Progress on the resolvability of GSIBs - the FSB
perspective
Speech by Klaas Knot at the 2nd SRM-EBF Boardroom
Dialogue
Brussels, 5 July 2019
At the second SRM-EBF boardroom dialogue, Klaas Knot gave a speech in which he described the
efforts in making banks resolvable. He also mentioned areas of concern for the coming years: trends
and priorities for achieving resolvability.
Let me start by saying that I am here in two capacities, wearing two hats as it were. I am here both as
vice-Chair of the Financial Stability Board, the FSB, and as president of the Dutch Central Bank. For
this speech I will be wearing my FSB-hat.
As you may know, the FSB has actually been the instigator of many of the reforms and policy
initiatives on bank resolution, including the topics being discussed today. With the development of the
Key Attributes for effective resolution regimes in 2011, the FSB created the blueprint for the European
resolution framework. This was followed by the TLAC standard for setting loss absorbing capacity for
G-SIBs. So far, this is the only international standard developed by the FSB. Other guidance developed
by the FSB covers topics such as bail-in, funding in resolution and operational continuity.
In this speech I will be taking the view of an FSB representative with a keen interest in making banks
resolvable. This view should provide insight into the trends and priorities for achieving resolvability.
Hopefully it will also guide your own efforts, as you work together with the SRB on topics such as:
completing resolution plans, implementing TLAC and modelling funding in resolution. And even though
the FSB focuses on policy development for G-SIBs, I think these topics are equally relevant for other
banks.
Resolution planning and achieving resolvability
I will start with resolution planning and achieving resolvability, the topic you discussed before lunch. In
my view resolution planning has always been a means to an end. It is about getting a deep
understanding of how a bank is organized and functions. It is about asking fundamental questions on
what functions need to be continued and how to achieve this. Resolution planning forces authorities to
consider all these aspects and it focuses the mind. Through resolution planning, the authorities can
form an informed view on what is needed to ensure a bank is resolvable.
The FSB monitors progress in resolution planning, in its annual Resolvability Assessment Process and
reports on this to the G20. The good news is that significant progress has been made, especially in the
area of resolution planning. All G-SIBs have a resolution plan that sets out a resolution strategy. The
plans have also been discussed between the various relevant resolution authorities involved with the
bank in the crisis management groups. However, this in itself does not make banks resolvable.
Resolvability means readiness at both the level of the bank and the authorities, to implement the
resolution strategy if necessary. At the FSB, we observe that this reality has now also dawned on both
authorities and banks.
We see the positive trend that authorities are increasingly focussing on banks and their own
capabilities to execute resolution strategies. This will take time and effort and requires the allocation of
sufficient resources to this task across the board.
A lot of the proverbial low-hanging fruit has already been picked by the banks. For instance, identifying
and mapping critical services. At the FSB we are finding out more and more that the devil is in the
detail. The Resolvability Assessment Process in this context has identified areas in the context of
operational continuity where banks and authorities should increase their capabilities.
In my view there are three areas of priority when it comes to ensuring banks are ready to implement
the resolution strategy. It is perhaps not surprising that two of those are in the domain of data
availability in resolution. I am referring to centralizing contract management for critical service
contracts in the context of operational continuity, and ensuring good quality data for valuation
purposes. If this data is not quickly and easily accessible, implementing resolution in a short timeframe
is extremely difficult.
The other priority area is understanding how financial market infrastructure will react if the bank is in
resolution. If banks in resolution cannot conduct market operations, any effort by any authority is
likely to fail. All of the three topics I mentioned require a deep-dive into the DNA of a bank - and then
I have not even started on TLAC.
TLAC
This morning, you also discussed the setting of MREL in order to achieve resolvability. MREL was
developed almost simultaneously with TLAC and there are of course a lot of similarities between the
two. The TLAC term sheet developed by the FSB determines the minimum amount of loss-absorbing
capacity G-SIBs should have. Last month, the TLAC principles were implemented in European
legislation through the banking package.
This means that, as of last Friday, all G-SIBs in Europe are required to have a minimum loss absorbing
capacity of at least 16% of Risk Weighted Assets, plus the combined buffer requirement. The European
legislation on some aspects goes beyond the TLAC term sheet, for example by requiring MREL targets
for all banks instead of only G-SIBs. Also, the new BRRD2 introduces binding minimum subordination
requirements for banks with over 100 billion Euro on their balance sheet. This will ensure that
sufficient loss-absorbing capacity is available for bail-in during resolution.
The FSB has been monitoring the progress G-SIBs are making in building up loss absorbing capacity.
We see that progress has been steady and significant, both in the setting of TLAC requirements by
authorities and in the issuance of TLAC instruments by banks. This has been instrumental in enhancing
resolvability and boosting market confidence in authorities' capabilities to address "too-big-to-fail"
risks.
However, despite all this, we are not at the end of the road yet. The TLAC review that the FSB recently
finalized, has shown that additional steps relating to loss-absorbing capacity are necessary.
I will address three topics where I believe progress is required. First, it is clear that there will be less
issues when bailing-in a subordinated liability compared to bailing in a senior instrument.
No Creditor Worse Off issues come to mind in this context. The TLAC term sheet, by way of exception,
allows for senior instruments to be counted towards TLAC. In my view, more analysis is required as to
how these exceptions influence the resolvability of banks.
