BRRD Directive: the European framework for banking recovery and resolution

The 2008 financial crisis highlighted the need for better supervision of bank failures to protect taxpayers and economic stability. The European BRRD (Bank Recovery and Resolution Directive), initially adopted in 2014 (Directive 2014/59/EU) and revised by BRRD II in 2019 (Directive (EU) 2019/879)is the cornerstone of this new regime. It imposes on banks and the authorities precise mechanisms for anticipating and managing crises, marking a decisive step towards a overview of European banking resolution, the overall framework of the Banking Union. This article sets out the main points of this complex but essential regulatory framework.  

What is the Banking Recovery and Resolution Directive (BRRD)?

The Banking Recovery and Resolution Directive (BRRD) establishes a set of harmonised rules and procedures within the European Union for managing the difficulties of credit institutions and certain investment firms. It was introduced as a direct result of the lessons learned from the global financial crisis.

Context and objectives: avoid recourse to public funds ("bail-out")

Before the BRRD, the failure of large banks often threatened global financial stability, frequently forcing governments to intervene with public funds to prevent a systemic collapse - a practice known as "bail-out".. This approach raised moral hazard issues and placed a heavy burden on taxpayers.. The fundamental objective of the BRRD is therefore to break this link between banking crises and public finances.. To this end, it is putting in place mechanisms for the orderly resolution of failing banks, with the losses being borne first and foremost by the bank's shareholders and creditors, in accordance with the "bail-in" principle..  

The BRRD thus aims to preserve financial stability, ensure the continuity of banks' critical functions (such as payment services or holding deposit accounts), protect covered depositors and minimise the cost to taxpayers.. It is part of a wider project to strengthen the European financial architecture, in particular through the Single Resolution Mechanism, the role of the CRU.  

Scope: credit institutions, investment firms, financial holding companies

The scope of the BRRD is broad and mainly covers the following entities established in the European Union, as defined in Article 1 of Directive 2014/59/EU:  

• Credit institutions, i.e. undertakings whose business is to receive deposits or other repayable funds from the public and to grant credit for their own account [cite: 81].  
• Investment firms that provide certain investment services and whose failure could have a systemic impact. The BRRD II directive has clarified certain aspects of their loss-absorption and recapitalisation capacity.  
• Financial holding companies, mixed financial holding companies and certain mixed holding companies.  
• Branches of third-country institutions established in the EU, under certain conditions.  

Member States may extend the application of some of these rules to other financial entities..  

National resolution authorities: designation and independence

Each Member State of the European Union must designate one or more National Resolution Authorities (NRAs).. These authorities are responsible for implementing the resolution powers and tools set out in the BRRD. They may be the national central bank, a ministry or a specially created or designated public administrative authority.. In France, this function is carried out by the Autorité de contrôle prudentiel et de résolution (ACPR) within its resolution college..  

A fundamental aspect is the operational independence of these authorities. Even if the resolution authority is integrated into another institution, such as the central bank or the supervisory authority, strict measures must be taken to avoid conflicts of interest, particularly between the functions of prudential supervision and resolution.. The staff dedicated to resolution must therefore operate within a distinct organisational structure, with separate lines of authority. This independence is a guarantee of objective and effective decision-making in times of crisis.  

Preventive planning: recovery and resolution plans

The BRRD introduces a culture of prevention by requiring specific plans to be drawn up: recovery plans, prepared by the banks themselves, and resolution plans, drawn up by the resolution authorities.

Recovery plans: purpose and content

The main objective of a recovery plan, as stipulated in Article 5 of Directive 2014/59/EU, is to enable an institution to restore its financial viability after a significant deterioration in its situation. Under no circumstances should these plans rely on the possibility of exceptional public financial support..  

Development by banks (individual and group)

All entities falling within the scope of the BRRD are, in principle, required to draw up and keep up to date a recovery plan.. Simplified requirements may apply to entities presenting a lower risk to the stability of the financial system. The Directive distinguishes between individual recovery plans, for entities which are not part of a group subject to supervision on a consolidated basis, and group recovery plans, drawn up by the parent undertaking of the group.. In principle, an entity covered by a group plan does not have to draw up an individual plan, unless the competent authority requires it because of the specific characteristics of that entity..  

Crisis scenarios and measures envisaged (capital, liquidity)

Recovery plans must consider a range of severe crisis scenarios, both systemic and idiosyncratic, which could impact the institution. For each scenario, the plan should detail a range of possible recovery measures to restore financial strength. These measures may relate to capital (e.g. capital increase, debt conversion) or liquidity (e.g. access to emergency sources of financing, disposal of assets).. EBA has provided guidance on the range of scenarios to be applied.  

