We have previously written about HM Treasury’s January 2024 consultation on “Enhancing the UK special resolution regime”, which proposed a new mechanism allowing the Bank of England (the Bank) to request funds from the Financial Services Compensation Scheme (FSCS) to cover certain costs associated with a resolution in the case of the failure of a small bank or building society.
Following the recent UK General Election, the King’s Speech on 17 July confirmed the new Labour Government’s intention to proceed with these proposals, and the Bank Resolution (Recapitalisation) Bill (the Bill) was introduced in the House of Lords on 18 July.
HM Treasury’s consultation set out proposals for a “targeted enhancement” of the resolution options available to the Bank which is intended to give the Bank more flexibility to manage small bank failures effectively and limit risks to the public purse, taking into account the lessons learned from the failure of Silicon Valley Bank (SVB) in spring 2023.
The Bill and the consultation response published in parallel by the Government confirm that the new Government broadly intends to maintain the position set out in the consultation. The main modification to the initial proposals is that the ex-post levy on the banking industry which will be used to cover the FSCS’s costs where the new mechanism is applied will exclude credit unions, which will not be required to contribute. At least in the context of these special resolution proposals, the new Government’s approach therefore appears to be one of continuity with previous Government policy.
In addition to the introduction of the Bill, the Government will update the Special Resolution Regime (SRR) Code of Practice (as further set out below) in consultation with the Banking Liaison Panel. The Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) will also consult on relevant updates to their rulebooks resulting from these amendments to the regime.
Changes to the resolution regime introduced by the Bill
Which measures have been retained from the original consultation?
We have summarised the powers currently available to the Bank (as the UK’s resolution authority) to stabilise or resolve banks in our previous blog post on these proposals. The main change to these powers under the new Bill, reflecting the consultation proposals, is the introduction of a mechanism which would allow the Bank to request funds from the FSCS to cover costs associated with a resolution in the case of the failure of an institution in scope of the resolution regime (such as costs of recapitalising the failed firm and the operating costs of a bridge bank). This would be applied alongside the exercise of existing resolution powers.
As was the preferred proposal set out in the consultation, the Bill provides for amounts contributed by the FSCS in this regard to be funded after the fact through a levy on the banking industry, and expands the FSCS’s levy-raising powers accordingly.
Beyond the core mechanism introduced by the Bill, most other aspects of the measures consulted on in January have also been retained. This includes the proposal to disapply certain conditions, which are seen as too onerous for small firms to meet, on existing resolution financing arrangements in cases where the new mechanism is used.
What changes have been made to the proposals set out in the original consultation?
The Government’s changes in the finalised proposals to the original measures consulted on are limited. They include the following:
- The Government notes that consultation respondents were mostly supportive of recouping funds from the entire banking sector, but some concerns were raised on the inclusion of certain types of entities, including credit unions, within the payment perimeter for the FSCS ex-post levy. As the Government acknowledges that credit unions are not within scope of the special resolution regime, they will not be required to contribute to the costs of recapitalisation if the new mechanism is used.
- Although this point was not raised by respondents, the Government has noted that the Bill includes an explicit ability for the Bank to require a bank under resolution to issue new shares. This ability, complementing the Bank’s existing powers, is intended to facilitate the Bank’s use of the funds provided by the FSCS to meet a failing bank’s recapitalisation costs.
Government response to further concerns raised by respondents
The Government’s consultation response sets out a large number of comments raised by respondents and the Government’s views on these points. Many of these relate to very specific concerns raised by individual respondents, but some may be of particular interest:
- The Government notes that several respondents suggested ways in which the scope of the new mechanism may be narrowed, such that it could be used only for a smaller set of banks. However, in its response, the Government has stated that although the new mechanism would generally be used in relation to the resolution of small banks, it is appropriate for the mechanism, in principle, to apply to any banking institution within scope of the resolution regime. This would ensure that the resolution authorities have sufficient flexibility to respond in any limited cases where the mechanism could be appropriate for other firms.
- The Government states that a number of respondents proposed additional safeguards to limit and assess costs of the new mechanism to industry. Industry suggested that safeguards to be introduced could include, for example, a requirement that FSCS funds are only used for resolution where this would be less costly than insolvency. However, the Government’s view is that the public interest test remains the appropriate test for the exercise of resolution measures, and introducing specific additional requirements, for example, for the Bank to choose the least costly option could hamper its ability to take the most appropriate action to advance its resolution objectives. To address such concerns on the new mechanism’s costs for the banking sector, the Government is planning to update the SRR Code of Practice to provide greater clarity on how the Bank will take account of the costs to the FSCS when considering whether to use the new mechanism.
- To address concerns over costs to industry, the Government also intends to make changes to the SRR Code of Practice in relation to ex-post scrutiny of the authorities’ resolution actions. The Bank is already required to make reports to the Chancellor following the exercise of certain resolution powers, and the changes are expected to require the Bank to disclose in such reports (which will be publicly available) the estimated costs to industry of the options that were considered in cases where it made use of the new resolution mechanism. The Government’s view is that this strikes the right balance between seeking transparency over costs and ensuring the Bank’s flexibility to respond to specific circumstances.
- We have noted above that the Bill would not require credit unions to fund amounts provided by the FSCS to the Bank under the new mechanism. Respondents also raised other institutions which it may be appropriate to exclude from the levy’s payment perimeter, including larger banks (which would not be expected to benefit from the proposals) and branches of third country banks. However, the Government considers that there are benefits to maintaining a broad-based levy, such as affordability to the industry, and that the wider sector would also benefit from the mechanism due to its effects on financial stability and contagion risks. Therefore, such firms (which, unlike credit unions, are in scope of the resolution regime) should not be excluded.
- HM Treasury’s consultation had set out possible other methods of financing the proposals. Some respondents had raised arguments in favour of such other methods, including that the failing bank should itself contribute to the costs of its failure through an ex-ante levy approach or through minimum requirements for own funds and eligible liabilities (MREL) for smaller firms. However, the Government views an ex-post levy as the most proportionate and effective solution; it avoids high upfront costs, ensures that the sector only pays when it needs to and is consistent with the approach to FSCS depositor pay-outs.
Respondents also raised more general proposals or concerns in relation to the broader resolution regime, a number of which the Government has addressed in its consultation response. However, the Government has stated that the successful UK resolution of SVB demonstrated the effectiveness of the existing resolution regime, which provides a robust but flexible framework. As such, the proposals introduced by the Bill are intended only as a modest enhancement and, in the Government’s view, it would not be appropriate to make fundamental changes to the underlying resolution framework.
