Executive Summary

AuthorHellwig, Martin F.
IPOL | Economic Governance Support Unit
4 PE 624.417
The greatest challenge for valuation in resolution and for the resolution procedure itself is to establish
credibility and legitimacy. “Value” is not something objectively given that one can easily measure.
“Value” refers to a counterfactual, an exchange of an object for money that does not actually take place.
The counterfactual nature of the concept creates no difficulties if similar objects actually are traded in
markets. But even then one must be cautious about the possibility that the expression of a desire to
trade may affect market prices.
For assets that are not traded in markets, the valuation of risks and of the costs of potential liquidity
problems of the holder necessarily involve a certain element of arbitrariness. The same is true for the
assessment of probability distributions of future returns on loans because default is a rare event and
moreover, conditional probabilities of default are highly contingent on the situation of the overall
economy and of relevant markets, such as real-estate markets.
In the BRRD and the SRM Regulation, the no-investor-worse-off principle plays a major role, but the
principle raises several questions because the ex post outcome under an insolvency procedure is
unknown and often unknowable. An application of this principle from an ex ante perspective, at the
time when the resolution decision is taken raises question s about the treatment of risk and risk premia.
When the sale-of-business tool is applied, the sales price itself provides a good reference for Valuation
3, at least if the bidding process was sufficiently competitive. An assessment of competitiveness of the
bidding process should take account of the fact that a small number of bids received may reflect the
poorness of the bank’s assets and prospects rather than a lack of competition.
The concept of “economic value”, as distinct from market value, is problematic if there is no feasible
strategy attached to it. The judgment that prices are abnormally low, so that holding and managing
them promises greater value may be a legitimate business judgment, but it presumes that this strategy
of holding and managing them is actually feasible. If valuation is based on this strategy, an assessment
of hold v alue ought to take account of risk and of illiquidity costs.
Any strategy of holding assets needs funding. The BRRD and the SRM Regulation are silent on the
subject of funding in resolution. The lack of provisions for funding in resolution is a major reason why
time pressure is so strong in the European Union, unlike the United States, where the FDIC can obtain
interim funding by borrowing from the Treasury. To reduce the time pressure on valuation and
resolution and to make holding assets a viable strategy, it would be desirable to amend th e legislation
to provide for funding in resolution.
In the case of BPE, due to the run on the bank, time pressure also affected the valuation by external
valuers (Valuation 2). The proposal to allow for a moratorium on payouts would not solve the problem;
it might however have disastrous side effects. Some time might by gained if the valuation process was
initiated sooner, with appropriate safeguards against indiscretions that might themselves trigger a run.
Providing the valuation with more time may improve the information that is available, but it cannot
eliminate the elements of subjectivity and arbitrariness inherent in the valuation of risks and of
illiquidity of non-tradable assets. It also cannot eliminate the elements of subjectivity in the assessment
of conditional probability distributions of future returns where reliable data are altogether missing.

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