Remedial measures to protect financial institutions in distress
In our previous article, we highlighted the regulations governing the establishment of systemically important financial institutions (SIFIs) in the Kingdom.
Before we proceed further with more details on the same issue, let us define SIFIs once again. It can be a bank, insurance firm, or other financial institution whose failure could cause significant disruption to the overall financial system and the economy.
Last week, we highlighted some mandatory conditions for the establishment of a SIFI. The most important condition is having a recovery plan, which must be produced within 180 days from the date of submission of a formal request for a license to operate in the Kingdom.
As we mentioned earlier, the newly introduced system deals with all details governing the operations of such financial institutions in the country within the legal framework set by the Saudi Central Bank and the Capital Market Authority.
The competent authorities issue a license to a financial institution once all conditions are met.
The stability of a SIFI is of paramount importance to a country’s economy. Financial regulators take necessary measures to ensure the protection of the national economy by creating checks and balances to ensure continuity of a systemically important financial institution and contain the damage that an unstable institution might cause to the financial system of the country.
These government bodies ensure remedial measures are taken to stabilize a SIFI.
The regulators regularly monitor the operations of SIFIs to predict any disturbance that could affect their continuity and ability to meet obligations. This could be forecast if an institution lacks the financial and administrative resources to maintain liquidity, ensure risk management, and lacks the funds needed to fulfill its legal and financial obligations. Another indicator of trouble is a decline in the value of its assets against the total sum of its liabilities or an expected plunge in the value of assets soon rendering the facility incapable of paying its debts.
In the case of financial groups, companies within a conglomerate create safety nets by signing agreements to support each other in times of crisis. However, a SIFI may not qualify for support, if it disrupts the group’s operations. Other group members only lend support to an ailing SIFI, if they do not get in harm’s way and if the support does not negatively impact the position of the financial institution offering the support.
Under the new laws in the Kingdom, a supporting institution needs approval from the competent authorities to rescue a SIFI.
Support can be provided to a financial institution in the form of loans, loan guarantees, granting of assets to be used as collateral.
The government regulators may take different remedial measures to help an ailing SIFI, which includes the sale of the financial institution, establishment of a transitional facility, separation of strategic assets of the institution, and amending its rights.
Of course, the competent authorities follow a set of rules while taking remedial measures. There are certain regulations such as owners of a SIFI in distress shall bear the losses, followed by the creditors of the facility. The authorities also take into consideration the order of priority of the creditors’ debt and treat them fairly so that none of them receives a sum less than what he would have obtained if the institution was liquidated.
The authorities also make sure to reduce the potential negative impact of these measures on other companies within the financial group and avoid unnecessary depreciation of the assets and reduce the cost of the remedial measures as much as possible.