During the 2007–09 global financial crisis, €213bn of taxpayers’ money was lost as a result of EU bank rescues. The bloc tried to bring an end to taxpayer-funded bailouts when it adopted the Bank Recovery and Resolution Directive (BRRD) in 2014 and established the Single Resolution Board (SRB) in 2015 as the central resolution authority in the euro area.
The aim of the 2014 framework was to resolve failing banks, minimising negative impacts on the economy and on public finances.
However, experience has shown that many failing medium-sized and smaller banks have been managed with solutions outside the resolution framework. Once again, taxpayers’ money was used.
In April 2023, the European Commission (EC) published a legislative proposal to update the bank crisis-management framework that had been in place since 2014. It aims to deal with the failure of medium-sized or smaller banks that were wound up under national insolvency regimes outside the resolution framework in the past.
The legislative package is now being discussed by European institutions. While the proposal will not become law before 2024, and may still undergo several changes, the debate on the proposals has begun in earnest.
Has the framework worked so far?
Before 2014, failing banks could only undergo normal liquidation and state aid.
Santiago Fernández de Lis, global head of regulation at BBVA, says: “We now have a framework in which we have more capacity to react to a banking crisis and to limit the exposure of public funds.” However, crisis management has been very heterogeneous and crises have been solved in different ways, he admits.
This is “because of a discrepancy in criteria for extraordinary public support between the European resolution framework and the national liquidation frameworks,” he adds.
There is a need to align national insolvency laws to ensure more consistent legal handling of bank failures, adds Rym Ayadi, professor at the Bayes Business School and chair of the European Banking Authority’s Banking Stakeholder Group, speaking in a personal capacity.
The SRB has intervened twice. In 2017 it transferred Spain’s Banco Popular Español to Banco Santander; and in 2022, it oversaw the insolvency filing of the Austrian subsidiary of Russia’s Sberbank after its parent was hit by EU sanctions.
In other cases, such as Veneto Banca and rival Banca Popolare di Vicenza in 2017, many would have expected that the SRB would step in, says Hilmar Zettler, head of banking supervision and deposit protection at the Association of German Banks.
For the two Italian banks, which had been declared likely to fail by the European Central Bank (ECB), it was decided that the winding up was to take place under national proceedings. However, the Italian resolution authority decided they were systemic entities and therefore extraordinary public support was granted, in the form of a €4.8bn cash injection.
Dominique Laboureix, chair of the SRB, says: “We decided in some cases not to intervene because we could not recommend something better than liquidation. Based on the legislation, there was no public interest for these banks because they were unlikely to create systemic risk at national level.”
Some feel that despite the strength of the privately funded safety nets put in place since 2014 — deposit guarantee schemes (DGSs) and resolution funds are expected to exceed €55bn and €80bn, respectively, by 2024 — there has been a certain reluctance to step in when it was needed.
Finally, the current framework lags behind in dealing with cross-border banking groups, which are systemically important, says Ms Ayadi.
Earmarked for resolution
The new proposal aims to improve the current framework, though Mr Laboureix points out that these proposals are not a sign of a lack of faith in the current system. Instead, the aim is to bring more banks into the standard resolution framework instead of letting them go into liquidation.
Today there are around 160 EU banks earmarked for the resolution framework, representing the vast majority of risk-weighted assets. “So, that means that the increase in the number of banks [that are] regionally systemic should be, in my view, limited to around 30 banks,” notes Mr Laboureix.
Increasing the scope of European solutions while reducing national ones makes sense to many practitioners. “I have a positive view, perhaps not shared by all the banks in the EU,” Mr Fernández de Lis says, referring to the new proposals.
Some support the need for an adjustment to the current framework, but believe the new approach entails a far-reaching expansion of the resolution regime to many small and medium-sized banks. “From our point of view, this is absolutely not necessary,” Mr Zettler explains.
He points to the banks that are not supervised by the ECB, but are too big and too complex to be handled by the DGS. “And for those institutions, we need clear rules to where they belong — and many of them belong to the Single Resolution Mechanism (SRM),” Mr Zettler notes.
“We need a special regime for systemic relevant banks that cannot be resolved at a national level,” he adds. “We need the European SRM.”
Not everybody agrees on broadening the definition of the ‘public interest test’, which the SRB uses when faced with a failing bank to understand if resolution is a better option than insolvency. Christian M Stiefmueller, senior adviser at Finance Watch, a non-governmental association that conducts research and advocacy on financial regulation, does not think there is a need for recasting the public interest. “At the end of the day, the problem does not lie with the definition at the EU level, rather with the way it is applied at the national level,” he notes.
Deposit guarantee schemes
To reduce the likelihood of bailouts, the 2014 BRRD only allows the use of public funds after bank shareholders have covered losses on up to 8% of the bank’s balance sheet — the so-called ‘8% rule’.
Based on precedents from earlier banking crises, 8% was deemed by regulators to be adequate to cover a bank’s losses in most instances, and keep it afloat long enough to either return to an even keel or be sold to another institution.
The new proposals look at privately funded safety nets, such as DGSs and resolution funds as a complement to banks’ internal loss absorption capacity or minimum requirements of own funds and eligible liabilities (MREL).
