Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany

1. Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany Role of Deposit Insurance in Bank Resolution Framework – Lessons from the Financial Crisis November 13-16, 2011 JODHPUR, INDIA Dirk Cupei Director Deposit Protection Association of German Banks Vice Chairman European Forum of Deposit Insurers (EFDI)

2. Contents • E U R O P E • Germany- Crisis management • - Restructuring fund

3. Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany I. E U R O P E

4. Overview of the EU framework for cross-border crisis management in the banking European Union Deutschland Public Consultation regarding an EU framework for Cross-Border Crisis Management in the Banking Sector October 2009 May 2010 Communication on bank resolution funds Communication on a new EU framework for crisis management in the financial sector October 2010 Consultation on technical details of a possible European crisis management framework December 2010/ January 2011 End 2011 Expected: Com Proposal for a directive on Crisis Resolution and Bank Resolution Fund 4

5. Overview of the EU framework for cross-border crisis management in the banking According to the available working version of the proposal for a directive, the EU framework is currently more or less as follows: Scope: (Deposit-taking) credit institutions, investment firms and financial holding companies. Resolution authority: Member states will be required to set up a resolution authority that may be part of the banking supervision set-up if arrangements have been made to avoid conflicts of interest.

6. Recovery plans The content of recovery plans will be proportionate to the size and complexity of institutions. As part of the risk management process called for in the directive, institutions will be required to draw up recovery plans that have to be updated on at least on annual basis. Supervisors will provide institutions with different scenarios, requiring them to draw up a recovery plan for each of these. Recovery plans should not assume access to any public financial support. Detailed requirements for content of recovery plans (e.g. with regard to preparatory arrangements to facilitate the sale of business lines). Supervisors will be required to assess the effectiveness of recovery plans and to request modifications if necessary. They may instruct institutions to remove obstacles to implementation (e.g. by making changes to their business strategy or governance structure).

7. Intra Group Financial Support Parent and subsidiaries may enter into an agreement on financial support arrangements. The agreement will be reviewed by supervisors and presented to the shareholders’ meeting for approval. The management body will be authorised by the shareholders’ meeting to provide financial support under the agreement, but only if it can be assumed that the support will be repaid and it is justified by a superordinate “common interest of the group” as a whole. Financial support must be notified to supervisors, who may prohibit or restrict it within 48 hours after receiving notification.

8. Resolution plans – Preparatory andpreventative powers Resolution authorities will be required to draw up resolution plans, to update these at least on an annual basis and to review them on the basis of predefined criteria. Proportionality principle will apply like with recovery plans, but resolution authorities may waive resolution plan requirement if an institution is not considered to be systemically relevant. Institutions will be required to provide highly detailed information for development of resolution plans, e.g. to identify major or most “critical” counterparties and analyse the impact of their failure on them (should ultimately be equivalent to workload imposed by recovery plans).

9. Resolution plans – Preparatory andpreventative powers Resolution authorities will assess resolvability of institutions and inform them of any obstacles to implementation of resolution plans they have identified. Institutions must propose measures for removing these obstacles. Positive: no justification for intervention if obstacles to resolution lie outside institutions. Negative: resolution authority does not share plans with institutions. For groups, resolution colleges will be set up. If necessary, resolution authorities may order measures themselves, e.g. to make changes to the structure of an institution, restrict business activities, issue CoCos.

10. Early Intervention In cases where there is a significant deterioration in the financial situation of an institution, supervisors may require the institution to, among other things, implement the recovery plan, adopt measures to improve its financial situation or present plans for reaching an agreement with creditors. Appointment of a special manager (≈ “special representative” within the meaning of Section 45c of the German Banking Act) for a period of not more than one year. Special manager must have same rights as senior management of the institution (e.g. right to convene shareholders’ meeting).

11. Early Intervention Will also be empowered to initiate “rescue measures” against the will of senior management. In the case of groups, joint decision is to be taken by the resolution college within one week; in the absence of a joint decision within 10 days, the consolidating supervisor may take a decision; the EBA will take a conciliatory decision on cases referred to it within 5 days.

