Abstract
This paper deals with bank crisis management in light of the Northern Rock debacle on the one hand and the ongoing credit crisis on the other. Following a brief narrative of the events from September 2007 (with the run on Northern Rock) to February 2008 (when the government announced its nationalisation), the paper examines the legislative and regulatory responses in the UK, and assesses some features of what is expected to be a new special resolution regime (SRR) to deal with banks in distress (including both pre-insolvency measures and insolvency). Although financial markets and institutions have become international in recent years, regulation remains constrained by the domain of domestic jurisdictions. This dichotomy poses challenges for regulators and policy makers. If at the national level, bank crisis management is complex (with the involvement of several authorities and the interests of many stakeholders), this complexity is far greater in the case of cross-border bank crisis management, both at the EU level and at the international level. In any financial crisis, it is necessary to have a clear and predictable legal framework in place to govern how a financial institution would be reorganised or liquidated in an orderly fashion so as not to undermine financial stability. We do not have such a framework yet with regard to cross-border banks, neither at the European level nor at the international level. This paper analyses some of the European and global initiatives to confront these cross-border challenges, which affect lender of last resort, deposit insurance arrangements and insolvency proceedings.
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References and Notes
Northern Rock was formally a building society. ‘The Northern Rock Building Society had originally been set up in 1965 following the merger of the Northern Counties Permanent Building Society (established in 1850) and the Rock Building Society (established in 1865). The new society demutualised and converted to a bank in 1997 with a separate Northern Rock Foundation being set up in 1996 to continue its local community and charity work. Northern Rock enjoyed spectacular growth and expansion subsequently. It was quoted on the FTSE 100 Index from 2000 (and was only re-transferred to the FTSE 250 in December 2007 following the recent difficulties). Northern Rock was one of the five top mortgage lenders in the UK. By 2006 it had revenues of £5bn and around 6,400 employees with sub-divisions in Guernsey and separate branches in Ireland and Denmark (…) Before the crisis, the bank's funding had comprised approximately 50 per cent securitisation, 10 per cent covered bonds and 25 per cent wholesale. Retail deposits only represented 22.4 per cent of funding as against its total liabilities and capital’. See Walker, G. (2008), ‘Northern Rock falls’, Bankers' Law, Vol. 2, No. 2, pp. 4–12.
On 14th September, Northern Rock announced that ‘extreme conditions’ in financial markets had forced it to approach the Bank of England for assistance. The bank's website collapsed under the strain. See http://www.bbc.co.uk/blogs/newsnight/2007/09/friday_14_september_2007.html, Accessed 24th April, 2008.
See Memorandum of Understanding of 1996 revised in 2006 between HM Treasury, FSA and the Bank of England, http://www.hm-treasury.gov.uk/documents/financial_services/regulating_financial_services/fin_rfs_mou.cfm, Accessed 20th April, 2008.
See http://news.bbc.co.uk/1/hi/business/7007076.stm, Accessed 3rd April, 2008. Lloyds had asked for a £30bn support facility, which was rejected by the Bank of England.
The Banking (Special Provisions) Act 2008, http://www.hm-treasury.gov.uk/consultations_and_legislation/banking/banking_specialprovision_bill.cfm, Accessed 20th April, 2008.
The Transfer Order came into force, and the transfers under it were made on 22nd February, 2008.
The coverage of the Northern Rock saga in Financial Times during this period was outstanding. Gillian Tett and Martin Wolf have provided excellent analysis of various issues associated with the credit crisis in general and Northern Rock in particular.
The words of Hal Scott and George Dallas, although written in another context (‘End of American dominance in capital markets’, Financial Times, 19th July, 2006) resonate in this comparative analysis: ‘While the European approach to regulation may prove to be a more adaptable and sustainable model for global companies, we need to be alert to its vulnerabilities…’.
