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NATASHA AHMETAJ: RECOVERY AND RESOLUTION PLANNING FOR THE BANKING SECTOR

Opening remarks by Ms Natasha Ahmetaj, Second Deputy Governor of the Bank of
Albania, at the Regional Conference on Recovery and Resolution Planning, Tirana,
15 November 2018.

The views expressed in this speech are those of the speaker and not the view of
the BIS.

Central bank speech  | 
22 November 2018
by Natasha Ahmetaj
PDF full text
(44kb)
 |  5 pages

Dear ladies and gentlemen,

Welcome to this regional conference organized by the Bank of Albania in
cooperation with FinSAC, a valued partner in our path towards development.

The financial crisis of 2008 remains the starting point of a number of
discussions, as many of our present efforts originate from this period. The 2008
crisis was a tough test for the capability of a state to manage national and
cross-border crises. This test became even more relevant for its global
capability, if we take into account that the crisis originated in advanced
economies, but spilled over into emerging markets and developing economies.

In order to safeguard core financial services for their citizens and firms,
governments were forced to use public funds, by injecting money and issuing
guarantees for distressed financial institutions at unprecedented levels. From
October 2008 to October 2011, the European Commission approved EUR 4.5 billion
from public funds to support financial institutions. Naturally, this support
helped to curb, at least in the short-term, a massive bankruptcy of banks and
the collapse of the real economy. On the other hand, it burdened taxpayers with
deteriorated public finances. This forced situation strengthened the need to
reflect on the protection of the taxpayers and public finances in times of
crisis, without sacrificing the prevalence of public interest. Such reflection
served to promote discussion on the adequacy of financial markets’ regulation to
withstand crises. Two important shortfalls in the regulatory framework were
identified.

First, the banking legislation established clear rules for the orderly entry of
new participants in the market but did not define the mandatory requirements for
an orderly exit for the troubled market participants. Now in the post-crisis
period, almost everyone agrees that, in the absence of a resolution regime, in
order for a smooth and orderly exit of problematic banks, governments were
forced to use public funds. Second, as a result of the high level of financial
integration internal shocks in a given country were transmitted across borders
to other countries, transforming them into a global issue.

The post-crisis analysis motivated the European Union to assess issues related
to banks’ recovery and resolution, and consider strengthening the existing
cross-border cooperation, to reflect better the actual integration of financial
markets. Today, the banking union in Europe has introduced harmonized rules
about resolution throughout the European Union, and a unified application for
the euro area. More specifically, the legislation of the European Union has
activated the European Bank Recovery and Resolution Directive (BRRD) for all
member countries and has established the Single Resolution Mechanism (SRM) in
the euro area, as well.

The BRRD creates such instruments for a preventive recovery and early
intervention in a bank, designed to avoid the failure of a bank, as well as
facilitate an orderly resolution when banks are failing, to protect the public
interest. The new Law replaces the standard insolvency proceedings of a bank
with the resolution undertaken by the relevant authority. Banks’ failures and
financial crises may be common events. They are very costly, as well, which, in
some cases, can be as high as 40–60% of the Gross Domestic Product. This
includes losses in deposits, weakening of access to finance and loss of public
confidence in the financial system, which, in turn, reduces its capacity to
support economic growth and decrease poverty. Also, standard insolvency
proceedings for failing banks proved inadequate in times of crisis because they
did not address systemic risk nor ensured the continuity of critical functions;
moreover, they did not protect depositors. These procedures require time, long
negotiations as well as complex arrangements with creditors, which may damage
and further diminish the asset value of the distressed bank, hence causing
severe consequences for the real economy.

For this purpose, the new Recovery and Resolution Law provides the Supervisory
and Resolution Authorities with the legal capacity and the necessary instruments
for restructuring bank operations, in the event its possible failure jeopardizes
financial stability or undermines other objectives of the regulator. The aim is
clear: on the one hand, we have the public interest on financial stability,
while, on the other hand, remain the shareholders of the bank, who have
voluntarily undertaken the risk by investing in the bank. If the shareholders
rely on the possibility of an implied state guarantee for banks, this
constitutes a moral hazard on their part, therefore increasing their risk
appetite. The implementation of the Resolution Law formally eliminates the basis
for the expectation for any such guarantee.

