Bank Failure

Financial institutions have an international orientation and facilitate cross-border transactions. The scope and nature of the financial industry therewith triggers different legal systems and thus regulatory arbitrage. Distinctions between jurisdictions can create severe challenges for stakeholders. As a response to regulatory violations and sanctions evasions, regulators can intervene for solvency and non-financial matters.

Ordinary bank failure occurs when a financial institution is unable to meet its obligations. A mismatch between assets and liabilities, or the funding of long term debt with short term obligations invites for a reset. This reset can be validated by a write down of a part of the bank’s assets, for example by the creation of a bad bank holding the non-performing or distressed assets. When violations conflict with the public interest, bank failure can lead to administration, resolution and closure. Closure often leads to dissolution where creditors participate in the losses of the bank.

Bank failure may lead to a partly write down of a claim. Deposit protection is capped to a predefined insured amount. Therefore, creditors need to realize the hazards of the financial institutions they choose to cooperate with prior to their engagement. In the unforeseen event of banking failure, all stakeholders should assess their potential by regaining appropriate advice. Since bank failure has connotations with corporate insolvency and liquidation procedures, unsecured claims are at risk.

Creditors who wish to secure their position can either secure their investment by contract via fixed or floating charges, or any other type of collateral. Not only banks have the position to negotiate securities over money they lend out, but also customers can also set additional requirements. These acts are only possible prior to banking failure, administration or resolution and should therefore be taken into consideration on an ex-ante basis.

Unexpected closure of a financial institution leads to uncertainty for stakeholders and creditors in particular. To avoid heavy losses, a thorough understanding of different procedures is evident. A combination of law and economics provides the appropriate route to positive results. From the very first moment of banking failure, creditors need to stay on top of developments not to miss relevant and important requirements for (partial) repayment.