Bank liquidation does not greatly differ from traditional and more common corporate liquidation. However, the function and position of financial institutions and liquidity providers in the global economy justifies a slightly different approach to default. Central banks and their respective regulators seek to protect the local and global financial system. A balanced approach towards maintaining confidence in the system and limiting tax payer input prevails. Deposit protection and investor compensation provides creditors with a maximized protective cover for their claim against the bank or credit institution. To avoid excessive and unlimited risk taking and moral hazard, the agreement between financial institutions and their customers provides for the resolution framework and enables civil action between the contract parties for contractual breaches and defaults.
Similar to regular companies, financial institutions can also fail and ultimately dissolved. As an additional safeguard, deposit protection distinguish banks from corporations. A standardized approach to corporate liquidation requires the withdrawal of the operational license of the bank as a credit institution. Liquidation then must be approved by the court or the regulator. As long as no consensus is reached between the parties, and the court has not decided on the liquidation, no further action can be taken, and the patience of creditors is tested.
The initial step of bank resolution is named administration. During this stage, account holders often get access to limited resources of the bank and may therefore withdraw small amounts from their accounts. A special administrator resumes control over the bank whilst a resolution plan seeks to identify possibilities for a continuation of several activities by a bail in of debt, or a full dissolution of the bank. Meanwhile, the domestic deposit protection scheme is triggered to repay qualifying creditors their account balance up to the insured amount. Following the administration stage, a liquidation procedure can commence. The moment before a liquidation is agreed on may take several years of negotiations, settlements and even court interventions.
Most retail customers of banks and other financial institutions assume that the bank liquidation procedure is the holy grail in the recovery process. This assumption is only correct when the winding up procedure is unrelated to capital and liquidity shortages and the financial institution has sufficient capital to repay all creditors on demand. Empirical evidence of historic bank failures has proven that this is a very unique situation and consolidated accounts often reveal a different outcome.
To understand bank resolution and recovery, creditors should look further than liquidation procedures. The combination of early intervention measures, alternative dispute resolution, out of court settlements, deposit protection, the liquidation and eventually civil claims against the wrongdoers safeguards maximum repayment. Therefore, most creditors should expect a staged repayment of their outstanding account balance. The timeframes involved depend on the complexity of a case. However, one can expect that resolution rather takes years then months. As such, creditors owe it to themselves to participate in every single opportunity to regain access to their assets.