Determining the conditions for resolution

Resolution action can be taken by the resolution authority only if an institution is failing or likely to fail (FOLTF).

An institution is failing or likely to fail if

or there are objective elements to support a determination that one of the above will occur in the near future.

In addition, the following conditions for resolution also need to be met:

Resolution objectives

When using resolution tools and exercising resolution powers, the resolution authority takes the resolution objectives into account and selects the most suitable resolution tools and powers to achieve these objectives.

The German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz – SAG) sets out the following resolution objectives:

Valuation

Before the resolution authority issues a resolution order, it must arrange for a fair, prudent and realistic valuation of the assets and liabilities of the institution to be carried out by an independent auditor or carry out a provisional valuation itself.

This valuation also serves as a basis to determine whether the conditions for resolution are met and how the planned resolution tools are to be used in a specific case.

Liability cascade

When absorbing losses and recapitalising an institution, the resolution authority is bound by a liability cascade according to which the shareholders and creditors of a bank are liable in a resolution in the same order of priority as they would be in the context of insolvency proceedings. As a result, the instruments/liabilities below are to be used consecutively in the following order:

This ensures that, in the event of a crisis, the institution's owners and creditors (and not taxpayers) are first in line to help resolve the crisis. Covered deposits held by members of the public remain protected.
BaFin, the Deutsche Bundesbank and the FMSA have drawn up a joint interpretation guide on the classification of liabilities under insolvency law.

Resolution tools

In addition to extensive resolution powers, the resolution authority has the following resolution tools at its disposal:

Write-down and conversion of relevant capital instruments

If the conditions for resolution are met, the resolution authority must order the application of this tool to ensure that relevant capital instruments (Additional Tier 1 instruments and/or Tier 2 instruments) are written down and/or converted into shares or other Common Equity Tier 1 instruments. Depending on a number of other factors, the institution's original shareholders lose their legal position entirely or it is diluted at least.

Bail-in tool

The bail-in tool gives the resolution authority the power to write down the eligible liabilities of an institution in full or in part and/or convert these liabilities into shares or other Common Equity Tier 1 instruments in the institution.

As with the previous tool (to be prioritised), the bail-in tool involves an absorption of the institution's losses by writing down eligible liabilities; these liabilities are used to the extent required by converting these into shares or other Common Equity Tier 1 instruments in order to recapitalise the institution.

If the resolution authority uses the bail-in tool to recapitalise an institution, the institution has to prepare a restructuring plan.

Sale of business tool

The sale of business tool enables the resolution authority to transfer the institution (or part of its business activities) to a third party without the consent of shareholders.

The resolution authority has both the power to transfer shares issued by an institution under resolution to a recipient, or all or part of the institution's assets, rights and liabilities to the recipient.

Transfer to a bridge institution

This tool gives the resolution authority the power to transfer the shares or the assets, rights and liabilities of the institution under resolution to a bridge institution. The bridge institution is to be operated with a view to

• maintaining access to critical functions and
• selling the bridge institution or its assets, rights and liabilities to one or more private sector purchasers when conditions are appropriate within a two-year period (this can be extended if necessary).

For instance, the bridge institution can be used to separate systemically important parts from those that are not. The institution's critical functions are transferred to ensure their availability on the market even while the institution is being resolved.

Transfer to an asset management company

This tool enables the resolution authority to transfer all or parts of the assets, rights and liabilities of an institution under resolution to an asset management vehicle without the consent of shareholders.

With this tool, the resolution authority can help relieve the balance sheet of the institution under resolution or the bridge institution. Alternatively, assets can be transferred to an asset management company to maximise proceeds and/or prevent insolvency proceedings from having an adverse effect on financial markets (should insolvency proceedings be opened for the residual institution).

This tool can only be used in combination with one or several other resolution tools.

Valuation for a comparison with a hypothetical insolvency

The main objective of an insolvency is to maximise proceeds from the insolvency estate for creditors, while a resolution within the meaning of the Bank Recovery and Resolution Directive (BRRD) or the SAG is aimed at achieving the resolution objectives.

Compliance with the principle that no shareholder or creditor can be worse off as a result of resolution action than they would be under normal insolvency proceedings is verified by an independent expert.