Bankruptcy and Insolvency Rules for Banks — Detailed Explanation with Case Laws

Jurisdiction: Spain / European Union, with comparative international principles

Bank insolvency is fundamentally different from ordinary corporate insolvency. A bank cannot usually be treated like an ordinary company because its failure can immediately affect depositors, payment systems, financial stability, other banks and the wider economy.

For that reason, modern banking law generally prioritizes early supervisory intervention, recovery planning, resolution and depositor protection rather than simply placing a failing bank into an ordinary insolvency proceeding.

1. What Does Bank Insolvency Mean?

A bank may encounter two related but different problems.

Insolvency

The bank's liabilities exceed the value of its assets, or it is unable to meet obligations as they fall due.

Illiquidity

The bank may have assets exceeding liabilities but cannot obtain cash quickly enough to meet immediate payments.

This distinction is extremely important.

A bank can be:

solvent but illiquid

or

insolvent and illiquid.

A liquidity crisis can nevertheless develop into insolvency if depositors withdraw funds rapidly or assets must be sold at distressed prices.

2. Why Ordinary Bankruptcy Rules Are Not Enough

Suppose an ordinary manufacturing company becomes insolvent.

Its creditors may seek:

• liquidation;
• appointment of an administrator;
• asset realization;
• distribution according to insolvency priorities.

If a major bank were handled in exactly the same manner, however, the consequences could include:

deposit runs → payment disruption → interbank contagion → credit contraction → systemic crisis.

Bank insolvency law therefore has additional objectives:

1. protect depositors;
2. maintain critical banking functions;
3. preserve financial stability;
4. prevent contagion;
5. protect public funds;
6. allocate losses to shareholders and creditors where appropriate;
7. maintain critical payment services; and
8. permit an orderly exit from the market.

3. Spain's Legal Framework

Spain operates within the EU banking-union framework.

The main components include:

Capital Requirements Regulation — CRR

Provides prudential requirements concerning capital, liquidity and risk.

Capital Requirements Directive — CRD

Provides important supervisory and institutional requirements.

Bank Recovery and Resolution Directive — BRRD

Directive 2014/59/EU establishes the EU framework for bank recovery and resolution.

Single Resolution Mechanism Regulation — SRMR

Regulation (EU) No 806/2014 establishes the framework for resolution within the Banking Union.

Spanish Law 11/2015

Spain implemented the EU recovery and resolution framework through Law 11/2015 on the recovery and resolution of credit institutions and investment firms.

Deposit Guarantee Scheme

EU deposit-guarantee rules generally protect eligible deposits up to:

€100,000 per depositor per bank.

In Spain, the Fondo de Garantía de Depósitos de Entidades de Crédito (FGD) performs the relevant deposit-guarantee function.

4. Recovery Versus Resolution

These concepts must be distinguished.

Recovery

Recovery is the bank's attempt to restore its financial position before failure.

Examples:

• raising capital;
• selling assets;
• restructuring liabilities;
• reducing risk;
• obtaining liquidity;
• disposing of business units.

Banks are required to prepare recovery plans identifying actions that could restore viability during financial stress.

Resolution

Resolution occurs when a bank is failing or likely to fail and ordinary liquidation is considered unsuitable because resolution is necessary in the public interest.

Resolution authorities can intervene before the situation becomes uncontrollable.

The objective is:

preserve critical functions while allocating losses without relying unnecessarily on taxpayer-funded bailouts.

5. "Failing or Likely to Fail"

One of the central concepts in EU bank-resolution law is:

Failing or Likely to Fail (FOLF).

A bank may be considered FOLF where circumstances indicate that it can no longer, or is unlikely soon to be able to, satisfy the conditions for authorization.

Relevant circumstances can include:

• serious capital deterioration;
• inability to pay debts;
• serious liquidity problems;
• regulatory breaches;
• liabilities substantially exceeding assets;
• inability to meet obligations as they fall due.

The assessment is not necessarily postponed until formal bankruptcy has occurred.

This is one of the biggest differences between ordinary insolvency and bank resolution.

6. Early Intervention

Supervisors can intervene before the bank reaches formal failure.

Possible measures can include:

• requiring implementation of recovery measures;
• replacing management;
• requiring changes to business strategy;
• requiring capital strengthening;
• appointing a temporary administrator where legally appropriate;
• requiring asset disposals.

The policy is:

intervene early → preserve value → reduce resolution costs.

7. Resolution Authority

For significant institutions within the Banking Union, the Single Resolution Board (SRB) plays a central resolution role.

