CIRSF Annual International Conference 2022
Lisbon, 15 September 2022
Law Faculty - University of Lisbon (FDUL)
Main Auditorium
OF THE IN A
THE FUTURE EU FINANCIAL SYSTEM NEW GEO-ECONOMIC CONTEXT
TO FINANCIAL STABILITY WITH THE RETURN TO INFLATION AND UNCERTAIN GROWTH
CHALLENGES - HOW
PROGRESS IN AND MAY AVOID FINANCIAL FRAGMENTATION
BANKING UNION CAPITAL MARKETS UNION
The role of crisis management in creating a safer financial system: how
can the bank recovery and resolution framework pave the way?
Ladies and Gentlemen,
I would like to greet Professor Luís Morais, whom I congratulate for the
commitment in organising these annual conferences and for always being
able, not only to identify some of the most relevant and topical issues for
the financial sector, but also to bring together so many distinguished
speakers.
I also want to thank Professor Luís Morais for having invited me, once again,
to participate in this annual conference. It is always a pleasure to attend
such a relevant event but I have to say that it is especially heartwarming to
be here today, as we are finally able to meet in person again.
My intervention for today is focused on the role of crisis management in
creating a safer financial system and on how so much work is still required
in this front in spite of the impressive progress achieved in the last decade.
Crisis management in the financial sector has gained considerable
importance following the financial crisis in 2007-2008.
As we are all well aware, the financial crisis forced the recognition that
public authorities, namely in the European Union, did not have the
necessary instruments to deal with failing or failed financial institutions.
There were no effective and targeted recovery measures to prevent failure
of distressed institutions nor any specific toolbox to safeguard financial
stability and to preserve critical services to the economy when failure was
inevitable.
The financial crisis and its ensuing consequences reminded us all that
failures do happen and that in fact financial institutions do not operate -
and are not supposed to operate - in a zero-failure regime.
Therefore, the purpose of policymakers, regulators and public authorities is
not to prevent the failure of financial institutions at all cost, but rather to
ensure that distressed financial institutions can either be recovered or can
exit the market in an orderly manner, while preserving continuity of their
critical functions, safeguarding financial stability and avoiding or minimising
the use of public funds.
The lessons learnt from the financial crisis eventually led to the awareness
that a framework was needed to make sure that the financial sector
adequately performs its vital role to the economy both in good times as in
bad times.
For decades, the discussions around creating conditions for a safer financial
system had been centred on making institutions sounder, namely through
adequate capital and liquidity levels, appropriate governance, and ever
more robust supervisory action.
In essence, the focus in the past had been, almost exclusively, on reducing
the likelihood of failure by strengthening the resilience of financial
institutions.
This regulatory and supervisory pillar has not become less important. Much
to the contrary, immense progress has been achieved - also in response to
the financial crisis - in terms of strengthening the prudential regulatory
framework and reinforcing supervision.
The point I would like to make is that such developments have been
accompanied by significant progress also in the regulatory framework on
crisis management.
Creating and maintaining a safer financial system involves ensuring that
institutions are more resilient as much as it involves creating the conditions
so that distressed institutions and crises can be handled effectively.
I am certain that you will all agree that having a robust crisis management
framework in place is perhaps even more important today, in the face of
the uncertainty emerging from new challenges to financial stability, such as
the ones created by the pandemic and now those resulting from the
tremendous energy crisis, the situation of high inflation and the new geo-
economic environment, as discussed this morning.
In the financial sector, a reflection on crisis management probably has to
start with the so-called Bank Recovery and Resolution Directive, or BRRD.
Indeed, the adoption, in the European Union, of the BRRD, in 2014, was a
landmark - and a very ambitious one - on providing authorities with the
appropriate instruments to intervene, in a timely and expeditious way,
when credit institutions begin to show signs of financial difficulties or are
already failing or likely to fail.
But the recovery and resolution regime created for the banking sector was
only the beginning.
If we go back to the "Key Attributes of Effective Resolution Regimes for
Financial Institutions" issued by the Financial Stability Board in 2011 - which
set the international standard for resolution regimes in the wake of the
financial crisis - we realise that the focus was not just on the banking sector
but actually on the full spectrum of the financial system, including financial
market infrastructures and insurance companies.
