2023 Bank Crisis: Lessons for Future Resolution

Do you remember the bank failures of 2023?

They were the first real test of the international resolution framework that was established after the Global Financial Crisis of 2008. The resolution framework was supposed to make the resolution of failing banks feasible without severe systemic disruption and without exposing taxpayers to loss. But did it work as intended?

The answer is not so simple.

While the authorities managed to stabilize the situation and prevent a global meltdown, they also faced some serious challenges and limitations in applying the resolution framework.

In some cases, they opted for alternative solutions that were not consistent with the objectives and principles of the framework. In other cases, they encountered technical and operational difficulties that hindered the execution of the resolution strategy.

In this blog post, I will explain what happened in the bank failures of 2023, what were the implications for the resolution framework, and what are the lessons learnt for the future.

I will focus on two main episodes:

the acquisition of Credit Suisse by UBS in Switzerland, and
the failures of three regional banks in the US.

These episodes illustrate the different aspects and challenges of the resolution framework and the need for further improvements and enhancements.

This blog adopts the ideas of the work of FSB titled "2023 Bank Failures: Preliminary lessons learnt for resolution".

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Bank Failures of 2023

The bank failures of 2023 were triggered by a combination of factors, such as:

Long-standing difficulties and operational challenges faced by some banks, such as Credit Suisse, which had announced a strategic review and a change of management in mid-2022.
Downgrades by credit rating agencies, which increased the funding costs and reduced the market confidence of some banks, such as Credit Suisse and Silicon Valley Bank (SVB).
Rumors and speculation on social media, which amplified the solvency and liquidity concerns of some banks, such as Credit Suisse and Signature Bank.
Contagion effects from the failure of SVB in the US, which was the first bank to collapse in March 2023, due to its exposure to the crypto market and the collapse of a major hedge fund. The failure of SVB triggered a wave of deposit withdrawals and market pressure on other banks with similar business or funding models, such as Signature Bank and First Republic Bank.

The authorities in Switzerland and the US had to intervene to resolve the failing banks and restore market stability. They used different approaches and tools, depending on the situation and the legal framework of each jurisdiction. However, they also faced some common challenges and limitations, such as:

The lack of effective public sector backstop funding mechanisms to support the resolution and restore market confidence. The authorities had to rely on emergency legislation and liquidity facilities to provide funding to the failing banks or their acquirers, which raised the potential risk of taxpayer exposure and moral hazard.
The choice of resolution strategies and optionality of resolution tools. The authorities had to balance the trade-offs between different resolution options, such as bail-in, transfer, or merger, and consider the impact on the financial stability, the creditor hierarchy, and the market acceptance. In some cases, the authorities preferred to facilitate a commercial transaction outside of resolution, rather than applying the resolution framework as planned.
The communication, coordination, and speed of bank runs. The authorities had to communicate and coordinate effectively with the relevant stakeholders, such as the home and host authorities, the depositors, the creditors, the investors, and the public, to ensure the smooth implementation of the resolution and the prevention of panic and contagion. They also had to cope with the increased speed of bank runs due to the digitalization of banking services and the use of social media.
The operationalisation of bail-in. The authorities had to address the legal and technical issues related to the execution of bail-in across borders, such as the recognition of foreign resolution actions, the valuation of the firm and its liabilities, the conversion of debt into equity, and the impact on financial markets.
The post-stabilisation restructuring. The authorities had to ensure that the resolved banks or their acquirers had a viable business model and a sound capital and liquidity position after the resolution, and that they could address the operational and integration challenges in the medium and long term.

These challenges and limitations revealed some gaps and weaknesses in the implementation and execution of the resolution framework and raised some questions about its effectiveness and feasibility.

Why the Resolution Framework Matters?

You may wonder why the resolution framework matters, and why you should care about how the authorities handle the bank failures. After all, you may think that as long as the banks are stabilized and the financial system is safe, the details of the resolution process are not that important.

But that is not true.

The resolution framework matters a lot, for several reasons:

It affects your money and your rights. If you are a depositor, a creditor, or an investor of a failing bank, the resolution framework determines how your money and your rights are protected or affected in case of a bank failure. For example, if the authorities apply bail-in, you may lose some or all of your money, or receive new shares of the bank in exchange. If the authorities facilitate a merger, you may receive a different compensation or face different terms and conditions. If the authorities use public funds, you may indirectly bear the cost as a taxpayer.
It affects the financial stability and the economic growth. If the resolution framework is not effective and credible, it may fail to prevent or contain the systemic impact of a bank failure, and cause a domino effect on other banks and financial institutions, or a loss of confidence and trust in the financial system. This may lead to a financial crisis, which may have severe consequences for the real economy, such as a recession, a contraction of credit, a rise in unemployment, and a decline in income and welfare.
It affects the incentives and the behaviour of the banks and the market participants. If the resolution framework is not consistent and predictable, it may create moral hazards and distortions in the market. For example, if the authorities bail out the failing banks or their creditors, they may encourage excessive risk-taking and reduce market discipline. If the authorities deviate from the resolution framework or the creditor hierarchy, they may create uncertainty and confusion in the market, and undermine the credibility and the effectiveness of the framework.