National resolution authorities participate in implementing resolution decisions.

In Spain, FROB has an important resolution role under the national framework.

The institutional architecture therefore generally involves:

ECB / supervisory authorities

↓

SRB / resolution authorities

↓

FROB and other national authorities

↓

bank / bridge institution / purchaser / asset-management structure

depending upon the circumstances.

8. Resolution Objectives

EU law identifies several important resolution objectives.

These include:

Continuity of critical functions

Essential services such as payment and deposit functions should continue where possible.

Avoidance of significant adverse effects on financial stability

The failure should not trigger broader systemic disruption.

Protection of public funds

Resolution should reduce reliance on extraordinary public financial support.

Protection of covered depositors

Deposit-guarantee protection is preserved.

Protection of client funds and assets

Customer assets should be protected within the applicable legal framework.

9. Main Resolution Tools

Four major resolution tools are particularly important.

A. Sale of Business

The authority transfers shares or assets/business activities to a private purchaser.

The objective is rapid continuity without requiring the entire institution to remain independent.

B. Bridge Institution

Critical activities are transferred temporarily to a bridge bank.

The bridge institution operates the essential business while a longer-term solution is developed.

C. Asset Separation

Certain assets are transferred to an asset-management vehicle.

This can isolate impaired or difficult-to-value assets from the viable banking business.

D. Bail-in

This is one of the most important post-financial-crisis reforms.

Instead of taxpayers absorbing the losses, qualifying shareholders and creditors bear losses.

The basic principle is:

shareholders first → subordinated creditors → other eligible creditors

subject to the statutory hierarchy and exemptions.

10. Bail-In

Suppose a failing bank has:

€5 billion losses

and insufficient capital.

A resolution authority may impose losses on shareholders and eligible creditors through the bail-in mechanism.

This can involve:

• cancellation of shares;
• dilution;
• conversion of debt into equity;
• reduction of principal;
• write-down of eligible liabilities.

The objective is to recapitalize the institution internally.

11. Liabilities Generally Excluded From Bail-In

Not every liability can simply be written down.

The BRRD framework contains exclusions and special treatment.

Examples can include, subject to the detailed statutory conditions:

• covered deposits;
• certain secured liabilities;
• liabilities relating to client assets held in specified circumstances;
• certain short-term interbank liabilities;
• certain employee liabilities;
• certain tax/social-security liabilities;
• liabilities that cannot reasonably be transferred or bailed in without disproportionate disruption.

The exact treatment depends upon the statutory provisions and resolution circumstances.

12. Deposit Protection

The EU deposit-guarantee framework generally protects eligible deposits up to:

€100,000 per depositor per credit institution.

Example:

Customer has:

€70,000 current account + €20,000 savings account = €90,000

The amount is within the general €100,000 protection limit, subject to applicable rules.

If the customer has:

€150,000

the ordinary guarantee does not mean the entire €150,000 is automatically protected.

Certain temporary high-balance protections may apply in specified circumstances.

13. Bank Creditors and Insolvency Ranking

Where a bank enters liquidation rather than resolution, creditor hierarchy becomes crucial.

A simplified structure may include:

1. secured claims;
2. preferential claims;
3. covered deposits;
4. other deposits according to applicable statutory ranking;
5. senior unsecured liabilities;
6. subordinated liabilities;
7. shareholders.

The precise hierarchy depends upon applicable EU and national law and the nature of the liability.

The fundamental principle is:

Not all bank creditors stand on the same legal footing.

14. No Creditor Worse Off Principle

The No Creditor Worse Off (NCWO) safeguard is a central protection in EU resolution law.

A creditor should not ultimately suffer a greater loss through resolution than it would have suffered if the institution had instead been liquidated under ordinary insolvency proceedings.

If an independent valuation establishes that a creditor would have received more in hypothetical liquidation than it actually received through resolution, compensation may be available through the resolution framework.

This balances:

resolution efficiency

against

creditor property rights.

15. Moratorium and Temporary Restrictions

Resolution authorities may have powers to temporarily restrict:

• payment obligations;
• enforcement rights;
• termination rights;
• certain creditor actions.

The purpose is to prevent a disorderly run on the institution while resolution is being implemented.

These measures must operate within the applicable statutory safeguards.

16. Automatic Termination Clauses

A bank's contracts may contain provisions saying that certain events trigger termination.

Resolution law may restrict the ability of counterparties to terminate contracts merely because the bank has entered resolution, subject to statutory exceptions.

