A research team at the Leibniz Institute for Financial Research (SAFE) has conducted an analysis of the acquisition gains related to the banking turbulence of spring 2023. The report suggests that transparent auctions with a sufficient number of bidders are preferabe to negotiated sales, and reduce the chance of windfall gains for acquiring banks.

The analysis is based on the acquisitions of Credit Suisse by UBS, Signature Bank by New York Community Bank, Silicon Valley Bank by First Citizens, and First Republic by J.P. Morgan Chase.

In relation to the four acquisitions, the research team found „abnormal stock returns of the acquiring banks and other bidding banks," providing evidence that the winning banks made a good deal and paid a price that was below market value. The rushed sale of the banks led to massive losses for bank shareholders, bondholders, and the U.S. Federal Deposit Insurance Corporation (FDIC).

The SAFE report says that relying solely on accounting figures for valuations can be misleading, „as these numbers alone cannot accurately reflect the economic value of acquiring a failed bank.“

With little time, the buyer has more negotiation power. This is a significant difference between crisis sales and mergers and acquisitions of banks in normal business operations, according to the European Single Resolution Board (ESRB). In a crisis, there is less time for lengthy due diligence examinations. Therefore, in a crisis, the final price is influenced by the shorter time frame and higher uncertainty.

All four failed banks were dealt with in a similar manner, being sold off relatively quickly to an acquiring bank. Authorities were apparently taken by surprise, because the collapses were not caused by undercapitalisation, but by illiquidity.

From the SRB's perspective, it is clear that time is a crucial factor in a banking crisis. Rapid crisis resolution is key to restoring confidence in the banking sector. „And that can mean looking for a buyer overnight or over a weekend“, says the SRB.

In response, Florian Heider, Scientific Director at SAFE, argues that crises often don't happen overnight, can be seen approaching weeks in advance. Therefore, resolution authorities should act in time, preferably when nothing has happened yet.

The cause of bank collapses is highly relevant for the decision-making process. If problems are caused by undercapitalisation, they develop slowly. In this situation, „liquidation ends a gradual process of capital erosion, and authorities have enough time to prepare the liquidation process,“ says the working paper, authored by Tobias Tröger, Director of the SAFE Cluster Law and Finance, and Heider.

The authors of the study suggest that transparent auctions with a sufficient number of bidders are preferable to negotiated bank sales." "Even before an institution gets into trouble, a data room should be prepared for potential buyers so that an auction can take place. In principle, two bidders are sufficient for an auction,“ Heider argues.

The researchers suggest that resolution authorities such as the SRB prepare better and earlier for auctions as part of resolution planning. Furthermore, both significant and less significant banks should be examined for possible sales.

The suggestion is not so much aimed at the FDIC. „To some extent, the FDIC has established such a process," Tröger notes. „The US authority also has the advantage that, like a supervisor, it is directly in the banks on-site. There is no equivalent in Europe.“

However in the case of Credit Suisse, there was no politically viable alternative to selling the bank to UBS.

To achieve the goal of auctions, better preparation by banking supervision and resolution authorities is necessary. It is difficult to assess the SRB's preparations from the outside, but the research paper suggests that there appears to be no process for preparing an auction. But similar to a normal transaction, due diligence documents and information for potential bidders must be made available as early as possible. Preparations for auctions should be part of resolution planning, a core task of the resolution authorities, including the Single Resolution Board.

The framework for Crisis Management and Deposit Insurance (CMDI) allows for effective pre-packaging purchase and assumption/sale of business resolutions. However, it inevitably falls short of preventing bank runs, which can often trigger panic that spreads beyond the weak bank to the entire banking system.

According to the researchers, even non-significant banks should be included in resolution planning. For instance, SVB was not classified as a systemically important institution or an other systemically important institution. If a bank in this category were to fail in Europe, only national laws would apply, and not the SRB's intervention.

The EU Commission's proposal for a CMDI Review also addresses the issue. Resolution authorities should make preparations without prior intervention measures, so that they can react as quickly as possible to a deterioration in the situation of an institution. Additionally, a digital platform should be established to share information with potential buyers, according to the Commission.

Europe would be well advised to anticipate the impossibility of initiating bankruptcy proceedings for large - but less significant - banks, given the massive uncertainty and systemic risk associated with bankruptcy.

The SRB says that resolution planning and crisis preparedness for „less significant institutions“ (LSIs) is a very important area of work for the resolution authority, and for national resolution authorities. Referring to a report on resolution planning for LSIs, it says that the number of LSIs for which resolution plans exist has reached 97%.