## IADI Core Principles on the Use of Deposit Insurance Funds in Resolution

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### Introduction and purpose
- Strengthen resolution regimes so government bailouts are the last, not first, resort.
- International standard: Key Attributes of Effective Resolution Regimes for Financial Institutions (KA) prescribes tools, powers, and funding arrangements to resolve “any financial institution that could be systemically significant or critical if it fails.”
- Paper objective: present a framework to weigh relative advantages of different resolution funding options, document developments to date, and discuss advantages and disadvantages of options.

### Resolution funding — definition, objectives, and context
- Definition and context:
  - Resolution: exercise of powers and tools under the legal framework that applies to failing systemic financial institutions (SIFIs) by a public resolution authority tasked with preserving financial stability.
  - KA3 requires powers to effect a transfer of assets and liabilities to establish a temporary bridge institution and, among others, to bail in creditors.
  - Resolution powers should be exercisable quickly and without requiring shareholder or creditor consent; resolution regimes are distinct from ordinary corporate insolvency regimes.
- Why funding is needed:
  - Buttress internal resources of the failed SIFI.
  - Replace illiquid, encumbered, or impaired assets.
  - “Grease the wheels” of resolution (e.g., back transfer of deposits, purchase impaired assets, inject liquidity after a bail-in).
- Placement within safety net: resolution funding sits within a well-designed financial safety net comprising the resolution authority, lender of last resort, supervisors, deposit insurance authority, and ministry of finance.
- Resource needs vary:
  - Isolated non-systemic failures: protecting insured deposits via transfer or prompt reimbursement by the deposit insurance scheme (DIS) may suffice.
  - Systemically important banks: additional resources may be needed for capital and/or liquidity, continuity of critical functions, and protection of creditors deemed systemic.
  - System-wide crises: may require exceptional measures (e.g., guarantees of assets or liabilities or capital injections by the government).
- Principle: Preserving critical functions does not imply that all creditors must be fully or partially protected.

### Loss-absorbing capacity and need for external funding
- Building firm-specific loss-absorbing capacity is crucial (e.g., TLAC for G-SIBs: regulatory capital, subordinated debt, long-term debt).
- Calibration difficulties: depends on intervention timing, resolution strategy, asset valuations (going-concern vs gone-concern), and contagion risks.
- Risks of bail-in: using up loss-absorbing capacity through bail-in may increase risk of runs on wholesale creditors and contagion.
- Core contention: authorities should be able to access or promptly mobilize additional resources for orderly resolution.
- KA 6.1 recommendation: resolution funding arrangements should be set up in advance so authorities are not constrained to rely on public ownership or bail-out funds.
- Three broad arrangements (KA 6.2):
  - (a) privately (industry)-financed deposit insurance funds,
  - (b) privately funded resolution funds,
  - (c) temporary access to government funds within a mechanism allowing ex post recovery from the industry of costs incurred by government (ex-post resolution fund).

### Using central bank funds in resolution
- Central banks may provide liquidity support to a bank in resolution, subject to adequate safeguards.
- Central bank roles:
  - Provide ELA to entities in resolution where solvency is in doubt but the entity is systemic and viable within a realistic, time-bound recapitalization or resolution plan.
  - Provide liquidity to ensure continuation of critical functions (e.g., while creating a bridge bank).
- Sequence and governance:
  - Resolution and/or supervisory authority should first make a positive determination of viability.
  - Once viability is determined, central bank decides on ELA provision and associated safeguards, including any government indemnity.
- Constraints:
  - Central bank balance sheet should be used only for providing liquidity on a prudently collateralized basis; central bank should not provide capital or unsecured loans to a bank in resolution.
  - ELA can complement but not substitute for the resolution funding arrangement envisaged in KA6.

### Using deposit insurance funds in resolution — arguments, limits, and safeguards
- Arguments for using DIFs in resolution:
  - Deposit insurance and resolution roles are closely aligned in preserving financial stability and reducing deposit run risk.
  - Economies of scale: funds collected for payout can also support resolution, avoiding liquidation and payout.
  - Resolution actions (e.g., transfer of retail deposits) can preserve depositor confidence, continuity of services, maximize value, and often secure higher “going-concern” asset values.
- Legal and mandate constraints:
  - Use of DIS funds in resolution requires a legal framework allowing it (e.g., DIS with a dual “risk or loss minimizer mandate” or “pay box plus” mandate).
  - IADI Essential criterion 8 of core principle 9: a deposit insurer not being the resolution authority should have the option, within legal framework, to authorize use of its funds for resolution up to the net cost it would have incurred in a liquidation payout.
- Typical insufficiency in systemic cases:
  - DIS primary objective is to cover insured deposits and is normally calibrated to cover losses in a fraction of the insured pool, not the failure of a large systemic bank or generalized crisis.
  - Such events typically require significantly more resources than those available in a paid-in DIF.
- Recommended safeguards when using DIFs:
  - Net least-cost test.
  - Back-up line of credit from the government.
  - Consider caps so paid-in deposit insurance funds do not drop below a certain level, e.g., 50 percent of the target ratio.
  - Avoid exposing DIS to significant uncertainty and risk (e.g., avoid “open bank assistance” that should be central bank/ELA remit).
- Rationale for a separate resolution fund:
  - Needed for resolution of nonbank financial entities (may not take deposits or contribute to DIS).
  - Addresses limitations and cross-jurisdictional differences in DIS legal frameworks.

