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The reason which prompted me to write this article was a rather recent article in the Cypriot newspaper Politis dated Sunday April 4th, 2023, and authored by Ioannis Trikides whereby it was stated that the National Bank of Switzerland bailed out Credit Suisse with the sum of 50 billion euros to help its liquidity, before it was actually sold to UBS.
The above has prompted me to briefly discuss some of the similarities and differences of bail-in ideas by comparing the Swiss system with the European Union System.
A bail-in is the preferred way for too big to fail. Investors – not taxpayers – are responsible for the losses of the bank. As the Euro Area Summit statement of June 2012 stated: “We affirm that it is imperative to break the vicious circle between banks and sovereigns.”
In an article dating back to April of 2019, authored by the well-respected Thomas F. Huertas, he argues that bail-in is the key to making banks resolvable. In other words, if correctly applied it should allow the banks to be able to continue to perform their critical economic functions without interruption and without taxpayer support. I quote:
“Resolution may begin with bail-in. But it does not end there. Resolution only ends when the bank if fully born again, i.e., when the resolution authority ceases to control the bank and the bank returns to normal governance and supervision. How that should happen has received relatively little attention.”
This notion of the bank being able to continue functioning after bail-in has received wide support by other leading authors on the point. However, in the case of Laiki Bank in Cyprus, things did not quite turn out in this way.
It seems that the critical point is the time at which the bank enters into resolution. The balance sheets therefore are critical for the decision of the resolution and for the resolution tools to be used.
Capital adequacy and liquidity requirements of the banks are directly assessed with ratios based on balance-sheet values.
Under the Swiss law for the decision of entering into resolution, the first step is the drawing up of an interim balance sheet based on the bank’s ordinary financial reporting. The main aim of the valuation at this stage is to verify the extent of losses and the need for recapitalisation. The valuation must at least be provisionally completed before the type of resolution is decided on, or the bail-in is carried out and it does not necessarily need to follow strict accounting rules.
The resolution authority must draw up a liquidation balance sheet in addition to the modified interim balance sheet for two main reasons. First, in order to aid the decision whether the bank should be restructured, wound-up or partially restructured.
Secondly, a comparative calculation of the creditor welfare after restructuring and in the case of a hypothetical bankruptcy of the whole bank is required for the no-creditor worse off principle (NCWO). The valuation is conducted on a going concern assumption and in contrast, a liquidation balance sheet is drawn-up on a gone-concern basis, which means that assets are to be recognized at a realizable value.
The restructuring plan must provide information on the bank’s assets and liabilities, and it must contain a balance sheet both before and after the restructuring. The firm’s financial state is displayed before the implementation of restructuring measures (opening balance sheet) and after the completion of the restructuring (final balance sheet). The final balance sheet will summarize the effects of restructuring and the new capital.
Similar provisions we find in the BRRD, with regards to the preparation of a valuation. Article 36 provides for an independent valuation but if not, it is possible the resolution authority (RA) may carry out a provisional evaluation. If a provisional evaluation is carried out, then as soon as possible an ex-post definite evaluation must be carried out by an independent person. When bail-in is to be applied, the valuation is to form an opinion on the extent of the write-down or conversion of eligible liabilities. If the RA decides to use the bail-in tool, it must determine how far up the creditor hierarchy will have to go in order to recapitalize the bank. The bail- in amount must be finalized (Art. 46, BRRD). In order to do this, the bank must establish – on the basis of a valuation conducted by an independent valuer (Art. 36) – the amount of additional CET1(Common Equity Tier 1) capital necessary to bring CET1 capital to zero. It then needs to estimate the amount by which eligible liabilities need to be written down or converted, in order for the bank in resolution to attain CET1 capital ratio that will restore market confidence in the bank.
A similar provision for the NCWO is found in the BRRD, Art. 74. Article 74 provides for a further valuation for the purpose of assessing whether shareholders and creditors would have received better treatment if the institution under resolution had entered into normal insolvency proceedings. Member States shall ensure that a valuation is carried out by an independent person as soon as possible after the resolution action has been affected. This evaluation is distinct from the valuation carried out under article 36. The NCWO valuation assumes that the failed bank has no access to liquidity, and it also assumes that the failed bank conducts a fire sale of its assets immediately after entering resolution at the time when the markets may be under stress. So, according to the respectable author Yves Mauchle, in effect the NCWO under the BRRD is unrealistic and it provides in reality no real constraint on the resolution authority.