Therefore, it is important to have a robust and reliable resolution framework that can achieve the following objectives:

To make the resolution of failing banks feasible without severe systemic disruption and without exposing taxpayers to loss.
To protect the vital economic functions and the continuity of critical services provided by the banks.
To allocate the losses to the shareholders and the unsecured and uninsured creditors of the banks in a manner that respects the hierarchy of claims in liquidation.
To ensure a level playing field and a fair treatment of the stakeholders across jurisdictions and markets.

The Key Attributes of the Resolution Framework

The solution to the problem of bank failures is the international resolution framework established by the Key Attributes of Effective Resolution Regimes for Financial Institutions, which is the global standard for resolution regimes endorsed by the G20 in 2011. The Key Attributes set out the responsibilities, instruments, and powers that the resolution authorities should have at their disposal for firms that could have a systemic impact if they fail. They also set out the recovery and resolution planning requirements, the resolvability assessments, and the cross-border cooperation arrangements for such firms.

The Key Attributes are based on the following principles:

Resolution should be initiated when a firm is no longer viable or likely to be no longer viable, and has no reasonable prospect of becoming so. The resolution regime should provide for timely and early intervention by the authorities.
Resolution should be carried out by a designated administrative authority or authorities. The resolution authority should have the operational independence, the resources, and the expertise to exercise its resolution powers.
Resolution should aim to preserve the continuity of the firm’s critical functions and services and to avoid adverse effects on the financial system and the real economy. The resolution authority should have the power to transfer the assets, liabilities, and operations of the firm to a solvent third party, a bridge institution, or an asset management vehicle.
Resolution should respect the hierarchy of claims in liquidation while providing flexibility for the resolution authority to depart from the general principle of equal treatment of creditors of the same class, if necessary to achieve the resolution objectives. The resolution authority should have the power to write down and convert the liabilities of the firm into equity or other instruments of ownership (bail-in).
Resolution should not rely on public solvency support and should not create an expectation that such support will be available. The resolution authority should have the power to impose temporary stays on the exercise of early termination rights and to ensure the continuity of essential contracts and services^ex-ante. The resolution authority should have access to a funding mechanism that does not rely on public funds but is financed by the financial industry through ex ante levies or other mechanisms.

The Key Attributes also provide for the recovery and resolution planning requirements, the resolvability assessments, and the cross-border cooperation arrangements for the firms that could have a systemic impact if they fail. These elements are crucial for the preparation, the execution, and the success of the resolution process.

The Lessons Learnt: What We Can Do Better

The bank failures of 2023 have shown that the resolution framework is not perfect and that there is room for improvement. Here are some lessons learnt from the recent events:

The resolution framework should be more flexible and adaptable to the specific circumstances and challenges of each case. The authorities should have the discretion to choose the most appropriate resolution strategy and tools, based on the nature, the size, the complexity, the business model, the funding structure, the risk profile, the market conditions, and the legal and regulatory framework of the failing bank.
The resolution framework should be more transparent and predictable to reduce uncertainty and the speculation in the market. The authorities should communicate clearly and timely about their resolution plans and actions, and provide regular updates and explanations to the stakeholders.
The resolution framework should be more robust and resilient to withstand the pressure and the volatility of the market. The authorities should have sufficient resources and capabilities to manage the resolution process and to cope with the operational and technical difficulties.
The resolution framework should be more consistent and harmonious across jurisdictions and markets. The authorities should cooperate and coordinate their resolution actions, and respect the principles and the standards of the international resolution framework.

The Recommendations: How to Strengthen the Resolution Framework

Based on the lessons learnt, here are some recommendations for the future:

Enhance the public sector backstop funding mechanisms to support the resolution and restore the market confidence, without exposing taxpayers to loss.
Improve the choice of resolution strategies and optionality of resolution tools, to balance the trade-offs between different resolution options.
Strengthen the communication, coordination, and speed of bank runs, to ensure the smooth implementation of the resolution and the prevention of panic and contagion.
Address the operationalisation of bail-in, to resolve the legal and technical issues related to the execution of bail-in across borders.
Facilitate the post-stabilisation restructuring, to ensure that the resolved banks or their acquirers have a viable business model and a sound capital and liquidity position after the resolution.

In conclusion, the bank failures of 2023 have tested the resolution framework and revealed its strengths and weaknesses. They have also provided valuable lessons and insights for the future. It is now up to the authorities and the industry to learn from these lessons, to adapt to the new challenges, and to strengthen the resolution framework. This is not only a technical or regulatory issue, but also a matter of public interest and social responsibility. After all, the ultimate goal of the resolution framework is to protect the financial stability, the economic growth, and the welfare of the society.

P.S. What are your thoughts on the bank failures of 2023 and their implications for the resolution framework? Do you agree with the lessons learnt and the recommendations provided in this blog post? Please share your comments and feedback below. Your input is valuable and appreciated. Thank you for reading and learning with us!

I hope this blog post helps you understand the bank failures of 2023 and their implications for the resolution framework.

Remember, learning is a lifelong journey, and every piece of knowledge is a step forward. Keep learning, keep growing, and keep making a difference in the world. You are capable of more than you know. Believe in yourself, and never stop exploring and discovering. The world is full of wonders and mysteries, waiting for you to unravel and understand. So, let’s embark on this exciting journey of learning and discovery together. Let’s make the world a better place, one piece of knowledge at a time. Happy learning!

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

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