Otherwise, resolution could become impossible.

For example:

bank enters resolution → thousands of contracts terminate → collateral demanded → liquidity disappears → viable business collapses.

Resolution legislation therefore provides protections against certain forms of automatic destabilization.

17. Set-Off and Netting

Financial contracts frequently contain:

close-out netting

and

set-off rights.

These are especially important in derivatives and interbank markets.

Resolution law generally recognizes the need to preserve legitimate netting arrangements while preventing counterparties from using contractual rights in a way that undermines orderly resolution.

18. Bank Insolvency and Central Bank Liquidity

A bank facing a liquidity crisis may seek emergency liquidity assistance.

But:

liquidity assistance ≠ permanent solvency support.

A central bank may provide liquidity against appropriate collateral under its applicable framework, but a fundamentally insolvent institution cannot necessarily be kept alive indefinitely merely through central-bank liquidity.

This is why liquidity, solvency and resolution frameworks must interact.

19. Spanish Example — Banco Popular

One of the most important European bank-resolution examples is:

Banco Popular Español S.A.

In June 2017, the bank was determined to be failing or likely to fail.

The resolution authority used the sale-of-business tool, transferring the bank to Banco Santander for €1.

Shareholders and certain creditors suffered losses.

This case became a major test of EU resolution law.

20. Banco Santander and Others v JUR

General Court, Joined Cases T-12/15, T-158/18 and related litigation

The Banco Popular resolution generated extensive litigation concerning:

• valuation;
• shareholder rights;
• creditor treatment;
• procedural fairness;
• ownership;
• the legality of the resolution decision.

The EU courts examined whether the resolution framework had been lawfully applied.

Importance

The litigation confirms that bank resolution is subject to judicial review even though authorities have broad technical and economic discretion.

21. Algebris (UK) Ltd and Anchorage Capital Group v Single Resolution Board

General Court, Joined Cases T-570/17 and T-575/17

The applicants challenged aspects of the Banco Popular resolution.

The General Court examined issues surrounding the SRB's resolution decision and the legal framework governing resolution.

Principle

Resolution authorities possess significant discretion in highly technical financial assessments, but their decisions remain subject to EU-law requirements and judicial review.

22. Banco Santander v Commission / Banco Popular Litigation

The broader Banco Popular litigation has also addressed:

• shareholder rights;
• valuation;
• access to documents;
• procedural rights;
• the sale process;
• the legitimacy of the resolution decision.

These cases are particularly valuable for studying the tension between:

financial stability

and

property rights of shareholders and creditors.

23. Kotnik and Others

CJEU, Case C-526/14

The case concerned bank recapitalization and burden-sharing in Slovenia.

The Court considered whether shareholders and subordinated creditors could be required to absorb losses before public funds were used.

Importance

The case supports the post-crisis principle that:

bank investors cannot automatically expect taxpayers to absorb losses.

This philosophy is central to the modern European bail-in regime.

24. Ledra Advertising v European Commission and ECB

CJEU, Joined Cases C-8/15 P to C-10/15 P

The case arose from the restructuring of Cypriot banks during the financial crisis.

It involved severe measures affecting depositors and other stakeholders.

The Court considered the relationship between financial-stability measures and fundamental rights.

Importance

Bank crisis-management measures must operate within the EU legal order and respect applicable fundamental-rights protections.

25. Landeskreditbank Baden-Württemberg v ECB

CJEU, Case C-450/17 P

The case concerned ECB classification and supervisory competence under the Single Supervisory Mechanism.

Relevance

It illustrates the central role of EU-level supervision in the Banking Union.

For Spain, significant institutions may therefore be supervised through the ECB/SSM framework, while national institutions remain subject to the applicable supervisory allocation.

26. Trasta Komercbanka and Others v ECB

CJEU, Joined Cases C-663/17 P, C-665/17 P and C-669/17 P

The case concerned the withdrawal of a bank's authorization.

Relevance

Loss of authorization can become a critical precursor to insolvency or resolution.

It demonstrates that prudential supervision and bank-exit mechanisms are closely connected.

27. Banco Popular — Why the Case Is Important

The Banco Popular resolution demonstrates why modern banking law tries to intervene before conventional insolvency proceedings destroy the value of the bank.

If authorities had simply waited for:

cash exhaustion → payment default → conventional insolvency

the bank's critical operations could have collapsed.

Instead:

FOLF assessment → resolution → sale to Santander → continuity of critical banking functions.

