Striking a balance between resilience and resolution
Recovery and resolution
Recovery and resolution planning have become key issues for banks, their supervisors and authorities as a crucial line of defense.
Recovery and resolution planning have become key issues for banks, their supervisors and resolution authorities, as highlighted in our recent publications Recovery planning and Resolution: an evolving journey in Europe.
Supervisors are focusing increasingly on the credibility of banks' recovery plans, because these plans should provide a crucial line of defence if banks suffer losses or face liquidity difficulties. Most banks are reasonably well advanced in establishing the core elements of recovery planning - identifying critical functions, using a sufficiently wide range of scenarios, developing a comprehensive suite of recovery options, and ensuring that recovery planning is well governed.
But banks have made less progress in testing their recovery plans and integrating their recovery planning with other aspects of risk management. The supervisory focus is extending to how banks update and test their recovery plans, including through the use of scenario planning and simulation exercises; how well banks integrate their recovery planning with their risk management more generally; and how supervisors can reflect the quality of a bank's recovery planning in Pillar 2 capital requirements.
The ECB expects banks to include breaches of its Pillar 2 capital Guidance (P2G) as an early warning signal in recovery plans, while the EBA recommends that banks should align their recovery planning with the "serious but plausible" scenarios used for ICAAP/ILAAP stress tests. Recovery planning is also part of the assessment of a bank's governance within the EBA's SREP Guidelines, so the ECB could reflect deficiencies in recovery planning in Pillar 2 capital requirements in 2018.
Meanwhile, resolution authorities - including the Single Resolution Board (SRB) and the Bank of England - are building up their resolution planning, including a focus on the critical operational and finance-related services on which the continuity of a bank's critical functions depends; specifying the minimum amount of own funds and eligible liabilities (MREL) that each major bank should hold, and how these should be pre-positioned across a banking group; and requiring banks to enhance their preparedness (data and processes) for a third party valuer to undertake different types of valuation at short notice (the EBA and the Bank of England have already published papers on valuation, and the SRB is expected to finalise its guidance on valuation soon).
Although many of the largest banks (in particular G-SIBs) have made good progress in issuing MREL-eligible liabilities, many other banks subject to a resolution strategy have made less progress and may be over-estimating the appetite of investors to buy bail-inable debt. Many banks remain unable to demonstrate convincingly and in detail that the provision of critical services is sufficiently resolution-proof. And most banks are not yet in a position to facilitate third party valuations to determine rapidly whether the bank should be put into resolution and, if so, the choice of resolution tools.
Finally, both banks and the authorities need to integrate recovery and resolution planning. This reflects the close links between recovery and resolution planning in preserving the continuity of critical functions, and the balance to be struck between resilience and orderly resolution.