See ‘Actions by the New York Fed in response to liquidity pressures in financial markets’, Testimony by Timothy F. Geithner, President and Chief Executive Officer of the Federal Reserve Bank of New York before the US Senate Committee on Banking, Housing and Urban Affairs, Washington, DC, 3rd April, 2008, http://www.newyorkfed.org/newsevents/speeches/2008/gei080403.html and Federal Reserve Announces Establishment of Primary Dealer Credit Facility, at http://www.ny.frb.org/markets/pdcf.html, Accessed 20th April, 2008.
For instance, Andrew Campbell, Peter Cartwright and Dalvinder Singh, in their response to the January 2008 consultation document explain that: ‘In the Insolvency Act 1986 a new corporate rescue procedure, the administration order, was included for the first time as an alternative to liquidation in appropriate circumstances. Administration orders have been used with some degree of success in relation to banks in the past, the best-known example being the administration of Barings Bank in 1995. Under this procedure the FSA (FSA) has power to petition the court for the appointment of an administrator in relation to a bank that is either insolvent or is likely to become insolvent’.
See Banking Reform — Protecting Depositors: a discussion paper, 11th October, 2007 at http://www.hm-treasury.gov.uk/consultations_and_legislation/bankingreform/consult_banking_reform.cfm, Accessed 20th April, 2008. The consultation period for this paper ended on 5th December, 2008.
Consultation on the reorganisation and winding-up of credit institutions http://ec.europa.eu/internal_market/bank/windingup/index_en.htm, Accessed 20th April, 2008.
The Treasury Committee published its fifth report of Session 2007–08, ‘The run on the Rock’ (HC 56-I) on 26th January, 2008. See http://www.parliament.the-stationery-office.co.uk/pa/cm200708/cmselect/cmtreasy/56/5602.htm, Accessed 20th April, 2008.
‘Financial Stability and Depositor Protection: Strengthening the Framework’, Bank of England, HM Treasury and FSA, Cm 7309, 30th January, 2008, http://www.hm-treasury.gov.uk/documents/financial_services/financial_stability_framework.cfm, Accessed 20th April, 2008.
ibid.
ibid., point 4.5.
In point 4.14, it is stated that among the new SRR tools, a new ‘bank insolvency procedure’ is to be introduced if the pre-insolvency resolution is not feasible or if the immediate closure of the bank is considered to be the best solution. In point 4.34, the document further states: ‘A failed bank is currently subject to ordinary insolvency procedures. These range from corporate rescue mechanisms, such as administration and a company voluntary arrangement, to winding up a company's affairs through formal liquidation. Current insolvency procedures appear to have significant weaknesses in relation to banks’ (emphasis added).
According to Hüpkes, E., Special Resolution and Shareholders Rights (paper presented at the workshop organised by Cass Business School on the new UK Regime for Resolution of Banking Problems on 7th April, 2008), ‘Shareholders have legitimate rights that need to be respected in a special resolution regime. (…) [I]t is necessary to provide a clear legal framework with adequate intervention powers that make the restriction or elimination of shareholders rights predictable as does the corporate insolvency regime’.
Section 13.3 of the Federal Reserve Act, which was invoked in the rescue of Bear Stearns, was a useful provision to provide a legal basis for the rescue of an investment bank, Bear Stearns (March 2008) marks the first time since the 1960s that the Fed authorised the provision of emergency funds to any financial institution other than a regulated bank. See Financial Times, 15th March, 2008. Fed officials said that Bear Stearns (the fifth largest US investment bank) was not too big to fail, but ‘too interconnected to be allowed to fail at a moment when markets were extremely fragile. ‘The Fed acted under section 13.3 of the Federal Reserve Act, which gives it authority to lend to any individual, partnership or corporation n unusual and exigent circumstances’. That authority was last invoked in the 1960s and Fed officials said loans were last disbursed in the 1930s. As an investments bank, Bear Stearns did not have access to the Fed's discount window lending. So the Fed arranged back-to-back transactions with JP Morgan to give Bear indirect access to the window. JP Morgan bought Bear Stearns paying $2 per share (later revised to $10 per share).
