Natasha Ahmetaj: Recovery and resolution planning for the banking
sector
Opening remarks by Ms Natasha Ahmetaj, Second Deputy Governor of the Bank of Albania, at
the Regional Conference on Recovery and Resolution Planning, Tirana, 15 November 2018.
* * *
Dear ladies and gentlemen,
Welcome to this regional conference organized by the Bank of Albania in cooperation with
FinSAC, a valued partner in our path towards development.
The financial crisis of 2008 remains the starting point of a number of discussions, as many of our
present efforts originate from this period. The 2008 crisis was a tough test for the capability of a
state to manage national and cross-border crises. This test became even more relevant for its
global capability, if we take into account that the crisis originated in advanced economies, but
spilled over into emerging markets and developing economies.
In order to safeguard core financial services for their citizens and firms, governments were
forced to use public funds, by injecting money and issuing guarantees for distressed financial
institutions at unprecedented levels. From October 2008 to October 2011, the European
Commission approved EUR 4.5 billion from public funds to support financial institutions.
Naturally, this support helped to curb, at least in the short-term, a massive bankruptcy of banks
and the collapse of the real economy. On the other hand, it burdened taxpayers with deteriorated
public finances. This forced situation strengthened the need to reflect on the protection of the
taxpayers and public finances in times of crisis, without sacrificing the prevalence of public
interest. Such reflection served to promote discussion on the adequacy of financial markets'
regulation to withstand crises. Two important shortfalls in the regulatory framework were
identified.
First, the banking legislation established clear rules for the orderly entry of new participants in the
market but did not define the mandatory requirements for an orderly exit for the troubled market
participants. Now in the post-crisis period, almost everyone agrees that, in the absence of a
resolution regime, in order for a smooth and orderly exit of problematic banks, governments were
forced to use public funds. Second, as a result of the high level of financial integration internal
shocks in a given country were transmitted across borders to other countries, transforming them
into a global issue.
The post-crisis analysis motivated the European Union to assess issues related to banks'
recovery and resolution, and consider strengthening the existing cross-border cooperation, to
reflect better the actual integration of financial markets. Today, the banking union in Europe has
introduced harmonized rules about resolution throughout the European Union, and a unified
application for the euro area. More specifically, the legislation of the European Union has
activated the European Bank Recovery and Resolution Directive (BRRD) for all member
countries and has established the Single Resolution Mechanism (SRM) in the euro area, as well.
The BRRD creates such instruments for a preventive recovery and early intervention in a bank,
designed to avoid the failure of a bank, as well as facilitate an orderly resolution when banks are
failing, to protect the public interest. The new Law replaces the standard insolvency proceedings
of a bank with the resolution undertaken by the relevant authority. Banks' failures and financial
crises may be common events. They are very costly, as well, which, in some cases, can be as
high as 40-60% of the Gross Domestic Product. This includes losses in deposits, weakening of
access to finance and loss of public confidence in the financial system, which, in turn, reduces
its capacity to support economic growth and decrease poverty. Also, standard insolvency
proceedings for failing banks proved inadequate in times of crisis because they did not address
systemic risk nor ensured the continuity of critical functions; moreover, they did not protect
depositors. These procedures require time, long negotiations as well as complex arrangements
with creditors, which may damage and further diminish the asset value of the distressed bank,
hence causing severe consequences for the real economy.
For this purpose, the new Recovery and Resolution Law provides the Supervisory and
Resolution Authorities with the legal capacity and the necessary instruments for restructuring
bank operations, in the event its possible failure jeopardizes financial stability or undermines
other objectives of the regulator. The aim is clear: on the one hand, we have the public interest
on financial stability, while, on the other hand, remain the shareholders of the bank, who have
voluntarily undertaken the risk by investing in the bank. If the shareholders rely on the possibility
of an implied state guarantee for banks, this constitutes a moral hazard on their part, therefore
increasing their risk appetite. The implementation of the Resolution Law formally eliminates the
basis for the expectation for any such guarantee.
