HMT consults on resolution regime changes for small banks

HM Treasury (HMT) published Enhancing the Special Resolution Regime Consultation on 11 January 2024.

The consultation proposes a new funding mechanism to manage the failure of small banks and limit risks to public funds in response to the spring 2023 banking sector volatility. The purpose of the proposals is to ensure the failure of one or several non-systemic banks will not create a financial stability risk.

What does this mean?

The BoE has three broad strategies for the resolution of banks. These are: recapitalisation through a bail-in; transfer of all or part of the firm to a bridge bank or buyer; and placing the firm into Bank Insolvency Procedure (BIP). Firms for which the resolution strategy is a BIP are not required to hold Minimum Requirement for own funds and Eligible Liabilities (MREL) for bail-in purposes. It is this category of firm (deemed ‘small banks’) that HMT’s consultation focuses on.

HMT is concerned that in the event of a failure of a small bank, where there is no credible buyer, additional capital may be required to support the entity and ensure continuity of access to deposits. The failure of Silicon Valley Bank UK (SVB UK) has reinforced that the failure of banks which are not deemed to be systemically important can create risks to the economy, in particular when individuals and businesses do not have continuity of access to deposits.

In light of this HMT is proposing a new mechanism allowing funds provided by the banking sector to be utilised to provide the following costs arising during a resolution:

the costs of recapitalising the failed bank
the operating costs of a Bridge Bank
HMT and the BoE’s costs in relation to the resolution.

As with the current depositor protection arrangements, the funds would be provided by the Financial Services Compensation Scheme (FSCS) as needed in the event of a failure, and subsequently funded by a levy on the banking sector. Where the mechanism is used in relation to a small bank, changes are unlikely to impose additional upfront costs on levy-payers.

In the long-run, HMT may consider establishing a mutualised fund, built up in advance, and drawn on in the event of resolution. A prefund, financed by levies on the banking sector, could be less costly to the sector as a whole than imposing individual MREL-type requirements on small banks which could also potentially hinder competition.

HMT expects the sector to benefit from reduced disruption from small bank failures, including a reduced risk of contagion, as well as increased public confidence and investment.

In principle, the new mechanism could be applied to any banking institution within scope of the Special Resolution Regime and where the Bridge Bank or Private Sector Purchaser options are being deployed. As a result, the mechanism could not be used for credit unions. A failure of a third-country branch would also be excluded, as the responsibility for resolving such a firm lies with the relevant home resolution authority.

The resolution regime supported by the new mechanism would not replace the BIP in all cases, and any decision to deploy stabilisation powers would remain subject to the resolution conditions as now and assessed by the BoE on a case by case basis.

No changes are being proposed to either the resolution conditions or the resolution objectives, to facilitate the use of the new mechanism.

HMT’s consultation aims to complement a broader focus on increasing the speed of deposit pay-outs, including the way in which the FSCS makes compensation payments. The PRA will also review the FSCS protection limit in 2025.

Resolvability also remains a key focus for the BoE, including through working with larger firms to embed the Resolvability Assessment Framework.

What do firms need to do?

Prepare for an ongoing focus from regulators on recovery and resolution capabilities.

Ensure data, particularly on depositors, is robust and accurate.

Monitor the progress of HMT’s proposals and future legislative change.

The proposal is a targeted amendment to the resolution regime in the UK. For larger banks the BoE’s approach to resolution is unlikely to change as a result of the proposals. While HMT does not currently envisage upfront costs as a result of the proposals, there could potentially be additional costs for the banking sector in the event of failures among small banks. The turmoil in the banking sector in 2023 also means that the focus on recovery and resolution planning will be a key priority for the PRA (as reflected in the PRA’s UK deposit takers 2024 supervisory priorities letter).

For those small banks which could be subject to the new powers, there may be further implications. The focus on ensuring continuity of access to deposits may mean the BoE revisits resolution strategies for small banks and increases the focus on resolution planning for this segment of the market. Banks of all sizes are likely to see a focus from the regulator on accurate data on depositors through the single customer view.

“SVB UK’s resolution does highlight the potential challenge of managing the failure of a small bank where resolution action is judged to be necessary in the public interest at the time of failure, but without access to additional capital resources that might be needed to facilitate the resolution.”