Resolution Planning Asks How a Bank Would Be Taken Apart
After 2008, large banks were required to write instructions for their own orderly failure. The exercise revealed how few of them could actually be resolved.
The Problem Being Solved
In 2008 authorities faced a choice between rescuing large institutions with public money and allowing failures that would damage the wider system.
Neither option was acceptable. Rescues created the expectation of future rescues, and uncontrolled failure was demonstrated by Lehman to be genuinely destructive.
The objective of resolution planning is to create a third option: let the institution fail while keeping its critical functions operating and imposing losses on its investors rather than on the public.
Living Wills
Large banks are required to produce resolution plans describing how they could be wound down. These document legal entity structures, critical operations, interdependencies, service arrangements, and how each part could be separated.
The exercise itself proved informative. Several institutions discovered that their own structures had grown so complex that separating them was genuinely difficult: shared technology across entities, service agreements that would terminate on insolvency, and legal structures organised for tax rather than for separability.
Supervisors rejected early plans and required structural changes, which is arguably the most valuable outcome. Banks were made simpler because they had to demonstrate they could be taken apart.
Bail In
The central mechanism is bail in: writing down or converting the claims of creditors into equity, recapitalising the institution using its own investors rather than public funds.
| Order of loss absorption | Claim |
|---|---|
| First | Common equity, wiped out |
| Second | Additional tier 1 instruments |
| Third | Subordinated debt |
| Fourth | Senior unsecured, in some structures |
| Protected | Insured deposits |
For this to work, an institution must maintain sufficient bail in able liabilities. Requirements exist specifying minimum amounts of instruments that can absorb loss, held by investors who understand the risk rather than by other banks.
The 2023 Tests
Two very different cases arrived within weeks.
The United States regional bank failures were resolved through the deposit insurance framework, with the institutions sold and all depositors protected under a systemic risk determination. Shareholders and some creditors lost, uninsured depositors did not.
The Credit Suisse case was resolved by a state facilitated merger rather than through the resolution regime that had been designed for exactly this. Additional tier 1 instruments were written down entirely while shareholders received consideration, which inverted the ranking many investors believed applied.
The write down was permitted under the specific terms of those instruments and it was widely unexpected, and it repriced that entire market immediately.
What the Cases Revealed
Both outcomes departed from the framework as designed. In one, uninsured depositors were protected beyond the stated limit. In the other, a negotiated merger substituted for the resolution process.
The reasonable interpretation is that authorities facing a live crisis will choose the option that contains it fastest, and that carefully designed regimes are subject to the judgement of people in a room at the weekend.
That is not a criticism of the individuals involved. It is a realistic assessment of how resolution frameworks perform under pressure, and it is worth holding alongside any claim that the problem has been solved.
The Cross Border Difficulty
The hardest unresolved issue is international. A global bank operates through entities in many jurisdictions, each with its own regulator and insolvency law.
In a failure, national authorities have strong incentives to protect assets located in their own jurisdiction, which conflicts with a coordinated group wide resolution. Agreements exist to manage this and they have not been tested on a large cross border failure.
The Bottom Line
Resolution planning exists to allow a large bank to fail without a public rescue, using bail in to recapitalise from its own creditors. The planning exercise made institutions structurally simpler, which is a real achievement. The 2023 cases showed that authorities under pressure will still improvise, that stated creditor rankings can surprise their holders, and that cross border resolution remains untested.