The paper "Bank Resolution Costs, Depositor Preference, and Asset by Daniel Hardy" is a good example of a finance and accounting article. Businesses operate in environments that are characterized by many risks. Economic risks are one of the major threats that businesses are exposed to as was seen during the recent economic, financial crisis. The 2007/2008 global economic crisis impacted negatively on most businesses some of which were forced to close or downsize to remain in operation. Banks were among the businesses that were badly affected by the crisis. However, the economic crisis also served as a lesson to banks as it pointed the need to reform the resolution procedures by banks to enable banks to be able to cut down the costs and minimize the risk of spillovers.
In this article, "Bank Resolution Costs, Depositor Preference, and Asset, Daniel Hardy take a critical analysis at the resolution structure of banks from the perspective of bankruptcy costs and debt restructuring. Hardy begins by noting that collateralization of borrowing coupled with deposit preferences are some of the most effective ways of cutting the cost of resolving disputes among creditors that are triggered by bankruptcy or resolutions (97).
According to the author, the resultant benefit that can be capitalized into bank value instead of being left to affect the returns expected by creditors ought to result in lower overall costs of funding and low distress notwithstanding the rising encumbrance of the bank's statement of financial position. Hardy claims that the benefit is maximized when the resolution by banks is commissioned early enough to ensure that the preferred depositors remain protected in full (97). Hardy proceeds to note that, just like debt restructuring and bankruptcy, resolutions made by banks are not only characterized by a high degree of risks and uncertainties but also requires a lot of negotiations.
In this respect, Hardy noted from the recent financial crisis that conflicts that are triggered by bankruptcies or debt restricting have the potential of causing an increase in the costs as well as unnecessary delays in resolutions (98). Because such costs and delays are costly to banks, Hardy came up with a suggestion that he believes that if implemented, cost result in a significant reduction in costs.
In this respect, Hardy suggested that to minimize the costs; the regulator should consider making claims of bankruptcy-remote through policy and legislation (100). Such measures include making bankruptcy claims remote through private agreements; when a depositor enjoys the privilege of preferred status or when banks issue covered bonds supported by a collection of quality assets. The author also noted that, because bankruptcy remoteness helps in minimizing conflict resolution costs in cases of bankruptcy or debt restricting, the resultant asset encumbrance can be used to reduce bankruptcy costs, which would in turn results in low funding costs, as well as minimize the chances of distress. The Main Learning Points from Reading This Article Hardy's report serves as a valuable learning tool on many fronts.
The first critical lesson learned from the article is the need for banks to avoid filing bankruptcy as much as possible by ensuring that banks remain afloat and post good performance. The author attributes this to the fact that there are many costs that are associated with filling bankruptcy proceedings, which is costly not only to the bank but also to other stakeholders of the banks, such as shareholders and creditors.
Similarly, the bankruptcy proceeding is not just costly but is also a very complex and time-consuming process that businesses should avoid as much as possible. According to Hardy, the cost of a bankruptcy proceeding is even higher when the externalities, such as spillovers onto the entire confidence in the financial system is allowed to occur (99). Hardy highlights both direct and indirect costs that are associated with bankruptcy proceedings to teach readers of the importance of avoiding bankruptcies (99).
The direct costs include those paid to the liquidators or administrators and those paid to the authorities, such as courts, financial institutions, and government agencies. There are also indirect costs that are associated with filing bankruptcy proceedings, including those linked to the destruction of assets and loss of sales and profits during the bankruptcy proceedings. Customers who may want to obtain loans from banks may also find it difficult getting financial assistance because of the poor liquidity position of a bank.
Additionally, the creditors of the bank are also affected by bankruptcy proceedings in the sense that they also bear the costs because of the illiquidity of their assets, but also because the creditors have to be involved in the litigation and liquidity process. Therefore, because bank resolution is a complex and costly undertaking, this teaches the importance of ensuring that situations that might force a bank into resolution are avoided to prevent the risk of incurring such costs.
Brown Rudnick LLP. Alert: Changing the Priority of Claimants: New Depositor Preference Legislation, 21 January 2015. Web. 24 March 2016 http://www.brownrudnick.com/news-resources-detail/2015-01-alert-changing-the-priority-of-claimants-new-depositor-preference-legislation
Hardy, Daniel C. Bank Resolution Costs, Depositor Preference and Asset Encumbrance. Journal of Financial Regulation and Compliance, 22.2 (2014): 96 – 114. Print.
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Osterberg, William P., and Thornson, James B. Depositor Preference Legislation and Failed Banks' Resolution Costs. Cleveland Federal Reserve Working Paper 97/15 (1997): 1-21. Print.