Financial institutions often fail because of internal challenges. These challenges can be the result of poor management and excessive risk taking that trigger liquidity shortages. Solvability issues may bring the capital position of the bank at risk. Insufficient loss absorbing coverage allows regulators to intervene and therewith avoid that public reactions cause bank panic and a run on the capital of the bank, creating further problems for society and the tax payer.
Public confidence is the driver behind a proper functioning society. This means that agreements are honored and protected, and external safeguards are provided via legal systems. The financial industry plays a critical role in this framework. The principles of the free market economy allows the market to regulate itself, while its participants reward or discipline conduct and results. Yet, the ideal marketplace is difficult to incorporate and maintain and not all customers have the same legitimate objective. As such, bank regulation aims to ensure the stability of this system.
The main function of international bank regulators is to protect the global financial system and maintain public confidence. Money creation and the structure of financial institutions is exclusively based on trust and confidence. Fractional reserve lending, quantitative easing, securitization and other techniques to cultivate and leverage available liquidity only survive under the circumstances where creditors maintain balances with financial institutions and leave a surplus on their accounts. As a consequence, the stability of the financial system is highly interconnected with the real economy that ensures economic growth and ultimately improves employment prospects.
Contagion and systemic risk in banking and finance has the potential to boost exorbitant financial crises and additional adverse effects. This system requires governments to monitor the connection between the public confidence in the financial industry and the factors that influence this sense of stability and reliability. It follows that non-financial risk factors at present are part of regulatory scrutiny. This enters the subjects of soft law, codes of conduct and anti-money laundering and counter terrorism financing regulations.
Privately owned financial institutions are often smaller in size than its systemic counterparts that are considered too big to fail. It may look like systemically important financial institutions are prioritized. However, their position in society justifies a distinct approach to their potential failure and possible liquidation. As such, legal frameworks have been harmonized and peer pressure, sanctions and financial isolation generate further pressure towards unwilling market participants. This brings us at the point where regulators, such as the Financial Crimes Enforcement Network (FinCEN), initiate global action against financial institutions they accuse of being a primary institute of money laundering concern.
Legal frameworks to mitigate the risk of bank failure and consequential or even contagious effects are covered by several directives and laws that often contain overlap but sometimes stand alone. These laws include but are not limited contract law and insolvency law. Creditors therefore can mitigate risk and maximize their outcome by formulating their recovery plan. Such a plan must contain and consider different recovery strategies to produce the desired results. Failure to submit claims within the pre-defined timeframe or outside the parameters of the submission requirements often result in rejection or dismissal of the claim. Therefore, it is mission critical that creditors assess these very strategies and think them through because liquidation procedures often result in asset write-downs and creditor losses.
From Bank Failure to Bank Liquidation
Financial institutions in distress should be kept in a vacuum to avoid access exposure to overall societal and systemic risk. To alleviate risk for creditors and contagious effects, several actions are taken by regulators or resolution authorities. The responsible resolution authority assesses whether a financial institution is failing or likely to fail, whether resolution is in the public interest; and whether there is a private sector solution. Resolution for financial institutions that fail or are likely to fail seek safeguards to protect depositors, assets and public funds, to ensure the continuity of the critical functions of the institution, to minimize risks to financial stability, and to avoid unnecessary destruction of value.
Following the European Bank Recovery and Resolution Directive, financial institutions and banks fail or are likely to fail when the financial institution infringes the requirements for continuing authorization in a way that would justify the withdrawal of the authorization; the liabilities of the financial institution exceed the assets; the financial institution is unable to pay its debts as they fall due; where extraordinary public financial support is required to keep the financial institution alive.
Once the state of bank failure is established, financial institutions go through several stages of resolution. The first step for the resolution authority is to determine the feasibility to restart (all or part of) the operations of the bank. Several tools and safeguards are available to support these decisions. These include tools for bail-in, sale of business, bridge institutions, asset separation vehicles, and traditional insolvency and winding down.
