Corporations can voluntary seize trading or be forced to discontinue their operations due to capital and liquidity shortages or regulatory violations. Banks and other financial institutions are merely corporations with a license to operate as a credit or (electronic) money institution. As such, their role in society has a systemic character. Failure of a financial institution may disrupt the critical functions of the real economy. Therefore, bank stress, failure and liquidation must be handled with utmost care by all stakeholders involved.
Most bank failures are the result of financial challenges where the bank is unable to meet its obligations towards the creditors. Creative bookkeeping, like Lehman Brothers did, can delay the discovery of excessive risk taking and even bigger financial losses. Another major reason for bank failure is the assumed violation of international anti-money laundering regulation. In this scenario the bank does not necessarily has financial challenges but is alleged a risk to the confidence in and stability of the global financial system.
Smaller private banks and financial institutions vulnerable for abuse, are often well capitalized. Still, the asset-liability mismatch and the maturity gap always deliver challenge when a run on the bank occurs. As such, value fluctuations and financial challenges of all financial institution should be handled with utmost care.
Staged asset recovery
International bank customers do not always choose for the best solution to serve their needs. The best solution provides stable and reliable deposit protection for a well-capitalized systemic bank registered in a jurisdiction with strict bank regulation that is seldom transgressed. This combination is so strong that even a bail-in of debt in matters of bank restructuring does not hurt that much for the creditors involved.
When a bank fails and a bail-in or liquidation is the only way to resolve the matter, creditors are repaid in a staged asset recovery procedure. At first there is often limited access to the account balance for withdrawals. These limitations are required to avoid a run on the bank and a devaluation of the corporate assets leading to further economic decline. The moment that the resolution plan is announced, the deposit protection scheme can be activated to repay insured creditors a maximum amount. The deposit guarantee scheme takes place prior to the liquidation. Creditors who fail to claim under the DGS or who don’t qualify for deposit protection, are then handed down to the corporate liquidation. This liquidation follows a creditor hierarchy where, depending on the value of the assets of the failed bank, creditors may experience a write-down or haircut on their claim. As a final point, creditors may start civil action against the wrongdoer who is responsible for their loss. Obviously, a court must confirm the legitimacy of such claims before losses can be claimed via civil action.
Hair-cut and asset write down in bank liquidation
Asset and fund recovery in bank liquidation follows a staged recovery pattern. As explained in this article, there are three main categories under which money is repaid to creditors. Alongside these three main categories, creditors can also take matters in their own hands and start civil action. The combination of the traditional resolution strategies with external action delivers the best outcome. However, financial institutions fail for a reason. Due to the nature of the business of banking and credit supply, bank failure and liquidation almost always has an impact on the value of the assets of the bank. Therefore, as unfortunate as it may sound, a hair-cut and asset write down in bank liquidation is always to be expected. Creditors can do several things to maximize their position. As such, the level of the hair-cut and asset write down can be partly controlled by themselves.