Considering the central role played by banks in the economy of the
European Union and perhaps the perception that systemic risks emerging
from the banking sector are higher, the initial focus of legislators and
policymakers in the European Union was on creating a recovery and
resolution regime for the banking sector.
It is clear, however, that other sectors are to follow.
In December 2020, the co-legislators in the European Union approved a
Regulation establishing a special regime for the recovery and resolution of
central counterparties.
Similar to the bank recovery and resolution regime, the objectives of the
framework for the recovery and resolution of central counterparties are,
among others, to ensure the continuity of the critical functions of central
counterparties that are failing or likely to fail, to preserve financial stability
and to avoid a significant adverse effect on the financial system and its
ability to serve the real economy, while minimising costs to taxpayers.
To this end, a legal regime was established, which, in essence, is very much
similar to that laid down in the BRRD, in particular regarding its objectives,
its overarching principles and the set of powers and tasks entrusted to
resolution authorities.
Also with regard to the resolution instruments, and although the
framework for the recovery and resolution of central counterparties
foresees some specific instruments for these entities, they share some key
characteristics with the bank resolution regime, such as the powers of
write-down and conversion, the sale of business and the creation of bridge
central counterparties.
The resolution measures envisaged in the resolution framework for central
counterparties are indeed quite similar, both in material and in procedural
aspects, to banking resolution measures.
However, there is more to come in the build-up of effective crisis
management capacity in the financial sector.
In September 2021, the European Commission presented a proposal for a
new legal framework on the recovery and resolution of insurance and
reinsurance companies.
The proposed Directive is currently under discussion and is likely to be
published in the near future. It is motivated by the acknowledgement that
the possible failure of insurance companies can have significant impacts on
policyholders, beneficiaries, injured parties or affected businesses and can
in certain cases, amplify financial instability.
The proposed Directive - already labelled "Insurance Recovery and
Resolution Directive", or "IRRD" - also builds on the bank recovery and
resolution framework and one can easily see that it shares with the
framework its objectives, its overarching principles and even the set of
resolution powers and tools.
As the European Insurance and Occupational Pensions Authority (EIOPA)
wrote in July, the proposal for an IRRD "is a way to complete the picture",
following the adoption of the recovery and resolution framework for banks
and for central counterparties.
This authority also stressed that there are indeed important similarities
between the newly proposed framework for the resolution of insurance
companies and the BRRD, which it considers to be fully justified given that
both frameworks are inspired by the same international standards and that,
to a certain extent, the general process of a resolution does not need to
differ considerably across sectors.
EIOPA further recalls in its July Paper that the 2008 financial crisis showed
the need to have proper recovery and resolution frameworks for different
segments of the financial sector, that insurance failures and "near misses"
in the insurance sector are not rare and that regular insolvency procedures
can be cumbersome and unable to manage a failure of an insurer in an
orderly fashion, as is also the case for the banking sector.
Also very recently, the European Banking Authority (EBA) - in their Opinion
of June 2022 on the ongoing review of the Directive on payment services in
the internal market (PSD2) - recalled that specific powers should also be
devised to deal with possible failures of payment institutions and electronic
money institutions. The EBA suggests that some of those tools take the
shape of powers to appoint temporary administrators, possible early
intervention measures and resolution-like measures or orderly wind down
strategies.
All this confirms that there is full acknowledgment, across all sectors, of the
importance of effective crisis management frameworks in creating a safer
financial system. It also confirms that, in spite of the very significant
progress of the last decade, mostly concentrated on the banking sector, a
lot of work is still ongoing and is yet to come.
As the banking sector pioneered the way, it is only natural that the
foundations laid down by the BRRD and the work carried out in the last
years by banking resolution authorities will be used as inspiration and as a
basis for the development of resolution frameworks in other sectors.
In spite of some substantive flaws in the bank resolution framework (which
will certainly be addressed by the next panel), it is relatively undisputed that
its fundamentals are robust overall and can generally be applicable to
sectors other than the banking sector. This applies to namely:
a) The underlying principles of the bank resolution framework, such as
the principle according to which losses are to be borne, first and
foremost, by shareholders and creditors;
b) Its legal safeguards, such as the "no creditor worse off principle";
c) The conditions that have to be met for the adoption of resolution
measures, such as the need to confirm that the institution is failing
or likely to fail and that resolution is needed in the public interest;
d) The legal powers entrusted to resolution authorities, such as the
power to write down or convert relevant capital or debt instruments;
and
e) The set of resolution measures, such as the bail-in tool, the asset
separation tool, the sale of business and even the bridge institution
tool.
