Too-big-to-fail: Why the recovery and emergency plans are not (and cannot be) applied

The alternative to the SPE procedure is the so-called "multiple point of entry" procedure (MPE). A "too-big-to-fail" recovery and emergency plan following this principle would provide for the intervention of the resolution authorities in those countries where the legally independent companies of the same group are active. Since the individual companies often rely on services provided by other companies of the same group, e.g., through IT systems or cash management integrated at the group level, the MPE procedure poses major challenges for the authorities in coordinating their actions. In addition, agreement must be reached on valuations, recapitalisation of viable subsidiaries and liquidity needs. In an environment where confidence in a bank's ability to survive has already been shaken, a resolution process that gets bogged down in negotiations over these aspects and responsibilities would defeat its purpose of restoring confidence. It would only further endanger the entire group of companies, increase the risk that other banks will also get into difficulties- and exacerbate the crisis-like situation. Since de facto, only the MPE procedure is available at this moment, a supervisory authority will not even initiate the restructuring procedure.

2. Risks of contagion and uncertainty

The recovery and emergency plans provide for far-reaching possibilities to convert so-called bail-in eligible debt instruments into equity, to absorb losses. From the perspective of the ailing bank, this is an obvious way to recapitalise. From a creditor institution's point of view, however, this conversion of securities can put its own balance sheet in distress. So, there is a certain contagion risk from these debt conversions.

Even if it is possible to restore the solvency of the ailing bank and prevent contagion, uncertainties remain. On the one hand, there is the question of the viability of the restructured bank's business model and of structural deficiencies that were not recognised by the restructuring or could not be remedied. If losses are large, a recapitalization via bail-in eligible debt instruments may not suffice and there may not be enough liquidity. This may also put the bank's subsidiaries under pressure. Emergency liquidity assistance by the central bank can help to ease liquidity squeezes. In any case, however, a bail-in cannot completely relieve the market of the uncertainties created by the original crisis – regardless of whether the resolution is carried out according to the SPE or the MPE principle. Thus, since a bail-in can only contribute to solving the problem to a limited extent, a supervisory authority may not even initiate a bail-in.

3. Challenges of rapid recovery and resolution

The implementation of an emergency  plan is a complex matter. In order to prevent bank runs and calm the financial markets, it is important to act quickly and implement a recovery and emergency plan swiftly despite its complexity. Since the relevant documents comprise thousands of pages, quick implementation is difficult. In addition, fast action requires FINMA to be well informed about the systemic relevance or irrelevance of the individual banking activities to be able to effectively protect the crucial functions in the event of a crisis. Thus, FINMA must have a thorough knowledge of the solvency and overall business activities of the subsidiaries of the supervised banks. Especially in SPE proceedings, where FINMA's decisions have a significant impact on companies abroad, FINMA must also be well informed about the economic situation of these companies. A pertinent evaluation of assets can be extremely complex at globally active, systemically relevant banks. For instance, mathematical modelling is needed to evaluate derivatives that are not traded in open markets, and the assessment of counterparty risk is especially tricky and uncertain in crisis situations.  

Ideally, the recovery and emergency plan's biggest steps should be implemented over a weekend. After closing of business on Friday, the authorities will start assessing the assets of the ailing bank during Saturday and inform shareholders and creditors of the results of the assessment on Sunday. This will include the conversion of debt instruments into equity and the new provision of liquidity. Finally, before opening for business on Monday, all stakeholders are informed about the bank's solvency and the recovery plan, and bank runs are prevented.

In the case of systemically important big banks, such rapid restructuring and resolution cannot take place. Nevertheless, the recovery and emergency plans and the financial market supervision must be geared towards rapid action. Any delay increases uncertainty and leads to a withdrawal of debtors - a dynamic that can end in a bank run.

Of course, the difficulty of quickly rehabilitating and resolving troubled banks is not primarily due to the complexity of emergency plans, but to the complexity of the business of big banks itself. It is possible, and sometimes inevitable, that an intervention in a bank will affect its ability to function, so that it is no longer able to conduct important business, with potentially serious consequences for the rest of the financial market. The possibility of such collateral damage, the enormous information requirements, the impossibility of completing the entire process quickly and the complexity of the plans to govern resolution and recovery are examples of practical problems that may dissuade a supervisor from applying an emergency  plan.

4. Conclusions

A restructuring and resolution process for big banks is desirable from a rule-based point of view and FINMA has worked hard to achieve this. At present, however, the emergency plans formulated are not sufficiently accepted internationally. Moreover, the implementation difficulties and uncertainties are too great for their application in a crisis-like situation to be expected to make a stabilising contribution and preserve the systemically important parts of a failing bank. It is therefore necessary to fundamentally rethink the "too-big-to-fail" concept.