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Single Point of Entry - a resolution strategy addressing the home – host issue in Europe’s Banking Union

Blog post
| Thursday, 22 April 2021

Resolution planning has come a long way since the financial crisis 2007/08 and is now firmly rooted in the Banking Union’s regulatory framework. Preserving financial stability in all 21 Banking Union Member States and beyond is key[1], and this guides the SRB’s approach to resolution planning and of course to any resolution decision. Bank resolution strategies are designed to follow the general principles set for resolution, in order to meet the resolution objectives set out in the Single Resolution Mechanism Regulation (SRMR). An important consideration in resolution planning is the decision between Single Point of Entry (SPE) and Multiple Point of Entry (MPE)[2]. Both approaches are valid and the decision for either largely depends on the business model of the bank under consideration. I would like to take a closer look at the SPE strategy, what the key components are and how our approach could be strengthened.

Under an SPE approach, the group resolution authority is committed to all subsidiaries remaining well-capitalised going-concern entities that stay “out of resolution”. Only the resolution entity, i.e. the parent company, will be the direct target of resolution powers, and operational subsidiaries are preserved and would not themselves be subject to resolution. The SPE approach avoids the disruption caused by the application of resolution action, potentially by multiple authorities in multiple entities, within a group that is dependent on intragroup services and, at the same time, needs to acknowledge that most company, tax and insolvency laws focus on individual legal entities.

The SPE approach is generally premised on the use of an “open bank bail-in resolution strategy”, but other strategies, such as sale of business, could also apply. In principle, the SPE approach relies on the upstreaming of losses to the parent and the down streaming of capital to an ailing subsidiary. In the Banking Union, the prepositioning of internal MREL[3] instruments is a key mechanism for facilitating this. The Bank Recovery and Resolution Directive (BRRD) and SRMR, set a very prudent internal MREL requirement, which clearly comes at a price and was a subject of debate, as it may lead to the fragmentation of the financial resources of internationally active groups by “locking-in” resources that could otherwise have been freely used.

Prepositioned internal MREL clearly provides a safeguard for the subsidiaries and thus the ‘host states’. However, it is not the only solution and it might not even be enough in some cases. As the aim is that the subsidiary stays out of resolution, i.e. stays in going concern, there is a need to avoid the possibility that management may be prevented from providing funding to subsidiaries for fiduciary reasons, leading to the failure of the subsidiary. An effective means of providing for this, over and above prepositioned capital and internal MREL, may be insolvency-proof, cross-border guarantees under which the parent is legally obliged to cover the subsidiary’s losses, thus keeping the subsidiary in going concern as intended by the SPE strategy.[4]

By enshrining the SPE approach into the bank’s financial structure in going concern, the economic commitment of a parent to its subsidiary will be enhanced over and above that already achieved by the prepositioning of internal MREL. This should also reduce any concern that the SRB might opt for a variant strategy that is misaligned to the interests of a subsidiary. In effect, the resolution authority’s discretion would be materially limited.

The key issue is to ensure the subsidiary is not “abandoned” in resolution, even in cases where the parent itself is ailing. While we can be sure that the SRB would not do so, given the objectives set out in the SRMR, effective and enforceable arrangements should support the SRB’s objectives and provide greater certainty regarding the resolution strategy. Such arrangements could be contractual ones, like group support agreements, with clear triggers that could be linked to the group’s recovery plan.

Requiring subsidiaries to preposition high levels of internal MREL instruments can be viewed as a safeguard, ensuring that the capital position of subsidiaries can be maintained. Internal MREL aims at avoiding the need to recapitalise subsidiaries through the independent application of resolution tools, and limits dependency on the parent for funding. At the same time, excessive “ring fencing” of capital at subsidiary level leads to fragmentation of financial resources and risks leaving insufficient resources at parent level, potentially meaning resources would not be available for transfer to any stressed subsidiaries.

An important question for the EU’s co-legislators will be whether the need for a high level of prepositioned resources at the subsidiary level could be reduced by putting in place effective and enforceable contractual arrangements. If so, this would increase the potential amount of resources at the parent level, which can then be flexibly distributed to stressed subsidiaries depending on needs in a crisis scenario. This aligns to the broader work on ‘Unallocated TLAC’ at the FSB level, which highlights the benefits of having resources available centrally to enable the rapid recapitalisation of subsidiaries, where prepositioned resources prove insufficient. Beyond contractual arrangements, further consideration could also be given to enhancing the availability of such funds in a crisis, possibly through imposition of a special manager, or requirements to hold assets that can be rapidly transferred.

An alternative way to address this issue could instead be for banks to move to a branch structure, with businesses in ‘home’ and ‘host’ states forming part of the same, single legal entity, with a single balance sheet. This might be a way of enabling the efficient allocation of capital within banking groups. This would be a decision for banks to make, with due consideration of both the legal and regulatory aspects, and also the pros and cons for their business model that such a change in structure might entail.

In conclusion, the SRB is working to enhance the SPE approach, in the first place through the tools already provided for under the SRMR. Making banks resolvable means diligently implementing resolution plans to enable the use of the preferred resolution strategy, if and when needed. This includes MREL and internal MREL but also appropriate arrangements that ensure the resolution entity will “take care” of a subsidiary located in a different EU Member State in the event of a crisis.

As stated, the debate about ring fencing vs. fragmentation is still ongoing and it will for sure also play a role in the upcoming work plan for the completion of the Banking Union to be discussed by the Eurogroup in coming months. Any revisions to the framework will have to strike a fair balance between an adequate level of pre-positioning at the subsidiary level, and ensuring that resources can be deployed effectively in resolution. This would ensure a further alignment between the financial structure of the group and the SRB’s resolution strategy, further build trust within the Banking Union and hopefully render the debate about ‘home and host’ within the Banking Union obsolete.

[1] Preserving financial stability is one of the resolution objectives set out in Article 14 SRMR. The other objectives relate to continuity of critical functions, protection of public funds, protection of covered depositors and investors, and protection of client funds and client assets.

[2] For further information, see the article “How to adapt a bank for MPE resolution strategy

[3] Internal minimum requirements for own funds and eligible liabilities

[4] Looking to international practice, such as “Secured Support Agreements” in the US, we see a recognition that some level of resources remains at the centre, while providing certainty to host authorities that subsidiaries would be supported in a crisis and the cost of failure is not left to the host state.

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Elke König
Former Chair at Single Resolution Board

Dr Elke König is Chair of the SRB, responsible for the management of the organisation, the work of the Board, the budget, all staff and the Executive and Plenary sessions of the Board. The Strategy, International Relations and Communications Unit and the Internal Audit function report directly to her.

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