Cross-Border Bank Resolution: A Global Analysis

The document's central theme revolves around the conflict between new bank resolution frameworks and the established principles of insolvency law. These frameworks, designed to manage the collapse of large financial institutions, often clash with the fundamental objectives of fairness and creditor protection inherent in insolvency procedures. The study highlights this tension as a primary obstacle to the effective implementation of these new bank resolution mechanisms. The introduction underscores the complex challenge of balancing swift crisis management with the need to respect established legal principles. This inherent tension is the driving force behind the analysis, prompting a deep dive into the intricacies of cross-border implications and their effects on the international financial landscape. The authors use a three-layered framework to systematically examine this fundamental conflict, identifying how this tension can lead to inefficiencies and undermine the efficacy of the frameworks. The study aims to provide a comprehensive understanding of these challenges and the potential consequences.

The section delves into the long-standing debate surrounding cross-border insolvency, contrasting universalist and territorialist viewpoints. Universalist approaches advocate for a single, globally recognized procedure and legal framework, emphasizing efficiency and fairness in creditor treatment. However, the document notes that territorialist perspectives counter this by highlighting the potential neglect of creditors' interests in jurisdictions other than the one where the main insolvency proceedings are held. This conflict is particularly relevant in the context of bank resolution, where decisions made in one jurisdiction can have significant spillover effects on other countries. The analysis underscores the challenges of balancing these competing interests and how the choice between these approaches directly impacts the effectiveness of cross-border bank resolutions. It further highlights the complexities that arise from differences in resources, accounting practices, legal systems, and resolution regimes across jurisdictions, particularly emphasizing the difficulty of reaching a globally consistent approach to crisis management.

The study introduces the concept of a “trilemma” in open economies: the tension between maintaining financial stability, fostering financial integration, and preserving national policy autonomy. Schoenmaker's argument, cited in the document, suggests that only two of these three goals can be fully achieved simultaneously. This framework is applied to the context of bank crises, illustrating the difficult choices nations face when managing cross-border financial issues. The decision to prioritize financial stability and global banks might necessitate a compromise in national sovereignty. The study emphasizes the need for pre-commitment to mutual recognition and coordination, either through centralized authorities (like those in the Eurozone), harmonized systems (like the EU), or common rules through international conventions or model laws. It explores how the practical limitations of each alternative inevitably contribute to the challenges faced in resolving cross-border banking crises.

The analysis includes several key case studies to illustrate the practical challenges of cross-border insolvency and bank resolution. The LBI hf v Kepler Capital Markets case, for example, demonstrates both the application and the limitations of the principle of automatic mutual recognition within the European Economic Area (EEA). The decision highlights the complexities of enforcing measures based on legislative provisions rather than explicit judicial or administrative actions, emphasizing the potential inconsistencies in different jurisdictions. The case of the Irish Bank Resolution Corporation (IBRC) exemplifies the recognition of foreign proceedings, showcasing a successful instance of cross-border cooperation. These examples, however, are limited to specific contexts and situations, demonstrating the lack of a universal, consistently applied framework for global banking crisis management. They illustrate that the issues of recognition and enforcement of cross-border actions are highly specific to the particular legal context involved.

The document contrasts the EU's approach with the United States' unilateralist system for cross-border bank resolution. The US system, with its focus on domestic creditor protection, is highlighted for its limited cooperation with foreign proceedings. The powers granted to the FDIC and OCC are significant, allowing them to prioritize US creditors and restrict the repatriation of assets. The limited applicability of the UNCITRAL Model Law to foreign banks with US branches is also noted as a significant constraint to international cooperation. This section effectively illustrates the lack of global harmonization in crisis management and emphasizes how unilateral actions, driven by national interests, often hinder effective resolution across borders. This comparison further underscores the complexities faced when establishing a unified approach to cross-border banking crisis management.

This section lays out the fundamental conflict between universalist and territorialist approaches to cross-border insolvency. Universalist views favor a single, globally applicable procedure and legal framework for resolving insolvency, emphasizing efficiency and a level playing field for all parties involved. This approach simplifies the process and reduces transaction costs. However, the territorialist perspective argues that a universalist system risks neglecting the interests of creditors located in jurisdictions different from the one overseeing the main insolvency proceedings. National authorities have a duty to protect their domestic creditors, and a purely universalist system could potentially undermine this responsibility. The core tension here is between the need for efficient, globally consistent procedures and the imperative to safeguard the interests of creditors in every involved jurisdiction. This sets the stage for the further analysis of the challenges facing the implementation of international bank resolution frameworks.