For instance, the Resolution and Trust Corporation was created by the 1989 Financial Institutions, Reform, Recovery and Enforcement Act (FIRREA) to manage the assets of failed saving and loan associations. Debt-to-debt conversions (securitisation) and debt-to-equity conversions can also be useful debt restructuring techniques in some circumstances.
Banks (whether publicly or privately owned) are subject to EC competition rules (articles 81–89 EC Treaty), including state aid rules (Articles 87–89) as confirmed by the European Court of Justice in Zuchner v Bayerische Vereinsbank (Case 172/80 [1981] ECR 2021). With regard to Northern Rock, the Commission had already approved rescue aid in December 2007 (the emergency liquidity assistance provided by the Bank of England did not constitute illegal state aid), on condition that the support lasted no longer than six months and that it was aimed at keeping the bank afloat (state aid beyond six months must be targeted at restoring the long-term viability of a company and not distort competition). Following the nationalisation of Northern Rock in February 2008, and the formal Treasury notification on 17th March, 2008, the Commission has launched (on 2nd April) a new in-depth state-aid investigation into the government's bail-out. See http://www.guardian.co.uk/business/2008/apr/02/northernrock, Accessed 20th April, 2008. At the heart of the EU investigation is whether the long-term restructuring plan distorts competition. Danish banks have already made formal complaints to the European Commission alleging unfair competition in the European banking sector after the state aid given to Northern Rock. As regards Northern Rock, see for example http://www.euractiv.com/en/financial-services/eu-scrutinise-uk-aid-northern-rock/article-171333, Accessed 20th April, 2008. The issue of monetary financing is also at stake.
See point 4.39.
See Walker, above note 1.
See Campbell, A. The run on the rock and its consequences', Journal of Banking Regulation', Vol. 9, No. 2, p. 63. The case of Barings was in his judgment adequately handled via the use of the judicial process. Will an administrative process make it more likely that the authorities would act more quickly and more decisively than with a judicial procedure? What evidence is there to demonstrate that such an approach would be more efficient than making an application to a judge in the Commercial Court? The introduction of an administrative process also requires adequate appeal mechanisms. See also above note 10. ‘It is unclear why an administrative rather than a judicial process would more appropriate in the UK…’.
FDICIA Section 131 on PCA says, ‘The purpose of this section is to resolve the problems of insured depository institutions at the least possible long-term loss to the deposit insurance fund.’
See Hüpkes, E. (2003) ‘Insolvency — Why a special regime for banks’, in ‘Current Developments in Monetary and Financial Law’, Vol. 3, chapter 25, pp. 471–513, International Monetary Fund Publications, Washington, DC.
See Goodhart, C. (2004) ‘Multiple regulators and resolutions’, paper presented at the Federal Reserve Bank of Chicago Conference on Systemic Financial Crises: Resolving Large Bank Insolvencies, 30th September–1st October, 2004.
Basel Committee on Banking Supervision. Core Principles for Effective Banking Supervision (Basel Core Principles), http://www.bis.org/publ/bcbsc102.pdf, Accessed 20th April, 2008.
This is the title of a paper I am writing with Geoffrey Wood: ‘The Folly of Bankers and the Impotence of Regulators’.