Trigger indicators

An essential element of turnaround plans is the framework of qualitative and quantitative indicators. These indicators, which may be based on capital, liquidity, profitability or asset quality, are designed to signal a deterioration in the bank's financial position at an early stage. The plan should specify the thresholds for these indicators that would trigger the implementation of the envisaged remedial measures or, at the very least, an in-depth analysis of the situation by management.. The EBA has also published guidelines on the minimum list of these indicators.  

Examination and validation by the supervisory authorities

The recovery plans, once drawn up and approved by the institution's management bodyare submitted to the competent prudential supervisory authority for assessment. This authority shall examine the completeness, credibility and feasibility of the plan, ensuring that it is likely to restore the institution's viability quickly and effectively, without significant adverse effects on the financial system.. The resolution authority is also consulted to assess whether certain measures in the plan could have a negative impact on the institution's "resolvability".. If significant shortcomings are identified, the supervisory authority may require changes or even impose measures specific to the institution..  

Resolution plans: objective and content

Unlike recovery plans, resolution plans are drawn up by the resolution authorities.. Their objective is to define the resolution strategy envisaged for an institution should it become insolvent, in order to allow a rapid and orderly resolution while minimising the impact on financial stability and the real economy, and without resorting to exceptional public financial support..  

Preparation by the resolution authorities

The competent resolution authority for an institution (or the group resolution authority for cross-border groups) is responsible for drawing up the resolution plan.. This shall be done in consultation with the supervisory authority and, where appropriate, with other relevant resolution authorities (e.g. those of Member States where significant branches are located).. The establishment concerned has an obligation to cooperate and must provide all the information required to draw up the plan.. The SRMR specifies the role of the Single Resolution Board (SRB) in drawing up these plans for the largest entities in the banking union..  

Assessing the "resolvability" of an institution

A key stage in drawing up a resolution plan is the assessment of the institution's "resolvability".. The aim is to determine whether the institution can be placed in resolution in a credible and feasible manner, using the resolution tools provided for in the BRRD, while ensuring the continuity of its critical functions and avoiding undue contagion to the financial system.. This assessment takes into account the bank's legal and operational structure, the location of its critical activities, its information systems, etc.. The EBA has developed technical standards on the content of this assessment.  

Identifying and removing obstacles to resolution

If the assessment of resolvability reveals significant obstacles (e.g. an overly complex legal structure, an inability to separate critical functions, inadequate information systems), the resolution authority shall inform the institution accordingly.. It then has a period of time in which to propose measures to remedy these obstacles.. If the proposals are deemed to be insufficient, the resolution authority has the power to require the institution to take specific measures to remove these obstacles.. These measures may include the modification of legal or operational structures, the disposal of certain assets or activities, the creation of a parent financial holding company, or the issue of eligible commitments to meet MREL requirements.. For groups, this process is conducted within the college of resolution authorities..  

Early intervention by the supervisory authorities

Before a situation degenerates to the point of requiring resolution, the BRRD gives prudential supervisors powers of early intervention, as provided for in Articles 27 to 30 of the Directive.. These measures are designed to rapidly remedy a deterioration in the financial situation of an institution or a breach of regulatory requirements.  

Trigger conditions: risk of regulatory infringement, financial deterioration

Early intervention measures may be triggered when an institution breaches, or is likely to breach in the near future, the prudential requirements applicable to it (arising in particular from the CRR regulation or the CRD IV directive).. Simply anticipating an offence is therefore sufficient. Deterioration of the financial situation, an increase in leverage, a rise in non-performing loans, or excessive concentration of risk are examples of situations that may justify such intervention.. The EBA has published guidelines on the triggers for these measures.  

Possible measures: stricter requirements, request for specific actions, revision of the strategy

The supervisory authority has a range of graduated measures at its disposal. It may, for example :

• Require the company to implement the actions set out in its recovery plan or to draw up and implement a programme of specific actions.  
• Call a shareholders' meeting to approve urgent measures.  
• Requiring changes to the business strategy, legal structure or operational structure of the establishment.  
• Require the institution to contact potential acquirers to prepare for a possible resolution, in coordination with the resolution authority.  

More intrusive measures: removal of directors, appointment of a temporary administrator, etc.