It is not surprising, therefore, that the bank resolution framework is already
paving the way for the development of similar frameworks for market
infrastructures and for insurance companies.
The already ongoing "expansion" of the bank resolution framework to other
sectors will therefore contribute to making the financial system sounder,
and especially more prepared to withstand future shocks, even more so if
the experience gained in the banking sector can be used to amend and
correct those elements in the framework that need improvement.
As Vice-Governor of the Banco de Portugal, responsible for the mandate
entrusted to the central bank as the national banking resolution authority,
and as member of the Single Resolution Board, I witness the build-up of the
crisis management function with great expectation and joy.
These are crucial advances towards building a safer financial system, but
one must be conscious that their implementation and operationalisation
require legal, regulatory and also institutional adjustments.
As with the bank resolution framework - which required the designation of
bank resolution authorities in all Member States - the implementation of
resolution frameworks for central counterparties and for insurance and
reinsurance companies will require the designation of the relevant
resolution authorities.
Therefore, any discussion on the institutional set-up for the financial sector
will have to take into account the additional powers and tasks emerging
from resolution frameworks across all sectors of the financial system and
the need, dictated by European legal acts, to designate resolution
authorities also for market infrastructures and for the insurance sector.
Based on my experience in the development of the resolution function in
the banking sector, I can testify that making the resolution framework
operational and ultimately ensuring resolvability of financial institutions is
a daily challenge, which requires full-time dedication of skilled staff on a
permanent basis.
I am quite sure that, when the BRRD and the Regulation establishing the
Single Resolution Mechanism were first designed, no one anticipated the
technical, legal and operational complexity that the actual application of
the framework would bring about for resolution authorities and for the
banking system.
The progress since then has been remarkable at all levels:
•
The preparation of resolution plans and the selection of preferred
resolution strategies for all banking groups;
•
The significant improvement in terms of loss absorbing capacity by
credit institutions;
•
The build-up of the Single Resolution Fund;
• The densification of the regulatory framework;
• The design of new methodologies and procedures; and, perhaps
most important of all,
• The development of new skills and specific expertise to address bank
failures more effectively.
However, even if a lot has been accomplished in the banking sector,
multiple challenges still lie ahead and will continue to require the
commitment of both the Banco de Portugal, as the national banking
resolution authority, and of the Single Resolution Board.
For example:
▪
The build-up of loss absorbing capacity - which is essential to ensure
resolvability - is not completed and will require particular attention,
especially in the current financial market conditions;
▪
Resolution planning is growing more and more complex each day and
there is still work to be done in the road towards making resolution
plans fully operational and in ensuring that all institutions are
resolvable.
▪ The regulatory and policy work is becoming increasingly deeper, with
many avenues still to be better explored, namely concerning data
reporting and analysis; and finally
▪ The readiness of resolution authorities for any crisis event and for
dealing with cross-border groups also remain challenging elements.
In addition, there is a growing conscience that there are relevant flaws in
the existing resolution framework for the banking sector and that
substantive improvements are required.
The European Commission has therefore launched a procedure for a
structural review of the bank crisis management and deposit insurance
framework, as part of the debate on the completion of the Banking Union
and on its third and missing pillar, the European Deposit Insurance Scheme.
In the opinion of the Banco de Portugal, a review of the existing framework
is indeed necessary, as the experience gained in the last few years in the
European Union has shown that the current framework is not entirely
suitable for small and medium-sized banks with a deposit-based business
model and is also not suitable for system-wide events. This is largely due to
some rigidities introduced in the legal framework as regards the minimum
requirements for burden sharing and the rules on accessing the Single
Resolution Fund.
Moreover, I believe that it is widely acknowledged today that the lack of a
single deposit guarantee scheme is indeed detrimental to the proper
functioning of the Banking Union and creates very relevant distortions,
considering the progress already achieved in terms of integrating the
supervisory and resolution responsibilities.
I am certain that the debate on improving the existing crisis management
framework for the banking sector will be the focus of the next panel, so I
will end my intervention here, hoping that it may have served as an
introduction to the discussion that will follow, which I very much look
forward to watching.
Thank you for your attention.