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Cross-border bank resolution seen as next big challenge in post-crisis reforms

Cross-border bank resolution is the next big challenge facing the industry and regulators in the implementation of post-crisis reforms in Europe, according to market observers and financial authorities.

Resolving banks in an orderly way without jeopardizing financial stability has been one of the leading themes in post-crisis regulation. Having set the standards and requirements for capital and loss-absorbing capacity buffers, regulators are now focusing on implementation. And a core challenge in this phase is the division of resources between multinational banking groups and their subsidiaries in the case of a resolution.

Regulators 'ducked' the issue

For regulators, there is an inherent tension between prudential and resolution regulation, according to José Manuel Campa, the new chair of European Banking Authority.

Prudential rules, which are meant to minimize risks by setting minimum capital requirements, have been built on the concept of consolidated accounts and not much attention has been paid to the fact that resolution typically plays out on a deconsolidated basis, Campa said at a conference of the global Financial Stability Institute in March.

Regulators have "ducked" the issue of home and host jurisdictions for years and it was never addressed in the prudential standards for banks, Mark Branson, chair of the Financial Stability Board's Resolution Steering Group said at the same event. It is "ironic" that the first time that came back on the table was in the initial discussions about loss-absorbing debt capital, Branson noted.

Global and EU bail-in rules: key features
Global Total Loss-Absorbing Capacity (TLAC) standard EU Minimum Requirement of Eligible Liabilities (MREL)
Applies to Global Systemically Important Banks (G-SIBs) only Applies to G-SIBs and non-G-SIBS in EU
Effective from Jan. 1, 2019, external TLAC instruments should be 16% of risk-weighted assets/6% of leverage exposure

Effective from Jan. 1, 2019, external MREL instruments for G-SIBs should be 16% of risk-weighted assets/6% of leverage exposure

[No set requirement for non-GSIBs]

Effective from Jan. 1, 2022, external TLAC instruments should be 18% of risk-weighted assets/6.75% of leverage exposure

Effective from Jan. 1, 2022, external MREL instruments for G-SIBs should be 16% of risk-weighted assets/6% of leverage exposure

[No set requirement for non-GSIBs]

According to the Financial Stability Board: "The primary objective of internal TLAC is to facilitate co-operation between home and host authorities and the implementation of effective cross-border resolution strategies by ensuring the appropriate distribution of loss-absorbing and recapitalization capacity within resolution groups outside of their resolution entity's home jurisdiction."

EU authorities take a similar view with internal MREL.

He warned that the tension between home and host supervisors could lead to destabilization of global banking groups and give them no incentives to continue operating internationally. "We need to find a way of getting back to the concept that if global banks are going to exist they have to be allowed to have some fungibility in their capital and liquidity resources," Branson said.

The current rules for bail-in-able debt include a group-level, or external, requirement and an internal requirement which could be set for subsidiaries.

However, if the calibration at the subsidiary level is driven up too high, this will fragment the resources available to the group in case it runs into trouble. If requirements on the subsidiary level are set in the same way as external, group-level requirements, the sum of the internal requirements could exceed the external requirement as subsidiaries often have exposures to each other which net out at the group level, according to the Bank of England.

'Race to the top effect'

To avoid such "race to the top effect" at subsidiary level regulators have to find the "right balance between stability in all the individual jurisdictions and the ability for large conglomerates to still continue to play a role", Branson said.

However, supervisory coordination at home and host level could prove challenging given the lack of trust and potentially diverging interests of supervisors across jurisdictions. Apart from their different legal systems, each country's main aim will be to preserve financial stability and protect creditors in its own market, auditing firm KPMG said in an April 2019 report on bank resolution in Europe. Therefore, a mutual agreement on a resolution plan that is credible for the group as a whole and each of its subsidiaries could be difficult to achieve, the firm said. KPMG highlighted cross-border bank resolution as potentially the "greatest remaining challenge" for bank supervisors in the implementation of post-crisis regulatory reforms.

Home-host tug of war

Europe is a good example of that home-host tug of war because many small, mostly emerging European markets are dominated by large multinational banks, typically from western Europe.

For example, the banking market in the Republic of North Macedonia, like in many countries in the Western Balkans, is predominantly foreign-owned. Therefore, the resilience and stability of the local banking system is, to a large extent dependent on banking groups licensed in the eurozone, of which the European Central Bank is the home supervisor.

This can complicate the supervision of banks in the host financial system because the coordination of home and host supervisory arrangements in ways that meet the needs of both countries is both complicated and challenging, said Milica Arnaudova Stojanovska, director general for supervision, banking regulation and financial stability at the National Bank of the Republic of North Macedonia, or NBRNM.

"As a small host, the NBRNM faces the asymmetry between the systemic importance of the subsidiaries present on our market and their negligible role for the overall operation of the parent bank and thus the home supervisor," she said in an emailed comment.

That asymmetry is exacerbated by the fact that host countries which are outside the EU are not by default included in EU supervisory colleges, which are the vehicles through which supervisory activities are coordinated, Thorsten Beck professor of banking and finance at Cass Business School in London, said in an interview.

Greater transparency

There is no easy solution in syncing the interest of all stakeholder, as the rights and powers of non-EU member states are limited on a national level, Beck said. The only solution is to involve the non-EU host jurisdictions in the work of the supervisory colleges so they can raise their concerns, gain confidence into the overall process, and ultimately agree on a common approach in the resolution planning, Beck said.

"Smooth resolution of banks' subsidiaries in other European countries depends largely on cross-border cooperation and information sharing," Stojanovska said. Not being invited in supervisory and resolution colleges hinders mutual cooperation as the host authority does not know what approach the home supervisor might take to the resolution of the EU-based parent bank, she said.

"From a host authority perspective, the primary interest is the financial stability impact of the local subsidiary and how the resolution implemented by the home authority will affect this," she added.

Both Branson and Campa agreed a greater degree of transparency in resolution planning is essential in implementing resolution regulation.

Resolution is only going to work if market participants and clients believe in the process at the time of execution, Branson said. It is "a little bit of a fantasy" to believe any resolution process would run smoothly but getting "a clear design out there in public" about how the process would look like will be key for its success, he said.