If the situation deteriorates significantly, or in the event of serious breaches or administrative irregularities, and if the initial measures prove insufficient, the supervisory authority may take more intrusive measures. In particular, as provided for in Article 28 of the BRRD, it may remove one or more members of senior management or the management body who are deemed to be unfit.  

If even removing the directors is not enough, Article 29 of the BRRD allows the supervisory authority to appoint a temporary administrator.. This person may replace the management body or work with it for a maximum period of one year (exceptionally renewable).. Its powers are defined by the supervisory authority and are intended to rectify the institution's financial situation or to ensure sound management pending other measures.. For groups, the decision to appoint a temporary administrator at the level of the parent undertaking is taken by the supervisory authority on a consolidated basis, in consultation with the other authorities concerned..  

Conditions for triggering a resolution procedure

The transition to a resolution procedure is a major step, which is only envisaged when strict conditions are met, as detailed in Article 32 of the BRRD..  

Observation of a proven or foreseeable fault

The first condition is that an institution is in a situation of proven default or that it is objectively foreseeable that it will default in the near future ("Failing Or Likely To Fail" - FOLTF).. A fault can manifest itself in several ways:  

• The institution is in breach, or is likely to be in breach, of the conditions of its authorisation to a material extent, in particular as a result of losses which have absorbed a substantial proportion of its own funds.
• Its assets are less than its liabilities.
• He is unable, or will soon be unable, to honour his debts as they fall due.
• It requires exceptional public financial support (except in the very specific cases set out in the directive).

This determination is generally made by the competent supervisory authority (such as the ECB for major banks in the eurozone), but may also, depending on national law, be made by the resolution authority itself..  

The absence of a reasonable private alternative

The second condition is that there is no reasonable prospect that an alternative private sector measure (e.g. a capital increase by private investors, a sale of assets, a takeover by another institution without public intervention) or an early intervention measure (including the implementation of the recovery plan) could prevent the failure of the institution within a reasonable period of time..  

The need to act in the public interest (financial stability, protection of depositors)

Finally, a resolution measure is only taken if it is deemed necessary in the public interest.. This means that resolution must be preferable to normal insolvency proceedings in order to achieve the objectives of resolution, such as :  

• Ensuring the continuity of the establishment's critical functions.  
• Avoid significant negative effects on financial stability, in particular by preventing contagion.  
• Protect public funds by minimising the need for exceptional public financial support.  
• Protect covered depositors and investors under guarantee schemes.  

If a normal insolvency procedure can achieve these objectives in an equivalent manner without posing additional risks to financial stability, then resolution is not considered to be in the public interest..  

The crucial stage of independent valuation of the bank

Before taking any resolution measures, and even before deciding to write down or convert capital instruments, article 36 of the BRRD requires that a "fair, prudent and realistic" valuation of the institution's assets and liabilities be carried out.. This valuation must be carried out by a person who is independent of any public authority and of the establishment itself, in order to ensure its objectivity..  

The aim of this valuation is manifold:

• Inform the decision on whether the conditions for resolution have been met.
• Determine the extent of the losses to be absorbed and the level of recapitalisation required.
• Guide the choice of resolution instruments to be applied and their calibration (for example, the amount of commitments to be converted in the event of a bail-in).
• Ensure compliance with the principle that no creditor should suffer greater losses than they would have in the event of liquidation under normal insolvency procedures ("No Creditor Worse Off" - NCWO).  

In urgent cases, a provisional valuation may be carried out by the resolution authority, to be followed as soon as possible by a definitive and independent valuation.. This provisional valuation may include a margin for additional losses to take account of uncertainties..  

The resolution instruments provided for by the BRRD

Once the conditions for resolution have been met and the valuation carried out, the resolution authority has a toolbox, defined mainly in Articles 37 to 55 of the BRRD, to manage the failure of the institution.. The aim is to choose the most appropriate instrument or combination of instruments to achieve the resolution objectives effectively.  

The power of depreciation and conversion of capital instruments (CET1, AT1, T2)

Before or at the same time as the application of other resolution instruments, Article 59 of the BRRD gives resolution authorities the power to write down the nominal value of own funds instruments and eligible liabilities, or to convert them into Core Tier 1 capital instruments (CET1).. This measure is designed to absorb losses and recapitalise the bank. The order of loss absorption is strict: first CET1 instruments (ordinary shares), then additional Tier 1 capital instruments (AT1), and finally Tier 2 capital instruments (T2).. This hierarchy is intended to ensure that shareholders and holders of riskier capital instruments are the first to contribute to the absorption of losses before other creditors are affected, and in particular before any recourse to the internal bail-in instrument on other liabilities. Article 21 of the SRMR also sets out the conditions for this depreciation and conversion for entities covered by the Single Resolution Mechanism..  

