Objectives of resolution
All decisions taken by the Central Bank’s Resolution Authority are based on the objectives laid down in the Resolution Act. These objectives provide the foundation for an assessment of which measures should be taken and which resolution strategy is most suitable for financial institutions in Iceland. The purpose of the Act is laid down in five parts in Article 1 of the Act: to preserve financial stability and minimise the adverse implications of financial shocks by protecting insured deposits and investors, customers’ assets, and vital company operations; and minimise the risk that capital contributions from the Treasury will be needed. It follows from this that the Central Bank Resolution Authority is intended to:
- Safeguard the critical functions of financial institutions; i.e., to ensure the continuity of such functions;
- Preserve financial stability and minimise adverse repercussions of financial shocks, including by limiting contagion and maintaining market discipline;
- Minimise the risk that capital contributions from the Treasury will be needed.
- Protect insured investors and depositors; and
- Protect customers’ assets.
Critical functions according to the first objective are activities, services, or operations that are so important to the real economy or financial stability that their discontinuance would be likely to lead to disruption of economic activity or stability, owing to their scale or scope, market share, interconnectedness to other activities, complexity, or cross-border activities, provided that substitutable activities, services, or operations are not available. In order to achieve these objectives, the Resolution Authority is to minimise resolution costs and avoid the destruction of value unless it is necessary to achieve one or more of the above-mentioned objectives. Part of the objective of minimising the adverse effects of financial shocks implies that the Resolution Authority must work to avoid moral hazard. Moral hazard could weaken market discipline, as businesses’ and investors’ risk appetite will increase if they rely on the Government to rescue them if they end up in difficulty.
Conditions for resolution
In addition to the objectives specified in the Resolution Act, the following three conditions must all be satisfied in order for the Central Bank of Iceland Resolution Authority to be authorised to take action and apply the measures entailed in resolution. First, the Central Bank of Iceland, in consultation with the Resolution Authority, must have concluded that the institution is in financial distress. This implies that the institution cannot honour its obligations or is highly unlikely to be able to do so.
Upon being notified that an institution is in distress, the Resolution Authority decides whether resolution is needed in order to achieve the objectives laid down in the Act. In taking such a decision, the Resolution Authority determines whether the latter two conditions are met; i.e., whether the Authority is authorised to take action and apply the measures entailed in resolution proceedings. The second condition is that the Resolution Authority must have legitimate reason to believe that action by a private entity or other public entities, including early intervention by the Central Bank, will not prevent the failure of the institution within a reasonable length of time. The last condition is that the resolution action is deemed by the Resolution Authority to be necessary in the public interest. The Central Bank’s final decision on resolution is subject to prior approval by the Minister of Finance and Economic Affairs.