UK Finance has responded to HMT’s consultation on enhancements to the Special Resolution Regime. It proposes providing a new mechanism to facilitate the use of existing stabilisation powers for small banks that would otherwise be expected to be subject to the Bank Insolvency Process (BIP). The theoretical necessity for HMT’s proposals was highlighted by last year’s failure of Silicon Valley Bank UK (SVB UK).

The Bank of England had originally proposed using the BIP to wind up SVB UK. But it subsequently decided exercise of its resolution powers would be the better option to provide continuity of access to banking services to SVB UK’s customers, which were predominantly focused in the important Fin Tech sector. This route, it believed, would also better promote public confidence in the UK financial system, which would be in the public interest.

HSBC quickly purchased SVB UK. But had it not done so, the Bank of England’s Resolution Authority would instead have taken over to failed bank to allow it to keep operating. All banks, even ones temporarily owned by the Bank of England, must meet regulatory capital minima at all times. In the aftermath of a bank failure these would probably need topping up. The funds needed to recapitalise the bank, so it meets these minima, would have to come from somewhere and certainly not from the taxpayer.

The solution HMT proposed is that the Financial Services Compensation Scheme (FSCS) would initially provide the funding for the recapitalisation which would subsequently be recovered by an ex -post levy on the banking sector.

UK Finance agreed with this pragmatic solution but emphasised that in our view the BIP should remain the default option were a small bank to fail, rather than this new mechanism becoming the default route. We alerted HM Treasury to the risk that following its decision to use a stabilisation power it might be subject to class action from former shareholders or creditors, or alternatively be subject to regulatory investigations. In our response we made the point strongly that banks funding of the FSCS should not be used to defend such actions, vexatious or otherwise.

We also argued that a ‘No Credit Worse Off’ type approach should be applied when the Bank of England decided to apply a stabilisation mechanism rather than the BIP to ensure it was indeed the least expensive approach. To support this, we encouraged HMT to conduct a case-study based cost benefit analysis, using its experience from Dunfermline Building Society and SVB UK.

HMT’s proposes that funds should be recouped from the whole deposit taking class, asserting that the whole banking sector would benefit from the reduced disruption from small bank failures and the overall enhancement to public confidence in the banking system. Some members felt that this would not necessarily be the case and that that the principal beneficiaries would be other banks of a similar size and business model to the failed bank through the reduced contagion risk they would face. Nonetheless in the absence of a simple mechanism that would see survivor small banks pay a proportionately higher levy we agreed that an across the board levy was the most realistic approach.