Bank failures are a major concern for international bank creditors, as they can result in significant financial losses. In the United Kingdom (UK), the legal framework governing bank failures is designed to protect creditor interests, ensure market stability, and maintain public confidence in the financial system. Banking law in the UK is governed by a range of legislation and regulations, including the Financial Services and Markets Act 2000 (FSMA), the Banking Act 2009, the Prudential Regulation Authority (PRA) Rulebook, and the Bank Recovery and Resolution Directive (BRRD). Bank failures are primarily addressed under the Banking Act 2009 and the BRRD, which outline the regulatory framework for dealing with failing banks and the resolution tools available to authorities.
Several UK banks and credit institutions have faced hefty fines in recent years for various forms of misconduct, including Barclays, Royal Bank of Scotland (RBS), Lloyds Banking Group, and HSBC. The penalties have ranged from millions to billions of pounds, with wrongdoing including manipulation of foreign exchange and interest rate benchmarks, mis-selling of financial products, and failures in anti-money laundering controls. These banks have not been shut down due to the systemic importance of their operations, the potential impact on the wider economy, and the efforts made to address identified issues and improve governance.
Bank Failure in the UK
Bank failure in the UK is generally defined as a situation where a bank is unable to meet its obligations to its depositors, creditors, or counterparties, either due to insolvency or illiquidity. This can result from various factors, including poor management, excessive risk-taking, fraud, or macroeconomic shocks. The PRA and the Bank of England (BoE) are responsible for identifying and assessing the risk of bank failure in the UK.
The determination of bank failure in the UK is based on a range of criteria, including capital adequacy, liquidity, asset quality, management performance, and market conditions. The PRA and the BoE have the authority to conclude that a bank is failing or likely to fail if it no longer meets the minimum regulatory requirements, is unable to restore its financial position, or is at risk of insolvency or illiquidity. The PRA and the BoE have a legal mandate to intervene in the affairs of a failing bank and implement appropriate resolution measures to protect the financial system and the interests of depositors and other creditors.
Following the conclusion of a bank failure, the resolution authority (BoE) has various options to address the situation, including reorganization, recapitalization, restructuring, or dissolution. The most common reasons for bank failure in the UK include poor governance, inadequate risk management, fraud, and macroeconomic factors such as recession, interest rate changes, and financial market volatility.
Bank Supervision and Resolution Planning
Bank supervision and resolution planning in the UK are designed to preserve the critical functions of a bank and ensure the continuation of the organization in times of financial distress. The PRA and the BoE have the responsibility to monitor and enforce compliance with prudential standards, as well as to develop and implement resolution plans for banks under their jurisdiction. These plans are intended to minimize the impact of a bank failure on the financial system, maintain market confidence, and protect the interests of depositors and other creditors. When a bank within the UK’s jurisdiction fails, the resolution authority (BoE) follows a structured process that includes:
- Assessing the systemic risk posed by the failing bank and the potential impact on the financial system
- Coordinating with other relevant authorities, both domestic and international
- Selecting and implementing appropriate resolution tools and measures, such as the sale of the business, bridge bank, and asset separation.
The UK’s resolution authority has several options to reorganize, recapitalize, restructure, or dissolve a failed bank. These include sale of the business (the resolution authority may sell all or part of the failing bank’s assets and liabilities to a private-sector purchaser), a bridge bank (the authority may transfer the critical functions of the failing bank to a temporary bridge bank, which will continue to operate until a permanent solution is found), and asset separation (the authority may transfer the bank’s non-performing or problematic assets to a separate entity, such as an asset management vehicle, to facilitate the bank’s recovery and protect creditor interests).
Protection of Account Deposits and Creditor Interests
In the UK, account deposits and other creditor interests are protected by law through the Financial Services Compensation Scheme (FSCS), which covers deposits up to £85,000 per individual, per institution. In the case of a bank failure, the FSCS ensures that eligible depositors receive compensation for their losses, up to the coverage limit. Other creditor interests, such as secured lending and wholesale funding, are protected through the resolution process and the application of the BRRD’s creditor hierarchy and bail-in rules.
The UK’s regulatory framework aims to ensure that non-viable firms exit the market in an orderly manner, minimizing the impact on the financial system and protecting the interests of depositors and other creditors. This is achieved through a combination of effective supervision, early intervention, and the application of resolution tools that facilitate the restructuring or winding down of failing banks.
Bank Liquidation in the UK
Bank liquidation in the UK is governed by the Banking Act 2009 and the Insolvency Act 1986, which set out the rules and procedures for the winding up of failed banks. In the case of a bank liquidation, the assets of the bank are sold, and the proceeds are used to repay creditors in accordance with a statutory hierarchy of claims. Account holders of a failed bank in the UK should safeguard their position during the stages of statutory administration, deposit insurance, and bank liquidation.
UK bank failures, while concerning, are managed through a comprehensive legal and regulatory framework designed to minimize the impact on the financial system and protect the interests of depositors and other creditors. By understanding the laws and procedures governing bank failure in the UK, as well as the steps to safeguard their position, international bank creditors can navigate the complexities of financial distress with greater confidence and peace of mind.