Giuseppe Pennisi Draft
June 15 2014
MUDDLING THROUGH, ON-THE-BRINK
The Single Resolution Mechanism
1.
The
common framework toward national rules and procedures on banking resolution
Repeated bailouts of banks have created a
situation of deep unfairness, increased public debt and imposed a heavy burden
on taxpayers. In short, to ensure that the taxpayer will not have to bail out
banks repeatedly, in June 2012 the EC proposed a common framework of rules and
powers to help EU countries intervene to manage banks in difficulty. The
European Parliament (EP) and the Member States reached an agreement on this
framework on 11 December 2013, subject to technical finalization and formal
approval by both institutions. The Directive of the European Parliament and of
the Council establishing a framework
for the recovery and resolution of credit institutions and investment firms,
generally called the BRRD Directive, is a 333 pages document which set uniform
rules expected to enter into force on 1st January 2015. These rules
have the objective to provide authorities with the means to intervene
decisively both before problems occur (for instance by ensuring that all banks
have recovery and resolution plans in place) and early on in the process if
they do happen (for instance the power to appoint a temporary administrator in
a bank to deal with problems). Briefly, to create a culture of early
interventions (Davies, 2013).
The recovery and resolution plans are to be
reviewed and assessed not only by the national authorities but also by the EU
authorities, namely at each important stage by the European Banking Authority
(EBA) If, despite these preventive measures, the financial situation does
deteriorate beyond repair, the new rules ought to ensure that shareholders and
creditors of the banks will have to pay their shares of the costs through a bail-in mechanism. If additional
resources are needed, these will be taken from the national, prefunded resolution
fund that each CP has to establish and build up so it reaches, within ten years,
a level of 1% of covered deposits. All the banks have to pay into these national
funds; contributions are higher for banks that take more risks.
The mechanism is
expected to stabilize an institution about to call for bankruptcy so that it
can continue to provide essential services, without the need for bail-out by
public funds. Recapitalization through the write-down of liabilities and/or
their conversion to equity will allow the institution to continue as a going
concern. This will avoid the disruption to the financial system that would be
caused by stopping or interrupting its critical services, and will give the
authorities time to reorganize it or wind down parts of its business in an
orderly manner. This is what is, colloquially, called bail-in.
If a bank needs
to resort to bail-in, authorities will
first bail-in all shareholders and will
then follow a pre-determined order. Shareholders and other creditors who invest
in bank capital (such as holders of convertible bonds and junior bonds) will bear
losses first. Deposits under € 100 000 will never be touched: they are entirely
protected at all times. Deposits of individual persons and of small and medium
size enterprises (SMEs) above € 100 000 a) will benefit from preferential treatment
(depositor preference) ensuring that they do not suffer any loss before other unsecured
creditors (so they are at the very bottom of the bail-in hierarchy) and b) CPs can
use a certain flexibility to exclude them fully. In order to preserve
the recovery prospects of a bank and general economic stability, bailing-in will apply up to eight percent of a bank's total assets.
In most cases this will see shareholders and many bondholders wiped out. After
this threshold is reached, the resolution authority might grant the bank use of
the resolution fund; the fund may be accessed up to a maximum of five per cent of that bank's assets. r Thus, the rules support an
approach which places the responsibility of covering bank losses on private
investors in banks and the banking sector as a whole, to the furthest extent
possible, with the view of avoiding, or at least minimizing, moral hazard. In events, such as a
systemic crisis, it may be necessary to allow for the use of public funds to
finance bank resolution, recourse to government stabilization tools will be
possible after the eight per cent bail-in
and subject to prior assessment by the EC . The EC
will evaluate if the economic disturbances and potential threat to the
functioning of the Single Market justify it. Even in these instances, the use
of the resolution fund remains subject to EU State Aid control.
The BRRD Directive is not a single one-for-all operation but the most
recent and most significant step to set a single ‘rulebook’ for banking and
finance in the EMU, a ‘rulebook’ open to other EU States that intend to become
CPs to the banking union. There are stricter rules on hedge funds, short
selling and credit default swaps, a comprehensive set of rules for derivatives,
a framework for reliable high quality credit rating, reform of the framework
for market abuse, and reform of the audit sector.
This is, of course, only a summary of a set of a highly legalistic and
highly technical documents intended to harmonize national rules, procedures and
practices. It is difficult to say whether the 1ST January 2015 deadline
for adoption by all CPs will be met. An assessment of its effectiveness as well
as of possible fine tuning and/or revisions can be made only after a few years
of operations.
The BRRD provides for realistic timing when successive steps are called
for an action or a decision. However, on the assumption that the EMU initial
aim were to eventually become an Optimum Currency Area ( OCA) , it is a further
departure from this concept.
The main issue is whether and when the ‘book rule’ will mold the actual practices
of countries with drastically different deep rooted cultures, especially in
finance and banking as shown by a recent quantitative research (Guiso, Herrera, Morelli, 2013) ,
focusing on the two extreme cases , Germany and Greece. This, of course,
applies to other elements of the banking union, more specifically to the
molding of the cultures of the newly recruited staff by the ECB to handle the
supervision function.
2. The Single Resolution Mechanism (SRM)
As approved on 14 April 2014 by a very large
majority, the SRM will have three central elements: the ECB, a distinct Single Resolution
Board (SRB) and a Single Resolution Fund (SRF) with resources gradually
reaching 55 billion euro .The SRM is to be governed by two texts: a
SRM regulation covering the main aspects of the mechanism and an intergovernmental
agreement (IGA) related to some specific aspects of the SRF. Centralized
decision-making is hoped to be built around a strong SRB (in most document
named the 'Board'), made up by permanent members of the ECB, as well as the EC,
the Council, and the national resolution authorities. In most cases, when a
bank needs to be resolved in the euro area (not merely within the relevant
national resolution mechanism) or established in a EU Member State
participating in the Banking Union, the ECB will notify the case to the SRB,
the EC, and the relevant national resolution authorities. The SRB can meet in
two configurations. In its plenary session, the SRB will take all decisions of
a general nature and in its executive session, it will take decisions in
respect to individual entities or banking groups as long as the use of the SRF
remains below a €5 billion threshold.