The inherent complexities of cross-border insolvency are further highlighted by the existence of asymmetries across jurisdictions. Differences in resources, accounting practices, legal frameworks, and resolution regimes create obstacles to a smooth and consistent resolution process. The text points out that ignoring cross-border externalities can lead to globally inefficient outcomes, such as an under-provision of recapitalizations. The shift from bailouts to bail-in mechanisms, while intended to improve the situation, does not eliminate the basic tensions. This further complicates cross-border cooperation due to conflicts of interest among national authorities. The differing treatment of creditors based on their location and the implications of complex cross-border custody chains for assets underscore the practical difficulties of ensuring fairness and efficiency in international insolvency and bank resolution. The need for coordination and mutual recognition is presented as crucial for mitigating these challenges.

This section introduces the concept of a ‘trilemma’ facing open economies in the financial realm. The trilemma involves a difficult trade-off among financial stability, financial integration, and the ability to maintain independent national financial policies. The argument is that, in practice, it's only possible to choose two out of the three. This is especially relevant in the context of bank crises, as nations often find themselves needing to choose between fostering global financial stability through cooperation and maintaining control over their domestic financial policies. Using this trilemma, the authors highlight the tension between global financial stability, the existence of cross-border banks, and the preservation of national authority. The text emphasizes that achieving global financial stability and accommodating global banks might require nations to concede a degree of their sovereignty—a difficult prospect in practice. The need for a pre-commitment to mutual recognition and coordination is presented as a key step towards navigating this trilemma.

The document proposes various potential solutions for improving coordination and cooperation in cross-border bank resolution. The ideal scenario would involve a pre-commitment to mutual recognition of resolution actions across jurisdictions. This could take the form of a centralized system, as seen in the Eurozone, or a fully harmonized system like the EU's, aiming for single-jurisdiction status for resolution. Alternatively, common rules established through international conventions or model laws could provide a more universally applicable framework. As a less ideal option, the document considers a reliance on existing cross-border bank insolvency principles, unilateral recognition of certain actions, and contractual solutions. The analysis emphasizes the importance of a robust framework for cross-border cooperation and mutual recognition to prevent the conflicts of interest among national authorities that impede effective international bank resolution. The ultimate goal is to find a balance between respecting national sovereignty and fostering a global system capable of managing international banking crises.

This section examines the Bank Recovery and Resolution Directive (BRRD) and its impact on the principle of mutual recognition in cross-border bank resolution. The BRRD, the authors argue, has reinforced this principle by directly regulating the powers of resolution authorities and the applicable safeguards, reducing reliance on national laws. This contrasts with previous systems, where reliance on national laws created inconsistencies and difficulties in cross-border coordination. The BRRD aims for greater consistency in how resolution actions are treated across jurisdictions. However, the text also notes that while the BRRD promotes mutual recognition, it doesn’t completely eliminate the potential for conflicts and discrepancies, especially when dealing with creditors whose liabilities are governed by the laws of a third country. The discussion highlights Article 66 of the BRRD, focusing on its provisions for the recognition and enforcement of crisis management and prevention measures across borders. The implications of these provisions, particularly regarding bail-in measures, are analyzed in the context of potential conflicts between the interests of multiple jurisdictions.

The analysis incorporates relevant case law to illustrate the practical application and limitations of mutual recognition in cross-border bank resolution. The LBI hf v Kepler Capital Markets case (C-85/12) is cited as a key example. This case demonstrates that even legislative measures, if supported by appropriate judicial or administrative actions, can be subject to automatic mutual recognition under Directive 2001/24. The court's ruling in this case clarified the scope of mutual recognition, emphasizing that even measures not directly subject to challenge must be recognized without further formalities by host Member States. The document also mentions the LBI hf v Merrill Lynch International Ltd case (E-28/13) where the EFTA court upheld automatic recognition, further strengthening the principle. However, the document emphasizes that the practical implementation and enforcement of mutual recognition remains challenging and is not a complete solution to the complexities of international bank resolution, especially concerning jurisdictions outside the EU.

Despite its efforts to improve cross-border coordination, the BRRD’s effectiveness is not without limitations. The document points out that the BRRD's provisions for the recognition of bail-in measures, while logical in some respects, present problems when dealing with creditors located in a Member State but whose liabilities are governed by a third country's laws. Intervention in such cases could be difficult to justify, even on grounds of public policy. Furthermore, the BRRD's stipulation that safeguards and challenges to bail-in measures are subject to the laws of the resolution authority’s state, while strengthening mutual recognition, limits the rights of creditors to challenge actions under their own jurisdiction's laws. The section notes that this approach may lead to inconsistencies and potential unfair treatment. The inherent complexities of cross-border financial transactions and the conflicts between national and supranational interests continue to pose major challenges to effective bank resolution.

