Resolution plans define the preventive measures suggested by a financial institution to combat failure. The plan is composed by the bank itself post-hoc and thus before the critical event of bank closure takes place. Even though there is a close connection between the bank creating the resolution plan and the regulator, there are still parts of the banks activities that stay untouched since resolution plans focus on liquidity and other capital shortages. Regulatory violations and illegal activities of the bank are outside the scope of a regular resolution plan indicated by the bank. Yet, regulators and Central Banks have several tools to intervene and protect the public interest.
The public interest doctrine prevails to avoid that excessive risk taking and moral hazard triggers rescue missions at the expense of tax payers. Therefore resolution authorities have a mandate to intervene in an operating business, even when there are no signs of liquidity and capital shortages or other prudential indicators. The result is that both traditional bank failures and unconventional closures allow for intervention.
The outcome of a resolution plan leads to recapitalization or the liquidation of the bank. Capital adequacy criteria determine the minimum requirement for own funds and eligible liabilities (MREL). When the minimum capital level of the total risk exposure amount is below 8%, the financial institution loses its viability and must be shut down and thus liquidated. Via a liquidation assessment, the resolution authority can deviate from the minimal capital level to a level where they deem the sustainability of market confidence fit, as well as ensuring the continued provision of the critical economic functions of the financial institution. However, such exceptions only apply to financial institutions eligible for a continuation of the activities.
Upon the resolution decision, the authority can decide, based on the structure, business model and MREL position, to strategize the resolution process as a single point of entry (SPE), or a multiple points of entry (MPE) approach. The SPE requires the holding company to absorb the losses of the subsidiaries or branch(es), whilst assuming a subordinated position of the intragroup liabilities. The result is that losses are initially taken by the holding company and where such is impossible, will be written down or converted. An MPE approach differentiates between individual subgroups, business units, and branches. Therefore, resolution and liquidation takes place in an isolated environment.
In complex cross-border bank failure, different legal systems and variations in local regulation can delay swift resolution. Disputes between different jurisdictions on the leading position in bank resolution or liquidation can be resolved, under the strict exception that the dispute does not relate to fiscal responsibilities of one of the states involved, by mandatory and binding Mediation at the European Banking Authority (EBA).
Liquidation assessments take the NCWOL principle into account when the preferred resolution strategy is decided. Under this assessment no creditor should be worse off than in liquidation. The objective of resolution is to simplify, accelerate and protect a fair and stable process.
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