12. Resolution Last resort – presupposes, in addition to a situation in which an institution “is failing or likely to fail” (e.g. insufficient own funds), that resolution is in the “public interest” General principles include the following: shareholders and creditors must bear an “appropriate” share of losses; senior management must be replaced Resolution tools specified in the directive are: - the sale-of-business tool - the bridge institution tool - the asset separation tool (bad bank) - the debt write-down tool (haircut, bail-in) – further details of this are missing in the proposal (Articles 32 – 35) Detailed provisions dealing with international cooperation on resolution of groups within the EU and with third countries.

13. Suspension powers/netting agreements Resolution authorities will have three different intervention/suspension powers: the power to suspend payment or delivery obligations for a period of not more than 48 hours; the power to restrict the enforcement of security interests for a period that they may determine;

14. Suspension powers/netting agreements the power to suspend close-out and set-off rights under netting agreements for a period of not more than 48 hours, subject to the following restrictions: - covers only termination rights due to/in relation to prudential reorganisation measures - suspensive effect is removed if no transfer takes place - termination right comes into existence again where transfer takes place if termination right exists in relation to the acquirer - protection of the inseparability of transactions concluded under a netting agreement (no cherry picking – Art. 62)

15. Suspension powers/netting agreements • Further definition and requirements/exemptions for: - Restrictions with regard to security interests: exemptions from scope for certain types of security interest and requirements for the period in which restriction applies - Netting agreements: definition of the netting agreements covered and exemptions from the protection provided by Articles 48 and 62

16. Resolution tool financing arrangements (bank levy) e.g. by providing guarantees, purchasing assets or making loans; any losses and costs incurred by the use of financing arrangements must first be borne by shareholders and creditors. Arrangements must be financed by domestic credit institutions. Target level of funds: will be based on whichever amount is higher – 0.6 % of the covered deposits as defined under the Deposit Guarantee Schemes Directive or 0.12% of the non-equity liabilities of all institutions. Fund-raising period: target level of funds is to be achieved within a period of no longer than 10 years after the entry into force of the directive. 10% of target level may be made up of payment commitments by institutions.

17. Resolution tool financing arrangements (bank levy) Contributions will be levied annually; assessment must be based on at least one of the seven specified elements (including an institution’s systemic importance, the amount of its liabilities excluding own funds and deposits guaranteed under the deposit guarantee scheme, and the extent to which the institution has previously benefited from state support. Extraordinary contributions will be raised where necessary. Deposit guarantee schemes, provided they are used by member states for financing resolution measures, will be considered as financing arrangements for the purposes of the directive.

18. Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany Germany I. Crisis management

19. Regulatory consequences of the financial crisis • The regulatory approach to certain areas has changed, sometimes fundamentally, • in response to the financial crisis. • Major changes: • new capital and liquidity standards (Basel III) • reform of deposit guarantee schemes • new rules on restructuring “systemically important financial institutions” • Restructuring rules are needed because • entrepreneurial failure should ultimately lead to exit from the market, • state aid to ensure financial market stability should be phased out, • an instrument is needed for the orderly resolution of systemically important market participants, • competitive distortion must be avoided.

20. Approach of the German Restructuring Act New rules took effect end of December 2010/ beginning of 2011 Two-tier restructuring procedure Objective Financial market stability: no bank should be “too big to fail” or “too connected to fail” Early intervention and crisis management tools for supervisors Restructuring fund financed by special bank levy

21. 2nd tier: reorganisation procedure 1st tier: restructuring procedure Restructuring procedure crisis management by the bank itself • Bank deemed in need of restructuring if capital and liquidity position has deteriorated as described in Section 45 (1) of the revised German Banking Act (KWG).  Bank drafts restructuring plan • May not curtail third-party rights • But restructuring loans senior to other creditors in the event of insolvency • Existence of the bank is threatened(Section 48b (1) KWG) and this could jeopardise the stability of the system (Section 48b (2) KWG).  Bank drafts reorganisation plan • Curtailment of creditors’ rights possible, e.g. by reducing or deferring claims • Butno curtailment of claims covered by deposit guarantee schemes • Curtailment of shareholders’ rights possible(e.g. by hiving off parts of the company). • Debt for equity swaps with the approval of creditors