### IADI Core Principles (Essential criterion 8 of core principle 9)
- Conditions for a deposit insurer authorizing use of its funds for resolution when it is not the resolution authority:
  - a. deposit insurer is informed and involved in the resolution decision-making process;
  - b. use of deposit insurer’s funds is transparent and documented, and clearly and formally specified;
  - c. resolution results in a viable, solvent, and restructured bank limiting exposure of the deposit insurer to further funding for the same obligation;
  - d. contributions are restricted to the costs the deposit insurer would otherwise have incurred in a payout of insured depositors in a liquidation, net of expected recoveries;
  - e. contributions are not used for recapitalization of resolved institutions unless shareholders’ interests are reduced to zero and uninsured, unsecured creditors are subject to pari passu losses in accordance with legal claim priority;
  - f. use of deposit insurer’s funds is subject to an independent audit; and
  - g. all resolution actions and decisions using deposit insurance funds are subject to ex post review.

### Net least-cost test (Box 2)
- Definition: ensures costs to the DIF of contributing to a resolution event are no higher than costs the DIF would otherwise have incurred in a payout of insured depositors, net of expected recoveries.
- Operationalization:
  - Adopt/mandate a cap preventing the DIF from contributing more than the estimated net cost it would have incurred in liquidation.
  - Allow a gross (upfront cash) contribution up to the value of the insured deposits (the amount the scheme would have paid out upfront in cash in a liquidation).
  - An upfront cash or ‘gross’ contribution may be required to effect the resolution; the net least-cost test formulation should not prevent this.
  - Such use may be compulsory under national law.
- Rationale:
  - Resolution can be less costly if it delivers higher than liquidation value for the bank’s assets and liabilities.
  - The cap helps limit DIF contribution where insured deposits and also other creditors are protected.
  - Where insured deposits are preferred to other senior unsecured creditors, the net cost to the DIF in liquidation might be zero—this should not prevent DIF support if net cost is zero and policy outcomes (e.g., continuity of depositor services) are better.

### Systemic risk exemption
- Practice: Some countries (e.g., Canada, Japan, and the United States) allow DIFs to depart from least-cost principles where adherence could have a severe adverse impact on financial stability.
- Safeguards and conditions:
  - Any exception should be subject to strict governance safeguards to minimize moral hazard and ensure deployment only in extremis.
  - Availability of a separate resolution fund for systemic cases may reduce need for such an exemption.

### Separate resolution funds — roles, uses, and experience
- Purposes:
  - ‘Top up’ funding available from the DIF.
  - Protect uninsured creditors as needed.
  - Prevent contagion and preserve financial stability in a bank resolution.
  - Insulate the DIS from sizeable contingent liabilities when a systemic bank fails.
- Possible uses (in principle):
  - Make capital contributions to a bridge or bailed-in institution, or asset management vehicle (AMV).
  - Make loans to systemic financial institution(s) in resolution, including subsidiaries, a bridge institution, or AMV.
  - Support other measures necessary to preserve critical functions and maintain financial stability.
  - As a last resort, guarantee assets/liabilities or provide capital for systemic institution(s) outside resolution (“open bank assistance”).
- Observations:
  - Separate resolution funds are relatively new; international experience limited and approaches vary (ex ante vs ex post; governance; safeguards).
  - Funding demands in systemic failures or generalized crises could be very large, raising questions about “optimal” size, opportunity costs (if ex ante funded), and moral hazard impact.