The SRB imposes MREL targets on banks. In particular, the EC is proposing to use DGSs as a way of closing the gap between what the bank itself has accumulated in terms of loss absorption capacity and the public support.
“It is sort of trying to unpick the consensus following the 2008 crisis. If a bank is finding it difficult or expensive to achieve the 8% [MREL], let’s [put] the DGS … towards the 8% minimum,” Mr Stiefmueller says.
The impact of the DGS will be limited because the new banks earmarked for the resolution regime are generally small.
When it comes to the 8%, “we’re hearing a lot that it is difficult for these banks to reach and that it is calling their business model into question,” he adds. “I dispute that there is so much resistance mainly because these banks may need to replace cheap funding with more expensive funding.
“Why should we go for a contribution from the DGS, which is a collective contribution from the banking community to one failing bank, before you have actually made sure that the bank’s own investors have contributed 8%?” Mr Stiefmueller asks.
The DGS will not step in in place of a bank’s shareholders, the SRB insists.
“The impact of the DGS will be limited because the new banks earmarked for the resolution regime are generally small and will need to have built up loss-absorbing capacity,” says Mr Laboureix. The solution adopted in Europe is to always prefer private money, including from banks, instead of public money, he points out.
According to Finance Watch, a deal was done under the BRRD back in 2014. The European institutions accepted the existence of systemically important banks, but introduced the 8% rule.
“Basically, this was to be sure that the bank’s investors are on the hook, and taxpayers don’t get hit up to that level,” Mr Stiefmueller says. “This logic is now being called into question.”
Super preference questioned
Existing rules foresee a three-tier depositor ranking in which covered deposits rank first, followed by non-covered deposits of households and small and medium-sized enterprises, which rank above other non-covered deposits.
The proposal looks at changing the ranking of the creditors in a liquidation event, removing the so-called ‘super preference’ of the DGS and creating a single-tier ranking for all deposits.
According to rule-makers, this change is necessary to make sure that DGS resources can be used, boosting the availability of resolution funding.
This is heavily contested by some participants in the negotiations, because they think it will cost banks more money during liquidation. “But if we say that we can deal with a higher number of cases on the side of resolution, all these cases won’t go to liquidation,” Mr Laboureix says.
The super preference is viewed as essential by some. “With the super preference, there will be a quick recovery of compensation cases with no financial damage for the DGS,” Mr Zettler explains.
In contrast, the creation of a single-tier ranking for all deposits will increase the damages for the DGS and it will make the recovery, and especially the insolvency, much more complicated, according to Mr Zettler.
Bank resistance
There are concerns that the current proposals might increase the subsidies from larger banks to smaller ones, and that good banks will pay for the failing ones. “That’s exactly the mechanic of ensuring financial stability — to ask the banks to contribute ex-post,” Mr Laboureix says. “In the US, it is the same thing.”
Banks are not happy because they think that they will have to pay more frequently to refill the DGS. “Normally speaking, they should not pay more and they even should pay less,” Mr Laboureix says. “The more we prepare the banks for their failure, the less they fail, because they have built resilience.”
There is a cost to maintaining financial stability. And also there is a cost to remain resilient.
The other worry is about the inconsistency of a European authority taking decisions on the use of national DGS to be used in the context of a resolution, Mr Fernández de Lis says.
The financial sector is often wary of regulation and its associated costs. “But there is a cost to maintaining financial stability. And also there is a cost to remain resilient. Unless we end up accepting that banking is like any other sector,” Ms Ayadi notes.
Ultimately, there is a concern about the regulatory pendulum swinging back the other way. “I think we have seen it swing back with quite a vengeance for a few years now,” Mr Stiefmueller says.
Finally, there are different views among member states. There are very different schools of thought among member states, with some more likely to dip into public funds to protect their banks while others are more reluctant; this may also be a function of different views on fiscal policy.
“Some seem keen to carry on doing what they’ve been doing in the past, which is to selectively support the banks that are considered politically and systemically important,” says Mr Stiefmueller.
Lack of union
This proposal does not address the lack of a common deposit insurance scheme to complement the European banking union, but it will help move the industry in this direction, Mr Fernández de Lis says.
“We are disappointed that the whole banking union topic is just discussed from the perspective of crisis management and DGSs,” Mr Zettler adds. “We would be in favour of proposals that focus on further market integration in Europe.”
We are disappointed that the whole banking union topic is just discussed from the perspective of crisis management and DGSs.
In the US, there is a big, single market, and the rules for the banks are the same all over the country — at least in principle. “A European bank faces the challenge to adapt to 27 different jurisdictions,” Mr Zettler notes.
Many bankers stress the need for a strengthened funding in the resolution mechanism, with the possibility to have access to funding from the central bank to facilitate the resolution. “Normally these funds are recovered quite rapidly. Such liquidity injection during a crisis is important to stop speculative movement or adverse market dynamics,” Mr Fernández de Lis says.
It is essential that the system contains emergency liquidity assistance. In light of what happened with Credit Suisse and Silicon Valley Bank early in 2023, everybody was reminded that liquidity crises can happen much faster than solvency crises. “We need to have the ECB take the role of lender of last resort or at least coordinate national central banks,” Ms Ayadi says. “When you have a stress situation, this liquidity assistance becomes extremely important.”
