Open Review of Management, Banking and Finance

«They say things are happening at the border, but nobody knows which border» (Mark Strand)

The “preparation” function in the new banking legislative framework

by Vincenzo Troiano – Andrea Sacco Ginevri [[1]]

Abstract: This Article examines certain issues arising from the new regulation on bank crisis recovery and resolution, and specifically the so-called “preparation” function, which sets the rules regarding the prevention and early intervention in case of financial instability affecting credit institutions. The preparation function is analyzed herein taking into account the directive 2014/59/EU,  considering its impact on the concept of sound and prudent management of banks and on their governance structure. Finally, this Article explains how the “preparation” function impacts on the “corporate interest” of banks.

Summary: 1. Introduction. – 2. The “preparation” function under BRRD: preliminary remarks. – 3. Recovery preparation and “qualified” prudent management. – 4. Recovery plans under a governance perspective. – 5. Preparation tools and corporate interest of banks.

1.  The regulation on bank crisis recovery and resolution raises several interpretative issues concerning its systemic role and impact, also in relation to traditional concepts of banking and financial regulation.

Even without considering the trends deriving from the introduction of the single resolution mechanism in the Euro area, reference is made, for example, to the effect produced by the introduction of an internal guarantee mechanism to solve crisis situations or by the removal of clear distinctions between the in bonis supervision and the managing of instability.

In addition to such variations of previous concepts, new institutions, or disciplinary patterns, to be analyzed in the context of the new regulatory framework have been also introduced.

To such area of intervention belongs the so-called preparation function.

With this expression we summarize the set of rules aiming at regulating the prevention and early intervention in case of financial instability affecting credit institutions. This area has attracted close attention immediately after the 2008 financial crisis, in particular, since the late perception of the financial entities’ weakening, as well as the lack of capacity of facing it (by financial institutions and competent authorities) have often been mentioned among those factors that would have triggered and made possible the abovementioned systemic crisis[[2]].

The matter as outlined above may be analyzed from several and different perspectives: the different institutions composing the function itself may be examined; the preparation function, and in particular the scope that covers the drawing up of recovery plans, may be analyzed: (a) in terms of restoring the concept of sound and prudent management of business, and in particular of prudent management and qualified prevention, (b) otherwise in terms of banking corporate governance, including the implications in terms of adequacy of governance arrangements. The preparation function may also be scrutinized in connection with the changing notion of corporate interest of banking entities.

A subject too extended even to simply attempt an approach; therefore, our analysis will be limited to some preliminary considerations.


2. The directive 2014/59/EU (Bank Recovery and Resolution Directive, “BRRD”) – implemented in Italy by the legislative decrees no. 180 and 181 of November 2015 – aims at establishing a recovery and resolution framework for banks, in order to prevent the potential need to rescue credit institutions with taxpayer funds (so called bail-out); in other words, the new legal framework aims at preventing insolvency and, in the event of insolvency, at reducing its adverse effects[[3]].

The improvement of the capital adequacy and prudential tools introduced by “CRD IV”, as hoped by the European lawmakers, should have reduced the possibility of future crises. However, there is a need to empower authorities with a set of tools to timely and quickly intervene for those intermediaries who face financial crises or instability.

Thus, specific attention is given to the preparation and planning of those interventions that should be implemented in case of unfavorable circumstances[[4]].

The early analysis of possible adverse scenarios and measures that may be taken if such adverse scenarios were to materialize, should serve as a safeguard to protect the functioning of the system as a whole (including the various actors involved, with their own responsibilities: consisting of entities, supervisory authorities, resolution authorities) to react quickly and early upon the emergence of situations of instability[[5]].

While from a functional standpoint this constitutes the main feature of the preparation phase, it should be noted that such phase will have to be structured differently depending on whether it is aimed at preparing the recovery of the entity in difficulty, or rather the resolution of the crisis faced by the entity.

The directive indeed identifies two separate measures comprising the preparation phase, revolving around recovery plans and resolution plans. The former contain measures aimed at restoring the financial situation of an entity after a significant deterioration of the same. The latter include resolution actions that the competent authority may implement when the entity meets the conditions for resolution provided under the directive.

The two instruments differ in several aspects; (a) the entities responsible for the drawing up of the plans; (b) the authorities involved in the drawing up and approval process; (c) more generally, in terms of introduction, the systematic placement of the two instruments.

