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Tackling the "too big to fail" problem

Industry regulators are forcing banks to consider structural reform through recovery and resolution, separation of activities and capital adequacy.

Overview

In a drive to solve the “too big to fail” problem, industry regulators are forcing banks to consider structural reform—including recovery and resolution, separation of activities and capital adequacy.

Recent resolution reforms have given unprecedented new powers to both UK and EU regulators. Banks are expected to work with regulators to identify a suitable resolution strategy and demonstrate that the structure of their business facilitates it.

In the United Kingdom, regulators are focused on enabling bail-in and ensuring operational continuity, and they require banks to adopt either a single point of entry (SPE) or multiple point of entry (MPE) funding structure. Alongside resolution, UK regulators are also planning to force a ring-fence to separate systemically important banking activities.

In the European Union, regulators are requiring banks to produce two plans—a recovery plan and a resolution plan.

As banks consider the best way forward, two facts are clear. One is that every firm has a different starting point and a different strategy—and will therefore need to consider the impact of the regulation in the context of its circumstances and ambition. The other is that banks will need to build new capabilities. The required transformation effort will demand new skills and functionalities at scale, which banks may not currently have within their organizations.

Background

As authorities and regulators grapple with how to solve the “too big to fail” problem, banks are facing changing regulatory requirements, increased revenue and cost pressures, and an evolving and increasingly competitive banking landscape. Against this background, banks will have to make a significant investment in restructuring their organizations—something that is no longer a choice, but an imperative.

Accenture believes that this period will drastically reshape the global banking environment and generate major opportunities for banks that get it right. But first they must address three interlocking but distinct components of structural reform:

  • Recovery and resolution

  • Separation of activities

  • Capital adequacy

This report focuses on recovery and resolution.

Analysis

UK regulators have requested that each systemically important bank provide information on their capital, legal, governance and operating model structures in order to establish a preferred resolution strategy, with a focus on enabling bail-in and ensuring operational continuity. To enable bail-in, regulators will require banks to adopt one of two funding structures:

  • Single Point of Entry. All losses are absorbed by the parent holding company.

  • Multiple Point of Entry. Losses are absorbed by individual subsidiaries.

The Bank Recovery and Resolution Directive (BRRD) is intended to act as a consolidated European approach to resolution. Although there is expected to be a high degree of alignment between the BRRD and the UK resolution guidelines, understanding the relationship between UK and EU regulations will be critical for banks as BRRD law will need to be transposed into UK law. The BRRD requires banks to produce two plans:

  • Recovery plan. This plan should present a set of measures demonstrating how management would respond to a serious deterioration of a bank’s financial situation and identify a number of triggers to implement the plan.

  • Resolution plan. This plan should detail how the series of tools outlined in the BRRD could be used—singularly or in conjunction—to achieve resolution.

Alongside resolution, UK regulators are planning to force a ring-fence to separate systemically important activities. Each bank’s ring-fence is likely to have a different perimeter depending on its business model and strategy, while height will be more consistent across the “Big Five” banks.

Recommendations

The regulatory pressures faced by banks today are coinciding with the need to reduce costs, optimize the business and respond to a fast-changing competitive landscape. This combination of forces is driving banks into new territory, leaving them with no choice but to fundamentally restructure their business.

As banks consider the best way forward, two facts are clear. One is that every firm has a different starting point and a different strategy—and will therefore need to consider the impact of the regulation in the context of its circumstances and ambition. The other is that banks will need to build new capabilities. The required transformation effort will demand new skills and functionalities at scale, which banks may not currently have within their organizations.

In addition to the above—timing is key. The global banking industry is currently in a period where the various regulations are evolving and being finalized. This means there is a short window of opportunity to influence the regulation and support the legislative agenda for the benefit of all industry stakeholders. Banks are now actively engaged in the journey of regulatory engagement and have the opportunity not just to reshape their organizations, but also to help the regulators understand their specific challenges.

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Strategy