03 April 2018

BIS: Early intervention regimes for weak banks

Prudential authorities conduct early interventions with the aim of prompting banks to address their weaknesses in a timely way. Early supervisory interventions are normally authorised under regular supervisory powers, which generally allow for a significant amount of discretion and scope for supervisory judgment.

Some jurisdictions have set up more formal early intervention regimes that help supervisors directly address banks’ weaknesses and trigger effective action when specific conditions are met. As they limit the degree of discretion allowed to supervisors, these regimes also reduce the risk of supervisory forbearance.

Formal early intervention regimes differ across jurisdictions. The main differences relate to the indicators used to trigger early interventions, any categories or steps within the formal early intervention regime, and the range of powers and the degree of discretion allowed to supervisors when deciding to activate the early intervention regime. For instance, PCA relies solely on capital triggers whereas the EIM regime considers composite indicators, such as supervisory ratings and events deemed significant by the supervisory authority. PCA mandates intervention once the triggers are breached and prescribes the measures to be taken, whereas the EIM obliges supervisors only to take an explicit decision on whether to intervene and gives them considerable flexibility in selecting intervention tools. Regimes in India, Japan, Peru, the Philippines and other countries have features that lie somewhere between these two examples.

There are trade-offs to consider when setting the triggers for a formal intervention framework. Capital-based triggers are based on relatively simple, transparent and harmonised bank solvency indicators. Such triggers are explicit and make for an internally consistent framework. However, capital is often a backward-looking indicator of bank weaknesses. Other, more forward-looking indicators may lead to more timely action but are less transparent and objective, potentially raising consistency issues and litigation risks. Nevertheless, more recent formal early intervention regimes and most recently revised regimes tend to make more use of composite “early warning” indicators including supervisory ratings.

Similar trade-offs apply to supervisory action when triggers are hit. The obligation to take specified measures may reduce the risk of forbearance and ensure a timely response. But, by reducing or removing supervisory discretion, it can limit supervisors’ scope for adjusting their intervention to avoid putting unnecessary stress on the institution and for selecting the most appropriate measures. When formal early interventions are disclosed to market participants and customers, this lack of flexibility can have unintended consequences.

While formal intervention regimes cannot replace discretionary interventions based on regular supervisory powers, they provide useful backstops. They can be particularly effective when measures are required – such as the replacement of a whole management team or board of directors – that may not be enforceable under regular supervisory powers. At a minimum, the option to activate one of these formal regimes constitutes a credible threat for weak institutions, thus bolstering the effectiveness of regular supervisory measures.

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