Recovery plans are adopted by credit institutions themselves. It is true that the relevant legislation envisages significant occasions of dialogue with the competent supervisory authority during the plan preparation and, even more and in a more formal way, in the assessment phase; however, the plan remains an instrument that is drawn up and approved by the credit institution. On the contrary, the resolution plans are drawn up by the competent resolution authority; in this case, the entity subjected to the plan does not play an active role, but rather is subjected to significant obligations to report to and cooperate with the authority in charge of preparing the resolution plan.

This differences in structure with regard to the responsibility for drawing up the plans shows the evaluation of the legislator in relation to the prevailing interest in these two distinct situations: in the event of recovery, precedence is given to the autonomy of the concerned enterprise in assessing, in a forward-looking manner, the appropriate responses to deterioration in its financial condition; on the other hand, in the case of resolution, precedence is given to the public interest underlying the orderly management of crises, also considering the possible systemic impact of the same[[6]].

These instruments differ also with regard to the authorities that take part in the plan adoption phase. With regard to recovery plans, the competent supervisory authorities on the individual entities that have prepared the recovery plan are the ones to carry out the assessment on the adequacy of the plan itself. In this regard, the role of the resolution authorities is limited to the possibility of formulating recommendations to the competent supervisory authority with regard to those actions, envisaged under the plan, which could have an adverse impact during a possible resolution phase[[7]]. The resolution plan is – on the other hand – directly implemented by the entity’s resolution authority (and, in this case, the competent supervisory authority’s position is limited to cooperation with the resolution authority in gathering information necessary for the preparation of the plan)[[8]].

It is clear from the foregoing considerations, with regard to the systematic role of the two instruments being compared, that recovery plans fall more clearly under the supervisory area, whereas resolution plans fall within the area of crisis management or within the resolution area.

Recovery plans are positioned intrinsically within the ambit of ex-ante tools as instruments through which a default may be prevented; they are characterized by the previous imposition of measures to be implemented in order to stabilize the financial situation of an entity after a significant deterioration. Resolution plans, also informed on a preparatory ratio, are however positioned conceptually within the ambit of ex-post tools, as corrective measures to be taken if a default becomes inevitable, when recovery measures are not adoptable anymore and resolution mechanisms have to be adopted.

That said, if this main distinction is clear, it is worth noting that recovery plans, if they pertain to an entity that is not facing financial difficulties, nonetheless plan the measures to be implemented in order to overcome a hypothetical situation of deterioration; conceptually they fall on the border between the areas of prudential supervision – including the so called early intervention measures – and crisis management[[9]].

The institutional and functional structure introduced by the directive must lead to the consolidation over time of roles and responsibilities; which to date has not been thoroughly defined.

3. The significant relevance recognized to the preparation function, in particular to the recovery preparation – and thus to all the preparatory activities and assessments included in the competence of the bank – can be analyzed also considering its impact on the current concept of sound and prudent management of a credit institution.

The general clause of the sound and prudent management of the banks has always been appreciated for its flexible nature, and therefore, for its capacity to include in the course of time an updated meaning of an agere which results, at the same time, neutral in the interests pursued and aimed at achieving company’s profits through a management based on the protection of company’s assets[[10]].

The provisions of the package “CRD IV” gave reasons to view the sound and prudent management in the light of appropriateness of business organization and of capacity of assessing, monitoring and managing corporate risks[[11]]. The responsibility of the top-management in the definition of risk appetite of the banks summarizes this concept[[12]].

The introduction of specific instruments for the preparation of recovery of credit institutions, in case of potential events of (significant) capital and financial deterioration of the same, further qualifies the criterion of sound and prudent management. This latter is enhanced with a new meaning, identified in the need to prepare and adopt, and then observe and implement, specific preparatory measures which prevent and resolve the shallower and reversible crises, although these latter represent still far and potential scenarios[[13]].

In the drawing up of the recovery plan, the management body of credit institution is required to underline the risk factors – on the basis of plausible events, but still hypothetical – which could justify the provision, ex ante, of measures aimed at balancing the capital and financial situation of the company in case of its significant deterioration.

Therefore the concept of prudential management can be now read in the view of planning of the reaction measures for those risks that, even if non-current, are expected in case of adverse scenarios.

4. The considerations above explain the reason why the directive BRRD indicates that recovery plans are considered a governance arrangement under art. 74 of directive 2013/36/EU[[14]], with the consequence that, in the view of prudential supervision, the drawing up of such plans, their adoption, the monitoring on their periodic updating and so on, directly fall within the legal framework of the CDR IV and the related national legislation which concern such arrangements.

