When a bank fails, regulators need two qualities above all: Speed and agility.
That’s the message U.S. Federal Deposit Insurance Corp. officials are sending to their colleagues in Brussels working out how the European Union will shut down insolvent lenders.
Regulators need to move fast enough to limit disruption to the financial system, while staying nimble so they can pull back at the last minute if another solution emerges, Pamela Farwig, deputy director of the FDIC’s resolution and receivership division, said in a phone interview this month.
“If you had to tell them to stand down, you must be able to do that in very, very short order,” said Farwig, one of four U.S. officials who spoke at private workshop on bank closures with EU officials in June.
The FDIC’s practical tips and advice for Europe are borne of hard-won experience: it handled more than 500 bank closures during the financial crisis. Its seminar, part of a trans-Atlantic exchange, tackled issues like how to market a failing bank, and how to sneak up and close it on a Friday night.
“They were surprised at some of the things that can happen at the very last minute,” she said. “They just have not had that experience yet.”
When a lender is on the brink, the FDIC needs to fly under the radar to avoid roiling the markets or alarming depositors. Officials will try to line up a buyer in advance and then they even book hotel rooms and rental cars without mentioning the agency’s name.
“You have a team going into a very small town where everyone knows everyone -- when they see those different cars you have to be very careful,” Farwig said. “The last thing you want is a marquee that says ‘Welcome FDIC.’”
The EU officials are in the midst of a full-scale overhaul of their banking system, intended to shore up the euro area and prevent future financial crisis. Within the 18-nation currency bloc, the European Central Bank is taking on oversight within the 18-nation currency bloc. The EU is also building a Single Resolution Mechanism which will handle the mechanics of shuttering euro area banks.
“The stylized description of what’s happened is that the U.S. had a too-big-to-fail problem,” said Nicolas Veron of the Washington-based Peterson Institute for International Economics and the Brussels-based Bruegel research organization. “The European Union had a different kind of problem, which is that no bank could fail no matter how small.”
Even when the U.S. was bailing out Citigroup and other giant financial firms, it still shut down hundreds of banks from tiny Waccamaw Bank to Washington Mutual Inc, once the nation’s largest savings and loan.
All of these small and medium-sized lenders “faced market discipline,” Veron said. “Most junior creditors and many senior creditors lost vast amounts of money in the U.S. crisis while in Europe, until 2012, very few junior creditors and almost no senior creditors lost money.”
Portugal’s Banco Espirito Santo showed that even though the new system is still in a transitional phase, regulators are now willing to take action. The Bank of Portugal spearheaded a 4.9 billion-euro ($6.6 billion) takeover that will force losses on shareholders and other junior creditors, split the bank and sell off its healthy assets to cover the costs of dealing with the parts of its balance sheet that have gone sour.
Slovenia’s Abanka Vipa d.d. faced similar fortunes. Its shareholders and subordinated debt holders were wiped out as part of a state-backed capital injection and restructuring plan.
New EU regulations make it much harder to prop up failing banks -- and therefore more likely that struggling lenders will have to be closed. The rule changes go beyond the biggest banks and suggest that regulators at all levels will need to be more prepared to pull the trigger on a bank failure and impose losses on creditors.
The EU authorities’ conversations with officials from across the Atlantic are part of that transition.
“The European Commission cooperates with the FDIC on a regular basis,” spokesman Simon O’Connor said in an e-mail.
The EU and the U.S. agency hold twice-yearly meetings in Brussels and Washington, where the most recent session took place in May. Officials sometimes take part in short-term assignments with their counterparts, and there are periodic seminars like the workshop on bank failures in June.
“It makes perfect sense that Europeans would want to learn from U.S. practice,” Veron said. “There has really been a sea change in the way the public reaction to bank failures has been envisaged in Europe in the last two years.”