See The Times, 21st September, 2007, pp. 6–7. The claim that the assistance could not be covert is questionable in my opinion. A different interpretation of the Market Abuse Directive (in particular Article 6) and a dispensation of its more stringent implementation in the UK would have rendered the covert assistance possible in my opinion and in the opinion of other commentators, such as Charles Proctor. As Proctor (mimeo, 2008) points out: ‘The core provisions of the Directive have been transposed into UK law by the Disclosure Rules and Transparency Rules (“DTR”) of the FSA's Handbook. (…) It should be emphasised that the disclosure requirements do not directly apply to the Bank of England; they only apply to publicly listed entities — such as Northern Rock — and those responsible for arranging the issue of such securities. They do not therefore directly inhibit the Bank of England in the conduct of its “lender of last resort” function. Nevertheless, the point would clearly have been a concern to the Board of Northern Rock. The difficulty here is that, whilst the FSA's guidance allows an issuer to delay release of information about negotiations to restructure its debt, it does not allow it to defer disclosure of the fact that it is in financial difficulties. If this distinction appears curious, it must be recalled that the spirit of the rules is to promote early disclosure. The FSA has power to modify the disclosure rules in particular cases, and it may well be that a short-term dispensation could have been granted on the basis that a run on Northern Rock might have wider consequences for the financial system. It is not clear whether this option was considered or could have been used in this particular situation’. Walker, above note 1, points out, ‘The Northern Rock board and the FSA had both received legal advice that any assistance would have to be overt. Once a company had received emergency liquidity support, an announcement would have to be made to the market despite the concessions permitted under Article 6(2) of the Market Abuse Directive. The UK implemented requirements set out in Rule 2.5.1, 2.5.2 and 2.5.3 of the FSA's Disclosure and Transparency Rules which provided that disclosure could only be withheld where this would not mislead the markets and the confidentiality of the information could be ensured’.
See Lastra, R. (1999) ‘Lender of last resort, an international perspective’, International and Comparative Law Quarterly, Vol. 48, pp. 340–361 and Lastra, R. (2006) ‘Legal Foundations of International Monetary Stability’, Oxford University Press, Oxford, pp. 304–307 and 117–120.
See Bank of England, News Release, Special Liquidity Scheme, 21st April, 2008, http://www.bankofengland.co.uk/publications/news/2008/029.htm, Accessed 20th April, 2008.
See Financial Times, 22nd April, 2008. It is, however, worth pondering the following warning ‘Public liquidity is an imperfect substitute for private liquidity’, from Federal Reserve Governor Kevin Warsh. See Financial Times of 15th April, 2008, ‘Fed warns of slow healing for fragile markets’.
See FSA Internal Audit Review, 26th March, 2008, http://www.fsa.gov.uk/pages/Library/Communication/PR/2008/028.shtml, Accessed 20th April, 2008.
ibid.
See The Run on the Rock, above note 13, paragraph 31, pp. 19–20.
This point is also made by Walker, above note 1.
It can be argued that the relaxation of the clear boundaries between commercial banking and investment banking that the 1999 repeal of Glass-Steagall (via the Gramm-Leach-Bliley Act) in the US, paved the way for banks to engage in a broader range of activities in the capital markets. See Randall, W. L. (2008) ‘Lessons from the Subprime Meltdown’, at www.levy.org/pubs.wp_522.pdf. Securitisation allowed banks to earn income on the mortgage loans they originated, by moving these (some times risky) mortgages off their balance sheets to their affiliated investment banks (not subject to reserve and capital requirements) or to special purpose vehicles.
This part of the paper draws in part upon Lastra, R. (2007) ‘Cross border resolution of banking crises’ in Evanoff, D., LaBrosse, R. and Kaufman, G. (eds) ‘International Financial Instability: Global Banking and National Regulation’, Vol. 2, World Scientific Publishing Company Pte Ltd, Singapore, pp. 311–330.
For instance, the issue of foreign ownership of banks makes some host jurisdictions (where foreign ownership is high) reluctant to rely upon home country control. This has relevant implications in many eastern European countries (such as Poland).
See Krimminger, M. (2005) ‘Deposit insurance and bank insolvency in a changing world: Synergies and challenges’, in ‘Current Developments in Monetary and Financial Law’, Vol. 4, chapter 22, pp. 727–757, International Monetary Fund Publications, Washington, DC.
Article 13.1 of UNCITRAL's model law on cross-border insolvency does not permit ‘ring-fencing’.
In 1992, the Basel Committee published a document on The Insolvency Liquidation of a Multinational Bank. See generally Lastra, above note 39.
Article 1(2) of the UNCITRAL Model Law.
The text of UNCITRAL Legislative Guide on Insolvency Law is available at http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/2004Guide.html.
