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How the last financial crisis has driven improved resilience of banks

Banking insolvencies during the 2008 financial crisis highlighted areas that needed strengthening in the wider banking regulatory framework.

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The better the question

How can a long-term strategy stabilize a short-term crisis?

Experience navigating insolvencies during the financial crisis can inform the response to future shocks.

The continued financial difficulties faced by multiple industries in the wake of the COVID-19 pandemic gives the opportunity to reflect on the lessons learned from the Global Financial Crisis and consider how organizations can prepare for future shocks. 

Kaupthing Singer & Friedlander Limited (KSF) was a UK subsidiary of Iceland’s largest bank, Kaupthing Hf (Khf), offering banking services to individuals and small and medium-sized companies, in addition to wealth management services to high net-worth individuals. As the financial crisis reached its peak in 2008, banks were failing across the globe. The UK had already seen the nationalizations of several major household names and in Iceland Khf, as well as other major national banks, were also close to failure. 

At the request of the Financial Services Authority (FSA) and with the support of Her Majesty’s Treasury (HMT) and the Bank of England (BOE), EY insolvency practitioners were appointed as administrators of KSF the day before its parent, Khf, failed in Iceland. This appointment also occurred within 24 hours of being appointed as administrators of Heritable Bank plc, a subsidiary of Landsbanki, another Icelandic bank that had also failed. 

The EY team had significant experience previously advising BOE on contingency planning for two previous banks facing liquidity crises earlier in the financial crisis. With the lessons learned from the earlier bank nationalizations, it was determined that EY’s overriding objective as administrators was to ensure the smooth transfer of KSF’s retail internet-based deposits to ING Bank. At the same time, EY was to not only undertake the administration of the rest of KSF’s operations, but to also achieve a better result for the bank’s creditors who had claims totalling over £4bn (US$6bn) than would otherwise have been achieved from a liquidation.

The question, therefore, was how to devise a strategy – in the middle of a major global financial crisis – that stabilized the bank’s operations and maintained depositor confidence to avoid a run on other banks in the short term. Potential long-term value in the failed bank’s assets also needed to be identified. The ultimate goal was to maximize returns to creditors. 

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Rebuilding trust requires attention to detail

Improving operational efficiency is key to recovering from a crisis – and can reveal more effective long-term solutions.

The administration of KSF was complex. The Transfer Order stated EY had six months to complete the migration of 170,000 internet depositors to ING Bank. Furthermore, the bank had another 3,000 depositor balances due to a range of individuals, charities, corporate customers, local authorities, building societies, banks, other KSF Group companies and others. In addition, there were loan books worth a total of around £3bn (US$4.5bn) across three distinct portfolios; private banking, property and corporate; plus, a range of different subsidiaries that needed to be addressed.

With so many organizations and people dependent on this money to remain solvent during the growing financial crisis, EY had to continually remain conscious of the potential wider impact on KSF’s creditors’ business ecosystem – something of which HMT and the BOE were also acutely aware. 

Therefore, while acting fast to prevent panic in the heat of the financial crisis, both extreme attention to detail in addition to a longer-term perspective was required to overcome immediate operational concerns, maintain the confidence of the bank’s many depositors and maximize value for KSF’s creditors and other customers.

Addressing operational challenges to rebuild trust

In the run up to the collapse, as with most stressed businesses, KSF had been under intense operational pressure. In the early stages of the administration, there were a number of immediate IT, Legal and operational challenges that needed to be addressed. EY teams needed to rapidly bring together cross functional knowledge from multiple different competencies in order to help address these challenges and stabilize the business. 

For example, the bank’s accounting system and banking platforms were in a period of transition, with access also available to other Khf group entities outside of the UK. KSF also had no centralized legal department, meaning that there was effectively no standard loan or facility documentation. Lastly, the CFO had only been in place for a week prior to the administration, so was also in learning mode with the EY team.

Within the first few days, EY helped ensure both the banking platforms and accounting systems were stabilized and brought under control. Using the breadth of experience available across EY member firms, EY initiated longer-term projects to implement new accounting and banking systems that could be controlled more efficiently during the remainder of the administration process. 

EY was also able to provide stability and long-term leadership throughout the administration, supporting the bank’s loan management team, and providing continuity of support on a project that’s now run for 12 years.

In the early stages of the administration the EY team ensured they quickly understood the nature of the business and the complex operational challenges it faced. As a result, EY was able to implement a strategy that would start to provide reassurance and rebuild trust in the height of the crisis.

Establishing effective communications to maintain confidence

The Financial Services Compensation Scheme (FSCS) protects customers of failed regulated firms, including deposit-takers. Not only were the transfers of all internet-based deposits from KSF to ING Bank facilitated through FSCS, FSCS also protected the savings of any remaining depositor balances that were eligible. 

However, although customers already knew they would get their money back in due course, it was essential that EY worked effectively with FSCS to ensure a seamless response and that all communications were clear, accurate and timely to maintain public confidence.

James Darbyshire, FSCS chief counsel explains, “It was crucial to the effective and efficient protection of deposit-holders that FSCS and EY, as administrators, worked collaboratively on the insolvency of KSF. Not only did this allow deposit-holders to be paid promptly and in full, but it also helped to maintain public confidence in the wider financial services system at a time of crisis – a key part of FSCS’s mission.” 

As a result of successful teaming, the internet depositors were transferred to ING Bank via FSCS within only four months of EY’s appointment. The remaining deposits had to be thoroughly checked by both FSCS and EY to validate the eligibility of each depositor. This process took a number of months.  Once complete the savings of a further 2,000 non internet-based retail and SME depositors were protected. 