### Ex post versus ex ante resolution funds
- Ex post resolution funds:
  - Mechanism: public funds allocated to resolution and recovered from industry later.
  - Preconditions: procedure to determine systemic failure; mechanism to make public funding available at short notice; mechanism linking temporary support to recoveries and, if necessary, industry levies (KA 6.2) phased to mitigate procyclicality.
  - Advantages:
    - No burden on industry during stable times; lower opportunity costs.
    - Requires less administration.
  - Disadvantages:
    - Larger upfront borrowing by public sector during stress.
    - Stronger bank-sovereign links.
    - Less fair (beneficiaries did not contribute in advance).
    - More procyclical; higher burden on industry in stressed times.
  - Operational note: appropriate authority to provide temporary public funding is the government, not the central bank.
- Ex ante resolution funds:
  - Mechanism: pre-funded by industry contributions; resources readily available.
  - Advantages:
    - Readily available if sufficient resources collected.
    - Reduces need for upfront public funding.
    - Less procyclical; costs distributed over time.
    - Failed entity contributes in advance; risk-based levies can mitigate moral hazard.
    - Can fund administrative costs of the resolution authority.
  - Disadvantages:
    - Opportunity costs through lower bank profits with resources invested in low-return safe assets.
    - May need to be large to cover systemic risks—earmarking national savings.
    - A paid-in fund may fuel perception that uninsured creditors will be bailed out, increasing moral hazard.
  - Design considerations:
    - Operational features—perimeter, base, rate of the levy—are important and should be clear from the outset.
    - Deciding on appropriate fund size and assessing opportunity costs will be difficult.
    - Whether an ex ante fund reduces creditor-run risk remains an open question.

### Design and governance safeguards for resolution funds
- Credibility and moral-hazard mitigation:
  - Government backstop to the fund, triggered by clearly stipulated conditions and subject to subsequent recovery from the industry, enhances credibility.
  - Where build-up of an ex ante fund may be slow or infeasible, establish clear procedures for quick temporary funding (e.g., standing budgetary authorization for contingency up to a cap) and legal/operational frameworks for recovery via ex post mechanisms.
  - The institution managing resolution funding (typically the resolution authority) should be well governed, operationally independent, with arrangements for information sharing, accountability, regular assessment, audit, and ex post review.
- Measures to minimize moral hazard:
  - Effective resolution regimes promoting timely resolution.
  - Imposing losses on shareholders, subordinated creditors, and potentially senior unsecured creditors; removing failed firm management.
  - Differentiated premiums (for ex ante funds).
  - Price incentives to exit public backstops and return to market financing as early as feasible.

### Key design parameters for ex ante resolution funds (Box 4)
- Perimeter of the levy:
  - Minimum: all systemic financial institutions covered by the resolution regime.
  - Broader perimeter (e.g., all financial institutions) could address migration of systemic risk and recognize universal benefits.
- Base of the levy:
  - Should differ by institution type and funding model; take a broad, risk-based approach (e.g., include off-balance sheet items).
  - Simple balance sheet metrics may be distortionary across institution types.
- Target level:
  - No international consensus on adequate level.
  - Calibration could consider past resolution costs and structural features, resolvability assessments, and amount/distribution of loss absorbing capacity (LAC). TLAC applies only to G-SIBs.
  - Opportunity cost evidence: Laeven and Valencia (2012) estimate the median fiscal cost of 147 banking crises between 1970 and 2011 at 7 percent of GDP for all countries, and 10 percent for emerging market economies and developing countries; some countries incurred fiscal costs above 40 percent of GDP.
- Rate of the levy:
  - Should be variable and risk-sensitive; lower for non-systemic and less risky institutions.
  - Rate could be adjusted over the cycle to reduce procyclicality.
- Investments:
  - Ex ante funds should invest in highly liquid and safe assets (e.g., not placed in domestic financial institutions that may need resolution).
- Contingency line:
  - Resolution authority should have access to a government-provided credit line to complement ex ante funding given potential large gross financing needs.

### Examples and policy context
- U.S. example: Dodd-Frank Act established the Orderly Liquidation Fund (OLF) — an ex post resolution fund with a fiscal backstop — authorizing the FDIC to obtain temporary funding for resolution of systemically important nonbank financial institutions by borrowing from the U.S. Treasury via the OLF, subject to certain limits and caps.
- EU practice: Ex ante resolution funds are becoming more common in Europe; the EU requires national resolution funds in member states, with a view to gradual pooling into a Single Resolution Fund (SRF). Contributions are raised annually from credit institutions and investment firms authorized in the EU, while extraordinary ex post contributions can be levied when available financial means are insufficient.