This section contrasts the US approach to cross-border bank resolution with more cooperative models, highlighting its unilateral and territorial nature. Unlike systems emphasizing international cooperation and mutual recognition, the US system prioritizes the protection of domestic creditors and assets. The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) wield substantial power in resolving the failures of foreign banks operating within the US, with a strong emphasis on satisfying US creditors before considering the claims of foreign creditors or the transfer of assets abroad. This unilateral approach, the authors suggest, demonstrates a lack of commitment to international coordination and collaboration in managing cross-border banking crises. The limited scope for coordination with foreign proceedings further underscores the inherent conflict between national interests and global financial stability.

The document points out the limited applicability of the UNCITRAL Model Law within the US context. This international insolvency framework, designed to promote cross-border cooperation, has limited applicability to foreign banks with branches or agencies in the United States. The restrictions are explicitly mentioned, highlighting how US regulations effectively bypass the international standards established by the UNCITRAL Model Law. This demonstrates a deliberate choice to prioritize domestic regulatory control and protection over adherence to internationally recognized standards for insolvency proceedings. Foreign banks with federally chartered branches or agencies are instead subject to US receivership or reorganization proceedings under the authority of the FDIC or OCC, solidifying the primarily unilateral nature of the US approach to cross-border banking resolutions. The implications of this unilateral approach for global financial stability and the potential for conflicting jurisdictions are central to the analysis.

The section criticizes the absence of a robust and binding international framework for coordinating cross-border bank resolutions. While crisis-management groups (CMGs) and institution-specific Cooperation Agreements (CoAGs) exist, the document notes their non-binding nature and limited scope. These agreements largely focus on information exchange and planning, lacking a clear pre-commitment to recognize and enforce resolution tools across borders. This lack of legally binding agreements and mechanisms to ensure consistency in the treatment of cross-border debt among jurisdictions leaves a significant gap in the current global system for managing banking crises. The resulting uncertainty, the authors argue, gives national authorities strong incentives to prioritize domestic interests, potentially hindering efforts to maintain global financial stability. This emphasizes the need for stronger international cooperation and the development of a truly global, cohesive approach to managing cross-border financial failures.

This section contrasts the straightforward logic of deposit protection in domestic settings with the complexities that arise in cross-border situations. Domestically, the alignment of financial backstops and resolution authorities ensures consistent protection. For example, the FDIC in the US effectively manages both the resolution fund and the resolution process. However, cross-border scenarios introduce complications because foreign branch deposits may not be covered by domestic deposit guarantee schemes. Providing equivalent protection in such cases could be perceived as an implicit subsidy to foreign deposit guarantee schemes, potentially encouraging lax oversight by host authorities. This creates a tension between the policy goals of maintaining financial stability and ensuring fair treatment of depositors across different jurisdictions. The analysis sets the stage for a discussion of the conceptual and policy issues stemming from differing treatment of domestic and foreign deposits.

The core issues in cross-border deposit protection are presented as two-fold: conceptual problems regarding the definition of a “protected deposit,” and policy problems related to the relative status of domestic versus foreign deposits. The challenges arise from the potential for implicit cross-subsidies between different deposit guarantee schemes and the risk of regulatory arbitrage. The section notes the tension between ensuring adequate protection for depositors and avoiding the creation of unintended financial incentives that might compromise financial stability. The authors suggest that granting foreign branch deposits the same protection as domestic deposits could implicitly subsidize foreign deposit guarantee schemes and potentially encourage supervisory laxity in the host countries. This highlights the delicate balancing act between promoting trust in the banking system and minimizing potential risks and costs to individual nations and their taxpayers.

The analysis uses case studies to illustrate the practical challenges arising from differing treatments of domestic and foreign branch deposits in bank resolution. The Aresbank and Landsbanki case, examined by the EFTA court, highlights a situation where an inter-bank loan, despite not qualifying for repayment under the Icelandic deposit guarantee scheme, was still transferred to a bridge institution. This case emphasizes the difficulties of applying consistent principles of deposit protection across borders. The response to the 2008 financial crisis and the resulting UK FCA consultation paper and FDIC response further demonstrate the complexities and inconsistencies in the treatment of deposits across different jurisdictions. The reaction from firms to structure deposits to ensure dual payability and the subsequent FDIC action to exclude such deposits from preferred treatment highlight the ever-evolving nature of the challenges involved in balancing depositor protection with the need to mitigate risks to individual nation’s financial stability.

