Bankruptcy and reorganization procedures for cross‐border banks in the EU. Towards an integrated approach to the reform of the EU safety net

Date24 July 2009
Pages240-276
DOIhttps://doi.org/10.1108/13581980910972223
Published date24 July 2009
AuthorGillian G.H. Garcia,Rosa M. Lastra,María J. Nieto
Subject MatterAccounting & finance
Bankruptcy and reorganization
procedures for cross-border
banks in the EU
Towards an integrated approach to the reform
of the EU safety net
Gillian G.H. Garcia
Gillian G.H. Garcia Associates, Alexandria, Virginia, USA
Rosa M. Lastra
Centre for Commercial Law Studies, Queen Mary University of London,
London, UK, and
Marı
´a J. Nieto
Banco de Espan
˜a, Madrid, Spain
Abstract
Purpose The purpose of this paper is to examine the complexities of reorganizing and/or
liquidating troubled banks under the European Union’s (EU) current institutional framework as it is
defined by its directives and by national supervisory, remedial, and insolvency practices.
Design/methodology/approach – The paper compares provisions of different EU directives that
impact financial institutions and summarizes national remedial practices.
Findings – The paper documents the diversity that currently exists among national supervisory,
remedial and failure resolution practices for banks. It also assesses the economic efficiency of the
institutionalframework forresolving problembanks thatis defined by the Reorganizationand Winding-up
Directiveand identifies componentsof the directive thatcan hamper efficient cross-border resolutions.
Research limitations/implications – There is a deficiency in publicly available information on
EU member countries’ practices for disciplining and resolving troubled banks.
Practical implications The paper assesses issues/conditions that can hamper efficient
cross-border resolutions – issues on which policymakers should focus when they reform the current
framework. It also explores areas of coordination with other EU directives that deal with financial crisis
management that are relevant in the current financial crisis.
Originality/value – The paper makes policy recommendations for reforming the EU’s current
institutional framework for resolving troubled banks.
Keywords European Union,Banks, Financial institutions,International economics, Bankruptcy
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
The paper was prepared for the conference, Regulatory Response to the Financial Crisis,
organized by the London School of Economics (London, January 19, 2009).
The authors gratefully acknowledge comments received by the conference participants and
particularly from Andrew Campbell and Eva Hupkes. The views expressed here are those of
the authors and do not necessarily represent those of the Banco de Espan
˜a. Any errors are the
authors’ own. The authors would like to thank Niall Lenihan, Assistant General Counsel in the
Legal Services of the European Central Bank, for pointing out relevant EU rules with regard to
cross-border bank resolution.
JFRC
17,3
240
Journal of Financial Regulation and
Compliance
Vol. 17 No. 3, 2009
pp. 240-276
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581980910972223
Introduction
This paper analyzes the complexities of reorganizing and liquidating banks that have
cross-border activities within the European Union (EU) in the present institutional
framework that is defined by the relevant directives and national remedial supervisory,
pre-insolvency and insolvency procedures. Against this background, the objectives of
this paper are threefold: first, the paper assesses the economic efficiency of the
institutional framework that is defined by the Reorganization and Winding-up Directive
(2001/24/EC) European Parliament and Council (2001) and it identifies aspects that can
hamper efficient cross-border bank resolutions. These are issues on which policy makers
should focus at the time of reforming the present framework. Second, it explores areas of
coordination with other EU directives that also deal with relevant aspects to bank
financial crisis management. Third, it makes policy recommendations for refor m.
The financial crisisthat started in the summer of 2007 intensified afterthe collapse of
Lehman Brothers,which highlighted theimportance of having in place a legalframework
for dealing effectively with the resolutionof cross-border financialentities. Policy makers
on both sides of the Atlantichave declared systemic exceptionsin light of the events that
unravelled afterSeptember 2008. As argued by Nietoand Schinasi (2007, Table 1), under
this type of circumstance the gains from policy makers’ collective action through
cooperation are high[1]. Against this background, EU Ministers of Financecommitted to
take allnecessary measures to enhancethe soundness and stabilityof the banking system
in order to restore confidence in a context, where it is currentlyimpossible to predict the
duration of the current extraordinarily adverse events (Economic and Financial Affairs,
2008). The recapitalization of sound “vulnerable systemically relevant financial
institutions” was recognized as one means, among others, of appropriately protecting
the stability of the financial system. However, in thisnew environment, it should still be
possible for cross-border banks tobe reorganized and/or wound up, although, at the time
of writing, we have not seen this happen. The unwinding of the present government
support measures may create conflicts among national regulators and tax payers.