### Conclusions and policy recommendations
- Tailor resolution funding to institutional, market, and policy context:
  - Consider financial system characteristics (size, concentration, structure, risk appetite, role of banks vs nonbanks).
  - Consider legal and institutional safety-net architecture and synergies between depositor protection and resolution.
  - Assess institutional capacity to execute resolution actions.
  - Consider regional/harmonized frameworks and cross-border pooling.
- Priorities:
  - Adequate ex ante funding of a DIS is advisable where supporting arrangements are in place (sound financial sector structure; effective prudential regulation, supervision, and bank resolution; strong legal/judicial frameworks; accounting and disclosure systems). Establish a DIS with an ex ante fund and capacity to contribute to bank resolutions (e.g., a pay-box plus mandate).
  - The case for a separate resolution fund is not strong generally. In jurisdictions with ex post or underfunded deposit insurance, priority should be to increase the DIF’s resources and make it available for bank resolution, subject to safeguards.
  - If establishing separate resolution funds, consider an ex post design where scarce national savings are better deployed elsewhere.
  - If used, resolution funds should have clear legal and operational frameworks and safeguards to minimize moral hazard; deploy resources only in systemic cases after recognition of resolved entities’ losses to ensure burden sharing with shareholders and other creditors, and subject deployment to strict conditions.
- Operational readiness:
  - Establish clear procedures for quick allocation of resolution funding (e.g., standing budgetary authorization for contingency up to a cap).
  - Ensure coordination and information sharing among authorities involved.

### APPENDIX I — U.S. Deposit Insurance Funding in the Global Financial Crisis: overview and key facts
- DIF depletion and crisis metrics:
  - Pre-crisis DIF: US$52.4 billion or 1.22 percent of insured deposits.
  - Between January 2008 and September 2009, 120 U.S. banks failed.
  - DIF deficit reached US$8.2 billion by end-September 2009.
- Most costly failures for the DIF (explicit amounts):
  - Indymac: US$13.1 billion
  - Bank United: US$5.7 billion
  - Colonial Bank: US$4.5 billion
- Larger institutions (Bank of America, Citibank, Washington Mutual) ultimately did not incur losses for the DIF.
- FDIC responses and restoration measures:
  - Substantially increased assessments on the industry in a procyclical way.
  - Under a 2009 Restoration Plan, measures included a one-off mid-year assessment and mandating banks to pay an estimated three years of deposit insurance premiums in advance.
- Broader U.S. public support:
  - Troubled Asset Relief Program cumulative disbursals: $434 billion.
  - FDIC’s line of credit from the U.S. Treasury was increased from US$30 billion to US$100 billion during the crisis.
- Key takeaways:
  - Pre-crisis DIF buffer (US$52.4 billion; 1.22 percent of insured deposits) was insufficient against widespread small- and medium-bank failures.
  - Emergency measures (increased assessments, advance premium collection, expanded Treasury credit line) were necessary to restore the DIF and preserve confidence.
  - Crisis response involved far larger fiscal and liquidity measures outside the DIF, notably US$434 billion in TARP disbursals.

*Source: Technical Notes and Manuals 18/01 |   2018.*

### 1.  IADI Core Principles on the Use of Deposit Insurance Funds in Resolution . . . . . . . . . . . . 10

### 1.  IADI Core Principles on the Use of Deposit Insurance Funds in Resolution

### Introduction and purpose
- Strengthen resolution regimes so government bailouts are the last, not first, resort.
- International standard (Key Attributes of Effective Resolution Regimes for Financial Institutions, KA) prescribes tools, powers, and funding arrangements to resolve “any financial institution that could be systemically significant or critical if it fails.”
- Paper presents a framework to weigh relative advantages of different resolution funding options, documents developments to date, and discusses advantages and disadvantages of options.

### Resolution funding — definition, objectives, and context
- Resolution: exercise of powers and tools under the legal framework that applies to failing systemic financial institutions (SIFIs) by a public resolution authority tasked with preserving financial stability.
- KA3 requires powers to effect a transfer of assets and liabilities to establish a temporary bridge institution and, among others, to bail in creditors.
- Resolution powers should be exercisable quickly and without requiring shareholder or creditor consent; resolution regimes are distinct from ordinary corporate insolvency regimes.
- Resolution tools require readily available and sufficient funding to:
  - buttress internal resources of the failed SIFI;
  - replace illiquid, encumbered, or impaired assets;
  - “grease the wheels” of resolution (e.g., back transfer of deposits, purchase impaired assets, inject liquidity after a bail-in).
- Resolution funding refers to financing used to support use of resolution powers and achieve resolution objectives; it sits within a well-designed financial safety net comprising the resolution authority, lender of last resort, supervisors, deposit insurance authority, and ministry of finance.
- Resources required vary significantly with systemic risk; for isolated non-systemic failures, protecting insured deposits via transfer or prompt reimbursement by the deposit insurance scheme (DIS) may suffice.
- For systemically important banks additional resources may be needed to meet capital and/or liquidity needs, ensure continuity of critical functions, and protect creditors deemed systemic.
- System-wide crises may require exceptional measures as a last resort, e.g., guarantees of assets or liabilities or capital injections by the government.
- Preserving critical functions does not imply that all creditors must be fully or partially protected.

