Recovery Planning

Recovery planning is the preparation by a financial institution of a plan setting out how it would restore its financial position if it came under severe stress. The plan identifies warning signs, lists the measures available to rebuild capital and liquidity, and describes who would decide what and when. It is written and owned by the firm itself and assumes that no extraordinary public financial support will be available. Supervisors review it and can require improvements.

Recovery plans became a regulatory requirement after the financial crisis of 2007 to 2009, when many large banks proved unable to stabilise themselves and governments had to step in. They are one half of what is informally called a living will. The other half is resolution planning, which is carried out by the authorities and deals with what happens if recovery fails and the firm must be restructured or wound down.

The international standard is the Financial Stability Board's Key Attributes of Effective Resolution Regimes, first published in 2011, which calls for recovery and resolution plans for systemically important institutions. In the European Union, the Bank Recovery and Resolution Directive requires every bank and large investment firm to maintain a recovery plan, with simplified obligations for smaller firms, and the United Kingdom has kept equivalent rules. In the United States, the banking agencies have issued recovery planning requirements or guidance for the largest banks. The approach has been extended to central counterparties and, in a growing number of jurisdictions, to insurers.

Although formats differ, supervisors expect the same core elements:

• Indicators. A set of quantitative and qualitative measures covering capital, liquidity, profitability, asset quality and market conditions, each with thresholds that prompt escalation. Examples are the Common Equity Tier 1 ratio and the liquidity coverage ratio.
• Recovery options. The actions the firm could take, such as raising equity, cutting dividends and bonuses, selling businesses or portfolios, reducing lending, and accessing central bank facilities, with an estimate of how much each would raise, how long it would take and what might prevent it.
• Scenario testing. An assessment of whether the options would be sufficient in a range of severe scenarios, including a shock specific to the firm, a market-wide shock and a combination of both.
• Governance. How the plan is developed, approved by the board, integrated with risk management and invoked, including the escalation process when an indicator is breached.
• Communication. How the firm would inform supervisors, staff, investors, customers and the media.

The plan also describes the firm's structure, its critical functions and core business lines, and the interdependencies between group entities, so that the effect of each option on the rest of the group can be judged.

Recovery planning sits on a continuum. Ordinary capital and liquidity planning, including the contingency funding plan and liquidity stress testing, deals with moderate stress. The recovery plan covers more extreme conditions in which the firm's viability is in doubt but it remains under the control of its own management. Resolution begins when the authorities determine that the firm is failing or likely to fail.

The indicators are expected to be consistent with the firm's risk appetite statement and positioned so that the plan is triggered after normal limits are breached but well before minimum requirements. Breaching an indicator does not automatically launch any action; it obliges management to consider whether to act and to inform the supervisor. Supervisors themselves have early intervention powers, which allow them to require a firm to carry out measures from its plan.

Plans are generally updated at least annually and after any significant change to the firm's structure or business. The supervisor assesses whether the plan is complete, whether the options are credible and could be carried out quickly, and whether together they give enough overall recovery capacity. Where it finds material deficiencies, it can require the plan to be revised and, if necessary, direct the firm to reduce its risk profile, change its funding strategy or alter its structure.

Authorities have increasingly asked firms to test plans in practice through simulation exercises, sometimes called dry runs or fire drills, in which senior management works through a scenario.

Reviews by supervisors have repeatedly found weaknesses: recovery capacity overstated because several options depend on the same buyers or markets, optimistic timelines for disposals, indicators calibrated too late to give useful warning, and plans treated as a compliance document with little involvement from the business.

The bank failures of 2023 raised a further concern, which is speed. Deposit outflows driven by digital banking and social media occurred within days or hours, leaving little time to execute measures that take weeks. Supervisors have since emphasised liquidity options that can be used immediately, such as assets positioned in advance at the central bank, and the operational readiness to use them. Requirements for loss-absorbing resources, including the minimum requirement for own funds and eligible liabilities, belong to the resolution side of the framework. Oversight of the plan normally rests with the board risk committee, and the plan draws on the bank funding plan.

• Financial Stability Board
• European Banking Authority