Resolution Authorities Should Have Operational Independence: BIS

The institutional location of the resolution function is commonly the central bank, prudential supervisor or deposit insurer. This decision often entails trade-offs.

The BIS (Bank for International Settlements) has published a new paper presenting a review of the institutional arrangements for bank resolution frameworks in 16 jurisdictions.

The analysis showed that conflicts of interest between the resolution and supervisory functions can arise irrespective of whether they are institutionally co-located or separate.

The need for robust bank resolution frameworks was a major lesson drawn from the 2007-2008 crisis, prompting the FSB (Financial Stability Board) to develop the ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’.

According to the BIS paper, many jurisdictions have now substantially strengthened existing, or established new, frameworks for managing bank failures. However, it says these resolution frameworks must be supported by institutional arrangements that have several important features.

While the FSB’s ‘Key Attributes’ are not prescriptive about where resolution functions should be located within a jurisdiction’s institutional architecture, the paper points to a number of principles that institutional arrangements should meet, irrespective of their location.

“Core to those principles is the expectation that resolution authorities should have the necessary operational independence to carry out their functions, and that mechanisms are in place to control any conflicts of interest that arise between resolution and other functions carried out by the authority,” the paper says.

Globally, approaches to the institutional location of resolution functions vary with common locations being the central bank, the prudential supervisory authority or the deposit insurer.

The decision about where to locate the resolution function entails trade-offs, the paper says, adding that consideration should be given to the interplay between the operational independence of the resolution function and its cooperation with other relevant functions – the supervisory function in particular.

A key factor in all types of arrangement is the balance of operational independence for the resolution function with structures that allow it to benefit from synergies with the supervisory function, the paper says.

“When the two functions are located within the same institution, the internal arrangements generally need to balance the exploitation of synergies, on the one hand, and the management of potential conflicts of interest, on the other.”

For instance, in the US, the FDIC (Federal Deposit Insurance Corporation) has supervisory functions in tandem with its roles as deposit insurer and resolution authority for all US-insured depository institutions.

On the other hand, in most ‘hybrid models’, where the resolution function is split between two authorities, established institutional roles or expertise can be preserved.

For example, in Japan, the role of the DIC (Deposit Insurance Corporation) in executing resolution measures is a continuation of its pre-existing role as financial administrator in relation to failed banks, while the resolution-related functions of the Japanese FSA (Financial Services Agency) are linked to its financial stability mandate.

The BIS paper notes that when the resolution and supervisory functions are located in different institutions, the emphasis is likely to be on ensuring effective coordination and information-sharing between them.

The paper cited the example of two jurisdictions which have a resolution authority that is institutionally separate from both the supervisor and the central bank – Canada and Indonesia. It notes that the CDIC (Canadian Deposit Insurance Corporation) and the IDIC (Indonesia Deposit Insurance Corporation) are both the deposit insurer and the resolution authority for member institutions.

The paper notes that complex arrangements, such as hybrid models, primarily result from historical experience, and require greater coordination efforts.

Yet, such arrangements may not have been tested against the potential conflicts and stresses that could arise as work on bank resolution planning and resolvability develops or in the event of bank failures.

“Effective practices in this area may still be a work in progress,” the paper says.

The full paper is available here.

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