Luxembourg, a small European country known for its strong financial sector, has always been an attractive destination for banking and financial services. However, even the most robust financial systems can be susceptible to bank failures. International bank creditors, who fear losing money in Luxembourg bank failures, need to understand the legal framework, resolution processes, and steps they can take to safeguard their interests.
The legal framework governing the banking sector in Luxembourg is a combination of domestic and European Union (EU) laws. The most relevant domestic law is the 1993 Luxembourg Financial Sector Act, which regulates the licensing, operation, and supervision of banks. At the EU level, the key legislation includes the Bank Recovery and Resolution Directive (BRRD), the Single Resolution Mechanism Regulation (SRMR), and the Capital Requirements Regulation (CRR).
It is important to note that Luxembourg has generally been known for its strict financial regulations and a solid banking sector. However, instances of misconduct and regulatory breaches have occurred in the past. Some Luxembourgish banks and credit institutions have faced fines for various wrongdoings, although the penalties might not be as exorbitant as those faced by larger international banks.
Banque Internationale à Luxembourg (BIL): In 2020, BIL was fined €4.6 million by the CSSF for its failure to meet anti-money laundering and counter-terrorism financing (AML/CTF) obligations. The bank was found to have shortcomings in risk management, client due diligence, and transaction monitoring.
Clearstream Banking: In 2019, the CSSF fined Clearstream Banking, a post-trade services provider and part of Deutsche Börse Group, €12.5 million for insufficient AML controls. The fine was related to the bank’s failure to comply with AML regulations between 2010 and 2015.
Banque Havilland: In 2020, Banque Havilland faced a €4 million fine from the CSSF over deficiencies in its AML/CTF systems and governance. The bank was criticized for failing to establish an appropriate risk management framework and for inadequacies in customer due diligence.
While the instances mentioned above illustrate some cases of Luxembourgish banks being fined for misconduct, it is essential to understand that these situations are not reflective of the entire banking sector in Luxembourg. Overall, Luxembourg has a strong and stable banking sector, and such cases of wrongdoing are exceptions rather than the norm. The financial institutions were not shut down despite their wrongdoings for several reasons including proportionality, remedial action, systemic impact and the protection of shareholder property rights.
Bank Failure in Luxembourg: Definition and Determination
Bank failure in Luxembourg is defined as a situation where a bank is unable to meet its financial obligations, either due to insolvency or a severe liquidity crisis. A bank is also considered to have failed if it breaches regulatory capital requirements or if the competent authority determines that the bank is likely to fail in the near future.
The responsibility of determining bank failure in Luxembourg lies with the Commission de Surveillance du Secteur Financier (CSSF), the country’s primary financial regulator, and the European Central Bank (ECB), acting within the framework of the Single Supervisory Mechanism (SSM). The ECB has the authority to declare a bank failing or likely to fail if it concludes that the bank is unable to meet its obligations or if it breaches regulatory capital requirements.
Once a bank failure is concluded, the resolution process begins. The objective of the resolution process is to preserve the critical functions of the bank, ensure the continuation of the organization, and minimize the impact on financial stability. The most common reasons for bank failure in Luxembourg include poor management, insufficient capital, exposure to high-risk investments, and economic downturns.
Bank Supervision and Resolution Planning
Bank supervision in Luxembourg involves monitoring the financial health, capital adequacy, and risk management practices of banks. The CSSF and the ECB are responsible for supervising banks and ensuring their compliance with prudential rules. Resolution planning, on the other hand, focuses on preparing for potential bank failures by developing resolution strategies, identifying critical functions, and ensuring the availability of resolution tools.
The resolution authority in Luxembourg is the CSSF, which is also a member of the Single Resolution Board (SRB), the central resolution authority for the Eurozone. When a bank fails, the CSSF, in cooperation with the SRB, initiates the resolution process. The steps include:
- Assessment of the bank’s viability and determining if it is in the public interest to resolve the bank.
- Choosing the appropriate resolution strategy, which may involve the sale of the business, the establishment of a bridge bank, or asset separation.
- Implementing the chosen resolution strategy, which may include reorganization, recapitalization, restructuring, or dissolution.
In Luxembourg, account deposits are protected by the Fonds de Garantie des Dépôts Luxembourg (FGDL), which covers up to €100,000 per depositor, per bank. Other creditor interests are protected through the application of the creditor hierarchy in the resolution process, which prioritizes the order in which creditors’ claims are settled. The creditor hierarchy in Luxembourg follows the EU’s BRRD framework and is as follows:
- Common Equity Tier 1 capital instruments (e.g., ordinary shares)
- Additional Tier 1 capital instruments (e.g., contingent convertible bonds)
- Tier 2 capital instruments (e.g., subordinated debt)
- Senior debt (including uninsured deposits)
- Covered deposits (up to €100,000)
To ensure that non-viable firms exit the market in an orderly manner, the CSSF and the ECB closely monitor the financial health of banks and intervene when necessary. Early intervention measures can include requiring the bank to implement a recovery plan, replacing the management, or imposing additional capital requirements. If these measures prove insufficient, the CSSF can initiate resolution proceedings, which aim to minimize the impact on financial stability and protect depositors and other creditors.
If the resolution authority deems that it is not in the public interest to resolve a failed bank, it can initiate a liquidation process. In Luxembourg, bank liquidation follows the rules established by the BRRD and the Luxembourg Commercial Code. The liquidation process typically involves appointing a liquidator, identifying and valuing the bank’s assets, settling the bank’s liabilities, and distributing the remaining assets to shareholders.