5 Major Bank Failure Resolution Method

Major Bank Failure Resolution Techniques: Mitigating Risk and Protecting Depositors.

The stability of the financial system is crucial for a healthy economy. Bank failures can disrupt financial markets, erode consumer confidence, and have a cascading effect on businesses and individuals. 
To safeguard the financial system and minimize the impact on depositors, governments and financial regulators have developed various bank failure resolution techniques.
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Five major bank failure resolution methods employed by regulatory authorities worldwide:

1. Deposit Payoff:
2. Purchase and Assumption (P&A):
3. Bridge Bank:
4. Open Bank Assistance:
5. Whole Bank Resolution:

1. Deposit Payoff:

A deposit payoff is the most straightforward resolution technique. Here's how it works:

• Process: The regulatory body, like the Federal Deposit Insurance Corporation (FDIC) (https://www.fdic.gov/) in the United States, reimburses depositors for their insured accounts up to a designated limit.

• Impact: This method protects depositors to a certain extent, preventing bank runs and maintaining stability in the financial system. However, it can be disruptive for uninsured depositors and other creditors who may experience losses.

• Example: The FDIC used a deposit payoff to resolve the failure of Washington Mutual in 2008. Depositors with accounts under the insured limit ($250,000 per depositor in 2008) received full reimbursement, while uninsured depositors and other creditors faced losses.

2. Purchase and Assumption (P&A):

A P&A transaction involves finding a healthy bank to acquire the assets and liabilities (deposits) of the failing bank.Here's a breakdown:

• Process: The regulatory body negotiates the sale of the failing bank's assets and liabilities to another bank. This can be done in various ways, including a "good bank" purchase where the acquiring bank takes on only the performing assets and insured deposits, leaving the bad assets with the failing bank's estate.

• Impact: P&A transactions are preferred as they minimize disruption to depositors and maintain banking services in the affected community. However, the success hinges on finding a willing buyer and the financial health of the failing bank's assets.

• Example: The P&A approach was used in the resolution of Wachovia Bank in 2008. Wachovia's banking operations were acquired by Wells Fargo, ensuring continuity of service for depositors.

3. Bridge Bank:

The bridge bank technique involves creating a temporary institution to house the assets and insured deposits of the failing bank. Here's the process:

• Process: The regulatory body establishes a bridge bank, often with government funding, that takes over the insured deposits and some performing assets of the failing bank. The bridge bank then operates for a limited period until a P&A transaction can be arranged with a healthy bank.

• Impact: Bridge banks offer a temporary solution while a more permanent buyer is sought. This approach minimizes disruption and allows for a more thorough evaluation of the failing bank's assets before a sale.

• Example: The bridge bank strategy was employed during the resolution of IndyMac Bank in 2008. The FDIC established a bridge bank, IndyMac Federal Bank, which later became part of OneWest Bank.

4. Open Bank Assistance (OBA):

Open bank assistance involves providing emergency financial aid to a struggling but still operating bank. This aid can take various forms:

• Process: The regulatory body may provide short-term loans, liquidity guarantees, or capital injections to help the bank stabilize its finances and avoid failure. This can be a last resort before resorting to one of the other resolution techniques.

• Impact: OBA can be a less disruptive option compared to full-fledged bank failure resolution. However, it requires careful evaluation to ensure the struggling bank has a viable path to long-term recovery.

• Example: The European Central Bank (https://www.ecb.europa.eu/) used OBA to provide liquidity support to several European banks during the 2008 financial crisis. This helped stabilize the financial system and prevent a wider banking collapse.

5. Whole Bank Resolution:

A whole bank resolution involves selling the entire failing bank as a single entity. Here's what it entails:

• Process: The regulatory body attempts to sell the entirety of the failing bank, including its assets and liabilities, to another financial institution. This approach is less common than P&A transactions, as it may be difficult to find a buyer willing to take on all the risks associated with the failing bank.

• Impact: A whole bank resolution can be a quicker and more efficient solution compared to other methods.However, it carries the risk of potential job losses and disruption for the failing bank's employees.

• Example: The resolution of Landsbanki, an Icelandic bank, in 2008 involved a whole bank sale to a consortium of investors. While this approach prevented a complete shutdown, it did result in job losses and restructuring within the bank.

Choosing the Right Resolution Technique

The choice of bank failure resolution technique depends on several factors, including:

• Severity of the bank's financial problems
• Financial health of the bank's assets
• Availability of a willing buyer for a P&A transaction
• Potential for disruption to depositors and the financial system

The ultimate goal is to minimize the negative impact of the failure while protecting depositors and ensuring the continued functioning of the financial system.
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The Importance of Bank Failure Resolution Mechanisms

Effective bank failure resolution mechanisms are crucial for:

• Maintaining Financial Stability: By promptly resolving failing banks, regulatory bodies prevent contagion and safeguard the overall health of the financial system.

• Protecting Depositors: Deposit insurance programs, coupled with efficient resolution techniques, provide depositors with confidence that their money will be safe in case of a bank failure.

• Minimizing Economic Disruption: Swift and effective bank resolution techniques help to maintain credit flow and minimize the broader economic impact of a bank failure.

Conclusion

While bank failures can be disruptive events, the existence of robust resolution mechanisms plays a vital role in mitigating the risks and protecting depositors. Understanding these techniques empowers individuals and businesses to navigate the complexities of the financial system with greater confidence.

It's important to note that regulations and specific resolution techniques can vary depending on the country.