Recent events have also highlighted the importance of an integrated approach to the
EU financial safety net (prudential supervision, deposit insurance, reorganization and
winding up, and lending of last resort). EU policy makers are adopting, for the first
time since the harmonization of bank regulation that started in the EU in 1977, a
comprehensive approach to its reform[2]. This paper focuses on a proposal for reform
of the Reorganization and Winding-up Directive (2001/24/EC). It looks beyond the
present crisis to make recommendations for the recovered financial system in order to
discourage a recurrence.
The paper is divided into three sections in addition to this introduction. In Section 1,
we present empirical evidence of the lack of convergence of prudential supervisory
objectives and remedial powers in the EU, which makes the cross-border coordination of
supervision more difficult. Furthermore, incentive conflicts are likely to substantially
increase bank losses in case of a crisis. Section 2 presents some literature on bank
resolution and analyses whether the 2001 Directive on Reorganization and Winding-up
of Credit Institutions guarantees the objective of minimizing private and public costs.
More specifically, it delves principally into the question of the consistency in the
regulatory approach between the directives that govern prudential supervision and
reorganization and winding up as well as between the later and deposit insurance.
An Appendix to this section presents other EU regulations that apply to cross-border
Bankruptcy and
reorganization
procedures
241
financial crises. The final section concludes and presents a proposal for reform of the
Reorganization and Winding-up of Credit Institutions Directive.
1. Is there a convergence in supervisory objectives and remedial powers in
the EU? Some anecdotal evidence
In the EU, the legislative convergence process has developed around three bro ad
principles:
(1) home country control;
(2) mutual recognition; and
(3) minimum harmonization (with regard to requirements for chartering banks,
maintaining their solvency, insuring their deposits, and other factors).
The regulatory process in the EU, however, has not ensured a homogeneous
transposition of these agreed principles into national regulations and supervisory
practices. Consequently, different prudential regulatory and supervisory requirements
still exist. The extent of these differences is not well known because, with few
exceptions, there is a dearth of comparative studies of normal EU supervisory practices
or emergency resolution procedures[3]. Moreover, the EU has not sought to harmonize
practices relating to reorganization and winding up. In this section, we succinctly
present information gathered from multiple sources on divergences in many areas that
are critical for the success of normal supervisory actions and rescue operations for
cross-border banks. While we were able to obtain information describing most countries’
normal supervisory actions, we were less successful in discovering the ir processes for
dealing with seriously deficient banks[4].
1.1 Supervisory objectives
Table I shows that the objectives that countries set for their prudential supervisors are
often ambitious, varied, multiple, and extend well beyond ensuring mere compliance
with relevant laws and regulations[5]. It is perhaps not surprising that the supervisor is
charged with promoting financial stability in the 14 EU countries where the central
bank has supervisory responsibilities, but non-central bank supervisors elsewhere,
including those in Sweden and the UK, also have this mandate. Moreover, supervisors
in 15 countries are charged with protecting consumers and/or depositors and other
Objective Number of countries
Ensure compliance with relevant laws and regulations 17
Promote financial stability 18
Achieve the orderly and safe functioning of the financial system 13
Promote confidence in the banking system 6
Encourage efficiency in the banking system 9
Promote banks’ ability to compete 2
Protect consumers and or depositors 15
No information 1
Note: Number of EU countries
Sources: Freshfields Bruckhaus Deringer (2007) and IMF/World Bank (2001-2007)
Table I.
Supervisory objectives
JFRC
17,3
242

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