The downfall of a banks can have a contagious effect to other financial institutions due to the interconnectedness of these organizations. A systemwide crisis must be avoided to protect the stability of the financial system. Early intervention in bank resolution planning allow the responsible supervisor to act when the underlying challenges can still be resolved and the critical functions and value of the bank can be protected.
In early intervention, banks must prepare recovery plans while laying out measures they can take in the event of further deterioration of their financial situation. By doing so, their viability will be restored, and they will be able to resume normal business operations. The recovery planning process at the earliest stages of financial distress is a robust governance tool that outlines practical aspects for authorities to assess the effectiveness of recovery plans.
Financial support within a group of companies is recognized by most resolution authorities as a preventive measure to strengthen the stability of the group and the individual businesses. Initially, recovery planning is left to the banks involved, although supervisory authorities may intervene and place the bank under statutory administration to implement further measures for early intervention. In addition to the strict resolution tools and legal safeguards available to resolution authorities and supervisors, exceptional precautionary public support or recapitalization and nationalization are possible.
Resolution plans must be drawn up not only by the financial institutions involved, but also by the resolution authorities. Specifically, these plans lay out how to handle a failing bank that is no longer viable. They describe the application of possible resolution tools, and ways to ensure the continuity of the critical functions of the bank. As a first step it must be determined whether a bank is actually resolvable via its default option, bank liquidation or whether resolution is justified. Reorganization or restructuring may then be a valid option to maintain critical functions and avoid destabilization of the financial system and avoid tax payer funded rescue missions.
To conclude, early intervention measures give the competent authority effective tools to prevent a financial institution from closing. Supervisors, rather than the resolution authority, are empowered to react to financial problems at an initial stage when early intervention measures are used. This occurs well before an institution fails. On the basis of qualitative triggers and some quantitative elements, early intervention measures are implemented. Supervisors are thus given the discretion to make use of all information available when making decisions about applying them.