Although successful collaboration and communications enabled a favorable result in the case of the KSF administration, regulations introduced as a result of the 2008 crisis have now mitigated the risks of delays due to complex record keeping. All deposit-taking banks must now have a Single Customer View (“SCV”) database for their depositors to enable prompt repayment of eligible depositors in the event of the failure of a bank or other deposit takers. These SCVs are reviewed regularly by FSCS, which now aims to make payments to eligible depositors within seven days of a failure.

 

It was crucial to the effective and efficient protection of deposit-holders that FSCS and EY, as administrators, worked collaboratively on the insolvencies of KSF and Heritable Bank
James Darbyshire
Chief Counsel FSCS

Finding the long-term value during a short-term crisis

While also securing the savings of depositors in order to maximize value for creditors and ensure stability across the wider ecosystem, EY needed to understand the loan book and produce a long-term realization strategy to deal with the loans.

In consultation with the Creditors’ Committee, EY decided to take a longer-term strategy for both the loan books and KSF’s Asset Finance businesses. In order to create long-term value, a loan run-off strategy was implemented for the loan book. In addition, the asset finance businesses were restructured and consolidated, before being sold for a premium three years into the administration.

Throughout this process, it was essential that the creditors were kept informed and reassured that the EY administrators were making progress. Reassuring the creditors required regular communication and updates based on attention to detail, and a wide range of subject-matter experience.

This is why, since October 2008, the EY administrators have brought in a wide range of EY professionals from across the firm, many of whom remain with the Turnaround and Restructuring Strategy team, and continue to contribute to the success of this project. EY have been able to leverage scale and experience across Assurance, Tax, Consulting and Strategy and Transactions to bring in the right people to identify and address the right issues, in the right order, and at the right time to keep all stakeholders satisfied and achieve the best outcome for creditors.

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Building a more robust banking system through crisis

Lessons learned on operational and financial resilience could help banks weather the COVID-19 pandemic.

After over a decade of working out the loan books, the administration of KSF is close to completion. As of early 2021, the EY administrators expect to sell the two remaining assets and wrap up the administration in early 2022. To date, the EY administrators have also paid back 86.8p in the pound to creditors. 

I was really impressed with how the EY team mobilized at pace, and used their breadth of experience and expertise to deal with the myriad of issues that confronted them.
James Darbyshire
Chief Counsel FSCS

FSCS also recently wrapped up its involvement in the banking crisis. James Darbyshire said “FSCS makes recoveries wherever possible and cost-effective, to recoup the money we pay in compensation. Overall, we paid out £20.9bn (US$31.4bn) in compensation as a result of the banking crisis. We’ve recently closed the book on the 2008 banking crisis, having since recovered £20bn (US$30bn) of that from the failed banks, which shows how crucially important our recoveries process is.” 

James reflected that, “In our role as the largest creditor, I was really impressed with how the EY team mobilized at pace, and used their breadth of experience and expertise to deal with the myriad of issues that confronted them.  As a member of the creditors’ committee, I also saw first-hand how effectively and tenaciously the EY team resolved the complexities of each failure to ensure the best possible return for the general body of creditors over the lifetime of these estates.”

Reshaping regulation

EY administrators were appointed to the only three UK deposit-taking banks which failed in 2008 as well as having significant involvement in other bank restructurings or insolvencies for HMT or the BOE at the time. EY’s experience in dealing with these matters was used by HMT to inform some of the provisions of the Banking Act 2009. The failures and the lessons learned on operational and financial resilience have led to a more robust banking regulatory framework for the UK – one that has helped inspire similar regulatory reforms in other markets in the wake of the crisis. 

In particular, as EY was consulted by the UK government on potential regulatory changes in the wake of the financial crisis, their experience in the early stages of the KSF administration helped highlight the need for continuity of supply in an insolvency – not just of utilities such as gas and electricity but also, crucially for a financial services company, operational, accounting and IT systems.

I saw how effectively EY resolved the complexities of each failure to ensure the best possible return for the general body of creditors over the lifetime of these estates.
James Darbyshire
Chief Counsel FSCS

As a result of the financial crisis, all banks in the UK must now have recovery and resolution plans or “living wills” to ensure, inter alia, that some of the operational challenges EY encountered when appointed as KSF’s administrators should no longer create additional hurdles to overcome in a crisis.

Lessons for the COVID-19 pandemic and recovery

These inputs to the formation of the UK’s post-crisis banking legislation have helped to build more resilient British banks.  As a result, they are in a much better position to withstand future crises, including the widespread disruption caused by the COVID-19 pandemic.

That does not mean, however, that there will not be issues again – especially at some of the smaller financial institutions in the next year or two. Job losses and bankruptcies will mean that loan book performances are likely to deteriorate and some lenders that are dependent on wholesale funding may come under renewed pressure.

The global financial crisis resulted in significant change to the banking industry. Thanks to the introduction of more robust legislation and enhanced compensation schemes, retail depositors are well protected, reducing the risk of bank runs in the future. Major banks are also structurally sounder with more adequate capitalization than before and the improvements in legislation and regulation have, hopefully, lessened the future need for the interventions and formal insolvencies we saw in the Global Financial Crisis.

However, to remain safe, banks will need to continually review their resilience and growth strategies to navigate the economic and financial impact of the COVID-19 pandemic, and future challenges which may affect all or part of the global economy.

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