Memorandum submitted by the
1 The Bank of
The Special Resolution Regime
2 The Special Resolution Regime (SRR) for
failing banks is at the heart of the Bill (Parts 1-3). The
3 The SRR can be triggered only if two conditions are satisfied (clause 7): first, a bank must stop or be about to stop meeting its threshold conditions for authorisation, which include adequate capital and liquidity; and second, all possible actions to restore the position, whether by regulators, by the bank itself or by others, have been exhausted. The SRR is thus a last resort. Its very existence should act as an incentive for bank management to take necessary action to restore a failing bank to financial health. With more focused and forward-looking risk-based bank supervision, and more incentives for bank management to take necessary remedial action, an indicator of the success of the SRR will be that it is exercised only rarely.
4 But if a bank does fail, it is essential for the authorities, as an alternative to immediate committal to slow and uncertain corporate insolvency procedures, to be able to resolve its affairs quickly and effectively. The Bank, as the Special Resolution Authority, will act to safeguard the public interest, defined broadly (in clause 4) to include the maintenance of financial stability, the preservation of banking continuity and the protection of depositors, all at the lowest possible risk to the taxpayer, and will be required to balance the public interest with the interests of the failing bank's shareholders and counterparties, whose property rights are protected by the Human Rights Act 1998.
5 Depending on the systemic risk posed by the failure of the bank, an orderly resolution could take the form of a sale of part or all of the bank or its business to a private sector purchaser, either directly or by using a bridge bank initially (clauses 10-11), if necessary facilitated by the authorities. Alternatively, it could entail closure of the bank and rapid payoff of insured depositors (ie exercise of the new "bank insolvency procedure", as set out in Part 2 of the Bill). It is vital to have a range of options, as no two banking failures are alike. Although temporary public ownership will remain an option under the SRR (clause 12), a full alternative toolkit will ensure that it becomes a last rather than a first resort, thereby providing better protection to the taxpayer.
Partial property transfers
6 A bridge bank is likely to be used by the Bank where it believes that the failure of the bank will have wider adverse systemic consequences and that a buyer of part or all of the bank's business can be found within a short period (of up to a year). For this to work partial transfer powers are necessary. The aim is to preserve the viable parts of the business and to wind down the rest in an orderly way. A buyer may require some time to carry out due diligence on the failed bank's books, especially if it contains an extensive range of complex products. During that period a conservatively-run bridge bank, controlled by the Bank, will be needed to maintain whatever franchise value the failed bank retains. The bridge bank will take over as much of the failed bank's staff and systems as possible, ensuring that households and businesses have continuing access to their current and deposit accounts and overdraft and loan facilities. It will also have new senior management brought in by the Bank, and a new business plan.
7 Experience in the
8 Concerns have been expressed about the powers available under the SRR, notably those relating to partial property transfers. Two points must, however, be borne in mind here. First, as noted above, these powers will be exercised only if all other action, including voluntary action by shareholders and creditors of the failing bank, has failed, so that the only alternative is insolvency. And second, the exercise of the partial transfer powers will be subject to safeguards set out both on the face of the bill (in particular in clauses 42-43 and 55) and in secondary legislation (drafts of which will be available to the Committee during its hearings). One safeguard relates to netting and set-off arrangements, and will protect all master netting agreements and financial contracts under such agreements (clause 43). Another will ensure that, in a partial transfer, creditors whose claims are not transferred to a private sector purchaser or to a bridge bank will still at a minimum be compensated so that they are no worse off than they would have been (according to an independent evaluation) in an immediate liquidation of the whole bank (clause 55). Other safeguards will protect secured claims and the existing priorities of creditors, subordinated debt holders and shareholders in insolvency. And if necessary on financial stability grounds, it will still be possible to make whole non-transferred creditors.
9 It has been suggested that partial transfers should be restricted to retail deposit book transfers alone. We do not support that, for the major reason that systemic risk in a large bank failure, and the risk of contagion to other banks, is as likely to affect wholesale depositors and non-deposit creditors as retail depositors. And a potential buyer may be prepared to pay a greater premium for such business than for the retail deposits alone. Restricting partial transfer powers would once again make nationalisation more likely, as any whole bank solution is likely to require the full support of the state, increasing the risk to the taxpayer.
Bank also does not accept arguments that the use of partial transfers or other
powers in the SRR will increase the cost of capital to
Other aspects of the bill
(i) Deposit insurance and role of the FSCS
11 The Bank fully supports the Bill's reforms in Part 4 relating to deposit insurance, and related measures, notably the 7-day target for payout to insured depositors and the earlier raising of the compensation limit to £50,000. Further work needs to be done urgently to find a practical solution that would protect balances that are temporarily inflated above the compensation limit, for example as a result of house sale or receipt of a bequest.
12 In addition, the Bank believes that the
recent resolutions of Bradford and Bingley and the
13 In the absence of pre-funding, the FSCS has
to borrow the funds from the Bank or Government (as happened in the recent
resolutions) and subsequently levy the banking industry. That is one model, and
it is important to realise that the levy-payers will then pay no more, and most
probably less, than they would have done in a whole-bank liquidation. But a more
attractive alternative would be for the FSCS to call first upon a pre-fund;
recourse to Government borrowing would then be a last rather than first resort.
So the Bank supports the power in the Bill
(in clause 156) to introduce a pre-funded scheme when conditions in the banking
sector improve. This is a feature of many other countries' regimes,
including countries with similar degrees of concentration in the banking sector
14 The Bank also believes that the insurance premiums which banks should pay to build up such a fund should be related to objective measures of the riskiness of those banks. This is necessary to avoid any implicit subsidy of riskier banks: given that they benefit more from deposit insurance than less risky banks, it seems reasonable that they should pay a higher price for the privilege. This will help to reduce moral hazard and excessive risk-taking among banks. The bill contains a provision in clause 156 to introduce such risk-based deposit insurance premiums. And as noted above it seems better to levy such premiums before rather than after banking failures, not least because in the latter case the failed bank itself will pay no premium, while other banks, which may also have been adversely affected by the bank's failure or the circumstances that gave rise to it, will be less able to bear a levy.
(ii) Oversight of payment systems
15 The Bank will be given statutory oversight
(iii) Issuance of Scottish and Northern Irish banknotes
16 Part 6 of the Bill modernises the existing framework, almost unchanged since 1845, by which those commercial banks which were issuing Scottish or Irish banknotes at that time have been able to continue doing so. Back in 2005, the protection for holders of these notes was deemed to be inadequate in two respects. First, although the notes were required to be backed by Bank of England notes and coin, the letter of the law only required that to happen on Saturdays. Second, even when these backing assets were being held, they could not be earmarked in any way for the benefit of the note holders. Ranking behind protected depositors, as unsecured creditors of the issuing bank, the note holders would therefore have been at risk of losing the entire face value of their notes in the event that the issuing bank became insolvent.
17 Following extensive discussions with all
seven commercial issuing banks and other interested groups, agreement has been reached on the way in
which the Bank will in future regulate commercial note issuance in
(iv) The Bank of
18 The 1998 Bank of England Act provided for a
monetary policy objective, but the Bank's financial stability role was confined
to the Memorandum of Understanding that sets out the responsibilities of the
Tripartite authorities. The Bill gives
the Bank the responsibilities described above, and a new overall objective: to "contribute
to protecting and enhancing the stability of the financial systems of the