HMT proposes amendments to the resolution regime for smaller banks

HMT recently published a consultation proposing targeted amendments to the UK Special Resolution Regime (“SRR”) to reflect “lessons learned” from recent bank failures, including that of Silicon Valley Bank UK (“SVB UK”).  The consultation closes on 7 March 2024.

HMT re-iterates the Bank of England’s (“BoE’s”) March 2023 assessment that the UK already has a robust resolution regime for banking institutions which affords the BoE with sufficient powers and tools to resolve banks and to adjust to the circumstances of their failure, and which proved effective and delivered good outcomes for financial stability, customers and taxpayers in the resolution of SVB UK.

International regulators, including the FSB, and legislators such as the EU Commission have all considered the lessons learned from the bank failures of Spring 2023 with the EU Commission releasing its Crisis Management and Deposit Insurance (“CMDI”) proposals in April 2023. 

Similarly to the CMDI proposals, HMT’s proposed enhancements to the SRR are targeted to the resolvability of “smaller banks” or “small banks” i.e., banks which are not required to hold MREL above capital requirements. HMT notes that, in some cases of small bank failure, the public interest and resolution objectives, particularly in respect of continuity of banking services, may be better served by the use of the stabilisation tools rather than the Bank Insolvency Procedure (which has traditionally been the default strategy for smaller banks). This is an observation made by a number of international regulators with CMDI going as far as introducing sectoral or regional importance criteria for the purposes of the public interest assessment test. The same considerations have underpinned HMT’s consultation which aims to ensure that existing resolution tools can be applied to small banks in a way that achieves good outcomes for financial stability while also protecting taxpayers.

The UK Government believes that, in certain situations, in view of the options available, it may be in the public interest to transfer a failing small bank into a Bridge Bank or, as happened in the case of SVB UK, to a private purchaser, rather than placing such a bank into the Bank Insolvency Procedure. However, use of these transfer powers can pose risks to taxpayers given the potential need for the failing bank to be recapitalised (with that recapitalisation amount being similar to the concept of a shortfall amount in the context of determining the scope of a bail-in) or to cover other costs such as setting up the Bridge Bank or funding the acquisition. As smaller firms do not hold MREL above capital requirements (meaning there is no additional capital buffer to provide for a recapitalisation), HMT believes that it would currently be the only available source of funding.

To manage this risk to taxpayers’ funds, HMT proposes introducing a new mechanism that could be deployed alongside the exercise of the Bridge Bank and PSP transfer resolution powers. Similarly to the CMDI proposals which focussed on the use of Deposit Guarantee Scheme funds to facilitate the use of the asset transfer tool, the new proposed mechanism would allow the BoE to use FSCS funds to cover costs associated with a resolution. Such funds would be then recovered by the FSCS through an ex-post levy imposed on the banking sector (which may require certain changes to the current FSCS regime but would not necessarily result in lifting the current cap on the levy). The idea is that there would be no upfront increase of costs for the banking sector and the bank levy would be increased only after FSCS funds are used for a smaller bank resolution. In HMT’s view, these proposals mitigate risks to taxpayer funds in respect of the costs of small banks’ failures, by ensuring these costs are first met by the bank’s shareholders and certain creditors, and then as necessary by the wider banking sector.

The consultation paper includes key cost considerations of the proposals for the banking industry. It discusses potential use of any net proceeds of sale (e.g., after exit from a Bridge Bank) to set off future bank levies, as well as other potential solutions which have been considered such as the potential of imposing MREL requirements on smaller banks (which HMT believes would not be proportional and would prove difficult to implement due to a potential lack of demand for such instruments in the capital markets which would mean all MREL requirements would need to be met with further equity raises). In aggregate, HMT believes the FSCS proposals would be less costly for the banking sector.  

Implementation of the proposals in the consultation paper will require amendments to the Banking Act as well as to the PRA’s Depositor Protection Rulebook.  Separately, the PRA is due to conduct its regular review of the FSCS deposit limit by 2025.