The other 11 areas are: accounting, auditing, anti-money laundering and countering the financing of terrorism (AML/CFT), banking supervision, corporate governance, data dissemination, fiscal transparency, insurance supervision, monetary and financial policy transparency, payment systems, and securities regulation. See Lastra, R. (2006), above note 31, chapter 14.
Above note 12, Accessed 20th April, 2008.
Above note 39.
Memorandum of Understanding on Cooperation between the Financial Supervisory Authorities, Central Banks and Finance Ministries of the European Union on cross-border financial stability, 4th April, 2008 at http://www.eu2008.si/en/News_and_Documents/Press_Releases/April/0404ECOFIN_Memorandum.html, See also Press Release, Slovenian Presidency on Supervision and Crisis Management, 4th April, 2008 http://www.eu2008.si/en/News_and_Documents/Press_Releases/April/0404ECOFIN_SZJpredsedstva.html, Accessed 24th April, 2008.
See Zuberbuhler, D., ‘The financial industry in the 21st century’, Speech at the Bank for International Settlements, Basel, 21st September, 2000, cited in Lastra, above note 39, at p. 324, note 28.
See above note 31. There are three types of crises where the provision of emergency liquidity assistance could be critical: (1) crisis in the payment system; (2) generalised liquidity dry up (credit squeeze); and (3) the classic liquidity crisis (collateralised emergency credit lines to support individual institutions). NCBs are responsible for deciding (with MoF) whether to provide emergency liquidity assistance to individual institutions based on good collateral. Regarding Eurosystem monetary policy operations, only institutions subject to the Eurosystem's minimum reserve requirements (Article 19 ESCB Statute) are eligible to be counterparties to Eurosystem facilities and open market operations.
See Lastra (2006), above note 31, at 300.
Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, 7th April, 2008, http://www.fsforum.org/publications/FSF_Report_to_G7_11_April.pdf, Accessed 28th April, 2008.
IIF Committee on Market Best Practices Interim Report, 9th April, 2008 http://www.iif.com/, Accessed 28th April, 2008.
Basel Committee on Banking Supervision BCBS press release on steps to strengthen the resilience of the banking system, BIS Press Releases, 16th April, 2008, http://www.bis.org/press/p080416.htm, Accessed 28th April, 2008.
President's Working Group Issues Policy Statement To Improve Future State of Financial Markets, 13th March, 2008 http://www.ustreas.gov/press/releases/hp871.htm, Accessed 28th April, 2008.
See Wolf, M. ‘Bankers' pay is deeply flawed’, Financial Times, 16th January, 2008.
Acknowledgements
I am grateful for comments and suggestions received from members of MOCOMILA (Monetary Committee of the International Law Association) and from other colleagues participating in a workshop organised by Cass Business School on 7th April on the new UK regime for resolution of banking problems. Errors and limitations of judgment are the author's alone. This paper was completed on 30th April, 2008.
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1 Rosa M. Lastra is Professor of International Financial and Monetary Law at the Centre for Commercial Law Studies (CCLS), Queen Mary, University of London. She is a member of the Monetary Committee of the International Law Association (MOCOMILA), a founding member of the European Shadow Financial Regulatory Committee (ESFRC) and a senior research associate of the Financial Markets Group of the London School of Economics and Political Science. She has consulted with various governmental and intergovernmental institutions, including the International Monetary Fund, the World Bank, the Asian Development Bank and the Federal Reserve Bank of New York. She has written extensively in the field of monetary and financial law; her two authored books Legal Foundation of International Monetary Stability (Oxford University Press, 2006) and Central Banking and Banking Regulation (FMG of the LSE, 1996) are considered authoritative reference on the subject matter, nationally and internationally.
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Lastra, R. Northern Rock, UK bank insolvency and cross-border bank insolvency. J Bank Regul 9, 165–186 (2008). https://doi.org/10.1057/jbr.2008.12
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DOI: https://doi.org/10.1057/jbr.2008.12