Among the costs caused by the failure of a bank, contagion is probably the highest, since it turns
the problem of a single bank into a problem for the entire banking sector. It may happen for two
reasons: due to the spillover effect of a bank's exposure towards another, as well as due to
public panic, that causes eventual massive bank runs. This channel is particularly pronounced
for developing economies, where contagion is faster due to their weak financial literacy, the
historical lack of bank failures, and the presence of weaker institutions. In this context, the
resolution regime serves as a tool for restoring market discipline and avoiding the risk of
contagion. In essence, resolution is an integral part of banking supervision applied to the final
stage of a bank's life, should measures taken during the standard or intensive supervision stages
fail to improve the situation of a distressed bank.
The drafting of the resolution regime was accompanied by the strengthening of the supervision
regulatory requirements, which aim to increase the resilience of the bank and strengthen the
financial market structure to avoid the moral hazard. In the wake of the crisis, experts have
reached the conclusion that there is no bank model that would perform well or poorly in times of
crisis. Different models of failing banks showed that the issue stemmed from undertaking high
risk, financing with short-term instruments and insufficient protection offered by capital, even
where minimum requirements were met. This conclusion has been reflected in higher
supervisory requirements for quantity and quality of capital and liquidity, limits on the leverage
ratio and maturity mismatch between assets and liabilities. The banking sector needs to comply
with these requirements within a defined medium-term framework.
Regulatory measures are also accompanied by the consensus on the need for structural
reforms in the financial system, namely, separation of risk-bearing financial speculation activities
from deposit collection activities, and issues related with too big to fail banks, by discouraging
their excessive growth. The biggest lesson of the financial crisis was that micro-prudential
supervision of banks was not sufficient to safeguard financial stability because the system as a
whole behaves differently from individual parts. In an effort to make themselves safer, financial
institutions may undertake such behaviours that collectively damage financial stability. The
banking activity takes place through its own cycles, known as financial cycles, which may
deteriorate the business cycle of the real economy. Banks are exposed to collective
macroeconomic shocks, which weaken them, at the same time, thus affecting financial stability.
The understanding of this lesson dictated the need for macro-prudential supervision in addition to
the micro-prudential one. Among the most effective instruments of macro-prudential supervision
are the requirements for capital buffers to counter the creation of systemic imbalances, as well
as capital buffers for systemic banks, which being large enough, may cause social costs beyond
their individual dimension. Through this new capital composition, the macro-prudential
instruments manage the systemic risk before it materializes, decreasing the probability of
occurrence and, after its materialization, minimizing losses that are absorbed by the higher level
of capital.
But still a lot of work remains to be done.
It has long been recognized that a deeper financial integration also brings a better functioning of
the European Union. Yet, financial integration showed to be shallow and reversible and, after the
financial crisis, fragmentation increased against centralization and integration. The measures
undertaken to reduce liquidity within each country improved the national financial stability, but
neglected the effect on other countries. The banking union addressed these inadequacies by
concentrating the national financial policies at the central level and aiming to fulfil two objectives:
to ensure banks' soundness and promote a deeper integration of the banking sector.
The Single Supervisory Mechanism plays an important role in these objectives. A stronger and
more uniform supervision enhances banks' stability and provides them with a more coherent
framework of policies on cross-border banking, producing benefits compared with the
fragmented system of national supervision. As Mario Draghi says: "Let's keep in mind that
fragmentation starts with the decision by banks not to operate in regions where the risk-return of
lending is judged to be insufficient to remunerate their invested capital".
Supervisors' advice for banks in the post-crisis period remain the same: banks should adapt the
business model to be more effective and profitable, improve risk management and manage the
cleaning of the balance sheet from legacy assets. Despite the progress made, these tasks are
yet to be completed and now is the most appropriate time to finalize them. The regulatory
framework is clearer and more complete (the implementation of Basel III is starting), supervision
is clearer in terms of methodologies and policies, and the application of FinTech allows banks for
new ways to do business efficiently. Lastly, and more importantly, the overall macroeconomic
framework is stabilised and the positive economic growth is stable.
