Explainer - What happens if a bank, investment firm or credit union fails?

Banks, investment firms and credit unions (institutions) provide essential services that people, businesses, and the economy depend on. We save our money with them and, borrow from them, for example to buy a house with a mortgage.

Banks and investment firms also enable financial markets to function, thereby enabling economic activity. The 2008 financial crisis showed the damage that the failure of an institution can have on consumers, society and the wider economy. At that time when these institutions got into difficulty, governments used taxpayers' money to bail them out and prevent them from collapsing. This was because authorities in Ireland and across Europe had few other options, and lacked clear legal powers to deal with failing institutions in an orderly way.

What is resolution?

In the years since the financial crisis, a new process known as resolution has been developed to deal with the problem of failing institutions. Resolution allows the Central Bank of Ireland to step in and make sure that, if an institution fails, it does so in an orderly way that doesn’t require money from the taxpayer. The resolution process minimises the negative effects of a failing institution on consumers and, businesses.

In the case of a bank, and for certain investment firms’ failure, it allows public authorities to impose losses on shareholders and some creditors – instead of the taxpayer or depositors. As part of this new resolution framework, banks and certain investment firms are required to maintain a buffer that can be used to absorb losses. We call this buffer MREL (minimum requirement for own funds and eligible liabilities).

When is resolution used?

For most institutions, resolution simply means that insolvency (i.e. liquidation) proceedings will be the chosen process. This is similar to how non-financial firms that fail are dealt with. However, some institutions are too systemically important or interconnected, either in Ireland or in another EU Member State, for them to be liquidated in the normal way. For these institutions, the objective is to make sure they, or their critical functions, can continue to operate as normal. This is when resolution action may be appropriate.

Who leads the resolution process?

The responsibility for resolving banks is shared between Central Bank of Ireland and the Single Resolution Board (SRB), an EU agency based in Brussels.

The SRB leads the resolution of banks that are deemed significant by the European Central Bank and those that are cross-border within the euro area. The Central Bank leads the resolution of banks deemed “less significant”, i.e. the other banks, as well as investment firms and credit unions.

The SRB and the Central Bank work closely together in respect of both significant and less significant banks.

Who decides if a firm is resolved or liquidated?

The decision to take a resolution action depends on whether or not it is in the public interest to do so. This is determined by either the Central Bank or the SRB, depending on which authority is responsible. Once the appropriate approach has been determined, the Central Bank applies to the Irish High Court to authorise its decision and request the appointment of any necessary Court officers.

What happens to depositors?

If the institution is liquidated, the Deposit Guarantee Scheme (DGS) is triggered which protects eligible deposits. The DGS protects eligible deposits up to €100,000.

If the institution goes through resolution, depositors are also protected as the process is designed to safeguard them. Depositors should continue to have access to, and the use of, their money following a resolution.

How does the Central Bank prepare for a bank to fail?

The Central Bank prepares a resolution plan for banks, and certain investment firms. The plan determines the preferred strategy to be implemented in the event of failure.

For example, it will identify how important the bank is for the financial system and/or wider economy, and which resolution tools should be used.

The plan also helps identify and address any obstacles the Central Bank may face.

However, if a bank, investment firm or credit union actually fails, the Central Bank may take a different approach to resolution than was originally planned for, depending on the circumstances.