Among the costs caused by the failure of a bank, contagion is probably the
highest, since it turns the problem of a single bank into a problem for the
entire banking sector. It may happen for two reasons: due to the spillover
effect of a bank’s exposure towards another, as well as due to public panic,
that causes eventual massive bank runs. This channel is particularly pronounced
for developing economies, where contagion is faster due to their weak financial
literacy, the historical lack of bank failures, and the presence of weaker
institutions. In this context, the resolution regime serves as a tool for
restoring market discipline and avoiding the risk of contagion. In essence,
resolution is an integral part of banking supervision applied to the final stage
of a bank’s life, should measures taken during the standard or intensive
supervision stages fail to improve the situation of a distressed bank.

The drafting of the resolution regime was accompanied by the strengthening of
the supervision regulatory requirements, which aim to increase the resilience of
the bank and strengthen the financial market structure to avoid the moral
hazard. In the wake of the crisis, experts have reached the conclusion that
there is no bank model that would perform well or poorly in times of crisis.
Different models of failing banks showed that the issue stemmed from undertaking
high risk, financing with short-term instruments and insufficient protection
offered by capital, even where minimum requirements were met. This conclusion
has been reflected in higher supervisory requirements for quantity and quality
of capital and liquidity, limits on the leverage ratio and maturity mismatch
between assets and liabilities. The banking sector needs to comply with these
requirements within a defined medium-term framework.

Regulatory measures are also accompanied by the consensus on the need for
structural reforms in the financial system, namely, separation of risk-bearing
financial speculation activities from deposit collection activities, and issues
related with too big to fail banks, by discouraging their excessive growth. The
biggest lesson of the financial crisis was that micro-prudential supervision of
banks was not sufficient to safeguard financial stability because the system as
a whole behaves differently from individual parts. In an effort to make
themselves safer, financial institutions may undertake such behaviours that
collectively damage financial stability. The banking activity takes place
through its own cycles, known as financial cycles, which may deteriorate the
business cycle of the real economy. Banks are exposed to collective
macroeconomic shocks, which weaken them, at the same time, thus affecting
financial stability. The understanding of this lesson dictated the need for
macro-prudential supervision in addition to the micro-prudential one. Among the
most effective instruments of macro-prudential supervision are the requirements
for capital buffers to counter the creation of systemic imbalances, as well as
capital buffers for systemic banks, which being large enough, may cause social
costs beyond their individual dimension. Through this new capital composition,
the macro-prudential instruments manage the systemic risk before it
materializes, decreasing the probability of occurrence and, after its
materialization, minimizing losses that are absorbed by the higher level of
capital.

But still a lot of work remains to be done.

It has long been recognized that a deeper financial integration also brings a
better functioning of the European Union. Yet, financial integration showed to
be shallow and reversible and, after the financial crisis, fragmentation
increased against centralization and integration. The measures undertaken to
reduce liquidity within each country improved the national financial stability,
but neglected the effect on other countries. The banking union addressed these
inadequacies by concentrating the national financial policies at the central
level and aiming to fulfil two objectives: to ensure banks’ soundness and
promote a deeper integration of the banking sector.

The Single Supervisory Mechanism plays an important role in these objectives. A
stronger and more uniform supervision enhances banks’ stability and provides
them with a more coherent framework of policies on cross-border banking,
producing benefits compared with the fragmented system of national supervision.
As Mario Draghi says: “Let’s keep in mind that fragmentation starts with the
decision by banks not to operate in regions where the risk-return of lending is
judged to be insufficient to remunerate their invested capital”.