Second, we have to make sure that adequately distributing loss-absorbing capacity within the group,
needs to be prioritized. This means making sure losses in subsidiaries can be upstreamed to the parent
company, and capital generated through bail-in can be downstreamed from parent to subsidiary.
Without an efficient internal mechanism, bail-in simply will not work. It is good to know: this topic also
has the attention of the SRB.
Third, further work is needed on bail-in execution. This has also been recognized within the FSB. Both
banks and resolution authorities should consider how they can ensure that the execution of bail-in is
effective.
Executing bail-in is a complex process that involves many actors and actions by both banks and
authorities. Bail-in also has distinct cross-border elements, as many banks have issued bail-inable
instruments in other jurisdictions. This is an area the FSB will be focusing on this year. I am glad that
the SRB and the banks are also making progress with the development of bail-in playbooks.
Funding in resolution
I will now turn to the topic, that will be discussed this afternoon: "funding in resolution". This topic,
which has often been referred to as the elephant in the room, is now firmly on the radar screen of
banks and authorities alike. Within the FSB we have observed that work has slowly started to ensure
that funding and liquidity will not be the constraining factor for an orderly resolution.
Resolution funding strategies and plans are being prepared. Banks have started building up core
capabilities, by developing automated scenario modelling and forecasting to address funding in
resolution, in line with the FSB's guidance on Funding Strategy Elements for an Implementable
Resolution Plan. However, this takes time and it requires a different mindset from bankers.
So here we encounter a third area of recommendations, after those on operational continuity and
TLAC. The area of bank's capabilities on funding in resolution.
Preparing for a resolution scenario goes beyond normal liquidity stress testing and contingency
planning in going concern. Banks must be able to estimate and address potential funding needs in a
variety of stressed situations and resolution scenarios, by applying even more conservative
assumptions than in normal stress tests. In addition, banks need to identify and monitor the collateral
that can be mobilized in a resolution scenario. So, I would like to urge everyone around the table to
dedicate sufficient resources to this topic tasks and not to consider this as something already covered
by recovery planning.
Despite efforts undertaken, liquidity gaps may eventually arise when an institution is put into
resolution. In particular in a slow-burning crisis situation, there is a risk that in the run-up to
resolution, more and more assets are being encumbered or disposed, as part of the recovery strategy.
A consequence of this, inevitably is that when the institution is declared failing or likely to fail, there is
insufficient collateral left for the institution to fund itself.
And here we encounter the fourth and final area of concern: the authorities. Authorities should
therefore work in parallel in two directions, to avoid institutions being unable to be resolved because of
a lack of funding. First, to avoid ending up in such a situation where all collateral is gone, it is
important that the bank is placed in resolution at a sufficiently early stage. In line with the FSB Key
Attributes of Effective Resolution regimes, liquidity indicators should be an important element in when
authorities determine that an institution is failing or likely to fail. Second, private and public funding
mechanisms should be put in place to close any potential liquidity gaps. In line with the FSB Guiding
principles, private sources of funding should be relied upon as a first-choice source of funding, to the
degree that such funding is available. In addition, an effective public sector backstop funding
mechanism should be available as last resort.
In several jurisdictions such mechanisms have been put in place in recent years: in countries like the
United States and the United Kingdom, through a combination of a resolution fund and a central bank
resolution liquidity facility. At the level of the Banking Union, the public backstop funding mechanism is
still very much a work in progress.
I understand the SRB has been exploring how the Single Resolution Fund can best be used for funding
in resolution. There are quite a few challenges that need to be overcome, like the form in which
liquidity will be provided and obtaining a rating for the Fund. I am sure the SRB will rise to the
occasion on these topics.
What has been achieved, is that the ESM will become the common backstop to the SRB's Single
Resolution Fund. This backstop can be used in case the Single Resolution Fund has been depleted. It is
therefore also available to provide liquidity support to resolved banks. Yet, we all know this may not be
sufficient to cover the liquidity needs of a GSIB
This leaves the question of the role of the Eurosystem, with regards to funding for banks in resolution.
At the moment, the technical work within the Euro Working Group focuses on ways to access ordinary
central bank liquidity facilities. The recent letter from Eurogroup President Centeno mentions further
work on proposals on SRB guarantees to the Eurosystem, and on the capacity of the SRB to provide
collateral to banks in resolution. You can imagine that, with my central bank hat on, I can only support
these initiatives.
Whatever the outcome of the technical work, the instrument should be designed in line with the FSB
Guiding Principles. This means: it should only be available on a temporary basis, when private funding
sources are insufficient, on conditions that minimize moral hazard.
Concluding remarks
When looking at the progress made on bank resolvability, I can say that from an FSB perspective the
glass is half full and that I remain optimistic. Much progress has been made on resolution planning,
TLAC and funding in resolution. This has helped to increase the resolvability of the banks and the
preparedness of the authorities.
The challenge will be to keep up the good work. This means banks should invest in improving their
capabilities to execute the resolution strategy. Authorities need to continue to provide the banks with
guidance and make sure they are operationally ready for a resolution case.
I hope I can count on your efforts in this endeavour of making your banks resolvable, especially in the
areas of operational continuity, TLAC and funding in resolution.
Thank you!