The framework presented above is a good guideline to address the remaining post-crisis
challenges. Is the adoption of international standards on financial stability safeguarding
necessary? The answer is yes, because the globalization and interconnection of the banking
sector needs the standardization of prudential regulation. However, while adopting international
standards, it is important to keep in mind two issues: First, these standards have to adapt to the
development level of the country and calibrated according to domestic conditions. Second,
international standards pose a minimum of requirements, leaving it at the discretion of individual
countries to undertake more stringent requirements.
The model of global integration is the economic model that has been adopted by most of the
transition countries, such as Albania. Under this guidance, the Albanian banking market has
demonstrated clear willingness and objectives for a swift harmonization with the legal framework
of the European Union's banking system, as well as with its significant changes since 2008.
Although there are no cases of bank failures in the history of the Albanian banking sector, we
have identified in our banking legislation the same loopholes found in other European economies.
The development of hypothetical scenarios for coping with a potential exposure of the Albanian
economy to the Greek sovereign debt crisis evidenced that the Bank of Albania - as the
supervisory authority of the banking sector - did not have all the necessary legal instruments to
manage insolvency situations in systemically-important banks. This need for a new legal
framework is addressed in both national and cross-border aspects, by the Bank Recovery and
Resolution Directive. In fact, the initial efforts to prepare and present the first recovery plan to the
Bank of Albania started in 2012. The relevant Regulation was approved by the Supervisory
Council of the Bank of Albania in 2014. But, of course, these efforts were made within the
supervisory legal authority and, as such, they were not sufficient. For this reason, during 2015,
with the support of World Bank's FinSAC project, the Bank of Albania started the difficult but
necessary work of harmonizing the European Directive into a new Albanian law.
The Law ''On the recovery and resolution of banks in the Republic of Albania'' entered into force
in July 2017, vesting the Bank of Albania with a new attribute, i.e. the Resolution Authority. This
attribute completes the financial security mechanism of the banking sector, with the Bank of
Albania responsible for regulating and supervising the banking sector, drafting macro-prudential
policies, performing the function of the lender of last resort as well as the implementation of
banks' resolution. Together with the deposit insurance scheme provided by the Deposit
Insurance Agency since 2002, the financial safety net framework in Albania is complete. For the
purposes of this Law, the Resolution Fund was created with contributions from the banking
sector. This Fund aims to reach ALL 6.3 billion within 2027.
The implementation of the Albanian recovery and resolution Law consists in three important
steps:
The first step is the drafting of recovery plans by each bank operating in Albania, with reliable and
concrete scenarios, as well as defining the indicators that signal the deterioration of the financial
situation of a bank before it becomes irreversible. When drafting recovery plans, the bank should
create credible options to withstand stress scenarios, constructing mechanisms that are part of
the daily management of the banking business and that do not remain just part of a hypothetical
plan. Although drafting recovery plans is the task of individual banks, the Bank of Albania, in its
capacity as the Supervisory Authority, plays an essential role in assessing the quality and
reliability of these plans.
During 2018, banks have prepared recovery plans based on a new bylaw adopted by the Bank of
Albania that sets out their detailed content. The opening panel of this Conference will present
concretely our assessment of these plans. In brief, we may say that our challenges remain the
same as those faced by other supervisory authorities, whether in European or regional countries.
In sound financial situations, such recovery planning allows the Bank of Albania to deeply
understand the structure and activity of the bank, thus supporting our supervisory process to
identify areas for improvement, as well as bank's self-diagnosis in these areas. In stressed
financial situations, the recovery plan is the main document the bank has to correct its difficulties
and, as such, it must be efficient, applicable and comprehensive.
