Introduction

• Author: Hellwig, Martin F.
• Pages: 5-6

Valuation reports in the context of banking resolution: What are the challenges?Valuation reports in

the context of banking resolution: What are the challenges?

PE 624.417 5

INTRODUCTION

In the aftermath of the financial crisis of 2007-2009, the European Union has introduced a legal

framework for bank resolution as an alternative to a traditional insolvency procedure. The Lehman

Brothers bankruptcy had shown that, even if the prevailing legal regime is debtor friendly and favours

the continuation of operations of the insolvent company, letting a major financial institution go into

bankruptcy can cause severe damage to the financial system. Bank resolution should provide a way to

deal with the bank’s problems without causing such damage.

Resolution affects the rights of banks’ creditors. In contrast to traditional insolvency law, the legal

norms concerning bank resolution prioritize the protection of the financial system over creditor

protection. In particular, the bail-in tool provides for the possibility of imposing losses on creditors

without going through an insolvency procedure.

Under the “no-creditor-worse-off” principle (Art. 73 (b) BRRD, Art. 15 Par. 1 (g), SRM Regulation), a bail-

in should not make any creditor worse off than an insolvency procedure would. However, the

counterfactual of what an insolvency procedure would imply for creditors is difficult, perhaps even

impossible, to ascertain.

Write-downs and conversions in a bail-in depend on the valuation of the bank’s assets. If the assessed

total value of assets falls short of the credi tors’ total claims, shareholder equity is written down. Debt is

bailed in, by write-downs or conversions, in the inverse order of its standing in the hierarchy of claims.

The impact of a bail-in on creditors is obviously very sensitive to the results of the valuation. For the

valuation, Articles 36 and 74 of the BRRD and Article 20 of the SRM Regulation stipulate a two-step

procedure. The first valuation takes place when the resolution procedure is initiated, the second, when

the resolution procedure is finished. The purpose of the first procedure is to provide a basis for the

resolution authority’s choice of actions, including a bail-in of creditors. The purpose of the second

procedure is to compare the claims of shareholders and creditors under the initial bail-in to the

payments they would have received in an insolvency procedure, providing for compensation if the

latter claims turn out to be larger.

In cases where the urgency of resolution precludes a valuation by independent agents that complies

with all conditions in the Directive and the Regulation, the resolution authority can proceed on the

basis of a provisional valuation. This provisional valuation must be replaced by a definitive valuation

that fulfils all the conditions in the Directive and Regulation as soon as po ssible.

These arrangements raise a number of questions. Some of these questions have been articulated in the

discussion about the European Banking Authority’s (EBA) regulatory technical standards (RTS).1 Some

of them have arisen from the experience with the resolution of Banco Popular Español (BPE) in June

2017.

One set of questions concerns the relation between the two valuations and the relation between them

and the valuations that preceded the authorities’ assessment that a bank was faili ng or likely to fail. EBA

observes that the three valuations occur in different circumstances and serve different purposes:

Valuations before the initiation of resolution (“Valuation 1”) provide information to market participants

in the absence of any intervention. Valuations at the onset of resolution (“Valuation 2”) provide an input

into the resolution authority’s decisions. Valuations after resolution (“Valuation 3”) serve as a basis for

implementing the no-investor-worse-off principle. To take account of these differences, EBA proposes

1 EBA (2017)