### Loss-absorbing capacity and need for external funding
- Building firm-specific, loss-absorbing capacity is crucial (e.g., TLAC for G-SIBs: regulatory capital, subordinated debt, long-term debt).
- Precise calibration of loss-absorbing resources is difficult ex ante; depends on intervention timing, resolution strategy, asset valuations (going-concern vs gone-concern), and contagion risks.
- Using up loss-absorbing capacity through bail-in may increase risk of runs on wholesale creditors and contagion.
- Central contention: resolution authorities should be able to access or promptly mobilize additional resources for orderly resolution.
- International standard (KA 6.1) recommends having resolution funding arrangements set up in advance so authorities are not constrained to rely on public ownership or bail-out funds.
- KA recognizes three broad types of arrangements consistent with efficient resolution:
  - (a) privately (industry)-financed deposit insurance funds,
  - (b) privately funded resolution funds,
  - (c) temporary access to government funds within a mechanism allowing ex post recovery from the industry of costs incurred by government (KA 6.2).
- These three options are collectively “resolution funding arrangements”; the third option is categorized as an “ex-post resolution fund.”

### Using central bank funds in resolution
- Central banks, as lenders of last resort, should be able to provide liquidity support to a bank in resolution, subject to adequate safeguards.
- A bank in resolution may need liquidity to ensure continuation of critical functions (FSB 2016a), e.g., while creating a bridge bank.
- Central bank may provide ELA to entities in resolution where solvency is in doubt but the entity is systemic and viable within a realistic, time-bound recapitalization or resolution plan.
- Sequence and governance:
  - Resolution and/or supervisory authority should first make a positive determination of viability.
  - Once viability is determined, it should be up to the central bank to decide on ELA provision and associated safeguards, including any government indemnity.
- Central bank balance sheet should be used only for providing liquidity on a prudently collateralized basis; central bank should not provide capital or unsecured loans to a bank in resolution.
- ELA can complement but not substitute for a resolution funding arrangement envisaged in KA6.

### Using deposit insurance funds in resolution — arguments, limits, and safeguards
- Arguments for using deposit insurance funds (DIFs) in resolution:
  - Roles of deposit insurance and resolution are closely aligned in preserving financial stability and reducing deposit run risk.
  - Economies of scale: funds collected to pay out deposit insurance could also support resolution, avoiding liquidation and payout.
  - Resolution actions (e.g., transfer of retail deposits to a healthy bank) can preserve depositor confidence, continuity of depositor services, maximize value, and reduce disruption; may secure higher “going-concern” asset values and a premium for deposit books.
- Legal and mandate constraints:
  - Use of DIS funds in resolution requires legal framework allowing it — e.g., DIS with a dual mandate for deposit insurance and resolution (“risk or loss minimizer mandate”) or where funds are available to fund resolution by a separate authority (“pay box plus” mandate).
  - IADI Essential criteria 8 of core principle 9 states a deposit insurer not being the resolution authority should have the option, within legal framework, to authorize use of its funds for resolution up to the net cost it would have incurred in a liquidation payout.
- Typical insufficiency of DIFs in systemic circumstances:
  - DIS primary objective is to cover insured deposits and is normally calibrated to cover losses in a fraction of the insured pool, not the failure of a large systemic bank or generalized banking crisis.
  - Such events typically require significantly more resources than those available in a paid-in DIF.
- Recommended safeguards when using DIFs in resolution:
  - Net least-cost test.
  - Back-up line of credit from the government.
  - Consider caps so paid-in deposit insurance funds do not drop below a certain level, e.g., 50 percent of the target ratio.
  - Avoid allocating DIF funds in ways that expose DIS to significant uncertainty and risk, e.g., providing solvency or liquidity support to an open bank outside of resolution (“open bank assistance”) — such support should be the central bank’s remit via ELA.
- Policy rationale for a separate resolution fund:
  - Funding is needed for resolution of nonbank financial entities (which may not take deposits or contribute to the DIS).
  - Establishing a separate resolution fund addresses limitations and cross-jurisdictional differences in DIS legal frameworks.