Sale of Business instrument

Provided for in Article 38 of the BRRD, this instrument enables the resolution authority to transfer shares or other securities issued by the institution subject to resolution, or all or part of its assets, rights or liabilities, to a private purchaser.. The consent of the shareholders of the defaulting institution is not required for this transfer.. The purchaser, on the other hand, must consent to the transaction. The resolution authority must seek to obtain the best possible price under transparent and non-discriminatory market conditions, while acting with the speed required by the situation.. The aim is to preserve the continuity of the activities sold and maximise the value for the remaining creditors of the entity in resolution. Article 24 of the SRMR also provides a framework for this tool for banks in the Banking Union..  

The Bridge Institution instrument

Where it is not possible or desirable to sell the business immediately to a private buyer, Article 40 of the BRRD allows for the creation of a bridge institution.. This is an entity wholly or partly owned by one or more public authorities and controlled by the resolution authority.. The shares, assets, rights or liabilities of the failing bank (or part of them) may be temporarily transferred to it.. The purpose of the bridging institution is to ensure the continuity of critical functions and to manage the transferred activities with a view to a subsequent sale to one or more private buyers, when market conditions are more favourable.. The relay establishment must be operating with a view to being sold and its period of existence is limited, in principle, to two years, which may be extended under certain conditions.. Article 25 of the SRMR deals with this instrument within the MRU.  

The Asset Separation instrument

The asset segregation instrument, described in Article 42 of the BRRD, makes it possible to transfer assets, rights or liabilities of an institution subject to resolution (or a bridge institution) to an asset management structure (often called a "bad bank").. The aim is to isolate "toxic" assets or assets that are difficult to value in order to clean up the institution's (or bridge institution's) balance sheet and thus facilitate its operation or sale.. The asset management vehicle is supervised by the resolution authority and has the task of managing the transferred assets with a view to maximising their value through an orderly sale or liquidation over an appropriate period of time.. This instrument can only be used in combination with another resolution instrument.as specified in Article 37(5) of the BRRD. Article 26 of the SRMR concerns this tool.  

The bail-in instrument: principle and liabilities concerned/excluded

Internal bail-in is one of the most emblematic instruments of the BRRD, detailed in articles 43 to 55.. Its fundamental principle is that losses should be absorbed and a failing bank recapitalised by its shareholders and a wide range of its creditors, rather than by taxpayers.. In practical terms, the resolution authority may exercise its power to reduce the nominal value of eligible liabilities (unsecured debts, certain deposits above the guarantee threshold) or to convert them into equity instruments (shares) of the restructured institution or of a new entity..  

A strict hierarchy of claims must be respected: shareholders absorb losses first, followed by holders of subordinated capital instruments (AT1, T2), then other subordinated creditors, and finally senior unsecured creditors.. Certain liabilities are explicitly excluded from bail-in, as set out in Article 44(2) of the BRRDdeposits covered by the deposit guarantee scheme (up to €100,000 per depositor and per bank).These include guaranteed liabilities (up to the value of the collateral), liabilities to employees (salaries, pensions), certain short-term commercial debts and liabilities to payment and settlement systems.. In exceptional circumstances, the resolution authority may exclude other liabilities from the bail-in if this is necessary to ensure the continuity of critical functions or to avoid widespread contagion, provided that losses are absorbed by other creditors or, as a last resort and subject to very strict conditions, by the resolution fund.. Article 27 of the SRMR, as amended by SRMR II, governs the application of bail-in under the MRU.. The implementation of the bail-in must be accompanied by a plan to reorganise the institution's activities..  

Minimum capital requirements and eligible liabilities (MREL)

To ensure that banks have sufficient capacity to absorb losses and be recapitalised in the event of resolution, without calling on public funds, the BRRD (article 45 et seq., substantially amended by BRRD II) introduces minimum capital requirements and eligible commitments (MREL). The SRMR also details these requirements for banks in the Banking Union.  

Objective: to ensure loss-absorption and recapitalisation capacity

The main objective of MREL is to ensure that a bank always has a sufficient amount of own funds and specific debt instruments ("eligible liabilities") that can be written down or converted into own funds (bail-in) in the event of resolution.. This capacity must be sufficient to cover the losses that would have led to the failure and to recapitalise the bank (or its successor) so that it can continue to operate, maintain the confidence of the markets and sustainably comply with the conditions of its authorisation.. The resolution authority shall set the level of MREL for each institution, on an individual and consolidated basis, taking into account its size, risk profile, resolution strategy and critical functions..  

