Following the great financial crisis in 2008, preventing future bail-outs for large, systemically important banks while minimizing the repercussions of bank insolvencies on the stability of the financial system has become a key policy objective for international standard-setters as well as national and supranational policy-makers and regulators. The focus has been not just on the prevention of systemic contagion and the protection of insured depositors and client assets and monies, but also on minimizing the public and private costs of containing bank crises. Given the global nature of the financial crisis and the cross-border economic implications, it is hardly surprising that initiatives to accomplish these objectives have been global in scope, but their implementation has inevitably been guided by the legal frameworks in the respective jurisdictions. 

The European Union (EU) and United States (US) frameworks establish a set of tools to ‘resolve’ a failing bank without recourse to formal court-supervised insolvency proceedings, thereby creating a clear policy demarcation between resolution and insolvency. Within this framework, which draws from the Financial Stability Board (FSB) approach, ‘resolution’ may be understood as functional alternative to court-supervised traditional insolvency procedures such as liquidation. In the EU it has become the preferred approach in bank resolution plans of national resolution authorities, partly reflecting the lack of credibility and feasibility of the national bank liquidation processes.

In a recent paper, entitled ‘The choice between judicial and administrative sanctioned procedures to manage liquidation of banks: A transatlantic perspective’ [forthcoming in: Capital Markets Law Review], we analyze the EU and US approaches to bank insolvency and reflect on the effectiveness of insolvency procedures for banks (and their holding companies in the United States), as well as on the advantages and disadvantages of a dual system that includes an administrative authority and court-supervised procedures. The paper also analyses the need for coordination through harmonization in the EU, especially in the euro area, and the need for enhanced substantive coordination with a view to developing the European Deposit Insurance System (EDIS).

We start from the insight that the recent statutory reforms established a regime that should impose broadly similar economic consequences for bank owners, management, and major stakeholders while avoiding potential detrimental knock-on effects that could result from the application of the traditional procedures under insolvency law. In this context, the principle that losses in bank debt should be borne primarily by bank owners and investors became paramount, while the ranking of claims in this context broadly, although not fully, follows the principles of general insolvency law, and creditors should receive no less because of ‘resolution’ than they would have received in a traditional insolvency liquidation of the relevant institution. 

At the same time, the introduction of resolution tools tailored to the needs of insolvencies of large, complex, internationally active banks and banking groups has not removed the existing approaches and procedures for dealing with institutions of ‘no public interest’. Indeed, within Europe the Bank Recovery and Resolution Directive (BRRD) expressly provides that where a failing bank’s outright liquidation under general insolvency laws would not give rise to concerns regarding public policy interests (the ‘public interest’ test), ‘resolution’ under the BRRD should not be allowed and the relevant bank should be liquidated in ordinary insolvency (bankruptcy) proceedings instead.

Against this backdrop, we then examine, adopting a Trans-Atlantic perspective for that purpose, the reasons for and potential implications of divergences in national approaches to insolvency management for banks below the ‘public interest’ threshold. In the EU, different national frameworks have been developed to deal with bank liquidation, and have been refined over time in response to the individual characteristics of the respective market structures, administrative (or court) infrastructures, and specific lessons learnt during individual incidents of bank failures. Consequently, although each system will usually be the product of a more or less path-dependent evolution, which may or may not entail the preservation of inefficient procedural or substantive solutions, the diversity of arrangements as such should be expected. In fact, the diversity of banking systems and administrative law traditions seems to explain, at least partly, the diversity of bank liquidation frameworks and the differences in their efficiency measured in terms of loss rates of the respective Deposit Guarantee Schemes. 

We find that the diversity of existing approaches to ‘no public interest’ insolvencies creates problems within the euro area and future participating members of the Banking Union for three main reasons:

· First, increasing integration of the European banking and financial markets almost inevitably means that cross-border implications of a liquidation can, and often will, arise even in cases involving small or medium-sized banks (e.g. runs on similar debt types in banks in other countries or simply debt-spread variations due to contagion). In this context, differences in residual national regimes could lead, inter alia, to differences in the treatment of creditors (secured or unsecured and even within each class, e.g. intragroup liabilities) and thus to differences in terms of economic outcomes, as well as to legal uncertainty, all of which contradict the very objective of an integrated common market for financial services. Furthermore, in the euro area the credibility of the euro relies on ensuring equal protection of insured depositors throughout the area, even in crisis-struck countries.

· Secondly, and more specifically, the efficiency of national regimes in dealing with bank insolvency will have an impact on the financial situation of national DGSs on which insured depositors have a claim, creating differences in liquidity and loss coverage needs of national DGSs (e.g. lengthy bankruptcy procedures may result in dramatic deterioration of the banks’ asset recovery values). The proposed pan-European deposit insurance scheme (EDIS), which by definition can arguably be seen as a burden-sharing arrangement based on commonly accepted principles, is hardly conceivable in an environment where differences in national bankruptcy administration and in the substantive treatment of claims in national bankruptcy laws result in substantial differences in terms of the economic value of a given claim against an ailing institution.

· Thirdly, the inefficiency of bank liquidation procedures to wind up the residual bank within a reasonable timeframe may lead to a decision by the resolution authority not to use the bridge bank resolution tool as a part of a reorganization procedure and avoid a situation of creating a residual bank that would be put in to winding up proceedings. Hence the effectiveness of the systemic banks’ resolution procedure could depend on the harmonization of at least certain substantive aspects of banks’ liquidation to the highest standards.

The views expressed in this Blog and in the referenced paper represent the authors’ views and not necessarily those of Bank of Spain or the Eurosystem, or the policies or views of Cleary Gottlieb or any of its partners.


Jens-Hinrich Binder is Professor of Law at Eberhard-Karls-Universitaet Tuebingen, Germany.

Mike Krimminger is Partner, Cleary Gottlieb Steen & Hamilton LLP, Washington DC, USA.

Maria Nieto is Advisor on Financial Stability at the Bank of Spain.

Dalvinder Singh is Professor of Law at the School of Law, University of Warwick, UK.