### IADI Core Principles on the Use of Deposit Insurance Funds in Resolution (Box 1)
- Essential criteria 8 of core principle 9: Where the deposit insurer is not the resolution authority, it has the option, within its legal framework, to authorize the use of its funds for resolution of member institutions other than liquidation. In such situations the following conditions are met:
  - a. the deposit insurer is informed and involved in the resolution decision-making process;
  - b. the use of the deposit insurer’s funds is transparent and documented, and is clearly and formally specified;
  - c. where a bank is resolved through a resolution process other than liquidation, the resolution results in a viable, solvent, and restructured bank, which limits the exposure of the deposit insurer to contributing additional funding in respect of the same obligation;
  - d. contributions are restricted to the costs the deposit insurer would otherwise have incurred in a payout of insured depositors in a liquidation, net of expected recoveries;
  - e. contributions are not used for the recapitalization of resolved institutions unless shareholder’s interests are reduced to zero and uninsured, unsecured creditors are subject to pari passu losses in accordance with the legal claim priority;
  - f. the use of the deposit insurer’s funds is subject to an independent audit; and
  - g. all resolution actions and decisions using deposit insurance funds are subject to ex post review.

*Source: Technical Notes and Manuals 18/01 |   2018.*

### BOX 2. Least-Cost Test and Systemic Risk Exemptions

### BOX 2. Least-Cost Test and Systemic Risk Exemptions

### Net least-cost test
- Definition: A net least-cost test ensures that costs to the deposit insurance fund (DIF) of contributing to a resolution event are no higher than the costs the DIF would otherwise have incurred in a payout of insured depositors of the entities being resolved, net of expected recoveries.
- Operationalization:
  - Adopt/mandate a cap that prevents the DIF from contributing more than the estimated net cost it would have incurred if the troubled entity had been liquidated.
  - Allow a gross (upfront cash) contribution up to the value of the insured deposits; i.e., the amount the scheme would have paid out upfront in cash in a liquidation.
  - An upfront cash or ‘gross’ contribution may be required to effect the resolution, and the formulation of the net least-cost test should not prevent this.
  - Such use may be compulsory under national law.12
- Rationale and implications:
  - A resolution can prove less costly if it delivers higher than liquidation value for the bank’s assets and liabilities.
  - The cap helps limit the DIF’s contribution where insured deposits and also other creditors are protected.
  - In jurisdictions where insured deposits are preferred to other senior unsecured creditors, the net cost to the DIF in a liquidation might be zero—this should not prevent a DIF from supporting other types of resolution (e.g., purchase and assumption) if net cost to the DIS is also zero and policy outcomes (such as continuity of depositor services) are better.

### Systemic risk exemption
- Practice: Some countries (e.g., Canada, Japan, and the United States) allow DIFs to depart from least-cost principles where adherence could have a severe adverse impact on financial stability.
- Safeguards and conditions:
  - Any exception should be subject to strict governance safeguards to minimize moral hazard and ensure deployment only in extremis, in a way that would not undermine confidence in the scheme or propagate contagion.
  - If a separate resolution fund is available for systemic cases, it may reduce the need for such an exemption.

### Separate resolution funds — roles and potential uses
- Purposes of a separate resolution fund:
  - ‘Top up’ funding available from the DIF.
  - Protect uninsured creditors as needed.
  - Prevent contagion and preserve financial stability in a bank resolution.
  - Insulate the DIS from sizeable contingent liabilities arising when a systemic bank fails to buttress depositor confidence and support broader stabilization plans.
- Possible uses (in principle):
  - Make capital contributions to a bridge or bailed-in institution, or asset management vehicle (AMV).
  - Make loans to systemic financial institution(s) in resolution, including subsidiaries, a bridge institution, or AMV.13
  - Support other measures deemed necessary to preserve critical functions and maintain financial stability.
  - As a last resort and for maintaining financial stability, guarantee the assets or liabilities of, or provide capital for, systemic institution(s) outside of resolution (“open bank assistance”).
- Observations on experience:
  - Separate resolution funds are a relatively new addition to resolution frameworks; international experience is limited and approaches vary (ex ante vs ex post; governance; safeguards).
  - Funding demands in systemic failures or generalized crises could be very large, raising questions about “optimal” size, opportunity costs (if ex ante funded), and moral hazard impact.

