The 2023 Banking Turmoil: Implementation Lessons for Resolution Authorities

In the midst of banking crises, policymakers often find themselves grappling with the truth of the saying ‘once the toothpaste is out of the tube, it is awfully hard to get it back in’. Restoring confidence in financial systems and containing the repercussions of financial instability prove to be daunting challenges.

The 2023 banking turmoil in the U.S. and Switzerland seemed poised to reinforce this lesson. Although authorities managed by and large to contain the most negative consequences, some reflections on the effectiveness of the post Global Financial Crisis prudential frameworks were produced and implementation issues in bank crisis management regimes were identified.

In a recent SRB Working Paper, we delve into the EU's crisis management framework, examining the implementation lessons that the banking turmoil of 2023 in the U.S. and Switzerland can offer to EU resolution authorities. The paper also explores potential regulatory and implementation changes to enhance the framework's effectiveness in managing banking crises in the European Union. In particular, we focus on three different aspects:

1. Bank runs, deposit insurance and resolution

The 2023 banking turmoil, and especially the SVB case, highlighted the vulnerability of banks to accelerated deposit runs, exacerbated by digital connections and large uninsured deposits. Given the relevance of deposits in bank business model—that is, their contribution to the bank franchise value—ensuring deposit stability is critical for safeguarding financial stability: an effective Deposit Guarantee Scheme (DGS), capable of curbing depositors’ incentives to run, is thus all the more needed in this respect.

Currently, reform proposals on the different ways to prevent bank runs and ensure financial stability are being discussed. These include considerations on the increase of the deposit insurance coverage for all or some categories of depositors (so-called targeted coverage) as well as a higher reliance on access to central bank liquidity by means of collateral pre-positioning. 

In Europe, increasing coverage might not significantly enhance financial stability: despite their very low number, uncovered depositors hold more than half of EEA deposits, so that even by raising the current coverage level (EUR 100,000) to EUR 1,000,000 would not represent a fundamental change, and risk of run behaviour would not be neutralised. Rather than increasing the coverage level, we recommend a closer supervisory monitoring of banks characterized by an excessive reliance on uninsured deposits. Concentration requirements in relation to uncovered deposits could also be considered.

Finally, we consider that deposit insurance schemes should play a more decisive role in funding resolution processes in Europe, similarly to the resolution model in the United States. However, DGS intervention in resolution is severely constrained by two factors: a) the absence of an EU-wide deposit insurance scheme (so called EDIS); b) the super-priority enjoyed by national DGSs in the creditors’ hierarchy, which prevents the satisfaction of the least-cost-test (DGS can intervene only if it would suffer greater losses in a liquidation procedure). In this respect, we consider that the Crisis Management and Deposit Insurance (CMDI) proposal of the European Commission would bring a substantial improvement to the EU crisis management framework, facilitating the use of DGSs as financial bridges in resolution.

2.  Optionality and flexibility in the use of resolution tools

The US, UK and Swiss authorities displayed flexibility in their resolution approaches. In the US, the FDIC relied on their traditional Purchase & Assumption (P&A) approach to quickly transfer the failing banks, avoiding widespread contagion among regional banks. As expected, shareholders and senior creditors were written down, avoiding moral hazard and promoting accountability. While the protection of unsecured depositors—via the systemic risk exception—increased resolution costs, the additional expenses will be recovered from the banking sector, in alignment with the general resolution principle according to which banks should pay for their resolvability.

In the UK, the SVB subsidiary was earmarked for liquidation because it was deemed to have no critical functions and no impact on financial stability in case of insolvency. However, the Bank of England changed its strategy in the face of potential disruption to the fintech sector, and finally decided to sell SVB UK to a larger bank. In Switzerland, the merger between Credit Suisse and UBS took place outside of resolution. However, according to the Swiss resolution authority, the resolution framework offered a viable and alternative option. Although this option was not eventually pursued, the Swiss crisis-management toolbox would have been poorer without resolution.

Optionality therefore remains key to successful crisis management. In the Banking Union, resolution planning for large banks has been largely based on the open bank bail-in (OBBI) approach. Since in most cases resolution authorities may find it difficult to find a purchaser for large and complex banks at short notice, the OBBI has been the preferred tool for the majority of resolution plans. However, there is also a need to further work on transfer tools, either in combination or as alternative to the OBBI, according to the scenario and type of bank.

3. Role of public liquidity backstop mechanisms in restoring market confidence during and after resolution:

​​​​​​​Recent events have underscored the necessity of promptly making liquidity available to firms both during and after resolution, in order to swiftly restore confidence in the resolved bank. At the international level, discussions are ongoing about the design features (size, duration, collateral, etc.) of such mechanisms and whether the absence of an adequate and explicit public liquidity backstop arrangement could undermine the credibility of resolution processes.

In this context, the diverse features of public temporary liquidity backstop mechanisms across different jurisdictions play a crucial role in ensuring their credibility and effectiveness. From an individual perspective, these mechanisms help meet and accommodate the funding needs of solvent firms facing temporary liquidity pressures. From a systemic perspective, they contribute to the stability of the broader financial sector. For instance, the frameworks in the US and Switzerland have been flexible enough to tailor the public liquidity backstop features to the specific needs that arose during periods of turmoil.

The Banking Union framework benefits from a Single Resolution Fund managed by the SRB, and a Common Backstop provided by the European Stability Mechanism, as soon as the latter is ratified. There is however a shortcoming in tail scenarios. For example, the failure of a large and complex bank requiring funding needs similar to those employed for Credit Suisse. 

Our work evaluates various proposals to address this issue at the Banking Union level. We conclude that a public funding backstop in the form of a guarantee, underpinned by the EU budget, would represent a robust and effective European solution. Specifically, this public guarantee could be provided by the European Commission and backed by the EU budget. Such an effective public and temporary liquidity backstop would align the Banking Union with the regimes in the US and the UK, thereby enhancing the credibility and effectiveness of the EU resolution framework.

The SRB Working Paper can be accessed here.

Niccolò Cirillo is a Policy Expert at the Single Resolution Board.

Francesco Pennesi is a Policy Expert at the Single Resolution Board.

Sebastiano Laviola is Central Director at Banca d'Italia and, at the time of writing of the paper, was a SRB Board Member responsible for Resolution Strategy and Cooperation.