My Lords, this clause and the new schedule to the Bill in Amendment 105 have the effect of amending the Banking Act 2009 to provide the Bank of England with a new stabilisation option—the bail-in option. Bail-in involves shareholders of a failing bank being divested of their shares or having their holdings severely diluted and creditors of the bank
having their claims cancelled, reduced or deferred to the extent necessary to restore the bank to financial viability. During the financial crisis it was not possible simply to allow banks which failed to enter insolvency, as other companies do when they fail. This is because of how interconnected the banking system is and because of the need to protect the banks’ customers by ensuring that they could continue to access essential banking services. This protection came at a very high cost to the taxpayer. These new powers will provide one solution to that problem by offering an alternative to insolvency which exposes shareholders and creditors to the losses of the bank, while enabling the bank to continue to operate as a going concern. This will help to ensure that taxpayers are never again required to bear all the costs of resolving failing banks.
It has long been the Government’s policy to develop such bail-in powers. This was an important strand of the Government’s response to the recommendations of the Independent Commission on Banking. The UK has also been at the forefront of the international development of bail-in. Along with other G20 countries, we endorsed the Financial Stability Board’s recommendation on bail-in in November 2011. We have also worked hard at ensuring that the EU would agree a feasible and credible bail-in tool, and have made substantial progress recently in this area. We believe that EU agreement on a common resolution recovery directive is near and, for this reason, the Government are now confident enough about the content of the directive to be able to bring forward bail-in powers through this Bill.
On the details of the amendments, paragraph 1 of the schedule introduces the bail-in option as an additional stabilisation option in the Banking Act 2009. When the bail-in option is deployed, the Bank of England can cancel, reduce or defer liabilities of the bank for the purposes of recapitalising it and restoring it to viability. It may also transfer some or all of the bank’s securities to a bail-in administrator to hold securities of the bank, or to perform other tasks as specified by the Bank of England, on a temporary basis. In any event, shares held by the original shareholders would be expected to be transferred or severely diluted in the course of resolution.
Paragraph 3 of the schedule sets out the conditions for use of the bail-in option. These are that the bank is failing or is likely to fail to satisfy the conditions for authorisation, that no action is likely to be taken to restore the bank to compliance and that the exercise of the power is necessary having regard to the public interest in: the stability of financial systems in the UK; the maintenance of public confidence in the stability of those systems; the protection of depositors; or the protection of any client assets that may be affected.
Paragraph 4 defines the power to make a special bail-in provision cancelling, modifying or changing the form of a liability of the bank in resolution. This power can be exercised only for the purpose of or in connection with cancelling, reducing or deferring a liability of the bank in question. Proposed new Section 48B also specifies a set of liabilities that are excluded from the power to make special bail-in provision. These liabilities are excluded for one of two main
reasons: either because they would not have been exposed to losses in insolvency or because exercising the bail-in powers on them would be likely to impede the resolution of the firm or create wider market instability. This includes deposits protected by the Financial Services Compensation Scheme or similar overseas deposit guarantee schemes, liabilities to the extent that they are secured, client assets, short-term liabilities owed to certain financial institutions outside the affected firm’s group, certain liabilities arising in respect of central counterparties and settlement systems, and certain debts owed to employees and trade creditors. The Treasury has the power to amend this list by order.
When the Bank of England exercises its special powers to bail in liabilities of a failing bank, it must make a report to the Chancellor explaining why it has done so. A bail-in should in general be done in a way that respects the treatment that creditors would have received if the bank had been allowed to fail and enter insolvency. In terms of economic effects, this means that the failing bank’s shareholders would be divested of their shares, or otherwise have their claims severely diluted, and subordinated debt holders would be exposed to losses. Senior debt holders would generally be exposed to losses only after subordinated debt holders. It would also generally be the case that creditors in the same class would bear losses on an equal footing.
In common with the existing stabilisation options in the Banking Act, the Bank of England may depart from these general principles where appropriate. If the Bank of England does so in exercising the special bail-in powers, this report could explain the reasons for doing so. The Chancellor will lay a copy of any such report before Parliament.
New Section 48H gives the Bank of England the power to require a bail-in administrator or one or more of the directors of the bank to draw up a business plan that includes an assessment of the factors that led to the failure of the firm and outlines a plan for addressing these problems. The plan must be approved by the Bank of England after consulting the PRA and the FCA and may require changes to be made before approving it.
New Section 48L specifies further powers available to the Bank of England, including powers to modify and convert securities that fall within the scope of the bail-in powers. New Section 48N enables the Bank of England to remove a director from a bank in resolution, or to terminate or vary a director’s contract. It also allows the bank to appoint new directors. New Section 48O enables the Bank of England to issue directions to directors of the bank.
New Section 48P gives the Treasury the power to make an order relating to the treatment of protected financial arrangements in a bail-in. Protected arrangements are defined as security interests, title-transfer collateral arrangements, and set-off and netting arrangements. These arrangements are entered into by the counterparties in order to minimise the risks associated with the financial instruments. Therefore it is right that these arrangements are respected to the extent possible while pursuing the special resolution objectives. This is analogous to the existing power for the Treasury
under the Banking Act 2009 to specify protections in the case of transfers of some but not all of the business of the bank under resolution.
The Treasury will be required to put in place compensation arrangements for affected shareholders and creditors following an application of the bail-in powers. These will include a no-creditor-worse-off safeguard that broadly provides that no shareholder or creditor should be left worse off as a result of the exercise of the bail-in powers than they would have if the bank had simply failed and entered insolvency. In addition, the Bank of England may exercise the bail-in option in respect of a banking group company if certain conditions are met.
First, the authorities must be satisfied that a bank in the same group meets the conditions for resolution. Secondly, the authorities must be satisfied that acting only in respect of the bank itself is not sufficient to achieve the special resolution objectives. The actions should seek to minimise the effects of the exercise of the power in relation to group companies on other undertakings in the group. It should only be to the extent necessary in order to achieve the resolution objectives.
I apologise for setting out the details of these provisions in some detail, but they are relatively new to your Lordships’ House and one of the essential components of the menu of provisions contained in the Bill to give a safer and more secure banking system. I commend the amendments to the House.
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