Banks have always had contingency plans. But the financial crisis demonstrated that many banks did not have viable plans to recover from severe shocks.
As a result, EU legislation (the Bank Recovery and Resolution Directive “BRRD”) has been put in place to require banks to develop credible recovery plans. Contingency planning for more severe and wide-ranging adverse scenarios should enhance the resilience of banks.
Banks should develop recovery plans that identify credible options to survive a range of severe but plausible stressed scenarios. This should be part of the good management of a bank, not just a response to a regulatory requirement. The recovery plan should also cover governance and decision-making; the continuity of critical economic functions; the specification of trigger points to activate recovery options; and internal and external communications.
In turn, a bank’s supervisor should assess the credibility of the bank’s recovery plan and, if necessary, require the bank to amend its plan, hold additional capital or liquidity, or restructure its business in order to make the plan sufficiently credible.
In practice, some banks have struggled to construct sufficiently credible recovery plans. A series of thematic reviews conducted by the European Banking Authority (EBA) have revealed inadequacies in some banks in the identification of core business lines and critical functions; the range of scenarios used by banks; governance arrangements; and the specification of recovery options.
Similarly, the European Central Bank (ECB) and the UK Prudential Regulation Authority (PRA) have highlighted areas for improvement in banks’ recovery planning, including in the content of recovery plans, the practical usability of plans, the governance and decision-making around preparing and activating recovery options, integrating plans with stress testing and risk management, preparatory measures and testing of plans, the identification of critical functions, and the coverage of material subsidiaries within group recovery plans.
Although this paper focuses on banks, there is a read-across to other types of financial institution – including insurance companies and asset managers – and to financial market infrastructure such as central clearing houses.