Equally, the prerogatives assigned to the competent authorities in relation to the prudential review, could be formally taken into account, in the overall assessment of the entity’s situation, even the content of the recovery plans.

As known, governance arrangements consist of all those mechanisms, procedures, processes, technical tools, placement in the framework of such factors, remuneration policies, aimed collectively at achieving and ensuring the governance and internal functioning of the entity. All of this is accomplished through an overarching structure that ensures the effective and prudent management of the intermediary and, in particular, of the risks to which it is exposed.

Considered from this perspective, namely as a governance arrangement, the recovery plan (rectius, its adoption) becomes a key instrument through which one of the main functions assigned to credit institutions’ management body is exercised[[15]].

The management body is assigned with general responsibility over the entity, approving and overseeing, inter alia, the implementation of its strategy concerning risk matter (article 8, paragraph 1, lett. a, directive 2013/36/UE).

The approval of the recovery plan constitutes an exercise in which the management body will have to demonstrate awareness of the bank’s position and all of the circumstances that may jeopardize its stability.

In performing such exercise, the management body may also decide to adopt immediately measures, aimed at reducing the identified sources of exposure to potential risk and underlying the scenarios envisaged under the plan.

Construed in these terms, the approval and the following update of recovery plans may constitute an element of regulation in the bank and in the performance of the management body, regarding the bank’s policies on the control of the exposure to risks[[16]].

On the other side, the particular depth of the analysis required during the assessment of recovery plans confirms the need, that has for some time been noted in the legal framework applicable to the sector, to enhance the qualitative composition of the management and supervisory bodies: in this sense, the deep knowledges and the diversified areas of specialized expertise constitute, for the management body as a whole, a fundamental requisite in order to be in a position to effectively fulfill the management body’s duties of examining and approving the plans in question.

5. Do the above mentioned considerations have an impact on the “corporate interest” of banks? In other terms, does the need to plan and implement initiatives to protect the potential deterioration of the banks, aiming at preventing scenarios that can cause a resolution (and, therefore, at avoiding its connected impacts on public finances) modify the traditional concept of “corporate interest” in banks introducing new goals to be pursued?

As anticipated, the new regulation stressed a trend towards the institutionalization of banks and, in particular, of their corporate governance, highlighting a banking corporate interest that now includes also the stability aims of the financial system as a whole[[17]].

Such a feeling seems supported by the preliminary comments following the introduction of the BRRD directive in Italy, which – underlining the apparent squeeze-out power of the resolution mechanisms implemented in Italy at the end of 2015 – pointed out (i) their negative impact on the shareholders and on certain stakeholders particularly exposed to the risk connected with their financial investment in the bank, as well as (ii) the relevant benefit for taxpayers, who will not be charged anymore by the practice of bail-out funded with community resources.

Actually, although it is clear that the new legislation on banking crisis aims at reducing the moral hazard once allowed by the bail-out mechanism – and, therefore, increases the financial risk of equity investments (or, however, of investments having similar exposure) without an equivalent increase of the profitability of these investments – the introduction, and implementation, of a preparation function of the banking recovery (which characterizes the BRRD grounds) aims at strengthening the protections granted to shareholders and to other similar equity investors of banks.

Indeed, one of the cornerstone of corporate law is the principle according to which who bear first the “financial cost” of the company’s insolvency are those who have invested in “equity”: this explains the qualification – as “residual claimants” – which foreign scholars generally grant to shareholders and to other similar investors (such as, for instance, holders of subordinated debt or of equity instruments, et similia).

However, the new element introduced by the BRRD is founded in the provisions according to which credit institutions shall adopt and implement preventive and mandatory measures,  aimed at excluding – or, at least, at mitigating – the possibility that equity investors would effectively bear corporate losses otherwise produced by the bank activity.

For such a purpose, the management body of the bank, on the one hand, and the competent supervisory authority, on the other hand, are called – since the beginning and with different tasks – to grant credit institutions a broad, effective and efficient ex ante set of tools useful to promptly react towards potential instability events or circumstances.

Thus, the preparation function of bank recovery contributes to substantially protect both the shareholders and other equity investors (who might bear the costs of a bank’s crisis), justifying a current management of the bank which shall respect, among others, the precautionary measures mentioned in the recovery plan, and therefore, able to preserve the economic and financial balance, also potentially, of the bank itself[[18]].