Supervisors’ advice for banks in the post-crisis period remain the same: banks
should adapt the business model to be more effective and profitable, improve
risk management and manage the cleaning of the balance sheet from legacy assets.
Despite the progress made, these tasks are yet to be completed and now is the
most appropriate time to finalize them. The regulatory framework is clearer and
more complete (the implementation of Basel III is starting), supervision is
clearer in terms of methodologies and policies, and the application of FinTech
allows banks for new ways to do business efficiently. Lastly, and more
importantly, the overall macroeconomic framework is stabilised and the positive
economic growth is stable.

The framework presented above is a good guideline to address the remaining
post-crisis challenges. Is the adoption of international standards on financial
stability safeguarding necessary? The answer is yes, because the globalization
and interconnection of the banking sector needs the standardization of
prudential regulation. However, while adopting international standards, it is
important to keep in mind two issues: First, these standards have to adapt to
the development level of the country and calibrated according to domestic
conditions. Second, international standards pose a minimum of requirements,
leaving it at the discretion of individual countries to undertake more stringent
requirements.

The model of global integration is the economic model that has been adopted by
most of the transition countries, such as Albania. Under this guidance, the
Albanian banking market has demonstrated clear willingness and objectives for a
swift harmonization with the legal framework of the European Union’s banking
system, as well as with its significant changes since 2008. Although there are
no cases of bank failures in the history of the Albanian banking sector, we have
identified in our banking legislation the same loopholes found in other European
economies. The development of hypothetical scenarios for coping with a potential
exposure of the Albanian economy to the Greek sovereign debt crisis evidenced
that the Bank of Albania – as the supervisory authority of the banking sector –
did not have all the necessary legal instruments to manage insolvency situations
in systemically-important banks. This need for a new legal framework is
addressed in both national and cross-border aspects, by the Bank Recovery and
Resolution Directive. In fact, the initial efforts to prepare and present the
first recovery plan to the Bank of Albania started in 2012. The relevant
Regulation was approved by the Supervisory Council of the Bank of Albania in
2014. But, of course, these efforts were made within the supervisory legal
authority and, as such, they were not sufficient. For this reason, during 2015,
with the support of World Bank’s FinSAC project, the Bank of Albania started the
difficult but necessary work of harmonizing the European Directive into a new
Albanian law.

The Law ‘'On the recovery and resolution of banks in the Republic of Albania'’
entered into force in July 2017, vesting the Bank of Albania with a new
attribute, i.e. the Resolution Authority. This attribute completes the financial
security mechanism of the banking sector, with the Bank of Albania responsible
for regulating and supervising the banking sector, drafting macro-prudential
policies, performing the function of the lender of last resort as well as the
implementation of banks’ resolution. Together with the deposit insurance scheme
provided by the Deposit Insurance Agency since 2002, the financial safety net
framework in Albania is complete. For the purposes of this Law, the Resolution
Fund was created with contributions from the banking sector. This Fund aims to
reach ALL 6.3 billion within 2027.

The implementation of the Albanian recovery and resolution Law consists in three
important steps:           

The first step is the drafting of recovery plans by each bank operating in
Albania, with reliable and concrete scenarios, as well as defining the
indicators that signal the deterioration of the financial situation of a bank
before it becomes irreversible. When drafting recovery plans, the bank should
create credible options to withstand stress scenarios, constructing mechanisms
that are part of the daily management of the banking business and that do not
remain just part of a hypothetical plan. Although drafting recovery plans is the
task of individual banks, the Bank of Albania, in its capacity as the
Supervisory Authority, plays an essential role in assessing the quality and
reliability of these plans.

During 2018, banks have prepared recovery plans based on a new bylaw adopted by
the Bank of Albania that sets out their detailed content. The opening panel of
this Conference will present concretely our assessment of these plans. In brief,
we may say that our challenges remain the same as those faced by other
supervisory authorities, whether in European or regional countries. In sound
financial situations, such recovery planning allows the Bank of Albania to
deeply understand the structure and activity of the bank, thus supporting our
supervisory process to identify areas for improvement, as well as bank’s
self-diagnosis in these areas. In stressed financial situations, the recovery
plan is the main document the bank has to correct its difficulties and, as such,
it must be efficient, applicable and comprehensive.

