On February 19, the ECB announced that it had informed the Latvian authorities of the need to impose a moratorium on payments by ABLV bank. This measure consists of suspending, at the authorities’ request, payments that a credit institution must make to prevent a massive outflow of funds from endangering its survival. This is commonly known as a “corralito”.
The ECB justified the moratorium to stabilize the outflows of funds occurring at the Latvian bank following reports related to money laundering. Five days later, however, the European supervisor reported that the bank was unviable due to the deterioration of its liquidity situation. The deposit freeze, therefore, did not achieve its objective of stabilizing the entity.
The 2014 Bank Recovery and Resolution Directive regulates the moratorium for entities that have already been declared unviable and are under the governance of the authorities. However, the moratorium to which ABLV was subjected occurred at a pre-resolution stage. In this case, the entity had not been declared unviable, but was in the process of deteriorating, and a deposit freeze was expected to stabilize it.
Currently, pre-resolution moratoriums are not included in the regulatory framework of all European Union countries. However, the European Commission wants this tool to be implemented throughout the EU with a homogeneous operation. Brussels’ proposal is part of the package known as the Risk Reduction Package, which has been under negotiation in Europe since November 2016 and promotes a modification of the prudential and resolution regulations for credit institutions.
These community negotiations address three aspects of the deposit freeze design. Firstly, there is discussion on whether it should be implementable before the entity is declared unviable (Latvian case) or after being declared unviable but before entering resolution. Secondly, the period during which the distressed entity may be subject to the payment moratorium is addressed. At this point, a period of between two and five days is being considered, which would deviate from international standards, set at two days, and could create greater uncertainties in international markets. Thirdly, it is being considered whether all of the entity’s liabilities should be subject to the deposit freeze or if retail deposits and derivatives should be excluded.
Before discussing the technical aspects of this tool, fundamental questions should be addressed, such as whether it is truly necessary and what collateral effects it could cause.
There is no doubt that the moratorium is useful, mainly for the resolution authority, which gains more time to make a decision. However, it is unlikely that once this tool is applied, the outcome will be anything other than resolving the entity. Therefore, we understand that the pre-resolution moratorium does not serve to avoid resolution. Along the way, however, it generates undesirable effects.
To begin with, the mere existence of this tool can generate panic among depositors and other investors of the entity: faced with the risk of restrictions being imposed on payments to an entity not yet declared unviable, creditors may accelerate the outflow of funds and worsen its situation. This has been expressed by various investors in numerous forums.
It should not be forgotten that the banking business relies on the trust of its clients and investors. This uncertainty could lead to an increase in the financial cost for entities, making banking liabilities that could eventually be affected by the deposit freeze more expensive. And ultimately, this could increase the cost of loans and other financial instruments or services.
Furthermore, it is not idle to think that the imposition of these measures on one credit institution could spread to others and generate a larger-scale financial instability problem.
Secondly, framing this tool within the regulatory framework of the deposit guarantee fund entails technical difficulties, given that the non-payment of deposits automatically activates the guarantees of the deposit guarantee fund.
Finally, the resolution framework was created, among other reasons, to ensure the continuity of critical economic functions that entities provide to the real economy. These include payment services and cash management for their clients. It is inconsistent for an entity to stop providing these critical services before entering a resolution process when the resolution framework is precisely what it seeks to avoid.
The new community resolution framework is already sufficiently comprehensive and ambitious today. There is no need to spice it up with measures of questionable utility, as the Latvian case demonstrates, and potential undesirable effects for the system as a whole.
Pedro Cadarso, Advisor