The above produces clear consequences in terms business and management decisions and, thus, on the corporate interest of banks.


* * * * *


[[1]] Text of the presentation, with the addition of notes, held at the Conference on “Banking and bail-in Crisis: what changes for banks and depositors?” at LINK Campus University of Rome, April 15, 2016. Although this paper is the result of a joint reflection of the authors, Vincenzo Troiano wrote the paragraphs 1, 2, 4 and Andrea Sacco Ginevri wrote the paragraphs 3 and 5.

[[2]] See Capriglione and Troisi, L’ordinamento finanziario dell’UE dopo la crisi, Turin, 2014, p. 81 ff.

[[3]] In this respect see Capriglione, Regolazione europea post-crisi e prospettive di ricerca del ‘diritto dell’economia’: il difficile equilibrio tra politica e finanza, in RTDE, 2016, I, 1 ff.; Stanghellini, La disciplina delle crisi bancarie: la prospettiva europea, in Banca d’Italia, Quaderni di Ricerca Giuridica della Consulenza Legale. Dal Testo unico bancario all’Unione bancaria: tecniche normative e allocazione di poteri, Acts of the convention held in Rome on September 16, 2013 no. 75, March 2014; Presti, Il bail-in, in Banca Impresa Società, 2015, p. 339 ff.; Di Brina, Il bail-in (l’influenza del diritto europeo sulle crisi bancarie e sul mercato del credito), report held during the annual convention of Associazione Orizzonti del Diritto Commerciale, Rome, February 26 and 27, 2016, 1 ff.; Guizzi, Il “bail in”nel nuovo sistema di risoluzione delle crisi bancarie. Quale lezione da Vienna?, in Corr. giur., 2015, p. 1485 ff.; Lemma, La nuova procedura di risoluzione: indicazioni per una insolvenza obbligatoria?, in RTDE, 2016, II, 23 ff.; Rossano, Nuove strategie per la gestione delle crisi bancarie: il bail-in e la sua concreta applicazione, in, 2016, 2 ff.; Gardella, Il “bail in” e il finanziamento delle risoluzioni bancarie nel contesto del meccanismo di risoluzione unico, in Banca e borsa, 2015, I, p. 587 ff.; Canepa, Crisi dei debiti sovrani e regolazione europea: una prima rassegna e classificazione di meccanismi e strumenti adottati nella recente crisi economico finanziaria, in Rivista AIC, 2015, p. 23 ff.; Cappiello and Capizzi, Prime considerazioni sullo strumento del bail-in: la conversione forzosa di debito in capitale, report held during the annual convention of Associazione Orizzonti del Diritto Commerciale, Rome, Febuary 21-22, 2014, 1 ff.

[[4]] See Stanghellini, cit., p. 156 ff.

[[5]] See Passalacqua, Diritto del rischio nei mercati finanziari: prevenzione, precauzione e cautela, Padova, 2012, passim; John-Litov-Yeung, Corporate Governance and Risk Taking, in The Journal of Finance, Vol. 63, Issue 4, 2008, p. 1679 ff.; Laeven–Levine, Bank Governance, Regulation, and Risk Taking, in NBER Working Paper no. 14113, 2008; Stulz, Governance, Risk Management, and Risk-Taking in Banks, in ECGI Finance Working Paper no. 427/2014, 2014.

[[6]] The report attached to the Italian legislative decrees implementing the BRRD clarifies that the legislative decree no. 181 – which amended the “Consolidated banking act” (legislative decree September 1, 1993, no. 385) by introducing, inter alia, the regulation on recovery plans (but not the regulation on the resolution plans, which find their legal framework in the legislative decree no. 180) – expressly intended to keep in the consolidated banking act “the institutions required by BRRD closer to the supervisory functions than the crisis management ones”.

[[7]] Article 6, paragraph 4, of the BRRD Directive, provides that the competent authority shall provide the recovery plan to the resolution authority. The resolution authority may examine the recovery plan with a view to identifying any actions in the recovery plan which may adversely impact the resolvability of the institution and make recommendations to the competent authority with regard to those matters. Compliant, art. 69-sexies, paragraph 2, of the consolidated banking act introduced by legislative decree no. 181/2015.

[[8]] See, in particular, art. 11 of BRRD Directive.