### Ex post versus ex ante resolution funds
- Ex post resolution funds:
  - Mechanism: Authorities allocate public funds to resolution and trigger recovery of those funds from the industry later.
  - Preconditions: Procedure to determine systemic failure; mechanism to make public funding available at short notice; mechanism linking temporary support to recoveries from firms’ stakeholders/creditors and, if necessary, industry levies (KA 6.2) phased to mitigate procyclicality.
  - Advantages:
    - No burden on the industry during stable times/lower opportunity costs.
    - Requires less administration.
  - Disadvantages:
    - Larger upfront borrowing by public sector at time of stress.
    - Stronger bank-sovereign links.
    - Less fair (beneficiaries did not contribute in advance).
    - More procyclical; potential for higher burden on the industry in stressed times.
  - Operational note: The appropriate authority to provide temporary public funding is the government, not the central bank.15
- Ex ante resolution funds:
  - Mechanism: Pre-funded by industry contributions; resources available readily for use.
  - Advantages:
    - Readily available for use, if sufficient resources collected.
    - Reduces need for upfront public funding.
    - Less procyclical (costs distributed over time).
    - Failed entity contributes in advance; risk-based levies can mitigate moral hazard.
    - Can fund administrative costs of the resolution authority.
  - Disadvantages:
    - Opportunity costs through lower bank profits with resources invested in low-return safe assets.
    - May need to be large to cover systemic risks—earmarking a large pool of national savings.
    - A paid-in fund may fuel perception that uninsured creditors will be bailed out, increasing moral hazard (potentially more than ex post fund).
  - Design considerations:
    - Operational features—perimeter, base, rate of the levy—are important and should be clear from the outset.
    - Deciding on the fund’s appropriate size and assessing opportunity costs of earmarked resources will be difficult (Table 1).
    - Whether an ex ante resolution fund reduces creditor-run risk remains an open question.

### Design and governance safeguards for resolution funds
- Credibility and moral hazard mitigation:
  - A government backstop to the fund, triggered by clearly stipulated conditions and subject to subsequent recovery from the industry, is necessary to enhance credibility.
  - Where build-up of an ex ante fund may take a long time or be infeasible, establish clear procedures for quick temporary funding by authorities (e.g., standing budgetary authorization for contingency up to a cap) and legal/operational frameworks for recovering costs through ex post mechanisms.
  - The institution authorized to manage resolution funding (typically the resolution authority) should be well governed, operationally independent, with arrangements for information sharing, accountability, regular assessment, audit, and ex post review of resolution actions and use of funds.
- Measures to minimize moral hazard:
  - Effective resolution regimes that promote timely resolution of failing financial institutions.
  - Imposing losses on shareholders, subordinated creditors, and potentially senior unsecured creditors of the failed firm, and removing the management of the failed firm.
  - Differentiated premiums (for ex ante funds).
  - Price incentives to exit use of public backstops and return to market financing as early as feasible.

### BOX 4 — Key design parameters for ex ante resolution funds
- Perimeter of the levy:
  - Minimum: all systemic financial institutions covered by the resolution regime.
  - Broader perimeter (e.g., all financial institutions) could address migration of systemic risk and recognize universal benefits from enhanced financial stability.
- Base of the levy:
  - Should differ by institution type and funding model; take a broad and risk-based approach (e.g., include off-balance sheet items).
  - Simple balance sheet metrics may be distortionary across different institution types.
- Target level:
  - No international consensus on adequate level of funding.
  - Calibration could consider past resolution costs and structural features of the financial system, resolvability assessments, and amount/distribution of loss absorbing capacity (LAC). TLAC applies only to G-SIBs.
  - Opportunity cost: Laeven and Valencia (2012) estimate the median fiscal cost of 147 banking crises between 1970 and 2011 at 7 percent of GDP for all countries, and 10 percent for emerging market economies and developing countries; some countries incurred fiscal costs above 40 percent of GDP.
- Rate of the levy:
  - Should be variable and risk-sensitive; lower for non-systemic and less risky institutions.
  - Rate could be adjusted over the cycle to reduce procyclicality.
- Investments:
  - Ex ante funds should invest in highly liquid and safe assets (e.g., funds should not be placed in domestic financial institutions that may need resolution).
- Contingency line:
  - Resolution authority should have access to a government-provided credit line to complement ex ante funding given potential large gross financing needs.

### Examples and policy context
- U.S. example: The Dodd-Frank Act established the Orderly Liquidation Fund (OLF) — an ex post resolution fund with a fiscal backstop — authorizing the FDIC to obtain temporary funding for resolution of systemically important nonbank financial institutions by borrowing from the U.S. Treasury via the OLF, subject to certain limits and caps.17
- EU practice: Ex ante resolution funds are becoming more common in Europe; the EU requires national resolution funds in member states, with a view to gradual pooling into a Single Resolution Fund (SRF). Contributions are raised annually from credit institutions and investment firms authorized in the EU, while extraordinary ex post contributions can be levied when available financial means are insufficient.

