How to Save a Failing Bank: The Art of Bank Transfers

Have you ever wondered what happens when a bank goes bust? How do authorities deal with the mess and prevent a domino effect that could bring down the whole financial system? And what happens to the customers and creditors of the failed bank?

In this blog post, we will explore one of the tools that authorities can use to resolve a failing bank in an orderly way: the bank transfer based on the publication from BIS. This is a process in which some or all of the assets and liabilities of a failing bank are sold to a healthy third party, usually another bank.

Sounds simple, right?

Well, not quite. There are many challenges and trade-offs involved in designing and executing a bank transfer, and we will look at some of them in detail.

But first, let’s understand why bank transfers are useful and how they compare with other resolution strategies.

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Why Bank Transfers?

When a bank is in trouble, authorities have to act quickly and decisively to protect the public interest and maintain financial stability. They have to balance several objectives, such as:

• Preserving the continuity of essential services that the bank provides to its customers and the economy, such as lending, payments and deposits.
• Protecting the depositors and other creditors of the bank from losing their money, especially those who are insured by a deposit insurance scheme.
• Minimizing the costs and risks for the public purse, by avoiding the use of taxpayer money or public guarantees to bail out the bank.
• Ensuring that the shareholders and managers of the bank bear the losses and face the consequences of their actions, in line with the principle of “no reward for failure”.
• Maintaining market confidence and preventing contagion to other banks and financial institutions.

There are different ways to achieve these objectives, depending on the situation and the legal framework of each jurisdiction. Some of the most common resolution strategies are:

• Open bank bail-in: This is a process in which the authorities write down or convert into equity some of the debt owed by the bank to its creditors, such as bondholders or subordinated debt holders. This reduces the liabilities of the bank and increases its capital, restoring its viability and allowing it to continue operating as a going concern. The advantage of this strategy is that it preserves the bank’s franchise value and its relationship with its customers and depositors. The disadvantage is that it requires a high level of loss-absorbing capacity at the failing bank, which may not be available for smaller or less complex banks.
• Piecemeal liquidation with depositor payout: This is a process in which the authorities close down the bank and liquidate its assets, while paying out the insured depositors in full and the uninsured depositors partially or not at all, depending on the recoveries from the asset sale. The advantage of this strategy is that it imposes losses on the shareholders and creditors of the bank, while protecting the insured depositors. The disadvantage is that it disrupts the bank’s business and may lead to a loss of franchise value, a fire sale of assets, and a reduction of credit availability in the economy.
• Bank transfer: This is a process in which the authorities sell some or all of the assets and liabilities of the failing bank to a healthy third party, typically another bank. The advantage of this strategy is that it preserves the continuity of the bank’s essential services and the access of the depositors to their money, while limiting the role of public authorities in managing the bank’s assets. The disadvantage is that it may require additional funding from the authorities to complete the transaction, and it may be difficult to find a suitable and willing acquirer in a stressed market.

As you can see, each strategy has its pros and cons, and there is no one-size-fits-all solution. Authorities have to choose the best option for each case, taking into account the specific circumstances and the legal framework. In some cases, they may also combine different strategies, such as using a temporary bridge bank to facilitate a bank transfer, or applying a bail-in before a bank transfer.

How to Design a Bank Transfer

A bank transfer may seem like a straightforward transaction, but it actually involves a lot of complex decisions and trade-offs. Authorities have to consider several factors at the same time, such as:

• The composition of the transfer: What assets and liabilities should be included in the transfer? How to balance the preferences of the potential acquirers with the objectives of the authorities? How to treat the sensitive liabilities, such as uninsured deposits, that may be difficult to write down or leave behind?
• The preparation of the transfer: How to monitor and understand the market conditions and the demand for the failing bank’s business? How to collect and provide accurate and timely information to the potential bidders? How to structure and market the transfer to attract the best offers?
• The eligibility of the bidders: Who can bid for the failing bank’s business? How to ensure that the acquirers are suitable from a regulatory and supervisory perspective? How to deal with new entrants or foreign bidders?
• The funding of the transfer: How to finance the gap between the value of the assets and the liabilities transferred? What sources of funding are available and under what conditions? How to minimize the costs and risks for the public purse?

Let’s look at each of these factors in more detail.

The Composition of the Transfer

One of the key decisions in a bank transfer is what assets and liabilities should be included in the transfer. This decision depends on several factors, such as the legal framework, the creditor hierarchy, the market conditions, and the funding availability.

On the liability side, a main decision point is whether to include both insured and uninsured deposits in the transfer, or only the former. Authorities have to respect the creditor hierarchy applicable in their jurisdiction, which determines the order of priority of the claims of different creditors in case of insolvency. Beyond that, the type of liabilities to be included in the transfer may reflect whether they are considered “sensitive liabilities”, ie those that are in theory capable of being loss absorbing but may be difficult to write down for social or political reasons, or because a write-down would risk contagion.

