Part I Elements of Bank Resolution Regimes, 1 Introduction

Subject(s):

Bank resolution and insolvency — Credit — Concept of money — Monetary system — Claims — Netting — Set-off

The introduction discusses why dealing with insolvent banks is fundamentally different from dealing with insolvent commercial companies. In ordinary corporate insolvency practice, commercial companies can be allowed to continue to operate while insolvent, by suspending payments on their financial liabilities while continuing to make payments on their commercial liabilities. This allows them to be reorganized or recapitalized rather than liquidated, which almost always results in better recoveries for their creditors, including their financial creditors. The problem in applying this model to a bank is that with a bank there is no meaningful distinction between financial and commercial liabilities. Virtually all bank liabilities are financial liabilities. Instead, the important distinction for banks is between long-term unsecured debt and other capital structure liabilities on the one hand, and short-term unsecured debt and other operating liabilities on the other. Banks can be allowed to continue operating after they reach the point of insolvency if their capital structure liabilities are made subordinate to their operating liabilities in advance. If that has been done, payments on their capital structure liabilities can be suspended while payments on their operating liabilities continue to be made after they reach the point of insolvency and they can be recapitalized (made solvent again) by converting their long-term unsecured debt into equity. This approach should stem runs, avoid contagion and preserve their critical operations for the benefit of the economy as a whole, and also result in better recoveries for all creditors, including the holders of their capital structure liabilities, compared to an immediate liquidation.