Convergence with the international TLAC standard for large banks

At international level, the Financial Stability Board (FSB) has developed a similar standard for global systemically important banks (G-SIBs): Total Loss-Absorbing Capacity (TLAC).. BRRD II and SRMR II have largely aligned the European Union's MREL framework with TLAC requirements for European G-SIBs and introduced specific requirements for other large banks ("senior banks").. The aim of this convergence is to ensure a level playing field at global level and to strengthen the resolvability of the major international financial institutions.. Accordingly, G-SIBs must comply with minimum MREL/TLAC ratios expressed both as a percentage of their risk-weighted assets (RWA) and as a percentage of their leverage ratio exposure..  

Eligibility criteria for instruments

Not all liabilities can count towards MREL. For a debt instrument to be considered as an "eligible liability", it must meet strict criteria defined in particular in article 72a and following of the Capital Requirements Regulation (CRR), as introduced or amended by the "Paquet Bancaire".. These criteria are designed to ensure that the instruments can effectively absorb losses in the event of resolution. Among the key conditions:  

• The instrument must be issued by the institution and fully paid up.
• It must have a residual maturity of at least one year.  
• It must not be secured by collateral or benefit from guarantees that would unduly enhance its ranking.
• It must not be subject to compensation arrangements that would compromise its ability to absorb losses.
• The contractual provisions must recognise the power of the resolution authority to write down or convert the instrument.
• The instrument must be subordinated to certain liabilities excluded from MREL (such as guaranteed deposits and senior operating debt). BRRD II also introduced a new category of "senior non-privileged" debt to make it easier for banks to comply with these subordination requirements.  

Compliance with these criteria is essential if the MREL architecture is to be credible and operational.

Guarantees and protection for creditors and shareholders

While the BRRD aims to make shareholders and creditors bear losses, it also provides safeguards to ensure fair treatment and avoid excessive instability.

The "No Creditor Worse Off" (NCWO) principle

A fundamental principle of the BRRD, set out in particular in Articles 34(1)(g) and 73, is that no creditor should suffer greater losses as a result of the application of resolution measures than it would have incurred if the institution had been wound up under a normal insolvency procedure.. This principle is known by the acronym NCWO ("No Creditor Worse Off"). To ensure compliance with this principle, an ex-post valuation must be carried out by an independent person after the resolution measures have been implemented.. If this valuation reveals that a creditor (or shareholder) has been treated less well than he would have been in liquidation, he is entitled to compensation for the difference, payable by the resolution financing mechanism (the resolution fund).. This principle is also set out in Article 15(1)(g) of the SRMR.  

Specific protection for certain contracts (guarantees, netting, covered deposits)

The BRRD (Articles 76 to 80) provides specific protections for certain types of contracts and arrangements in order to avoid unnecessary disruption and preserve the stability of financial markets during a partial transfer of assets and liabilities as part of a resolution.. These include :  

• Financial collateral arrangements and netting agreements The resolution authority must endeavour to transfer together the rights and obligations covered by such agreements or, if this is not possible, not to "break" these arrangements so as to preserve their economic effectiveness.  
• Covered bonds Provisions designed to protect holders of covered bonds by ensuring that the pool of cover assets remains allocated to servicing these bonds.  
• Payment and settlement systems The resolution authority must take measures to ensure the continued access of the institution (or its successor entity) to these critical infrastructures.  
• Covered depots As mentioned above, deposits covered by a deposit guarantee scheme (up to €100,000 per depositor per bank in the EU) are fully protected and excluded from the bail-in.  

These safeguards are designed to maintain confidence and limit the contagion effects of a resolution procedure.

The banking resolution framework introduced by the BRRD is dense and has major implications for financial institutions operating in Europe. Understanding its mechanisms is essential for navigating this regulatory environment. If your institution is affected by these obligations or if you would like a specific analysis, our expertise in banking law can help you. For an in-depth analysis of your situation and tailored advice on banking regulations, contact our team of lawyers by calling a banking lawyer.

Sources

• Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.
• Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorption capacity and recapitalisation of credit institutions and investment firms and Directive 98/26/EC.
• Monetary and Financial Code (articles relevant to transposition, in particular L. 613-35 et seq.).