Public authorities and international regulators seek to ensure a stable economy with high levels of public confidence. The financial industry is the backbone of the economy and thus directly linked to the quality of life of citizens. It is therefore in the public interest to protect and maintain the proper functioning of the global financial systems. Disruption, stress and failure must be scrutinized to plan accordingly and mitigate risk for society.

When a financial institution is failing or likely to fail, resolution plans are drafted by the designated and local resolution authority. Resolution planning and early intervention assesses the feasibility of a financial institution to maintain its operations without compromising stability whilst refraining from public support and tax payer input. A further distinction is made for the underlying reasons of (potential) failure. The cause of the matter is often derived from financial or insolvency challenges. Administrative reasons, such as regulatory violations, alleged criminal conduct and conspiracy to commit financial crime may penalize, sanction, or isolate financial institutions as well.

Systemically Important Financial Institutions are of critical importance for the economy and their failure has a potential contagious effect on smaller institutions. As such, there is a critical difference in the procedures for the resolution of systemic banks and their smaller counterparts. Bail-out procedures with tax payer input are mostly replaced by a bail-in mechanism where shareholders and other creditors participate in the losses of the bank. Still, it must be feasible and justifiable to restart the operations of the bank.

Resolution stages aim to find a solution for the troubled financial institution whilst maintaining its critical functions. Several tools and legal safeguards are available to mitigate the situation. These include the bail-in tool, the sale of business tool, the bridge institution tool, the asset separation tool and the government stabilization tools. Additional safeguards protect creditors via the NCWOL principle where no creditor should be worse off than under liquidation.

While regulators work on the protection of the financial system, creditors and especially the regular customers of the bank, are kept uninformed to avoid bank panic and a run on liquidity. The result is that closure comes abrupt and by surprise and almost always leads to stressful situations for bank customers.

When a financial institution fails or is likely to fail

Resolution authorities determine the feasibility of the continuation of the corporate activities of a financial institution in distress. Available options for resolution separate the total closure and winding down of the financial institution from several alternatives to continue part or all of the bank’s operations. These alternatives include but are not limited to the bail-in calculation, the sale of the business, the bridge institution, and the separation of the assets.

The assessment of the appropriate resolution strategy and the future of the designated financial institution initially aims to protect the public interest by avoiding a disruption of large scale confidence in the financial industry and rescue missions with tax payer input. The second objective is to ensure the proper functioning of the free market where supply and demand of services find each other without restrictions. Following the principles of the open market economy, lawmakers provide for a legal framework to dismantle the bank whilst providing for a structured and sound environment for financial institutions to fail safely.

Common regulatory fears of financial failure include bank runs and contagion to other financial institutions that ultimately triggers public dissatisfaction and panic. To avoid such situations and protect macro-economic stability financial institutions in distress are isolated, where customer deposits for private creditors are insured via domestic deposit protection schemes and the possible closure of the financial institution is executed via traditional winding down and insolvency procedures.

Sanctions, Designations and the Public Interest Doctrine

Not all financial institutions are closed due to financial and solvency challenges. Several are forced to end their business activities because of failure to comply with international standards and other regulatory violations. The financial system is critical for international trade and thus the global economy. Therefore, it must be protected from abuse. Rogue states, questionable corporations and suspect individuals can be sanctioned with for example penalties, asset freezes, forfeiture and confiscations. These sanctions also include trade limitations and designated targeting of international illicit conduct. Objectives of these politically, economic and administrative embargoes isolate suspect people, institutions, governments and assets from the global economy.

Sanctions often forbid public and private organizations, states and individuals to further engage in activities with the designated party. Targeted designations have a different nature and effect. These merely indicate that a state or organization is considered a potential threat to international stability, peace and security.

Financial institutions can be subject to sanctions and special designations. The US Treasury Department is at the forefront of international economic sanctions programs. As the US Dollar is considered the global reserve currency and benchmark for international trade, the United States strives to protect and maintain the stability of their value transfer system. The Patriot Act, that came into effect after the terrorist attacks of 9/11, provides the Treasury Department with extensive powers to control its financial ecosystem by designating foreign financial institutions and jurisdictions as primary money laundering concerns under Section 311 of the act.

Alleged wrongdoing by financial institutions may trigger scrutiny by the US based Financial Crimes Enforcement Network (FinCEN). Severe violations of international standards allows FinCEN to draft a Notice of Finding for proposed rulemaking and formally publish its findings in the Federal Register. A Notice of Finding is not a sanction. It merely indicates that the USA is planning to terminate access to the US Dollar to the designated financial institution. As such, external market-pressure forces the financial institution to either drastically change its operations to comply with international standards, or to stop activities. Examples of such market pressure are the disconnection from the system of correspondent banking, international asset freezing, regulatory scrutiny and intervention, and a run on the liquidity of the bank by anxious customers.

Systemically important financial institutions are financially penalized for wrongdoing or enter into deferred prosecution agreements with regulators to end the investigation and continue its operation. Its smaller and often publicly owned counterparts are hit in similar situations with special measures and designations under the Patriot Act. It seems unfair but it is therewith expected that when the designated financial institution does not improve its conduct, final closure of the bank is inevitable.

Bank Deposit Recovery Plan

This summery of the resolution procedures and available tools concretize the gap between the objectives of the authorities that aim to protect the public interest and individual creditors. Authorities want to maintain financial stability and do barely enough to achieve general consensus of intervention by limiting tax payer input and provision of a legal framework for bank closure and liquidation. The isolation of risk to the failing financial institutions and its customers avoids that outsiders with no relationship to the bank are drawn into expensive rescue missions for others. This approach is derived from traditional insolvency law where a mismatch between assets and liabilities may lead to the closure of a company.