This is the basic logic of modern bank-resolution law.

28. Ordinary Insolvency Versus Bank Resolution

29. Bank Insolvency and MREL

Another important European concept is:

Minimum Requirement for Own Funds and Eligible Liabilities — MREL.

MREL ensures that banks maintain sufficient liabilities capable of absorbing losses and supporting recapitalization in resolution.

The purpose is straightforward:

If the bank fails, there must be enough eligible financial resources available to absorb losses without requiring an immediate taxpayer-funded bailout.

This is closely related to the international TLAC framework for global systemically important banks.

30. Recovery Planning

Banks must prepare recovery plans identifying potential recovery actions.

Typical indicators can include:

• CET1 deterioration;
• liquidity deterioration;
• loss of market confidence;
• rating deterioration;
• deposit outflows;
• funding stress.

Possible recovery measures include:

capital raising → asset sale → business restructuring → cost reduction → funding replacement.

The purpose is to prevent temporary stress from becoming irreversible failure.

31. Resolution Planning

Resolution planning asks:

If recovery fails, how can this bank be resolved without destroying critical financial functions?

Authorities consider:

• legal structure;
• critical functions;
• operational dependencies;
• funding;
• liquidity;
• separability of businesses;
• bail-in capacity;
• MREL;
• cross-border structure.

This planning happens before the bank actually fails.

32. Cross-Border Bank Insolvency

Cross-border bank failure is particularly complex.

A Spanish banking group may have operations in:

• France;
• Germany;
• Italy;
• Portugal;
• Latin America;
• other jurisdictions.

A disorderly insolvency in one jurisdiction can affect creditors and depositors elsewhere.

EU banking-union mechanisms seek to coordinate resolution and supervision across participating states.

Internationally, the Financial Stability Board Key Attributes of Effective Resolution Regimes provide an important global reference point.

33. Systemic Risk

A bank's insolvency may create systemic risk through:

interbank exposures + derivatives + payment networks + common asset holdings + depositor confidence.

Suppose Bank A owes Bank B €5 billion.

If Bank A fails:

Bank B suffers loss → Bank B's capital falls → Bank B restricts lending → other banks become stressed.

This is why bank insolvency law is concerned not merely with the individual debtor-creditor relationship.

34. Practical Legal Example

Assume a Spanish bank has:

Assets: €100 billion

Liabilities: €95 billion

At first glance, it has:

€5 billion net assets.

But suppose depositors suddenly withdraw €20 billion.

The bank may have enough long-term assets to remain theoretically solvent but insufficient immediately available liquidity.

It therefore faces a liquidity crisis.

If emergency liquidity is unavailable and assets must be sold at large discounts, the €5 billion capital cushion can disappear rapidly.

The sequence could become:

liquidity stress → asset fire sale → capital erosion → FOLF determination → recovery/resolution → bail-in or sale.

35. Key Legal Principles

The modern Spanish/EU bank-insolvency framework can be reduced to ten principles:

1. Banks receive special insolvency treatment.
2. Supervisors intervene before formal insolvency where possible.
3. Recovery should be attempted while the bank remains viable.
4. Resolution is preferred where liquidation would threaten financial stability.
5. Shareholders generally absorb losses first.
6. Eligible creditors can be subjected to bail-in.
7. Covered deposits receive strong protection.
8. Critical banking functions should continue.
9. Resolution must respect creditor and property-right safeguards.
10. No creditor should ultimately be worse off than under the applicable counterfactual liquidation analysis.

36. Key Case-Law List

Conclusion

Bankruptcy and insolvency rules for banks are fundamentally different from ordinary corporate bankruptcy rules.

In Spain and the EU, the modern approach is:

supervision → recovery → early intervention → FOLF assessment → resolution where necessary → bail-in / sale / bridge bank / asset separation → depositor protection.

The principal legal framework consists of CRR/CRD, BRRD, SRMR, Spanish Law 11/2015 and the EU deposit-guarantee framework.

The most significant practical lesson from Banco Popular and related CJEU/General Court litigation is that a bank does not necessarily have to enter traditional insolvency proceedings before authorities can intervene. Where a bank is failing or likely to fail and ordinary insolvency would threaten financial stability, the EU resolution system allows authorities to restructure or transfer the institution while allocating losses to shareholders and eligible creditors.

The fundamental policy is therefore:

Preserve critical banking services, protect covered depositors and financial stability, while ensuring that bank losses are borne primarily by the institution's investors and eligible creditors rather than automatically by taxpayers.