Banks and other credit institutions often fail whilst facing capital and liquidity shortages. Even though there are other non-financial and thus regulatory reasons that may trigger failure, the nature and character of the global financial system enables a constant asset-liability mismatch. It follows that capital and liquidity are distinct and often misunderstood by the general public. Therefore, clarity on the repayment of bank deposits and other liabilities in bank liquidation is mission critical.
Bank liquidation generally follows local insolvency regulation. When the scope, size and nature of the financial institution at stake has an impact on the functioning of and confidence in the financial system, international resolution may be justified. In the European Economic Area for example, local regulators or central banks are responsible for the approval of a license to act as a credit institutions, whilst a banking license must be withdrawn by the European Central Bank. The withdrawal of the banking license allows the applicable state to handle the winding up as a standard corporate liquidation procedure. As a consequence, bank account holders and other creditors can examine the local bankruptcy, and insolvency frameworks to comprehend their position and status of their claim.
The role of the (provisional) liquidator
Once the banking license is annulled, a provisional liquidator submits a plan to the court to dismantle the company by collecting and realizing the assets to ultimately distribute these to creditors and the surplus, if any, to the shareholders. The liquidator acts as an officer of the court and has a duty towards the company. This means that the liquidator may start civil action and file criminal complaints for wrongdoing against the company. As a result, a general of funds that is available for distribution to creditors may improve by external legal actions.
When a liquidator discovers fraud or deliberate wrongdoing against the company, either by shareholders or other external parties, a complaint can be filed with the office of the public prosecutor. Hence the reason that many obscure shareholders wish to endlessly delay the appointment of a liquidator by initiating legal action in multiple jurisdictions. Once these actions are exhausted and the liquidation can finally begin, most creditors want it to be over fast and the liquidator finds little support for further actions against the wrongdoers. Most creditors unfortunately do not realize that their quest for a swift resolution therewith happens at their own expense and often results in a substantial loss of money.
Financial institutions whose license is taken away are mostly liquidated and dissolved. This can happen via a voluntary arrangement or receivership but is more often effectuated after the responsible court orders for a liquidation and appoints a qualified liquidator. Upon this appointment, the liquidator announces the liquidation in the local Gazette, or state journal. Creditors are invited to contact the liquidator for further instructions. A committee of inspection composed by several creditors helps the liquidator to execute his duties.
Insolvency or creditor hierarchy
Corporate liquidation and bank insolvency procedures do not treat all creditors equally. Contractual agreements are sometimes secured and may involve fixed or floating charges, or other securities that grants a priority status is matters of default. Therefore, the common insolvency or creditor hierarchy indicates isolated tranches under which repayment to creditors takes place. This means that the liquidator, regulators and tax authorities hold the highest position in this hierarchy where claims are paid in full to these claimants. It is followed by public and professional insurers, secured creditors with preferential debts whose claims are then paid in full. The remaining assets are transferred to a general pool for proportionate distribution on a ‘pari passu’ basis to the unsecured creditors. This is the position for regular bank customers and depositors. Since this is the third position and the previous positions were already repaid in full, deposits are at risk above the insured level. This insured level refers to the local deposit protection scheme that is often triggered prior to the approval of the liquidation. In the improbable event that all unsecured creditors are paid in full, shareholders and other subordinated debt is paid out of the remainder.
Bank liquidation and the failure of other credit institutions is a precarious matter. Creditors must preserve confidence in the financial system and tax payers should, only under extreme circumstances, be approached for a rescue mission of a financial institution. As a consequence, banks that can potentially survive see their losses bailed-in by unsecured creditors and shareholders, where deposit protection and investor compensation schemes safeguard a capped, yet insured account or investment balance.
The lengthy process of bank liquidation addresses different stages. The initial stage of a resolution often allows for limited access, at times combined with strict capital controls, to bank account transfers. This stage also provides opportunities for alternative dispute resolution, out of court settlements and third party arrangements. The next stage for repayment involves the activation of the local deposit protection scheme that covers a substantial but capped account balance. After the deposit guarantee scheme has repaid qualifying creditors, the liquidation can be approved by the court. This is the third and final scheme in the traditional repayment structure. Victimized creditors and those who experience a writedown of their outstanding account balance, can launch civil action against the wrongdoer. Yet, such additional action is not part of the traditional repayment structures and requires individual thought and decision making of the victim.