### Conclusions and policy recommendations
- Tailor resolution funding to institutional, market, and policy context:
  - Consider financial system characteristics (size, concentration, structure, risk appetite, role of banks vs nonbanks).
  - Consider legal and institutional safety-net architecture and synergies between depositor protection and resolution.
  - Assess institutional capacity to execute resolution actions.
  - Consider regional/harmonized frameworks and cross-border pooling.
- Priorities:
  - Adequate ex ante funding of a DIS is advisable where supporting arrangements are in place (sound financial sector structure; effective prudential regulation, supervision, and bank resolution; strong legal/judicial frameworks; accounting and disclosure systems). Establish a DIS with an ex ante fund and capacity to contribute to bank resolutions (e.g., a pay-box plus mandate).
  - The case for a separate resolution fund is not strong generally. In jurisdictions with ex post or underfunded deposit insurance, priority should be to increase the DIF’s resources and make it available for bank resolution, subject to safeguards.
  - If establishing separate resolution funds, consider an ex post design where scarce national savings are better deployed elsewhere.
  - If used, resolution funds should have clear legal and operational frameworks and safeguards to minimize moral hazard; deploy resources only in systemic cases after recognition of resolved entities’ losses to ensure burden sharing with shareholders and other creditors, and subject deployment to strict conditions.20
- Operational readiness:
  - Establish clear procedures for quick allocation of resolution funding (e.g., standing budgetary authorization for contingency up to a cap).
  - Ensure coordination and information sharing among authorities involved.

*Source: tnm1801 - BOX 2. Least-Cost Test and Systemic Risk Exemptions*

### APPENDIX I. U.S. DEPOSIT INSURANCE FUNDING IN THE

### APPENDIX I. U.S. DEPOSIT INSURANCE FUNDING IN THE GLOBAL FINANCIAL CRISIS

### Overview and impact on the DIF
- The Deposit Insurance Fund (DIF) of the U.S. FDIC was more than fully depleted during the global financial crisis.
- The DIF stood at US$52.4 billion or 1.22 percent of insured deposits prior to the crisis.
- Between January 2008 and September 2009, 120 U.S. banks failed.
- The DIF deficit reached US$8.2 billion by end-September 2009.
- Public confidence in deposit insurance remained high throughout the crisis.

### Major failures and costs to the DIF
- Most costly failures for the DIF (explicit amounts):
  - Indymac: US$13.1 billion
  - Bank United: US$5.7 billion
  - Colonial Bank: US$4.5 billion
- Largest cases by asset size (Bank of America, Citibank, and Washington Mutual) ultimately did not incur losses for the DIF.
- The number and cost of failures of small- and medium-sized banks were sufficient to exhaust the fund’s resources.

### FDIC responses and restoration measures
- The FDIC was forced to substantially increase assessments on the industry in a procyclical way (raising levies during financial stress).
- Under a 2009 Restoration Plan, the FDIC adopted measures including:
  - Applying a one-off mid-year assessment.
  - Mandating banks to pay an estimated three years of deposit insurance premiums in advance.

### Broader U.S. public support during the crisis
- Broader support costs dwarfed DIF measures:
  - Troubled Asset Relief Program cumulative disbursals: $434 billion.
- The FDIC’s line of credit from the U.S. Treasury was increased from US$30 billion to US$100 billion during the crisis.

### Historical context indicators (as reported)
- FDIC failed banks: Number per year, 1935 to 2013 (figure referenced).
- DIF balance: In US$ billions, 1935 to 2010 (figure referenced).
- DIF reserve ratio during crisis: In percent, 1935 to 2010 (figure referenced).
- Effective assessment rates: In basis points, 1935 to 2013 (figure referenced).
- Data source for figures: FDIC Annual Report 2013.
  - Prior to 1989, data are for the Bank Insurance Fund (BIF) and exclude insured branches of foreign banks.
  - For 1989 to 2005, data are for the BIF and the Savings Association Insurance Fund; for 2006 to 2013, figures are for the DIF.
  - DIF reserve ratio definition: the amount of funds held by the DIF as a percentage of insured deposits.
  - Effective assessment rate definition: the assessment rate as a percentage of the assessment base (prior to 2010 this was total domestic deposits and subsequently average consolidated total assets minus average tangible equity).

### Key takeaways
- Pre-crisis DIF buffer (US$52.4 billion; 1.22 percent of insured deposits) was insufficient against widespread small- and medium-bank failures.
- Emergency measures (increased assessments, advance premium collection, expanded Treasury credit line) were necessary to restore the DIF and preserve confidence.
- Crisis response involved far larger fiscal and liquidity measures outside the DIF, notably US$434 billion in TARP disbursals.

*Source: APPENDIX I. U.S. DEPOSIT INSURANCE FUNDING IN THE GLOBAL FINANCIAL CRISIS, Technical Notes and Manuals 18/01 (2018).*

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_Source: https://www.imf.org/-/media/files/publications/tnm/2018/tnm1801.pdf_