When a financial institution is failing or likely to fail, the local regulator assumes control and takes over administration of the financial institution. As such, the critical functions of the financial institution are maintained while resolution options are discussed and investigated. Capital controls to limit the outflow of liquidity are imposed on customers and the deposit protection scheme is eventually activated.

The conclusion of the resolution determines the further strategy to re-start all or a part of the operations, or wind down the financial institution. The main principle is that creditors and other stakeholders should not be worse of than under a liquidation. The available options include the bail-in of the financial and standard insolvency procedures.

Both a bail-in and the insolvency procedure follow a predefined creditor hierarchy. This hierarchy groups creditors and follows a top down approach where secured claims and liabilities have preference over unsecured creditors. For regular bank deposits, protection via a deposit guarantee scheme provides for an advance payment for qualifying creditors. This alleges that not all deposits and claimants are covered by deposit protection. The surplus of account balances above the insured amount as well as disqualified creditors are considered unsecured and subordinated debt in bail-in and insolvency procedures.

The creditor hierarchy in bank failure defines the following positions, that are paid in full and on a pari passu basis:

  • First position: costs of the liquidation, DGS advance payments, and the operational costs of the financial institution.
  • Second position: Senior debt, secured claims and liabilities.
  • Third position: Subordinated debt, claims and liabilities such as bank deposits.
  • Fourth position: Unsecured investments and fixed deposits.
  • Fifth position: Shareholder equity, tier 1 and tier 2 debt.

Corporate liquidation and dissolution starts with the appointment of a liquidator by the court. The liquidator has obligations towards the financial institution and thus works as an agent to the financial institution. The liquidator takes over the position of the shareholders to avoid conflicts of interest when assets are realized and distributed following the creditor hierarchy. As such, the duties of a liquidator are to wind up the financial institution, to collect in and realize the corporate assets and external holdings, and to make distributions to the creditors in accordance with the statutory scheme with any surplus being returned to the shareholders.

Realized assets are placed into a general pool for distribution to creditors. Creditors must submit within reasonable time a proof of debt and a proof of claim to establish its legitimacy. In large corporate liquidations, payments are made in tranches when assets are realized and available for distribution. A committee of inspection to act with the liquidators may be proposed. The committee is appointed by creditors and has indirect powers to monitor conduct of the liquidator and vote for specific acts on behalf of the company.

How We Help You Reclaim Your Deposit and Investment…

A general misconception applies to the safety of bank deposits. Most bank customers assume that all deposits are equally protected and that financial institutions are bailed out with tax payer money. This personal point of view is strengthened by the global financial crisis that emerged in 2008 where systemically important financially institutions all around the world were kept alive at the expense of society. Reality these days is different. General creditors and depositors are under the new rules for bank resolution similar to traditional liquidation procedures. The losses of a financial institution are imposed on the owners and creditors. As such, loss absorption takes place by the conversion of liabilities in a common equity instrument, or by writing down or writing off the principal amount of the liability.

Needless to say, there is an extensive legal framework to stop impermissible conduct, shut down a financial institution, and minimize risk for victims and creditors. However, the structure of the financial system is characterized by the theory of fractional reserve lending where only a fraction of deposits are backed by directly absorbable liquidity, replenished by an asset-liability mismatch. This systemic imperfection is inconsiderable in day to day practice but is negatively amplified in matters of failure since financial institutions are always unable to repay all debts on demand.

In general, creditors are uninterested in the system of asset and fund recovery. They just want their money back. Without much hassle and delay. And they often don’t consider further risk, ‘haircuts’ or write downs of their account balance. Based on the combination of the infrastructure of financial institutions, and the position of creditors, it is mission critical to use the system to your advantage.

For most creditors bank failure is a single occurrence. Others might have experienced the event before. All creditors must realize though that administration and liquidation procedures happen in a staged vacuum. This means that each step in the administration and liquidation process has its own rules and timeframes. Creditors who fail to comply with the indicated rules, who are not covered under this part of the regulation, or who cannot file their claim before the deadline expires, disqualify themselves for this part of the recovery. This is why all creditors in bank failure should:

Minimize Risk and Maximize Repayment!

To achieve the objective to minimize risk and maximize repayment, Legal Floris LLC approaches every step of the administration and liquidation procedures as a stand alone tool that should be used to its full advantage. The limitations per recovery strategy requires most creditors need to participate in several of these strategies to recover their investment. That is also why we strive to establish a long-term relationship with our customers and ensure maximum recovery of their outstanding credit.

The following steps are covered in the collaboration with our customers. Each step has its advantages and limitations. All steps together should get creditors as close as possible to maximum recovery. The approach used is only discussed with our customers to ensure its effectiveness. Steps include but are not limited to:

  • Step 1: Administration and Limited Access to Accounts
  • Step 2: Depositor Protection
  • Step 3: Dispute Resolution, Settlements and Other Civil Agreements
  • Step 4: Insolvency and Liquidation Procedures
  • Step 5: Civil Actions following Asset Write down

You have read this far for a reason. This is probably because like most creditors in bank failure and bank liquidation, you are left in the dark. Information provisioning by regulators such as the designated Central Bank, the failing financial institution, and others is not always up to date and comforting.

The fact of the matter is that asset and fund recovery in bank failure and bank liquidation requires a proven strategy and hard work to get things done. This is all new for you and the main problem is that creditors cannot afford to make mistakes because such mistakes can lead to disqualification.

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