National resolution authorities

What Are National Resolution Authorities?

National resolution authorities are specialized public bodies tasked with managing the failure of financial institutions, primarily banks, in an orderly manner. Their primary objective is to minimize the impact of a bank failure on financial stability, protect taxpayers from bearing the costs of bailouts, and ensure the continuity of critical financial services. These authorities operate within the broader domain of financial regulation, aiming to prevent contagion across the banking sector during times of stress. They possess legal powers to intervene in a failing institution before it becomes insolvent, orchestrating its restructuring or wind-down.

History and Origin

The concept of national resolution authorities gained significant prominence in the aftermath of the 2008 global financial crisis. Prior to this period, the mechanisms for dealing with failing banks often relied on traditional insolvency laws or costly taxpayer-funded bailouts, which proved inadequate for systemically important institutions²⁷, ²⁸. The crisis highlighted a critical need for a more structured and effective approach to manage large bank failures without destabilizing the entire financial system or burdening public finances²⁵, ²⁶.

In response, international bodies like the G20 and the Financial Stability Board (FSB) developed a framework known as the "Key Attributes of Effective Resolution Regimes for Financial Institutions" in 2011²³, ²⁴. These attributes laid out the essential features that national resolution frameworks should incorporate. This international consensus spurred jurisdictions worldwide to establish or enhance their national resolution authorities and equip them with specific powers and tools, such as "bail-in" mechanisms, to ensure that losses are absorbed by shareholders and creditors rather than taxpayers²¹, ²². This shift marked a fundamental change in how authorities approached financial distress, moving away from discretionary, case-by-case interventions towards a more predictable and robust resolution framework²⁰.

Key Takeaways

• National resolution authorities are governmental bodies designed to manage failing financial institutions, primarily banks.
• Their core mission is to safeguard financial stability, protect depositors, and prevent the use of taxpayer money for bailouts.
• These authorities were largely established or empowered in response to the 2008 financial crisis to address "too-big-to-fail" issues.
• They employ various tools, including bail-in, sale of business, and bridge banks, to facilitate an orderly resolution.
• Effective resolution frameworks require strong national powers, operational independence, and robust international cooperation.

Interpreting the National Resolution Authorities

National resolution authorities interpret the health of financial institutions by continuously monitoring their financial condition and assessing their "resolvability." Resolvability refers to a bank's ability to be wound down in an orderly manner without causing systemic disruption. This assessment involves intricate stress testing and detailed analysis of a bank's structure, critical functions, and interconnectedness. National resolution authorities work closely with supervisory authorities to identify early warning signs of distress and determine if a bank is "failing or likely to fail" (FOLF). Once this determination is made, the authority can activate its resolution powers, aiming to intervene before a full-blown crisis materializes¹⁹. Their actions are designed to minimize systemic risk and ensure that essential financial services, such as payment systems, continue to operate even as a bank is resolved¹⁸.

Hypothetical Example

Imagine "MegaBank Corp," a large, domestically systemic bank, faces severe losses due to a sudden downturn in a specific market segment. Its capital requirements are eroding rapidly, and it is on the verge of defaulting on its obligations. The country's national resolution authority, having closely monitored MegaBank's health through regular reporting and stress tests, determines it is "failing or likely to fail."

The authority decides to initiate a resolution process rather than a traditional bankruptcy, to avoid wider financial panic. It might implement a "bail-in," converting a portion of MegaBank's unsecured debt (a type of financial instruments) into equity, thereby recapitalizing the bank and imposing losses on its creditors and shareholders. Alternatively, it might arrange a rapid "sale of business," transferring MegaBank's healthy asset sales and customer deposits to a stronger, acquiring bank. This swift intervention aims to preserve critical banking functions and maintain public confidence, ensuring that depositors retain access to their funds and the financial system avoids a major shock.

Practical Applications

National resolution authorities are central to modern financial stability frameworks. In Europe, the Single Resolution Board (SRB) acts as the central resolution authority for major banks within the Banking Union, working in close cooperation with national resolution authorities in member states for smaller institutions¹⁶, ¹⁷. The SRB develops and implements resolution plans, aiming to ensure orderly resolutions across borders¹⁵.