The inclusion of uninsured deposits in the transfer can have several advantages. First, it can help preserve financial stability by reducing the incentive for a run on banks and preventing contagion to other banks and financial institutions. Second, it can help preserve the franchise value of the failing bank and the access of the depositors to their money, which may be important for the provision of credit and the functioning of the economy. Third, it can help attract potential acquirers, who may value the funding and the customer base provided by the uninsured deposits.

However, the inclusion of uninsured deposits also has some drawbacks. First, it can increase the funding gap between the value of the assets and the liabilities transferred, requiring more funding from the authorities to complete the transaction. Second, it can reduce the loss-absorbing capacity of the failing bank, leaving less room for imposing losses on other creditors, such as bondholders or subordinated debt holders. Third, it can create moral hazard and undermine market discipline, by protecting creditors who should bear some risk for their investment decisions.

Therefore, authorities have to weigh the pros and cons of including uninsured deposits in the transfer, and decide on a case-by-case basis, depending on the systemic nature of the failing bank, the market conditions, and the funding availability. In some cases, authorities may decide to include all deposits in the transfer, especially if the failing bank is systemically important or if there are concerns about financial stability. In other cases, authorities may decide to include only insured deposits in the transfer, especially if the failing bank is not systemically important or if there are sufficient funds to pay out the uninsured depositors.

On the asset side, another key decision is what assets should be included in the transfer. This decision depends on the market value and the quality of the assets, as well as the preferences of the potential acquirers. In general, authorities may prefer to include all or most of the assets in the transfer, to avoid the costs and risks of managing and liquidating the remaining assets. However, this may not always be possible or desirable, depending on the situation.

For instance, some assets may be difficult to value or transfer, such as complex or illiquid securities, or assets subject to legal disputes or regulatory investigations. In these cases, authorities may decide to exclude these assets from the transfer and retain them in the residual entity for later disposition. Alternatively, authorities may decide to include these assets in the transfer, but provide some form of support or guarantee to the acquirer, such as a shared-loss agreement or an asset protection scheme, to reduce the risks and uncertainties involved.

Another factor that may influence the composition of the transfer is the least cost criterion, which requires authorities to select the resolution option that minimizes the costs and risks for the public purse, relative to other options. This criterion may not always coincide with transferring all of the assets and liabilities of the failing bank, depending on how prospective acquirers weigh their bids. If bidders are willing to pay higher prices to exclude certain assets or liabilities from the acquisition, it is possible that a partial transfer would be the least costly resolution. However, not all least cost mandates have the same implications for the composition of the transfer, and authorities may have some discretion in applying this criterion, depending on the legal framework and the public interest considerations.

The Preparation of the Transfer

Another important aspect of a bank transfer is the preparation of the transfer, which involves several steps, such as:

• Monitoring and understanding the market conditions and the demand for the failing bank’s business
• Collecting and providing accurate and timely information to the potential bidders
• Structuring and marketing the transfer to attract the best offers

These steps are crucial for ensuring the success and the efficiency of the transfer, as they can affect the number and the quality of the bids, the speed and the certainty of the execution, and the value and the cost of the transaction.

One of the main challenges in preparing the transfer is to monitor and understand the market conditions and the demand for the failing bank’s business. Authorities have to assess the availability and the interest of potential acquirers, as well as the competitive implications of the transfer. They have to identify the most suitable and willing bidders, taking into account their size, strength, strategy, and compatibility with the failing bank’s business. They also have to anticipate and address any potential barriers or obstacles that may prevent or delay the completion of the transfer, such as regulatory approvals, antitrust issues, or legal challenges.

Another challenge is to collect and provide accurate and timely information to the potential bidders. Authorities have to ensure that they have access to reliable and up-to-date data on the financial condition and the performance of the failing bank, as well as the assets and liabilities to be transferred. They have to disclose this information to the bidders in a transparent and consistent manner, while respecting the confidentiality and the sensitivity of the data. They have to balance the need for providing sufficient information to enable the bidders to make informed offers, with the need for preserving the value and the stability of the failing bank, and avoiding leaks or rumors that could undermine the transfer.

A third challenge is to structure and market the transfer to attract the best offers. Authorities have to design the terms and the conditions of the transfer, such as the price, the payment method, the timing, the scope, and the support. They have to decide whether to use a competitive or a negotiated process, and whether to allow for multiple or single bids. They have to set the criteria and the process for evaluating and selecting the bids, and communicate them clearly to the bidders. They have to manage the expectations and the interactions of the bidders, and ensure a level playing field and a fair outcome.

The Eligibility of the Bidders

Another factor that authorities have to consider in a bank transfer is the eligibility of the bidders. Authorities have to ensure that the acquirers are suitable from a regulatory and supervisory perspective, and that they have the financial and operational capacity to absorb the failing bank’s business and to provide the essential services to the customers and the economy.

