VoxEU Column Financial Regulation and Banking

Winners and losers in bank resolution: Recent examples and a modest reform proposal

16 Sep 2024

In response to the 2023 banking crises in the US and Europe, the relevant authorities intervened to prevent contagion and distressed banks were sold at seemingly deflated prices. This column identifies three primary factors contributing to elevated profits in distressed bank mergers, particularly in Europe – the absence of a robust backstop, ineffective use of the bail-in tool in loss allocation, and lack of competition among bidders during the sale of distressed bank assets – and provides concrete policy recommendations to address these. In the longer term, the European resolution framework and deposit guarantee system need to be transformed along the lines of the FDIC.

Authors

Benoît Coeuré

Harry Huizinga

Elke König

Jan-Pieter Krahnen

Jonas Schlegel

In the spring of 2023, banks such as Silicon Valley Bank (SVB) in the US and Credit Suisse in Switzerland experienced significant deposit outflows, leading to their failure and acquisition by other banks. These deals resulted in significant losses for shareholders, bondholders, and the Federal Deposit Insurance Corporation (FDIC), with costs passed on to the broader US banking system, and risks for Swiss taxpayers.

While the owners and creditors of the failed banks suffered heavy losses, the owners of the acquiring banks appear to have made significant gains instead. In an article published in June 2023 entitled “The $44bn bailout bonanza”, the Financial Times referred to these resolution cases as “deals of a century” for the four acquirers. This raises the question of whether the profits made by the acquiring banks were excessive.

Are profits for acquirers in resolution excessive?

In a new CEPR Policy Insight (Coeuré et al. 2024), we take a renewed look at the profit calculations for the US and Swiss resolution cases in the 2023 banking crisis, based on two papers, Bertay and Huizinga (2023) and Heider et al. (2023), that were both commissioned by the European Parliament’s Committee on Economic and Monetary Affairs (ECON).

Policy insights

Policy Insight 134: Winners and losers in bank resolution: Recent examples and a modest reform proposal

Accounting-based as well as market-based approaches to measure profits reveal striking gains for acquirers such as First Citizens Bank, New York Community Bank, JP Morgan, and UBS. The analysis shows that these banks not only realised significant immediate accounting gains but also enjoyed considerable positive cumulative abnormal returns (CAR) in the short term.

For instance, First Citizens Bank's acquisition of SVB yielded a CAR of 68.7%, far surpassing rival bidders (e.g. PNC Bank and Citizens Bank, a subsidiary of Citizens Financial Group CFG) and the US bank benchmark index KBW Nasdaq Bank Index.

Figure 1 Abnormal returns for First Citizen Bank, the acquirer of SVB

Source: Yahoo, based on Heider et al. (2023, Figure 3)

These results indicate that acquirers have benefited immensely from potentially undervalued sales of distressed banks. Historical European cases show results in line with the findings for the 2023 cases leaving no doubt that significant gains for the acquirers are the norm.

The costs of resolution and resolution policies

First and foremost, minimising resolution costs is not the primary objective of resolution authorities; instead, their main goals are to preserve financial stability and protect taxpayers. Resolution authorities are supposed to ensure that shareholders and creditors of failing banks bear the costs, not the public. This requires a balanced approach that promotes financial stability while maintaining fair market competition and effective cooperation among various institutions involved in the resolution process.

Second, any investor seeking to acquire a failed or failing institution decides based on limited information and under high uncertainty. Observing a risk premium is consistent with these conditions. Moreover, while the acquirer may have tried to price the risk correctly, it may take more than a few months of observations for risks and opportunities to materialise. It is therefore difficult to assess the appropriate risk premium at the time of the resolution.

At a general level, resolution policies should aim to reduce excessive profits made by acquiring banks. For this to happen, a combination of ex-post measures, such as transfer tools and bail-in, and ex-ante preparation through robust bail-inable liabilities (MREL) and resolution planning, appears to be essential. Moreover, utilising tools such as bridge banks can buy time and improve negotiation positions, ensuring fairer asset pricing and minimising public costs during bank resolutions.

Policy recommendations to reduce acquirers’ profits

Substantial gains on the acquisition of banks in resolution are the norm. This holds true for market-based and accounting-based valuation methods and for US and European cases, raising the question of whether administrators have gone to sufficient lengths to protect creditors and taxpayers.

While financial stability concerns rather that resolution cost minimisation is the primary objective of resolution authorities, and a substantial risk premium for the acquirer may be consistent with a fair market return, this does not mean that acquirers’ profits cannot be reduced. We identify four areas of reform for the EU:

1. Strengthening a backstop, thereby alleviating time pressure

Creating a robust public backstop could offer temporary liquidity support, reducing the need for rapid asset sales at deflated prices. This would enhance market confidence and ensure more efficient resolutions without undue taxpayer losses.

2. Enhancing market discipline with bail-in debt

Improving the framework for bail-in debt is crucial. This involves setting robust minimum requirements for eligible liabilities (MREL) and ensuring that bail-in debt is held by investors with sufficient loss absorbing capacity, thereby reducing moral hazard and enhancing market discipline.

3. Increasing competition among bidders

Limited competition in the bidding process for distressed bank assets is another reason for potential underpricing and excessive acquirer profits. Encouraging a more competitive environment through transparent auction-like processes, coupled with comprehensive data rooms, can attract a wider range of bidders. Ensuring proper enforcement of competition rules and considering smaller banks, foreign institutions, and non-bank financial entities as potential acquirers can help mitigate market concentration issues and foster a healthier banking sector.

4. Transitioning to a European framework similar to the FDIC

Last but not least, the European resolution framework differs significantly from the US model, notably lacking a unified receiver like the FDIC. In the European banking Union, the receivership process is split between the SRB at the European level, more than 20 national deposit guarantee schemes, and national insolvency procedures. This fragmentation requires extensive cooperation among authorities, which consumes unnecessary time and adds further difficulties to the time-constrained resolution process. In the longer term, transitioning from the current system to a European framework similar to the FDIC would be a significant advancement and should be able to dampen resolution costs.

Conclusion

The 2023 banking crisis underscores the need for reform in bank resolution practices. By addressing gaps in backstop mechanisms, enhancing market discipline through bail-in debt, increasing competition in asset sales, and revising the European resolution framework in the direction of the FDIC model, we can create a more resilient financial system. Implementing these recommendations will help protect taxpayers, preserve financial stability, and ensure fairer outcomes in bank resolutions.