The second step of the new crisis management framework is related with the early intervention
in the bank. This step is activated if, after the implementation of the recovery plans, the bank's
actions fail to improve the situation. The Bank of Albania, in the capacity of the Supervisory
Authority, undertakes several concrete early intervention measures in the bank, before the bank
shows signs of insolvency. Currently, we are in the process of drafting bylaws for the early
intervention implementation in accordance with the new legal requirements.
The third step is the resolution of banks, applied by the Bank of Albania in view of the new
mandate. Similar to recovery plans, the resolution plans drafted by the Bank of Albania aim to
identify the legal and structural obstacles and difficulties with financial resources that banks face,
toward resolvability. In this regard, the resolution plans are one of the key instruments to facilitate
the Bank of Albania's resolution implementation.
This year in April, the Bank of Albania approved a bylaw that defines the content of resolution
plans. Then banks were required to report a broad set of data for drafting these plans, based on
the model of the European Banking Authority and we are currently in the process of drafting
them. The drafting of the banks resolution plans is complicated, which includes complex and
cross-border issues that must be implemented and coordinated within a short period of time.
Hence, the resolution planning is an on-going process and a long-term mission to remove
obstacles against the possibility for resolution action in banks. This planning does not mean
drafting an annual plan that is stored somewhere in some shelf and it is dusted off only when its
implementation is necessary; instead, it is the beginning of a long process of restructuring all
aspects of the banking business that may hinder this process. Our point of view is that this
process belongs equally to the Bank of Albania as the Resolution Authority and to the banks,
which must include its results into their daily business.
During the first cycle of this work in 2018, we have highlighted a number of issues that require
particular attention in planning, as well as in their following up by the banks:
The Bank of Albania must have access to qualitative data produced by banks, in order to
select the appropriate resolution strategy.
The exact identification of the bank's operational system interconnected with the critical
functions is important.
The proper understanding of contractual agreements and their respective treatment is
imperative, and, in particular
The provision of resolution funding sources constitutes a challenge.
Complying with the Minimum Requirement for Own funds and Eligible Liabilities (MREL), which
underpins the application of the new essential resolution instrument, the bail-in instrument,
remain the key challenge for the medium-term period. Complying with MREL is a challenge for
countries like Albania, due to the capacity of the domestic market to absorb (acquire and
maintain) the subordinate debt that may serve to fulfil the Minimum Requirement as well as due
to the capacity of the banks to restructure funding resources, which currently consist largely of
deposits. Consequently, to fulfil this obligation an interim period should be designed, without
prejudice, in any case, to the main objective of resolution implementation.
Finally, resolution is quite a challenging process for emerging and advanced economies. The
banking sector in the Balkans is dominated by foreign-owned banks. In Albania, subsidiaries of
foreign banks account for around 78% of banking sector assets, while those from European
countries account for 48%. The Bank of Albania is the Resolution Authority for seven subsidiaries
of EU based banking groups, of which four are classified as systemically important under the
mandate of the Single Resolution Board (SRB). Due to this, the signing of cooperation
agreements between the resolution authorities of the banking group and the local authorities
where the subsidiary operates is very important for coordinating actions, exchanging data for
planning and implementing the resolution, and coordinating crisis management. I have the
pleasure to share with you the news that the Bank of Albania has signed an important
cooperation agreement with the Single Resolution Board, i.e., the Resolution Authority of the
Banking Union, on 3 October 2018.
Dear ladies and gentlemen,
This Conference is the culmination of our work over the past 18 months for developing a
complete framework for bank recovery and resolution. For this reason, the presence of
colleagues from supervisory and resolution authorities from various entities assumes special
importance. We have representatives from the European Union at the central level, from
individual countries of the European Union and representatives from countries of the region,
national and foreign bankers as well as the representatives of the media. This presence means
sharing experiences and opportunity to evaluate what has been done.
I am confident that today, among other things, we will also build new bridges to coordinate our
efforts for a sustainable financial system, within and beyond geographical boundaries.