Authorities have to apply the relevant prudential and fit and proper requirements to the potential acquirers, such as the capital adequacy, the liquidity, the risk management, the governance, and the reputation. They have to assess the impact of the acquisition on the acquirer’s financial position and performance, and on its risk profile and business model. They have to verify that the acquirer has a credible and viable plan for integrating the failing bank’s business and for addressing any potential issues or challenges that may arise from the transfer.

Authorities also have to deal with the diversity and the complexity of the bidders, which may vary depending on the market conditions and the nature of the failing bank’s business. Authorities may face different scenarios, such as:

• Domestic vs foreign bidders: Authorities may have to deal with bidders from different jurisdictions, which may pose additional challenges in terms of coordination, cooperation, and information sharing among the relevant authorities, as well as in terms of legal and regulatory compatibility and consistency. Authorities may also have to consider the implications of the transfer for the financial stability and the sovereignty of their jurisdiction, as well as for the cross-border resolution and crisis management arrangements.
• Existing vs new entrants: Authorities may have to deal with bidders who are already established in the market, or who are new entrants, such as non-bank financial institutions, fintech firms, or private equity funds. Authorities may have to consider the implications of the transfer for the competition and the innovation in the market, as well as for the regulation and the supervision of the new entrants, who may have different business models, risk profiles, and cultures than the traditional banks.
• Single vs multiple bidders: Authorities may have to deal with multiple bidders who are interested in acquiring different parts of the failing bank’s business, or who are willing to cooperate or partner with each other in a joint bid. Authorities may have to consider the implications of the transfer for the fragmentation or the consolidation of the market, as well as for the complexity and the feasibility of the execution, which may involve multiple transactions and contracts.

The Funding of the Transfer

A final factor that authorities have to consider in a bank transfer is the funding of the transfer. Authorities have to finance the gap between the value of the assets and the liabilities transferred, which may arise due to the deterioration of the failing bank’s financial condition, the discount applied by the acquirer, or the inclusion of sensitive liabilities in the transfer.

Authorities have different sources of funding available, depending on the legal framework and the institutional arrangements of each jurisdiction. Some of the most common sources are:

• Deposit insurance fund: This is a fund that collects premiums from the banks and pays out the insured depositors in case of a bank failure. In some jurisdictions, this fund can also be used to finance a bank transfer, as an alternative to a depositor payout, if this is more cost-effective and in the public interest. The advantage of using this fund is that it reduces the reliance on taxpayer money and ensures that the banks contribute to the resolution of their peers. The disadvantage is that it may deplete the fund and compromise its ability to protect the depositors in the future.
• Resolution fund: This is a fund that collects contributions from the banks and other financial institutions and provides financial support to the resolution of failing banks. In some jurisdictions, this fund can be used to finance a bank transfer, as part of the resolution tools and powers available to the authorities. The advantage of using this fund is that it enhances the credibility and the effectiveness of the resolution regime and ensures that the financial sector bears the costs of the resolution. The disadvantage is that it may not be sufficient or available to cover the funding gap, especially in the early stages of the fund’s development or in a systemic crisis.
• Public funds: These are funds that are provided by the government or the central bank, either directly or indirectly, to finance a bank transfer. In some jurisdictions, these funds can be used to finance a bank transfer, as a last resort or as a temporary measure, if this is necessary to preserve financial stability and the public interest. The advantage of using these funds is that they can provide unlimited and immediate funding to complete the transfer and to restore market confidence. The disadvantage is that they can expose the public purse to significant costs and risks, and create moral hazard and distortions in the market.

Authorities have to choose the best source of funding for each case, taking into account the legal framework, the funding availability, the funding gap, and the public interest considerations. Authorities also have to ensure that the funding is provided on a temporary and conditional basis, and that it is recovered as much as possible from the failing bank, the acquirer, or the financial sector, in line with the principle of “no bailout”.

Conclusion

A bank transfer is a useful tool that authorities can use to resolve a failing bank in an orderly way, by selling some or all of the assets and liabilities of the failing bank to a healthy third party, usually another bank. A bank transfer can help preserve the continuity of the essential services that the bank provides to its customers and the economy, protect the depositors and other creditors of the bank from losing their money, and maintain market confidence and prevent contagion to other banks and financial institutions.

However, a bank transfer also involves many challenges and trade-offs, and requires careful design and execution. Authorities have to consider several factors, such as the composition, the preparation, the eligibility, and the funding of the transfer, and balance the different objectives and interests involved. Authorities also have to adapt to the specific circumstances and the legal framework of each case, and choose the best option among the different resolution strategies available.

To summarize, here are the main points of this blog post:

• A bank transfer is a process in which some or all of the assets and liabilities of a failing bank are sold to a healthy third party, usually another bank.
• A bank transfer can help preserve the continuity of the essential services, protect the depositors and other creditors, and maintain market confidence and prevent contagion.
• A bank transfer involves several factors, such as the composition, the preparation, the eligibility, and the funding of the transfer, and requires careful design and execution.
• A bank transfer depends on the specific circumstances and the legal framework of each case, and has to be compared with other resolution strategies available.

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

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