Banks in Crisis 2.0
Maple Bank GmbH’s insolvency has raised the opportunity to examine the relevant procedures triggered by credit institutions in crisis. Two questions that come to mind in this post-Lehman era are: what has been the effect of the transposition of the Banking Resolution and Recovery Directive (BRRD) which was transposed by the “Sanierungs- und Abwicklungsgesetz”(SAG), and furthermore, what has been the effect of the creation of the Single Resolution Mechanism?
Dr. Mathias Hanten | Head of Banking & Finance Deloitte Legal and Dr. Konstadinos Massuras | Partner Deloitte Legal
For banks which are not systemically relevant, almost everything has remained the same. This is at least, an indirect consequence of Section 67 of the SAG, which states systemic risk and use of tax dollars should be avoided in the case of a bank’s resolution.
Consequently, the German regulator “BaFin” tests the bank in question to determine systemic and tax payer risk. Only if and when these risks are substantial enough, the resolution instruments found in the SAG come into play. These instruments include bail-ins, transfers of assets, shares, liabilities, or modifying the legal relationships between the bank in question and third parties in order to recover and resolve the bank.
If however, there is neither systemic risk nor public funds at risk, BaFin has to refer to the national instruments and legal methods found in the German Banking Act (KWG). Where circumstances and positions are unclear, banks are often placed under a “moratorium”, pursuant to Section 46 of the KWG. To enforce a moratorium, the regulator must heed to the principle of proportionality, as found in German constitutional and administrative law. To establish which interlocutory measures can be used to face those dangers, BaFin usually applies a modified payment and sale prohibition, in order to protect the assets of the bank as long as the possibility to recover is under scrutiny.
The aim of the moratorium is to examine whether third parties will support the bank in question, or if a statement of compensation is required, pursuant to Section 10 of the Deposit Protection Act(EinSiG). Part 2 of Section 10 of EinSiG states that within 6 weeks, it must be confirmed whether or not compensation will be awarded. This deadline prevents a theoretical dead-end, which would be possible if an open-ended moratorium were possible.
In short, the moratorium should theoretically create a “timeout”. In practice however, sometimes it turns out that due to the prohibition of payments, open derivative positions cannot be closed, and contractual parties liquidate their collateral. Creditor measures during a moratorium are possible because of master agreements which include cross-default clauses, which from a creditor’s perspective, is the safest bet. However, these measures, e.g. such as the fire sale of collateral, often lead to losses, and for this reason, “timeouts” are less likely to occur under a moratorium.
Where a confirmation of compensation (Feststellung des Entschädigungsfalls) is required, it is worth noting that Section 10 of EinSiG resembles the confirmation of the inability to pay under Section 17 of the Insolvency Ordinance (InsO), as this confirmation requires BaFin to establish that the credit institution is both unable to repay due deposits, and that said institution does not have a realistic chance of doing so in the future.
The reasons for insolvency, over indebtedness and illiquidity, have not been regulated specifically for credit institutions. In the current Maple case, BaFin has deduced the credit institution is over indebted based on tax provisions the bank had to implement in their balance sheet.
However, it must be noted that the over indebtedness of a balance sheet is generally only a marker of possible over indebtedness in the scope of Section 19 of InsO. Over indebtedness occurs if existing assets of the credit institutions do not cover the existing liabilities.
Based on a positive prognoses this does not constitute a reason to apply for insolvency. By contrast, illiquidity occurs if the credit institution is unable to fulfil due payment obligations. A marginal threshold could be calculated if the complete liabilities stay below 10%, and because the credit institution will presumably not be able to pay their obligations, this will only constitute a threat of illiquidity. Therefore, there are two reasons for insolvency, over indebtedness, and illiquidity. The inability to pay triggers an obligatory application for insolvency, which in the case of credit institutions, is not an obligation of the managing directors, as they are only obligated to notify BaFin, as only BaFin can apply for insolvency on behalf of credit institutions.
However, in case of an insolvency application based on the threat of an inability to pay, the application must only be filed if the credit institution agrees. While for other creditors there are no deviations from the application of the insolvency ordinance, the compensation procedure for depositors shows a number of specifics. Where a credit institution is structured as a private legal entity, EdB GmbH is the responsible deposit guarantee scheme for the bank. This institution which is entrusted under Section 22, part 1 number 1 of EinSiG, compensates only up to 100,000 Euro.
If the credit institution participates in the privately run protection fund of German banks known as the Deposit Protection Fund of the Association of German Banks(ESF), this fund will currently compensate each creditor 20% of the credit institution’s equity under Art 72 of the CRR as outlined in Section 6 of their Articles of Association. The protective ceiling however will be gradually lowered to 15% by January 2020, and to 8.75% by January 2025.
According to Section 5, part 10 of the Articles of Association there is no legal claim to compensate. Though there is this caveat (which by the way has already been confirmed by rulings of German courts), the ESF has always compensated in every case in which pursuant to their view, compensation was justifiable. Even in cases where very large amounts were paid out, as in the case of Lehman Brothers Bankhaus AG, the ESF was able to compensate depositors. That time however, payment was based on a special contribution by the ESF’s participating banks, backed by a guarantee by the German Federal Agency for Market Stabilization (FSMA) which had to comply with State aid requirements.
The compensation procedure under the Articles of Association of the ESF, has two main aspects. Firstly, there must be a deposit subject to compensation, and a depositor who is entitled to be compensated. The ESF only compensates deposits which are correctly booked in a bank’s balance sheets as “liabilities towards clients” as defined in Section 21 part 2 of German Credit Institution Accounting Principles (RechKredV). Therefore liabilities towards credit institutions are not eligible for compensation. The same holds true for liabilities for which the bank has issued bearer bonds, as set out in Section 6 part 1 of the Articles of Association.
In the last few years, the insolvency quotas of credit institutions in Germany have been nearly 100%. It seems then, that either the appointed administrators are able to perform miracles, or otherwise, it must be asked if insolvency is really the appropriate resolution tool for credit institutions. A high insolvency quota may be based on a timely insolvency application, but it could also be based on a premature one.
Therefore it must be asked if there are more effective measures based on Section 46 of the KWG which could avoid insolvency. This holds true for a case like Maple Bank GmbH, where an over indebtedness is based on tax liabilities which are judicially contestable.
In short, the Maple Bank case does not lead to new insights with regard to the application of the new European SRM, but interestingly, it leads to insights with regard to the insolvency quota. If the insolvency quota reaches about 100% again, it must be asked if InsO is the right instrument to resolve non-systemically relevant credit institutions, or if it would be better to also apply the European recovery resolution mechanisms to smaller credit institutions.
This article has been published in the Börsen-Zeitung dated 27 Feburary 2016 on page 13. You may download the article by clicking on the download button on the lefthand side. Please note that the article published in the Börsenzeitung is in German language.