The Resolution of Banco Popular: Investigating the Effects of the BRRD and Testing the Early-warning Capacity of Regulatory Ratios

Edda Bergsli Bogen & Silva Fredrika Pelli

Student thesis: Master thesis

Abstract

The financial crisis of 2008 revealed significant weaknesses in the banking regulations in Europe. Without a harmonised framework for bank failures, governments all over Europe found themselves in the position of having to choose between taxpayer-funded bailouts or risking a systemic collapse. This was the build-up for the Bank Recovery and Resolution Directive (BRRD). A harmonised framework for dealing with distressed banks in the EU in a way that would no longer place the burden on taxpayers, but rather make financial institutions responsible for the consequences of their risktaking. This thesis studies the first European resolution case since the banking union and its supervisory pillars were established: the failure of the Spanish bank, Banco Popular. We study the case in two parts: from the point of view of its resolution and from an early-warning signal perspective. By investigating the resolution case, we evaluate the performance of the resolution framework of the banking union, namely the Single Resolution Board (SRB) and the BRRD. We see that the case demonstrates how under the BRRD the taxpayers are spared and creditors and shareholders are made to contribute to the losses by effectively enforcing a combination of the bail-in and sale of business tools. We critically discuss the transparency of the process and question the implications for various stakeholders of the bank. Our findings show that the key issues of the resolution and the framework as a whole is the lack of transparency in the valuation process, which has the potential to undermine the credibility of both the SRB and BRRD in the future. After a detailed discussion of the resolution of Banco Popular, we question whether its distress could have been detected earlier using key regulatory ratios, CAR, CET1, leverage ratio, LCR and NSFR. We find that historical observations do not reveal great variation in the sample of six Spanish banks. However, we take our analysis further and use the IMF method to stress test the sample with 2016 data. Our test reveals that Banco Popular’s capital ratios are significantly more sensitive to external shocks than its peers due to underprovisioning and low levels of Tier 1 capital. In addition, our investigation of these results together with the 2016 EBA stress test reveals how Popular’s bad asset quality and build-up of non-performing loans had a major impact on its failure, and argue that the EBA test falls short in comprehensively assessing asset quality. Finally, we conclude that stress testing should be used to determine the underlying causes for capital deterioration, and only after investigation of their sensitivity, can capital ratios be used as effective early warning signals for financial distress.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2018
Number of pages142
SupervisorsPoul F. Kjær