Question

6. What are the key features of debt recovery plans?

Answer 1

Key Features of Debt Recovery Plans:

As Debt Recovery Plans are more frequent in Banking sector, we can take banking sector for explaining the Key Features of Debt Recovery Plan as below:

1. Governance: A bank’s recovery plan is owned by the bank itself (in contrast to a resolution plan which ultimately has to be owned by the resolution authority). The plan should be discussed and approved by the bank’s board (unitary or supervisory).

Executive management should be responsible for preparing and testing the plan. Management information should be reported to senior management and the board on early warning indicators and any breach of triggers.

Clear decision‑making should be in place for the activation of recovery options.

2. Documentation and data: A bank’s recovery plan should be supported by good documentation, data and management information. The plan needs to be clear, well understood and capable of being activated by senior management collectively, not just by a small number of key individuals.

Data and management information should identify when triggers are breached or are likely to be breached.

3. Integration: A bank’s recovery plan should be integrated with the bank’s

• strategic, risk management and business decision making processes

• capital and funding planning, stress testing approaches and capabilities, and business continuity planning

• capital and liquidity assessments (ICAAP and ILAAP)

• overall risk management, including risk data aggregation and reporting.

4. Scope: A bank’s recovery plan should consider the recoverability of the whole banking group, and of any entity within the group that performs a critical function.

5. Critical functions: A bank’s recovery plan should identify the bank’s core business lines, critical functions and critical services; and the key legal entities and jurisdictions from which these are provided. Banks need to consider not only how recovery options might preserve the continuity of critical functions, but also the possibility that some recovery options might endanger this continuity.

For systemically important banks (SIBs) the key issue here is to identify the critical functions that most need to be preserved because these functions are critical for financial stability and the real economy. This in turn requires a focus on the critical shared services (whether outsourced or provided from within a banking group) on which these critical functions depend, and on how a bank can maintain its access to financial market infrastructure.

For other banks the focus on key functions reflects a risk‑based approach to the supervisory assessment of recovery planning.

The criticality of functions will therefore depend on:

• the nature of the function itself

• the systemic importance of the bank supplying the function

• the scope for rapid substitutability by other suppliers

• the level at which criticality is assessed – regional, industry sectors, national, and other countries in which a banking group operates.

For banks, critical functions are likely to include payments, custody, retail deposit taking and retail lending, specialist lending sectors (for example SMEs, industry sectors and regions), clearing and settlement, some wholesale market activities, and market‑making in certain securities.

6. Scenarios: A bank’s recovery plan should be based on a range of firm‑specific, market‑wide and systemic scenarios, and combinations of these. The scenarios should be severe but plausible, and should cover both fast‑moving and slow‑moving events. The scenarios should include, but not be limited to, the scenarios used by the bank for its stress testing (including both the bank’s own internal stress tests and stress tests set by regulatory authorities).

A bank should consider the potential impact of these scenarios on its:

• Capital, liquidity and profitability

• Credit rating, and the cost and availability of funding (including capital)

• Risk profile and operational capacity

• Group‑wide position, including material subsidiaries, and its intra‑group funding

• Critical functions and the key legal entities, businesses and jurisdictions in which these functions are located

• External counterparties.

7. Triggers: A bank should develop a set of triggers and early warning indicators to highlight when recovery options might need to be activated. These should include:

• Capital

• Liquidity and funding

• Profitability

• Asset quality

• Internal forecasts of future performance

• Market indicators (for example credit rating, CDS spreads, stock price)

• Macroeconomic indicators

• Loss of key staff

• Other triggers relevant to the bank’s business.

8. Recovery options: A bank’s recovery plan should include a range of measures that the bank could take to restore its financial position (and market confidence in its standing) following an adverse shock. A bank therefore needs to identify credible options to enable it to survive a range of severe stressed scenarios, and to ensure that specific recovery options are in place to respond to each specific trigger point.

The range of recovery options should not be limited to raising capital or other funding, but should also include cost reduction (through lower bonuses and dividends, and reducing operational costs) and more radical options such as restructuring and the sale of assets or businesses

Taking specific recovery options would not be automatic. Circumstances may dictate variations in practice. But a bank should have identified a central case presumption of which recovery options would be activated in response to each trigger, and should have in place clear escalation processes to decide which recovery options should be activated.

A bank should not assume that public support would be available, or that a central bank will provide liquidity beyond pre‑announced arrangements (including acceptable collateral).

9. Testing, feasibility and updating: Although not all recovery options can be fully tested, a bank should have processes in place to check – as far as possible – that its recovery options are credible and could be activated successfully. This should include both scenario analysis and simulation‑type exercises.

A bank should be clear about the feasibility of each recovery option – the time it may take to implement, the time it may take before the benefits materialise, potential obstacles to implementation, and any need for preparatory measures to facilitate the implementation of each recovery option (or the implementation of multiple recovery options at the same time).

A bank should analyse the impact of each recovery option, including not only its intended purpose but the risk of any unintended side‑effects.

These analyses should also include the feasibility and impact of undertaking multiple recovery options at once, inter‑dependencies among recovery options, and the effectiveness and limitations of recovery options during a market‑wide crisis.

A bank should update its recovery plan annually, or after significant changes to its legal or organisational structure, business activities or its financial situation.

10. Communication: A bank’s recovery plan should include plans for internal communication, external communication and keeping its supervisors and other stakeholders informed in the event that a recovery option is activated.