The Reserve Bank has published an issues paper seeking feedback on how it may operationalise its crisis management and resolution powers under the Deposit Takers Act 2023 (DT Act).
In the paper, the Reserve Bank is seeking feedback on:
- its proposed high-level approach to crisis management and resolution;
- potential updates to its existing "open bank" resolution tools;
- a potential bail-in resolution tool, including whether or not to recommend to the Minister of Finance that additional statutory powers are needed to deliver bail-in; and
- a new crisis preparedness standard.
In this insight, we summarise the crisis management and resolution powers under the DT Act and the Reserve Bank's initial thinking on a potential bail-in resolution tool. The consultation closes on 22 November 2024. If you have any questions on the issues paper, please get in touch with one of our experts below.
Crisis management and resolution powers under the DT Act
The crisis management and resolution powers under the DT Act build on the powers already contained in the Banking (Prudential Supervision) Act 1989 (BPS Act). Some notable differences include:
- Resolution will replace statutory management under the DT Act. The Reserve Bank is designated as the resolution authority for deposit takers to enable the powers that currently reside with a statutory manager to be exercised directly by the Reserve Bank.
- The Reserve Bank is required to prepare and maintain a resolution plan for each deposit taker and to publish a statement of approach to resolution.
- The Reserve Bank may issue new crisis management preparedness and bail-in standards that may require a deposit taker to prepare contingency and recovery plans and to issue a minimum amount of bail-in instruments.
- Several of the Reserve Bank's crisis management powers will no longer be subject to obtaining the prior consent of the Minister of Finance (eg the Reserve Bank's power to give a direction to a deposit taker or an associated person or to remove, replace or appoint a director of a deposit taker).
- The Reserve Bank has several new statutory powers related to crisis management and resolution under the DT Act that are not in the BPS Act. For instance:
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- the power to offer, issue or transfer any financial product in respect of which a deposit taker or an associated person in resolution is the issuer;
- the power to give a direction to a deposit taker to implement all, or part, of the deposit taker's contingency and recovery plans, to issue shares, and to trigger the contractual terms of bail-in instruments; and
- a new ipso facto protection that provides that certain contractual rights (eg the right to terminate or close out any transaction) are unenforceable against a deposit taker in resolution.
- The Reserve Bank may use the Depositor Compensation Scheme (DCS) fund to support a resolution measure in relation to a deposit taker, subject to conditions.
- The introduction of a "no creditor worse off" safeguard.
The existing prudential requirements under the BPS Act that relate to crisis management preparedness will be retained under the DT Act (with some modifications) and will be set out in standards (see our insight on the core standards here and our insight on the non-core standards here). For instance:
- The requirement for a deposit taker to prepare, maintain and comply with an internal capital adequacy assessment programme (ICAAP) and to comply with the capital buffer response framework (currently these requirements are set out in a bank's conditions of registration (CoRs) and the banking prudential requirements).
- The requirement for a deposit taker to prepare and maintain a contingency funding plan (currently this requirement is set out in a bank's CoRs and BS13).
- The Open Bank Resolution (OBR) pre-positioning requirements (currently these requirements are set out in a bank's CoRs and BS17).
- The outsourcing pre-positioning requirements (currently these requirements are set out in a bank's CoRs and BS11).
Many of the crisis management powers under the DT Act will apply to all deposit takers (eg the Reserve Bank's power to give a direction to a deposit taker or an associated person or to recommend to the Minister of Finance that a deposit taker or an associated person be put into resolution). The extent to which other crisis management powers will be available in relation to a particular deposit taker will depend on the standards that apply to the deposit taker via its conditions of licence.
For instance, the Reserve Bank is proposing that the outsourcing standard will continue to apply only to deposit takers with net external liabilities greater than $10 billion (see our insight on the non-core standards here). We would expect that the Reserve Bank's resolution plan for a Group 3 deposit taker would be more simple than the corresponding plan for a Group 1 deposit taker, where "closed bank" resolution tools (ie an orderly wind-down or a liquidation with a DCS payout) may be the preferred resolution strategy. The resolution plan for a particular deposit taker may also reflect any agreement that the Reserve Bank reaches with a home regulator of an overseas deposit taker or group as to whether resolution should occur on a "multiple-point-of-entry" or "single-point-of-entry" basis.
As is the case with statutory management under the BPS Act, the new resolution regime under the DT Act will co-exist with the other statutory management regimes that could potentially apply to a deposit taker in financial distress under the Corporations (Investigation and Management) Act 1989 and the Overseas Investment Act 2005.
Potential bail-in resolution tool
The Reserve Bank is seeking feedback on the potential role of a bail-in resolution tool. Bail-in provides an option to stabilise and recapitalise a failed deposit taker without the need to resort to public funds by imposing losses on pre-resolution shareholders and creditors.