The section explores the implications of these deposit preference issues for the interpretation of principles-based regulations. While the differing treatment of domestic and foreign branch deposits might seem justifiable in terms of reimbursement rights (linked to contributions to a specific DGS), using this difference to determine deposit preferences introduces discrimination without clear justification. The identical nature of the right (arising from a deposit) against the same entity (branches lack legal personality) makes this discrimination difficult to support. Transparency rules aiming to inform clients about applicable coverage are noted as inadequate to solve the core issue of which systemic policy goals are prioritized by these different treatments. The section underscores the lack of consistent application of principles and the need for a more unified and equitable approach to address these challenges in cross-border bank resolution.

This section focuses on the complexities introduced by intra-group funding mechanisms, particularly loans, in cross-border banking contexts. The authors note that the treatment of these loans varies significantly across jurisdictions. Some countries, like Italy, only subordinate intra-group loans that are considered “equity-replacing,” while others, such as Germany and Spain, apply automatic subordination to all or a broader range of intra-group loans. This inconsistency creates significant challenges for cross-border banking groups, as the same intra-group funding structure might be subject to different subordination rules depending on the jurisdiction. The differences in treatment can disrupt the basic operations of a banking group by creating unpredictable liabilities and potentially impacting the flow of funds within the group. The section uses this to highlight how the lack of harmonization across jurisdictions can be detrimental to efficient cross-border operations.

The analysis extends to the treatment of hedging agreements, such as derivatives, in cross-border insolvency and bank resolution. The authors argue that hedging agreements should generally be excluded from subordination unless they're viewed as an indirect means of funding within the group. However, they highlight that even this distinction is not universally applied across jurisdictions. Some countries, like Spain, automatically subordinate all related-party claims, which may include those stemming from hedging agreements, irrespective of their purpose. This inconsistency, compounded by varying approaches in other countries, poses significant risks to cross-border banking groups. The potential for recharacterization of agreements in some jurisdictions, leading to subordination in one country but not others, can create conflicting obligations and potentially disrupt the functioning of international banking groups. This lack of harmonization adds another layer of complexity to the already challenging task of coordinating cross-border bank resolutions.

The study explores how different jurisdictions treat security interests in the context of intra-group transactions and cross-border banking operations. It uses the example of a floating charge on securities collateral to illustrate how the characterization of security interests can vary greatly, leading to inconsistent outcomes. This inconsistency is particularly problematic for the treasury functions of a cross-border group that relies on a security interest to manage cash and instruments. The recognition and insolvency treatment of floating securities differs considerably among jurisdictions, meaning that an arrangement acceptable and functional in one country might not be enforceable or provide the same level of protection in another. This section emphasizes that the lack of harmonization in how these security interests are treated increases the uncertainty and risk faced by cross-border banking groups during insolvency or bank resolution proceedings. The different legal treatments hinder efficient functioning of the banking group and can impact the effective allocation of resources during a crisis.

The complexities of intra-group transactions are further examined in the context of Total Loss-Absorbing Capacity (TLAC) or Minimum Requirements for own funds and eligible liabilities (MREL) debt. The study examines the potential for inconsistent ranking of this crucial type of debt, highlighting how differences in statutory subordination rules among jurisdictions can lead to unforeseen outcomes. If ordinary senior debt is subordinated by statutory provisions but internal TLAC debt is subordinated by design, the resulting pari passu ranking might not align with the original resolution plans, potentially harming the interests of different group entities. This is especially problematic in cross-border settings where different group entities hold internal TLAC debt and ordinary debt, leading to unpredictable loss allocation and undermining confidence in resolution authorities' ability to effectively manage crises. The section suggests that even within regional frameworks like the EU, provisions to address these issues remain limited, emphasizing the ongoing need for harmonization and coordination.

Addressing the inconsistencies in the treatment of intra-group transactions requires a robust and cooperative procedural framework. While centralized decision-making, as in the Eurozone's Single Resolution Board (SRB), can facilitate coordination, even this system relies on a cooperative structure with potential for national authorities to object. The EU’s resolution college is presented as another method aimed at promoting common solutions, but even this system allows for objections and deviations from a unified “group resolution scheme.” Globally, the reliance on non-binding agreements like CMGs and CoAGs is shown as insufficient, highlighting the lack of a robust framework to address inconsistent treatment of debt and preserve critical functions. This absence of strong legally binding mechanisms for mutual recognition underscores the significant challenges involved in coordinating and resolving cross-border banking group failures and the importance of developing more effective frameworks for international cooperation.