The woes of the UK’s Co-operative Bank are instructive in many senses. Its saga raises questions about management and governance in mutually owned organisations, capital regimes for mutual banks and regulators’ role in supervising such institutions.
But there is a wider ramification of the Co-op’s radical new restructuring plan that may hold lessons for one of the biggest challenges still facing global regulators – how to design a ‘resolution system’ for the orderly rescue of a troubled bank.
Euan Sutherland, the Co-op’s chief executive, even suggested as much last week when he announced a deal had been reached to convert bondholder funds into equity, plugging a large capital hole at the group’s banking subsidiary. “This is the first bank to be rescued and to survive as a standalone entity without taxpayer money,” Sutherland declared.
For policy makers, particularly those in the US, UK and continental Europe that are leading the charge on devising a global resolution system, it is an interesting test case. “Bailing in” bondholders in times of crisis, by converting debt to equity, is seen as a vital change of approach from that forced upon governments in the 2008 financial crisis, when hundreds of billions of dollars of taxpayers’ money was used to prop up failing banks.
Banks have up to now been seen as different from non-financial companies, which would typically convert debt to equity in times of trouble. “What Co-op shows is that banks can be fixed through more normal corporate restructuring,” says one senior policy maker.
The example is a timely one. The European Central Bank is about to embark on an “asset quality review” of the eurozone’s banks, to be followed by an EU-wide stress test. The aim is to debunk sceptics’ fears that the region’s lenders are hiding a glut of bad assets at inflated values. Few pundits expect any lender’s assets to be shown to be so bad that valuing them correctly will break the bank. But just in case, the ECB wants a public sector backstop mechanism to be in place to fund a bailout.
That, say officials at the European Commission, would undermine the whole thrust of global regulatory reform in the area. Even if the EU’s incoming rules on bailing in bondholders – contained in the Bank Resolution and Recovery Directive – are not made law for another five years, the first port of call these days for any failing bank should be its own investors.
The ECB counters that it would be unfair to bondholders, and would scare them off from investing in European banks, if they were to be bailed in – not because the bank is collapsing, but merely because it is shown to have shortcomings in a regulatory review and stress test.
This is where the Co-op parallel really resonates. Sutherland and regulators at the Prudential Regulation Authority are not overseeing the resolution of a failed bank. This is a voluntary bail-in for a still-functioning bank. And by the looks of it, it is going to work: the Co-op Group’s 100 per cent ownership will be diluted to 30 per cent, but the bank’s future will be secured. So perhaps the ECB is wrong and the EC’s hardline approach could work.
But it would be a mistake to think the Co-op case study holds all the answers for future bank bail-ins. First, it has been a messy process. The Co-op took months to devise a plan to fix the £1.5 billion capital deficit at the bank. Now after several more months that plan has been dramatically revised to invert the normal seniority ranking of bondholders. Neither approach would suit a listed bank. Its shares would have to be suspended, and a regulator-managed bail-in process would have to enforce the legal ranking of creditors, with no room for compromise.
Second, the Co-op is unique in its structure and in the ethical principles it has purported to abide by. That has meant the Co-op Group, as a former 100 per cent shareholder, has felt strongly obliged to stand by its banking subsidiary. That is not normally the case with listed banks – from Royal Bank of Scotland to Citigroup, bailouts took place because shareholders were not prepared to inject fresh equity.
And finally, the Co-op is a simple domestic bank. The real challenges for resolution regimes relate to large, complex banks that operate in multiple territories around the world, via separately capitalised subsidiaries in some, and via capital-light branches in others.
In its name, though, the group does perhaps convey a vital lesson: to succeed in the creation of effective resolution regimes, regulators around the world should abandon their blinkered approach to looking after domestic interests and be more co-operative.
Patrick Jenkins is the Financial Times’ banking editor.
Copyright The Financial Times Limited 2013.