HML. Homeloan Management Ltd

Something that hasn't made the news as much as it might have done in recent weeks is the requirement for Systemically Important Financial Institutions (SIFI's) around the world to create a Recovery and Resolution Plan (RRP) - a key recommendation of the Financial Stability Board (FSB) that have become known in the industry as 'Living Wills'.

It caught our eye at HML as it’s a development touching on many areas of work we are involved in as a standby mortgage servicer to many of these banks.

So what’s happened and what does it mean?

The FSA, in August’s CP 11/16 paper says ‘the recent financial crisis highlighted the need for authorities to have more effective tools and information to enable the orderly resolution of financial institutions without needing to resort to taxpayer support. It also showed there was a need for such institutions to be better prepared to recover from situations of severe stress.’

According to the regulator, ‘Recovery Plans help firms plan how they would try to recover from severely adverse conditions that could cause their failure. They will set out in advance a firm’s ‘menu of options’ for dealing with a range of severe stress events. It is important that firms prepare these options before they are needed in order to enhance their effectiveness.’

And who will have to create an RRP?

In the UK, the Financial Services Act 2010 dictates that all UK deposit takers are required to have an RRP in place. According to the Bank of England Prudential Regulation Authority (PRA) it will regulate 157 UK-incorporated banks (of which 60 per cent form part of overseas banking groups), 48 UK building societies, 652 UK credit unions and 162 branches of overseas banks, split roughly equally between the European Economic Area and elsewhere. 

The FSA says it expects to publish final rules in the first quarter of 2012 in a Policy Statement. It expects certain provisions to come into effect during the first quarter of 2012, but there will be transitional provisions covering the majority of the requirements so that firms will have until June 2012 to prepare their initial RRPs.

At first glance this may seem like something of a global Business Continuity Planning (BCP) initiative, but early opinion suggests that the task could require re-appraisal of business strategy, legal entity, organisational structure and operating model before the end of 2012. Carrying out another administrative task like this is at odds with banks’ existing strategies to cut costs and drive efficiency.

One major bank recently announced that it is on track for £1bn cost savings this year, but I wonder if that includes provisioning for their RRP? And who will be paying for all of this in the end? Presumably it will ultimately be the banks customers.

Creating an RRP will certainly prompt all of these organisations to stress test the robustness of their existing crisis and exit strategies and could reveal surprising truths about future core and non-core assets. This is an area where we can see parallels to standby servicing.

For example, when setting up a ‘hot’ standby arrangement, where the standby servicer takes over operations in less than a month,  there is a typical set up time of up to six months, dependent on the complexity of the products and platform, to map and duplicate processes relating to the primary servicer’s mortgage operations.

To do something like this across an entire banking business would be a huge undertaking, not to mention the ongoing work involved with regular testing and assessments, which will presumably be required.

There’s no doubt this new requirement tells us a lot about how the world’s leaders view risk in large financial institutions and its potential influence on the future of the global economy. At the same time, one wonders what impact a further layer of regulation will have on the future innovation and development of this sector, two characteristics that don’t seem a natural fit.