In Switzerland a bail-in may only be implemented to the extent necessary, suitable and reasonable.
Swiss law provides that the principal aim of a bank restructuring is to ensure that the bank fulfils its licensing requirements, and it complies with statutory regulation. The recapitalization must be “without a doubt” sufficient for the bank to continue its business activities.
Under the BRRD, the scale of bail-in is established by Article 46. According to paragraph 1, the RA must determine the amount by which eligible liabilities must be written down, in order to ensure that the net asset value of the institution under resolution is equal to zero and then the amount by which eligible liabilities must be converted into shares or other types of capital instruments, in order to restore the Common Equity Tier 1 capital ratio, of either the institution under resolution or the bridge institution. The scale of recapitalization must be suitable to sustain sufficient market confidence in the bank under resolution or the bridge bank and enable it to meet licensing requirements and continue as a going concern for at least one year.
The Swiss legislature only aims at avoiding resource to state aid and explicitly makes reference to the possibility that state aid may be granted to SIBS (Systemically Important Banks). However, the conditions are not regulated, with the exception of ELA (Emergency Liquidity Assistance).
In contrast, the BRRD defines certain basic conditions under which funding could be made available in articles 56-58. The state aid may either consist of temporary public equity support (Article 57) or temporary public ownership (Article 58). The respectable author Yves Mauchle asserts that since these provisions are headed “Bail-in tool: ancillary provisions”, this clarifies that such public support is to be understood as a resource option if the bail-in fails to sufficiently stabilize a bank.
Thus, although the main purpose of the BRRD and the bail-in tool is to make the depositors of a bank responsible for the bank’s failure and not the taxpayer, this is contradicted by its explicit provisions for state aid.
According to Yves Mauchle, it is therefore, implicit in both Swiss law and EU law that the bail-in tool may not be sufficient to provide financial stability in the event of a systemic crisis. In Cyprus, the depositors of Laiki Bank know that too well after the 2013 savings ‘haircut’ which took place in Cyprus. literally depriving individuals of any amount, they had saved in the bank exceeding 100,000 euros, irrespectively of the amount deposited d. Needless to say that this caused a massive stir with families, individuals and corporations, leaving some close to financial ruin.
Although the BRRD specifically provides for state aid, in the case of Cyprus, as I am told, this was forbidden, in that it was a precondition for the loan that were about to receive, for it not to be used for recapitalizing our banks, i.e., forbidding state aid altogether. Thus, the Directive, which at the time was a mere bill, seemed to have been selectively used, in the case of depositors of Laiki Bank. The Directive was proposed in 2012. In 2013, selective parts of it were applied to Cyprus, as a form of an experiment, I suppose, and in 2014 it was adopted, but with the bail-in provisions to be adopted by Member States (MS) until January 2016.
On the other hand, the example of the Swiss bank shows clearly that the bank was bailed out and then sold, i.e., no bail-in, so the possibility of a state aid there became reality, whereas Cyprus, was dictated to act otherwise.
Finally, Article 43 (2) (a) of the BRRD provides that Member States shall ensure that resolution authorities may apply the bail-in tool, to recapitalize the institution to continue to carry out its activities and to sustain sufficient market confidence, only if there is as reasonable prospect that the application of that tool together with other relevant measures, including measures implemented in accordance with the business reorganization plan required by Article 52 will, in addition to achieving relevant objectives, restore the institution or entity in question to financial soundness and long-term viability.
Where the conditions of paragraph (a.) are not met the resolution authorities may convert to equity or reduce the principal amounts of claims or debt instruments that are transferred to a bridge institution with a view to providing capital for that bridge institution or under the sale of business tool or the asset separation tool.
According to Huertas, the simplest way for the RA to return the entire bank-in resolution to ordinary governance and supervision, is for the bank to be sold to a third party. In this case the failed bank ceases to be an independent institution.
This Directive has been amended by the European Directive 2019/879.
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