The second step of the new crisis management framework is related with the early
intervention in the bank. This step is activated if, after the implementation of
the recovery plans, the bank’s actions fail to improve the situation. The Bank
of Albania, in the capacity of the Supervisory Authority, undertakes several
concrete early intervention measures in the bank, before the bank shows signs of
insolvency. Currently, we are in the process of drafting bylaws for the early
intervention implementation in accordance with the new legal requirements.

The third step is the resolution of banks, applied by the Bank of Albania in
view of the new mandate. Similar to recovery plans, the resolution plans drafted
by the Bank of Albania aim to identify the legal and structural obstacles and
difficulties with financial resources that banks face, toward resolvability. In
this regard, the resolution plans are one of the key instruments to facilitate
the Bank of Albania’s resolution implementation.

This year in April, the Bank of Albania approved a bylaw that defines the
content of resolution plans. Then banks were required to report a broad set of
data for drafting these plans, based on the model of the European Banking
Authority and we are currently in the process of drafting them. The drafting of
the banks resolution plans is complicated, which includes complex and
cross-border issues that must be implemented and coordinated within a short
period of time. Hence, the resolution planning is an on-going process and a
long-term mission to remove obstacles against the possibility for resolution
action in banks. This planning does not mean drafting an annual plan that is
stored somewhere in some shelf and it is dusted off only when its implementation
is necessary; instead, it is the beginning of a long process of restructuring
all aspects of the banking business that may hinder this process. Our point of
view is that this process belongs equally to the Bank of Albania as the
Resolution Authority and to the banks, which must include its results into their
daily business.

During the first cycle of this work in 2018, we have highlighted a number of
issues that require particular attention in planning, as well as in their
following up by the banks:

 * The Bank of Albania must have access to qualitative data produced by banks,
   in order to select the appropriate resolution strategy.

 * The exact identification of the bank’s operational system interconnected with
   the critical functions is important.

 * The proper understanding of contractual agreements and their respective
   treatment is imperative, and, in particular

 * The provision of resolution funding sources constitutes a challenge.

Complying with the Minimum Requirement for Own funds and Eligible Liabilities
(MREL), which underpins the application of the new essential resolution
instrument, the bail-in instrument, remain the key challenge for the medium-term
period. Complying with MREL is a challenge for countries like Albania, due to
the capacity of the domestic market to absorb (acquire and maintain) the
subordinate debt that may serve to fulfil the Minimum Requirement as well as due
to the capacity of the banks to restructure funding resources, which currently
consist largely of deposits. Consequently, to fulfil this obligation an interim
period should be designed, without prejudice, in any case, to the main objective
of resolution implementation.

Finally, resolution is quite a challenging process for emerging and advanced
economies. The banking sector in the Balkans is dominated by foreign-owned
banks. In Albania, subsidiaries of foreign banks account for around 78% of
banking sector assets, while those from European countries account for 48%. The
Bank of Albania is the Resolution Authority for seven subsidiaries of EU based
banking groups, of which four are classified as systemically important under the
mandate of the Single Resolution Board (SRB). Due to this, the signing of
cooperation agreements between the resolution authorities of the banking group
and the local authorities where the subsidiary operates is very important for
coordinating actions, exchanging data for planning and implementing the
resolution, and coordinating crisis management. I have the pleasure to share
with you the news that the Bank of Albania has signed an important cooperation
agreement with the Single Resolution Board, i.e., the Resolution Authority of
the Banking Union, on 3 October 2018.

Dear ladies and gentlemen,

This Conference is the culmination of our work over the past 18 months for
developing a complete framework for bank recovery and resolution. For this
reason, the presence of colleagues from supervisory and resolution authorities
from various entities assumes special importance. We have representatives from
the European Union at the central level, from individual countries of the
European Union and representatives from countries of the region, national and
foreign bankers as well as the representatives of the media. This presence means
sharing experiences and opportunity to evaluate what has been done.

I am confident that today, among other things, we will also build new bridges to
coordinate our efforts for a sustainable financial system, within and beyond
geographical boundaries.

About the author
Natasha Ahmetaj
More from this author



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