In the United States, the Federal Deposit Insurance Corporation (FDIC) serves as a primary national resolution authority for insured depository institutions and also holds the Orderly Liquidation Authority under the Dodd-Frank Act for systemically important non-bank financial companies¹³, ¹⁴. These bodies routinely engage in resolution planning, where they require banks to prepare "living wills" – detailed strategies for their orderly wind-down in a crisis scenario. ¹²These plans address critical aspects like governance, operational capabilities, and the treatment of derivatives. ¹¹The work of national resolution authorities directly impacts financial instruments by shaping how losses are allocated and how the continuity of financial markets is preserved during distress. For instance, the FDIC has detailed guidance on the resolution of various entities, reflecting their broad practical application in managing financial distress.

¹⁰## Limitations and Criticisms

Despite their critical role, national resolution authorities face several limitations and criticisms. One significant challenge is the inherent complexity of resolving large, globally interconnected financial institutions, especially those operating across multiple jurisdictions, which can complicate cross-border resolution efforts. ⁸, ⁹Legal and operational inconsistencies between national frameworks can hinder effective coordination and information sharing among authorities worldwide.
⁶, ⁷
Another critique centers on the practical application of "bail-in" tools, particularly the risk of contagion if large-scale bail-ins trigger market instability or jeopardize the stability of other institutions. ⁵Some argue that the frameworks designed for individual bank failures may not be fully robust during systemic crises, where multiple institutions face distress simultaneously, potentially amplifying rather than mitigating shocks. ⁴Furthermore, there can be political pressure or delays in taking decisive action, which can ultimately increase the cost of resolution. ³The effectiveness of these authorities depends heavily on their operational independence and adequate resources, which can vary by jurisdiction. ²Challenges also arise concerning the liquidity provision for banks in resolution, as solvency provided by bail-in might not immediately address liquidity shortfalls.

¹## National Resolution Authorities vs. Deposit Insurance

While both national resolution authorities and deposit insurance schemes play crucial roles in safeguarding financial stability, their functions are distinct yet complementary.

National resolution authorities address the systemic implications of a bank's distress by providing tools to resolve the entire institution, including its critical functions and broader liabilities. Deposit insurance, on the other hand, provides a direct safety net for depositors, ensuring that their savings are protected up to a certain threshold, thereby preventing bank runs and maintaining trust in the banking sector. While a resolution authority might use funds from a resolution fund, a deposit insurance scheme relies on its own fund to cover insured deposits.

FAQs

What is the main purpose of a national resolution authority?

The main purpose of a national resolution authority is to manage the failure of a financial institution, particularly a bank, in an orderly way. This prevents widespread disruption to the financial system, protects depositors, and ensures that taxpayers are not responsible for covering the costs of a bank's failure. It aims to achieve financial stability without resorting to public bailouts.

How did national resolution authorities come about?

National resolution authorities largely emerged as a global response to the 2008 financial crisis. The crisis revealed that existing bankruptcy laws and ad hoc government interventions were insufficient to handle the failure of large, interconnected financial institutions without causing severe economic damage or requiring significant taxpayer funds. International efforts, led by the Financial Stability Board, advocated for specialized authorities with powers to resolve banks more effectively.

What powers do national resolution authorities have?

National resolution authorities are typically granted broad legal powers to intervene in a struggling bank. These powers can include taking control of the bank, selling off parts of its business, creating a "bridge bank" to temporarily operate critical functions, or implementing a "bail-in," where shareholders and some creditors absorb losses. Their goal is to recapitalize or wind down the institution while maintaining essential services and minimizing systemic risk.

Are national resolution authorities the same as central banks?

No, national resolution authorities are not the same as central banks. While both are crucial for financial stability, central banks primarily manage monetary policy, oversee the payment system, and often act as a lender of last resort. Resolution authorities, in contrast, focus specifically on managing the failure of individual financial institutions. They work closely with central banks and supervisory authorities, but their mandates and tools are distinct.

What is "resolvability" in the context of bank resolution?

"Resolvability" refers to a bank's ability to be resolved by authorities in an orderly manner without triggering a broader financial crisis or requiring taxpayer support. National resolution authorities assess banks' resolvability by reviewing their structures, operations, and readiness to undergo a resolution process. They may require banks to make changes to improve their resolvability, ensuring that a clear path exists for their effective wind-down if necessary.