CBN Headquarters

By Maryam Sadauki 
Bridge Banking and liquidation are both failure resolution options that are at the disposal of many explicit deposit insurance systems with failure resolution as part of their mandate, including the NDIC. Failure resolution refers to a series of systematic action designed to end a bank’s distressed condition.  An effective failure resolution mechanism is critical for sustenance of public confidence.  A number of other failure resolution options exist, some of which are used for salvaging a distressed institution from total collapse. Notwithstanding the option used, an effective resolution option should among others, focus on: maintaining public confidence and stability in the banking system; ensuring fairness, equity, transparency and accountability; instilling market discipline while discouraging moral hazards; and achieving minimum disruption to the payment system.

A Bridge bank refers to a temporary bank established to acquire the assets and assume the liabilities of a failed bank until a final resolution is accomplished.  The concept could be said to have originated from the United State of America (USA) through the establishment of the first bridge bank in 1987 by the Federal Deposit Insurance Corporation (FDIC). It subsequently became popular amongst deposit insurance systems because of the numerous advantages associated with its implementation in resolving failure of distressed banks. Currently, countries such as Japan, Korea, Colombia, among several others, had at one time or the other used Bridge Bank in resolving the failure of banks and the experiences had been rewarding.

Bridge banks have certain characteristics that are unique to them, which differentiate them from other types of banks. They include:
i)  Capital may and may not be required to set up bridge bank depending on the jurisdiction. For instance, capital is required for bridge bank in Colombia and Japan, while in USA and Korea it is not;

ii) It is owned by the deposit insurer and it remains a member of the deposit insurance system; and
(iii) It is usually operated for a short period, within which it is either handed over to an interested investor or put into outright liquidation.
As a failure resolution vehicle, bridge banking has certain conditions, which are necessary for its adoption, some of which include the following:
i) When a bank has an attractive franchise but in danger of failing before acquirers can be found;
ii) Usually adopted to maintain daily operations of a failed bank;
iii) In situations where a liquidator is reluctant to proceed with formal liquidation because either the failed bank is too large and there is no adequate funds available for payout or no enough time to market the bank’s assets to  investors; and
iv)When the number of failed financial institutions is very large and the failures have occurred during a short period of time and could assume a systemic dimension.

Some of the advantages of bridge banking include the following:
i) It affords timely intervention in the preservation of the functions of a failing bank;
ii) It gives depositors and creditors of financial institutions more confident by ensuring continuity of banking business;
iii)  Its establishment can provide the insurer with more time to find the right investors for the failing bank; and
iv) It preserves jobs in the affected banks.

Unlike bridge banking, which allows for continuity of operations of the distressed banks, liquidation is the termination of the functions and services being provided by the bank, when all efforts to salvage it have failed. It entails the winding up of the affairs of a bank for the reason of paying off its creditors in order of their preference and distributing what is left to the shareholders.

The process of liquidation commences with the closing of the affected bank and determining its assets as well as liabilities and it ends with the settlement of claims of both insured and uninsured depositors and other creditors. It is a very long process, which sometimes could span a period of between 10 and 20 years depending on the level of development of a country’s financial system and the economy.
Liquidation of banks could be too demanding in terms of resources, both human and financial as well as time. Little wonder that deposit insurers resort to liquidation as a failure resolution option only when it becomes absolutely necessary.

Some of the conditions that usually guide the choice of liquidation as a failure resolution option by a deposit insurer include:
i. Quantum of deposits of the bank(s), which must not be large but should be what the deposit insurer could handle with its Deposit Insurance Fund (DIF);
ii. Limited branch network so that the manpower resources of the deposit insurer would not be overstretched; and
iii.  Market share of the bank(s) should not be significant enough to trigger systemic crisis in the system.

The Nigerian experience in the area of failure resolution would make a good case in point when comparing bridge banking with liquidation of distressed banks. The corporation commenced the liquidation of banks in 1994 and to date it had adopted the resolution option on 48 distressed banks whose licences were revoked by the Central Bank of Nigeria (CBN). In adopting liquidation, the corporation had used two methods, namely, Payout and Purchase and Assumption. It adopted pay-out option for 35 banks that were closed between 1994 and 2003 while the 13 banks closed in 2006 were resolved using Purchase and Assumption. The decision to use liquidation as the most appropriate failure resolution option was informed by the size of the institutions in terms of assets and liabilities, branch network and aggregate market share of the institutions in the banking system, such that their outright liquidation would not trigger any form of run on the system.
At the time of closure of the banks in-liquidation, which brought to an end their operations in 582 branches, their total deposit liabilities stood at N187.23 billion, out of which N17.87 billion was insured deposit. Also, the total number of depositors of the banks in-liquidation stood at 2,716,257. Under this option, a total of 5,781 jobs were lost and the uninsured deposits amounting to N212.21 billion were put in a condition of uncertainty subject to the amount of recoveries made from the assets of the closed banks.

The NDIC commenced the adoption of bridge bank as a failure resolution option in 2011. Three banks among the eight recently intervened banks by the CBN that could not meet the recapitalization deadline were resolved using that option. Although the industry market share of the three banks in terms of their assets and deposits, was less than 5% at the time of closure, the number of employees, branches and customers across the nation, gave them the status of significantly important banks. Hence, the adoption of outright liquidation was considered undesirable.

Contrary to the use of liquidation in resolving the failure of banks by the NDIC, the adoption of the Bridge Bank option for the three banks produced the following results:

  i. Preserved and sustained daily operations of the three failed banks by ensuring that all the 577 branches serving about 4.7 million customers, continued to function;
ii.  Enabled all depositors to have access to a total deposit of N809.4 billion as against only N115.5 billion insured deposits guaranteed by the NDIC under a liquidation scenario;  iii.            Safeguarded 6,667 jobs in the affected banks; and
iv.  Enhanced confidence in the banking system.

From the aforementioned, it is very clear that the adoption of bridge bank as an alternative failure resolution option by the NDIC had resulted in saving numerous jobs and deposits, particularly the uninsured portion as well as save the Nigerian economy of the social costs associated with bank failures. This no doubt has helped in enhancing the confidence of both the depositors and creditors of the banks as well as prevented the systemic repercussions of the failure of the three banks on the entire financial system thereby ensuring financial and macro-economic stability in country.

•.Sadauki, a financial analyst, wrote from Abuja