Insolvency – why a special regime for banks? by Eva Hupkes ... - IMF

exercise broad discretion to decide whether or not to close a bank 36 , while insolvency law
defines narrowly the specific conditions that must be satisfied before proceedings can
commence. A trigger point under insolvency law is when the debtor institution has ceased to
meet its liabilities as they fall due. 37 In the case of banking, however, the inability to honor a
liability is not necessarily proof of insolvency, and may be due to a temporary shortage of
liquidity (which, in and of itself, may reveal a violation of legal liquidity requirements and
constitute an early indicator of solvency problems). Thus, the insolvency concept under
general law proves somewhat dysfunctional for banks. The regulatory determination that the
bank’s capital is impaired generally occurs before the determination of insolvency, as it is
understood according to insolvency law. 38 Another facet of banks that renders the application
of general corporate insolvency concepts more difficult is that, unlike other companies, banks
- even while experiencing financial difficulties - can continue paying creditors because they
typically have an on-going source of cash flow from, and no on-going payment obligations to,
depositors. Since it is the role of the bank supervisor to assess the bank’s capital and to
evaluate the quality of its assets, it is also the bank supervisor who determines at what point a
bank is no longer viable and must be closed; in other words, “a bank is insolvent when the
supervisor says it’s insolvent.” 39 Thus, insolvency is not the first relevant trigger for bank
intervention. In fact, once a bank is proven insolvent, it would be too late to intervene
effectively. It is the purpose of prudential regulation and supervision to ensure a close
monitoring of a bank’s financial condition. Growing financial losses, management failures
and shortcomings of internal systems and controls should prompt the supervisor to intervene
before such weaknesses develop into a situation where the bank becomes overindebted and
creditors incur losses. This is the raison d’être of prudential regulation and supervision. Given
this involvement of the bank supervisor in evaluating assets and determining solvency, in
many jurisdictions it is the bank supervisor who has the authority, to the exclusion of
individual creditors, to initiate insolvency proceedings. The banking laws of Austria,
Germany and Luxembourg, for example, reserve to the supervisory authority the right to
petition for bankruptcy. 40
Rules are therefore needed to clarify the applicable regime, whether general insolvency law or
specific banking legislation. Such rules would reconcile the grounds for intervention under
bank regulatory law versus the triggers for general insolvency procedures, and would define
the role of the bank supervisor relative to other authorities, in particular the courts, in the
initiation of insolvency procedures.
36 Eva Hüpkes, The Legal Aspects of Bank Insolvency 13 (2000).
37
See Orderly & Effective Insolvency Procedures, Key Issues, Legal Department
International Monetary Fund 1999, available via the Internet at
http://www.imf.org/external/pubs/ft/orderly/index.htm.
38 This is sometimes referred to as “regulatory insolvency”, see Hüpkes, supra note 36, at 13.
39 William A. Ryback, in Current Developments in Monetary and Financial Law, 223 (226)
(International Monetary Fund ed., 1999).
40 See supra note 26.
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