to 12 of 89/646/EEC of the Annex and include, among other things activities such as lending and financing of commercial transactions (including intercompany transactions), money brokering, safekeeping and administration of securities, safe custody services, and, trading for own account or for the account of customers in money market instruments, foreign exchange, futures and options, and transferable securities. Hence creditors involved in these activities see their DGS claim rejected.