Bank Resolution Fund

A bank resolution fund is a pool of money that a bank resolution authority can draw on to make the resolution of a failing bank work, for example by guaranteeing a bridge bank's obligations, lending to the bank during restructuring or covering losses after shareholders and creditors have been written down. The fund is financed mainly by the banking industry rather than taxpayers. The best-known example is the Single Resolution Fund (SRF) of the European Union's banking union.

A resolution fund is different from a deposit insurance fund. The Deposit Insurance Fund in the United States, or a European deposit guarantee scheme, exists to repay insured depositors; a resolution fund exists to finance the tools used to keep a bank's critical functions running. The two may interact, and in some countries one body runs both. How a failure would be handled is set out in advance through banking resolution planning.

Picture a group of building owners who pay into a joint emergency fund. If one building is badly damaged, the fund pays for scaffolding and temporary repairs so that the tenants can stay while the owner's insurers and lenders sort out the bigger bill.

A resolution fund does that for banks. The banks pay in during good times. When one fails, the authority can use the money to keep payments and deposits working while the bank is restructured, sold or closed, so that the bill does not land on the government.

The SRF was created by the Single Resolution Mechanism Regulation of 2014 and is managed by the Single Resolution Board. It was built up over eight years from 2016 through annual contributions from banks and certain investment firms in the banking union, with a target of at least 1 per cent of covered deposits in participating member states by the end of 2023. The SRB announced that the target had been reached, giving the fund roughly 80 billion euros. Contributions are calculated on each bank's liabilities, excluding own funds and covered deposits, adjusted for its risk profile. The fund began with national compartments that were gradually merged and is now fully mutualised.

EU member states outside the banking union keep their own national resolution financing arrangements under the Bank Recovery and Resolution Directive, with a similar target of 1 per cent of covered deposits.

• Guarantees and loans. Guaranteeing assets or liabilities of the bank in resolution or of a bridge institution, or lending to them.
• Asset purchases. Buying assets from the failing bank to support a sale or transfer.
• Compensation. Paying shareholders or creditors who would have done better in normal insolvency, under the "no creditor worse off" safeguard.
• Loss absorption. Contributing to absorb losses or recapitalise the bank in place of some creditors, but only after a large bail-in.

The last use is tightly limited. Under EU rules, the fund may contribute only after shareholders and creditors have absorbed losses equal to at least 8 per cent of the bank's total liabilities including own funds, and the contribution is generally capped at 5 per cent of those liabilities. The aim is to prevent the fund from becoming a substitute for a bail-out.

A resolution fund may be too small for a large crisis, so a public backstop is often planned. Euro area governments agreed to amend the European Stability Mechanism treaty so that the ESM could lend to the SRF as a common backstop, but the amendment has not entered into force because Italy has not ratified it. In the United States, Title II of the Dodd-Frank Act created an Orderly Liquidation Fund at the Treasury for resolving systemically important financial companies; it is not prefunded, and any borrowing must be repaid from the failed firm's assets and, if needed, assessments on large financial companies. In the United Kingdom, recent legislation allows the Bank of England to draw on money raised from the industry through the Financial Services Compensation Scheme to help recapitalise a failing smaller bank during resolution.

Critics argue that even 80 billion euros would be small compared with the balance sheets of the largest European banks, so the fund cannot by itself guarantee an orderly resolution of a major bank, and that the lack of a common liquidity facility for banks in resolution remains a gap. Others say the strict conditions on its use mean it will rarely be tapped, while banks complain that annual contributions added to their costs for years. Supporters reply that the fund's main purpose is credibility: by showing that money exists to support resolution, it reduces moral hazard and the expectation that governments will step in. It has so far been little used; the first SRB resolution, of Banco Popular in 2017, relied on a sale and write-downs rather than the fund.

• Single Resolution Board