[[9]] Pursuant to art. 3 of BRRD Directive, Member States may exceptionally provide for the resolution authority to be the competent authorities for supervision for the purposes of Regulation (EU) No 575/2013 and Directive 2013/36/EU. In this case, adequate structural arrangements shall be in place to ensure operational independence and avoid conflicts of interest between the functions of supervision and the functions of resolution authorities.

[[10]] In these terms see, Maugeri, Fusioni e scissioni di società per azioni bancarie, in Banca e borsa, 1998, I, p. 34 ff.

[[11]] See Passalacqua, Diritto del rischio nei mercati finanziari: prevenzione, precauzione ed emergenza, cit.; Scotti Camuzzi, Le nuove disposizioni di vigilanza sul sistema dei controlli interni nelle banche. Un commento introduttivo, in Banca e borsa, 2014, I, 168-9.

[[12]] In these terms see Brogi, Corporate governance bancaria e sana e prudente gestione, in Banca Impresa Società, 2010, p. 300.

[[13]] See Rulli, Prevenire l’insolvenza. Dal salvataggio pubblico alla risoluzione bancaria: rapporti con i principi della concorsualità e prime esperienze applicative, in RTDE, 2015, 286 ff.; see also Bentivegna, Fondi di garanzia dei depositi e crisi bancarie. Novità e profili problematici alla luce del nuovo framework regolamentare europeo in materia risanamento e risoluzione, in RTDE, 2015, 25 ff.

[[14]] See Article 74, paragraph 4, of the directive 2013/36/UE, abrogated by Article 124 of the directive.

[[15]] The directive 2013/36/UE defines the management body as an institution’s body or bodies, which are appointed in accordance with national law, empowered to set the institution’s strategy, objectives and overall direction, and which oversee and monitor management decision-making, and include the persons who effectively direct the business of the institution.

[[16]] See Amorello–Huber, Recovery planning: a new valuable corporate governance framework for credit institutions, in Law and Economics Yearly Review, 2014, p. 314.

[[17]] In this regard see Aa.Vv., Il governo delle banche (edited by Principe), Milan, 2015; Aa.Vv., La governance delle società bancarie (edited by Di Cataldo), Milan, 2012; in these terms Capriglione, La governance bancaria tra interessi d’impresa e regole prudenziali (disciplina europea e specificità della normativa italiana)”, in La riforma societaria alla prova dei suoi primi dieci anni, edited by De Angelis, Martina and Urbani, Padova, 2015, p. 89 ff.; Amorosino, La conformazione regolatoria della governance delle società bancarie da parte della Banca d’Italia, in Dir. banc., 2015, p. 209 ff.; Cera, Il buon governo delle banche tra autonomia privata e vigilanze pubbliche, in Riv. soc., 2015, p. 947 ff.; Montalenti, Amministrazione e controllo nella società per azioni tra codice civile e ordinamento bancario, 2015, I, p. 727 ff.; De Prà, Il nuovo governo societario delle banche, in NLCC, 2015, p. 525 ff.; Portale, La corporate governance delle società bancarie, in Riv. soc., 2016, 48 ff.; Calandra Buonaura, Il ruolo dell’organo di supervisione strategica e dell’organo di gestione nelle Disposizioni di vigilanza sulla corporate governance e sui sistemi di controllo interno nelle banche, in Banca Impresa Società, 2015, p. 19 ff.; Frigeni, Prime considerazioni sulla normativa bancaria in materia di “organo con funzione di supervisione strategica”, in Banca e borsa, 2015, I, p. 485 ff.; Hopt, Better governance of Financial Institution, ECGI Working Papers in Law, n. 207, 2013, p. 3 ff.

[[18]] It is also clear that, within the category of shareholders (and of other risk instruments’ holders), those protected by recovery preparation instruments are long-term shareholders – increasingly protected and encouraged by the European and Italian legislator – in defense of their investment attitude, which is naturally oriented to the sustainable growth in the medium-long term (in line with their nature of “loyal shareholders”). The long-term shareholders, indeed, will benefit – during the period of their investment– of the potential benefits deriving from the recovery preparation tools, whose contribution in terms of stability of the bank can be appreciated in the long term (even if they may affect the shareholders’ positions in the short term).

Vincenzo Troiano is Full professor of Financial Markets and Intermediaries Regulation in the Department of Economics of the University of Perugia. He is a member of the Consultative Working Group of the ESMA’s IPISC.

Andrea Sacco Ginevri, Ph.D in Law and Economics, Roma Tre University.




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