The economic impact of COVID-19 has drawn considerable comparisons with the financial crisis. Lessons learned from 2008 have led to more robust processes to allow banks to fail without impacting wider financial stability. In the context of the current economic climate, the regulator reminds banks of their resolvability obligations.
Proposed in 2019 and updated in October 2020, the Resolvability Assessment Framework aims to increase accountability around resolution and reduce the need for publicly funded bailouts. It builds on pre-existing requirements for resolution and recovery planning, valuation in resolution and operational continuity, and helps banks view these regulations collectively.
The Resolvability Assessment Framework consists of three key strands, reflecting the typical barriers to an orderly resolution.
1 Financial resources: Banks must have adequate resources and appropriate liquidity in order to meet their financial obligations without relying on public funds. This includes maintaining minimum requirements for own funds and eligible liabilities (MREL) to absorb losses and support re-capitalisation. Banks must also be able to assist with a prompt valuation of their assets.
2 Continuity: A smooth resolution relies on keeping business services and critical operational processes running. This will support clients, counterparties and suppliers, reducing the potential for economic harm and financial instability. To achieve this, banks must:
These rely on effective operational continuity in resolution (OCIR) processes, making sure critical functions can continue to operate.
3 Communication: Good management and oversight are integral to the resolution process, and assurance over governance processes is essential for all stakeholders. Staff, regulatory bodies, legislators and market participants need clear communication on resolution plans, progress and timescales.
Improving resolution planning is only half the challenge, the other being transparency and assurance that effective processes are in place. As such, major UK banks (that have the potential to cause the most disruption to the financial system) must complete the following:
In the report, the PRA expects to see a summary of the group structure, including elements that would support or hinder resolution (such as ring-fencing), as well as details of the resolution strategy. This will accompany a summary of how to execute the strategy, with specific reference to the three areas listed and the potential barriers, and a timeline for reducing identified risks. It will also include details of OCIR arrangements, resolution planning testing and governance processes.
Valuation is an integral part of the process and will initially decide if the firm is failing, or likely to, and if it needs to enter resolution. A second valuation will determine the value of all assets and liabilities, which informs the resolution methodology. A modified insolvency process is sufficient for many small banks in the UK and, after resolution, a third valuation will assess stakeholder outcomes to check they are no worse off than under insolvency. With such a key role in resolution, firms must be able to value their assets promptly, with appropriate data, management information and skilled resources in place.
An orderly resolution requires good contingency planning, and the Bank of England has provided a three-stage timeline to carry planning through to action.
1 Contingency planning: Under stressed conditions, the Bank of England will look at the firm’s financial strength and decide if the bank is failing, the overall value, recapitalisation needs and viability in the long term. This relies on the ability to value the firm’s assets quickly and accurately, and broader factors such as market conditions or potential restructuring options, among others. With so many factors at play, firms must try and test their capabilities and processes ahead of time.
2 The resolution weekend: Where possible, this stage would take place over a weekend to minimise disruption across the market and lasts from the time of the decision to resolve the bank to the next working day. The Bank of England will inform the public and appoint an administrator so it is vital that there is clear communication with all stakeholders.
3 Exiting resolution: This post-bail-in stage will last between three and six months, during which time it will remain under the control of the Bank of England. Within a month of the resolution weekend, the firm must submit its restructuring plan and details of how it will achieve viability again. Key considerations include valuation capabilities, restructuring options and effective scenario planning. If the Bank of England is satisfied that the plans are robust and credible, the firm will return to private control.
Essentially, the Resolvability Assessment Framework aims to draw all recovery and resolution-related regulations together to prevent firms taking a siloed approach to each. Recognising the interplay between each regulation and taking a co-ordinated, forward-looking approach is the key to an orderly bank resolution.
Contact Paul Young for further information on the Resolvability Assessment Framework, regulatory expectations and assurance over your approach.