To maintain its current capital position and avoid further deprecation of assets, the regulator assumes control of the troubled institution by the appointment of an external and special administrator. The domestic Deposit Guarantee Scheme (DGS) is activated, and insured deposits repaid following the local framework for depositor protection. That not every creditor and deposit is awarded the same protection is explained here.
After DGS claims are paid, the bank can resume its operations by separation of the toxic assets in a bad bank, and the feasible activities in a different business unit. If the public interest is served better by winding up the legal entity, liquidation procedures can start. Liquidation procedures most often lead to a write-down of value and depreciation of assets and therefore must be monitored with absolute care.
Legal Action, Insolvency and Winding Up
Non-resident bank customers have a different risk profile than domestic or the more standard retail customers. Therefore, the offshore banks and business units inside financial institutions transacting with these non-resident customers and their corporate entities, are often well-capitalized. Capitalization in the financial industry is however ambiguous and subject to serious misunderstanding. These misunderstandings originate from the combination of the structure and operation of the business of banking and finance, and the security of asset classes held with financial institutions.
Most offshore banks that failed over time were eventually forced to close. Their secluded business activities did not serve the general public interest and their failure had no serious consequences for the stability of the financial system. Traditional activities were seized, the banking license got revoked and the company was stripped of its permissions. This process prior to the start of the official liquidation is referred to as administration.
Banking is characterized by asset-liability mismatches that are intensified by strategic leverage. It follows that banks are unable to return deposits and investments on demand to all creditors. Bank failure that ultimate leads to bank liquidation considers different categories of assets. Secured assets are distinct from free assets. The secured assets have fixed or floating charges over the corporate assets. Secured creditors therewith have rights in rem against the assets for direct repayment of their debt. Other preferential claims include the costs of the liquidation, the DGS prepayments made to qualifying depositors during the administration stages, prioritized debt, fiscal claims, public penalties, and remuneration for staff members. The remaining and free assets form a common fund administered by the liquidator for the benefit of unsecured creditors. It must be emphasized that bank deposits without security, and those that are not covered by deposit protection or exceed its maximum coverage, are considered unsecured claims.
Liquidation procedures ensure that corporate assets are collected in and realized, whilst the liabilities are discharged and net surplus, where available, is distributed to the shareholders and others entitled to it. Bank liquidation can follow voluntary winding up agreements when assets match the liabilities. It is more common that the appropriate court approves a liquidation and appoints a liquidator. The liquidator holds a hybrid function of agent, fiduciary and agent whose powers are supervised by the court. Additional control functions are laid down with the committee of inspection nominated by the creditors.
Theoretically it is possible that the court pierces the corporate veil and holds shareholders and other controlling persons responsible for losses. This however is mostly part of the liquidation procedures. Therefore, the liquidation of the bank is normally seen as the last resort for creditors. At the end of a liquidation procedure effective creditor loss is determined and further legal action might be considered towards those responsible for final losses.
It is obvious that banking and finance is complex and that the center of gravity of asset and fund recovery lies in the initial stages of the resolution. The period from special administration to the approval of the liquidation by the court must be used to strategize, negotiate, settle and take legal action to receive early compensation and achieve a priority position in the liquidation.
Act Now and Diversify Your Recovery Options…
Personal assets and bank accounts are rights of property. These rights belong to creditors like yourself. Losing part or all value is disappointing and often unnecessary. Unfortunately though, asset and fund recovery is an exceptional and singular event where repayment does not provide for second chances. Creditors who fail to comply with the terms of a repayment offer lose their chance of recourse.
Those very creditors who cannot afford missteps and need their money returned need a radically different approach to recovery whilst considering every available route for repayment possible. As such, it is mission critical to plan and act to minimize risk and maximize recovery. Therefore, please complete the contact form below, or call us at 646 513 2855, for a detailed evaluation and assessment of your case. There is no obligation to hire us and take any action. After our call you will know your options and understand the future procedures. This helps you to decide on the actions or omissions to take.