The ECB supervisors will trigger the whole process, being responsible for
deciding whether a bank is on the brink of failing with contagion implications
for the entire euro zone not only for a national banking system. The SRB may
ask that the ECB takes such a decision . If the ECB declines to do so, then the
SRB itself may take the decision. The ECB is therefore the main triggering authority but the SRB may also play a role if the ECB is reluctant
to act or hesitates to do so. The EC will adopt draft resolution schemes,
action plans drawn up to address a specific case of a failing bank. The Council
is to be involved only at the EC’s express request. This is expected to avoid
pervasive political interference in individual resolution cases.
It is hoped that the time for taking a decision on a resolution scheme will
be short. The EP estimates that following the inter-institutional compromise
reached at the end of March 2014 ,
the decision-making process will be streamlined and as consequence, a resolution
scheme could therefore be approved within a weekend, from the closing of the US
markets to their opening in Asia. A system will be established, before the
regulation enters into force, which ought to enable the bank-financed SRF to
borrow on the market. This ought to allow the SRF to increase its firepower (in the EU jargon), an ability
which would be particularly crucial in the first years when the European
resolution fund will only have a small capitalization. There will be a rapid mutualization
of the ‘national compartment’ setup of the fund. Forty percent is to be mutualized
in first year, twenty percent in the second year, the rest equally over a
further six years. The national funds would pool sixty percent of all their
resources by year two.
According to a brief by the Secretariat of the EP, these preventive and curative mechanisms
should ensure that taxpayers shoulder negligible bank risk and that banks, like
any other business, may make profits but are also first in line to bear their
losses; in the worst case scenario, they can be wound up without risking a
general financial meltdown.
Would it work
speedily and efficiently? In rough terms, the process can be represented as
such (The Cato Institute, 2013)
The figure is, of course,
drawn by a staunchly free market ‘think tank’ that has little consideration for
a EMU increasingly more distant from an OCA. Also, it does not take into
account the changes made when the March 2014 inter institutional compromise was
reached. However, these changes are marginal. The process still looks like as
an Elizabethan times garden maze. Altogether, a (Gros,
2013)
As a matter of fact, about a
hundred individuals form nearly ten different institutions are involved in the
decision process . A paper by Washington-based the Cato Institute depicts the
decision making process as labyrinth , more specifically as an Elizabethan
times garden maze, a game for the pleasure and enjoyment of aristocrats and
high officials with plenty of time to spare, whilst very speedy , indeed, quick
decisions are required to help resolve any banking crisis. No doubt, the Cato
Institute is an extremist free market think tank, but also other commentators
have qualifies as ‘baroque’ the key aspects of the decision making procedure.
In my opinion, the decision making process as
now agreed upon by the European authorities is quite unlikely to be handled
within the short time span of a weekend when markets are closed. More significantly,
together with the bail-in clause, the
SRB and its procedure are more likely to act as a deterrent, as a force de frappe, to persuade major banks
that there is no free lunch and that rescue, if required, will be mostly at
their own cost.
3.
The BRRD and the
SRM
The BRRD and the SRM ought to be seen as an
integrated whole whereby the latter is called upon only if and when the national resolution
mechanisms have been , discreetly, tried, but without yielding the expected
results and there is the risk of contagion from a national banking crisis to
the European banking system. As indicated above in para. 1is to be seen as a
the most recent chapter of a ‘rulebook’ aimed at making uniform the national
mechanisms and providing for a basic crisis prevention culture in European
banking and finance in general.
On its own account, this
crisis prevention culture ought to be constructed on a number of pillars: a)
when banks get in trouble, private sector should be generally expected to
step-in with recapitalization and bail-in by stockholders and bondholders and,
if need be, taken over by another private financial institution without State
support; b) the least cost principle should guide the resolution authority in
deciding on the specific methods and procedures (when the national mechanism
provide for a plurality of methodological and procedural approaches); c)
private funds for the resolution should be escrowed in advanced by the national
private banking system so that, in case of need, they should be made available
swiftly ; d) if , as it often the case, crisis affecting banks are
macroeconomic in nature and follow asset market downturn, ultimately Government
support may be required to support the resolution escrow fund and priority
ought be given to helping resolution the most ‘contagious’ financial
institutions. Some authors do emphasize the appropriateness of a’ sufficient
geographical reach’ in order to ‘foster stability of banks’. Within the euro zone,
the ‘appropriate geographical reach’ is the euro zone itself due to the very
tight interplay of banking in the euro area. All authors do emphasize that
swift decision making is the crucial ingredient of financial crisis management
both at the national and the European level.
Two main issues emerge. On the one hand, the BRRD ‘
rule of book ‘ will require time to mould a uniform prevention culture in the
euro zone national resolution systems; this is inevitable and is one of the
reasons for the long transitional period foreseen before the SRF and the SRB
are fully operational. On the other hand, decision making in the SRM (as
presently provided) is far from the swift action – oriented method considered
required for the individual national mechanisms.
4Conclusions
This overview of
the SRM is a further indication that the EMU is an on-the-brink union muddling current problems and issues as they
come. This raises a broader question: after almost a quarter of a century from
the Maastricht Treaty negotiations and after several piece meal adjustments, is
it not high time to carry out a comprehensive review of the Treaty to update it
to circumstances (such as banking crisis) not foreseen when it was prepared?