Bail-in can be achieved in three different ways:
- Contractual bail-in: By requiring the deposit taker to issue a minimum amount of bail-in instruments whereby losses can be imposed on creditors by triggering specific contractual terms in the bail-in instruments to write-down the instruments or to convert the instruments into ordinary shares of the deposit taker.
- Structural bail-in: By imposing losses on pre-resolution shareholders and creditors by transferring certain performing assets and senior liabilities of the failed deposit taker to a new entity, leaving the remaining liabilities and equity with the failed deposit taker with a reduced pool of assets against which to claim in liquidation (ie creating a "good bank" and a "bad bank").
- Statutory bail-in: By providing the Reserve Bank with statutory powers to write-down liabilities, to convert liabilities into ordinary shares of the deposit taker, to cancel ordinary shares of the deposit taker, or to transfer ownership of the ordinary shares of the deposit taker to a third party.
Structural and contractual bail-in can already be achieved by the Reserve Bank using the existing powers under the DT Act. However, statutory bail-in would require amendments to the DT Act and potentially other legislation.
The Reserve Bank states in the issues paper that it is not consulting on changes to its 2019 Capital Review decisions and that any bail-in instruments would be issued in addition to the minimum capital requirements and prudential capital buffer that will be fully implemented once the transition period ends in July 2028.
The Capital Review decisions included removing write-down and convertibility features from the eligibility criteria for Additional Tier 1 (AT1) and Tier 2 capital instruments. At the time, the Reserve Bank was concerned that the complexity of the contractual terms to achieve write-down or conversion meant it was uncertain whether they could deliver going-concern capital. The concerns about the effectiveness of hybrid AT1 capital as going-concern capital appear to be shared by APRA, as indicated by its recent decision to phase out AT1 capital for Australian authorised deposit-taking institutions.
Despite the Reserve Bank's stated approach, there may be benefit in the Capital Review decisions being reviewed if contractual bail-in is the preferred bail-in resolution tool. This is because the same bail-in resolution tool could not be applied to all types of loss absorbing capital (other than common equity tier 1 (CET1) capital), potentially adding complexity.
In a resolution of a deposit taker, it is possible that AT1 and Tier 2 capital would remain in place after contractual bail-in instruments have been written off or converted into ordinary shares of the deposit taker, upsetting the usual hierarchy in liquidation. If this occurred, that usual hierarchy could be restored if AT1 and Tier 2 capital holders were also "bailed-in" via structural or statutory bail-in, but this may add complexity. The "no creditor worse off" safeguard may provide some protection for holders of contractual bail-in instruments in a situation where they are bailed-in in advance of holders of AT1 or Tier 2 capital instruments.
A simpler approach could be to modify the eligibility criteria for regulatory capital instruments to allow the same bail-in tool to apply to all loss absorbing capital (other than CET1 capital). If write-down or conversion of a contractual bail-in instrument is considered to be effective to deliver gone-concern capital in a resolution, then it is not obvious to us why it would not also be considered to be effective for Tier 2 capital (which is gone-concern capital) or even AT1 capital once it has ceased to have any going-concern value (ie because the deposit taker has been put into resolution on the grounds that it is non-viable).
Cabinet initially agreed to include statutory bail-in powers in the Deposit Takers Bill. However, due to the complexity of statutory bail-in, Cabinet later decided to limit legislative reforms to contractual and structural bail-in to allow the Deposit Takers Bill to progress. The complexities of statutory bail-in include: (i) ensuring the statutory bail-in powers in the DT Act (which result in investors' property rights being overridden) fit with other legislation; (ii) identifying which instruments would be eligible for statutory bail-in and determining the treatment of "legacy" instruments; (iii) ensuring that eligible instruments support statutory bail-in (eg via contractual recognition terms or disclosure requirements); and (iv) the potential tax implications if a write-down occurs.
The Minister has asked the Reserve Bank to report on the need for statutory bail-in powers before July 2025. The Reserve Bank has stated that it does not have a position on whether to recommend to the Minister to introduce a statutory bail-in power and is seeking feedback.
The particular features of New Zealand's deposit taking industry will influence the design of a bail-in resolution tool. That industry is dominated by 4 wholly-owned subsidiaries of Australian banks and also includes a government-owned bank and a number of mutually-owned deposit takers. The issue of a convertible bail-in instrument to external investors by these entities may not be desirable or possible. There may also be limitations on the issue of bail-in instruments to Australian parent banks via APRA's rules on associations with related entities (APS222) and adjustments to regulatory capital (APS111).
Bail-in could also result in changes to shareholdings that would ordinarily require a consent, licence, permission, clearance or other authority under other legislation (eg the Overseas Investment Act 2005 and the Commerce Act 1986). While the DT Act contemplates this situation arising in the case of structural bail-in, and provides that no such approvals are required, the same concessions are not provided for contractual or statutory bail-in.