22. German Restructuring Act Application BaFin Court Reports need for restructuring Restructuring plan Orders implementation Proposes special manager Appoints Impending difficulties: Restructuring by bank itself Affected Bank  Oversees restructuring Special manager Restructuring Reorganisation Restructuring

23. German Restructuring Act Application BaFin Court Threat to existence of bank threatens financial market stability Reports need for reorganisation Reorganisationplan - Curtailment of creditors´ rights Orders implementation - Dept-Equity-Swap • Acceptance of reorganisation plan requires • Approval of all creditors and shareholders • Endorsement by works (courts examine if necessary whether approval of individual groups of creditors may be waived) - Reorganisation/Living Off of units Restructuring has failed or likely to fail: Bank draws up reorganisation plan Appoints Affected Bank  Reorganisation manager Overses reorganisation Restructuring Reorganisation Restructuring

24. New supervisory tools Revision of prerequisites for intervention if bank’s capital / liquidity position deteriorates and new powers of intervention Section 45 KWG • Early intervention: supervisors will be able to instruct a bank to implement restructuring measures at an early stage. • Crisis management: additional tools with which to restructure and wind up an ailing bank. Section 45c KWG Power to appoint a special manager Sections 48a – 48s KWG Introduction of measures in the event of a threat to the stability of the financial system

25. Threat to a bank’s existence and the system as a whole(Section 48b KWG) Threat that the bank will collapse unless corrective action is taken • Indications of concrete impending default or overindebtedness not necessary. • Threat is assumed to exist in the event of a qualified breach of capital and liquidity requirements. Threat to bank’s existence threatens financial market stability If there is a danger of the threat to the bank’s existence will have a seriously adverse effect on • other firms in the financial sector, • the financial markets or • the confidence of investors and other market .

26. Regulatory instruments for crisis management Restructuring fond administers FMSA BaFin • e.g.: • Establishment of bridge bank • issues guarantees • recapitalisation measures Orders Sale Threat to existence of bank threatens financial market stability Systemically important units Bridge Bank Non-systemically important units Affected Bank Old Bank Resolution insolvency Restructuring Restructuring / Resolution

27. Lessons from Finacial Crisis for Bank Resolution – Presentation on Europe and Germany Germany II. Restructuring fund

28. Restructuring fund (bank levy) • Objective: to stabilise the financial markets • Targeted size of fund: 70 billion euros • Contributors to fund: • Principle: all domestic banks plus branches of foreign banks headquartered outside EU/EEA • Exceptions: KfW, Deutsche Bundesbank and regional development banks • Financing: annual contributions, first contributions due 30 September 2011 • Basis of contribution: amount of bank’s systemic risk • If additional resources needed: special levy • Tax implications: annual contributions non tax-deductible

29. Method of calculating contributions(Section 12 (10) of the Restructuring Fund Act) • Annual contributions depend on bank’s business volume, size and degree of integration in financial market; determined by total liabilities and unsettled derivatives. • Following balance-sheet liabilities will be deducted: 1. liabilities to customers, except for liabilities to legal entities in which the bank holds an interest, 2. participatory capital, except participatory capital with a maturity of under two years, 3. funds for general bank risks and 4. regulatory capital. • Progressive scale for annual contributions • German government issued a regulation to clarify details.

30. Total raised by annual contributions to restructuring fundFederal Ministry of Finance estimate in 2010*(figures are not actual anymore!) • Private banks 690 million euros • Landesbanken 319 million euros • Savings banks 60 million euros • cooperative banks 27 million euros • Annual total approx. 1.3 billion euros (new estimation total 800 Mio.) • * Source: German Council of Economic Experts, 2010/2011 annual report, published November 2010, p. 168.

31. Many thanks for your attention! Dirk Cupei Director Deposit Protection Association of German Banks Vice Chairman European Forum of Deposit Insurers (EFDI)