The impervious road to the
Single Resolution Mechanism (Srm)
of the European Banking Union (Ebu)
Giuseppe Pennisi
Introduction
Way back in the Spring 1992, a team of specialists from various
disciplines was preparing the program of the would-be-government expected
to result from the forthcoming political elections. A well known senior
economist from the Rome University La Sapienza joined the meeting with a
slight delay but with a thick book in his hand: the Maastricht Treaty which
had not yet been ratified by the required number of Member States. With a
sweet and sour smile, he told the others: «When this Treaty is effective, what
the government is doing with the Banco di Napoli and Banco di Sicilia will
not be allowed». At that time, in fact the Banco di Napoli and the Banco di
Sicilia were both about to file for bankruptcy and were being rescued by
other financial institutions with the support of the Italian Treasury and the
Bank of Italy as well as (for the Banco di Sicilia) of the Regione Siciliana1.
As a matter of fact, the Maastricht Treaty does not allow government support
to banks in trouble and considers it State aid, which distorts competition. If
the Euro Zone were an Optimal Currency Area (Oca)2, such interventions
would not be allowed. The Euro ‘founding fathers’ were well aware that
structural differences between the countries seeking to join the European
Monetary Union (Emu) would not have allowed the Euro area to become an
Oca for several years or even decades. They designed a path with specific
targets that would eventually turn the Emu into an Oca. However, actual
developments have been quite different than foreseen when the Maastricht
Treaty was negotiated in the 1990s. As a matter of fact, during the financial
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1 For a summary of these developments, see Riccardo De Bonis, Tre temi di politica monetaria, in «Studi
e note di economia», 1996, No. 2 and Mario Sarcinelli, La politica monetaria italiana negli anni ’80 e
’90; la revisione del modus operandi, in «Moneta e credito», 1995, No. 192. For similar and more recent
examples, W. Scott Frame, Andreas Fuster, JosephTracy, James Vickery, The rescue of Fannie Mae and
Freddie Mac, in «Federal Reserve Bank of New York Staff Report», 2015, No. 719 and Rosalind
Wiggins, Natalia Tente, Andrew Metrick, European Banking Union, D: Cross Border Resolution –
Dexia Group, in «Yale Program on Financial Stability Case Studies», 2014, 5D-V1».
2 Mario Sarcinelli, L’unione bancaria europea è sufficiente per stabilizzare l’eurozona?, in «Moneta e
Credito», 2013, No. 261.
The impervious road to the
Single Resolution Mechanism (Srm)
of the European Banking Union (Ebu)
GIUSEPPE PENNISI
crisis which started in 2008, there have been major government interventions
to rescue financial institutions; and there has been an increased fragmentation
of financial and banking markets. Also and as a consequence, special, ad hoc
European authorities and agencies have been created. Finally, increasing
divergences within the countries of the area are raising issues that touch on
the very survival of the single currency3. Within this context, the European
Banking Union (Ebu) was designed in 2012 to prevent crises, help to solve
them, and facilitate a better integration of European financial and banking
markets.
The main features of the European Banking Union (Ebu)
The Ebu, as originally designed, was expected to have three main legs.
The first leg is a Single Supervisory – or Surveillance – System (Sss)
whereby: a) surveillance of major financial institutions is to be carried out
directly by the European Central Bank (Ecb), and, b) agreed criteria and
methods are to be followed in surveillance of the other banks by the national
supervisory authorities of individual member States. The second leg is a
Single Resolution Mechanism (Srm) to handle major banking crises. The
third leg is a Single Deposit Guarantee Scheme (Sdgs) as a safeguard to
savers and depositors. In 2014, the Sss appeared to be well set to begin
operations so that the Ecb planned to hire nearly a thousand new employees
for this purpose and to build new headquarters in Frankfurt4. The Srm had
been designed, and its main elements had been agreed upon. But the Sdgs still
has a long way to go.
A preliminary assessment, however, can be formulated at this time. In
early 2015, the fledgling Sss started to operate, apparently to the satisfaction
of all the concerned parties5. The Srm has yet to be experienced and, thus,
proven. There have been no major developments on the Sdgs and there are
increasing doubts about the need for its establishment6. Nonetheless, there has
been a significant evolution, especially in relation to the Greek debt crisis
which made quite obvious the possibility of contagion to the entire financial
system of the area, and even to the rest of the world7. This article focuses on
the Srm because it is the essential and most original element for a well-
GIUSEPPE PENNISI
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3 Jamal Ibrahim Haidar, Can the euro survive?, in «The World Economy», 2015, Vol. 38, Issue 3.
4 Luis M. Hinojosa-Martinez, The Role of the ECB in Supervising of Credit Institutions, in Luis M.
Hinojosa-Martinez and Jose M. Beneyto (edited by), «European Banking Union - The New Regime»,
Kluwer, 2015.
5 Rosalind Z. Wiggins, Michael Wedow, Andrew Metrick, European Banking Union - The Single
Supervisory Mechanism, in «Yale Program on Financial Stability Case Study», 2014, 5A-VI.
6 Veerle Colaret, Deposit Guarantee Schemes in Europe. Is the Banking Union in Need of a Third Pillar?,
in «European Company and Financial Law Review», 2015, Vol. No. 2.
7 Sotiris Serbos, Eurozone’s Debt Crisis and US Strategy: A Return of Geopolitics for Europe, in Center
for Transatlantic Relations, School of Advanced International Studies, Johns Hopkins University,
forthcoming 2015.
functioning and well-integrated European capital market which is a pre -
requisite for a return to growth and development in the European Union (Eu)8.
Thus, this article expands and updates the contribution to the 2014 Astrid
publication9, taking recent evolution into account, as well as examining
several aspects of the Srm in greater depth. This is the real innovation in
international relations because, if memory serves, it has never happened
before that several countries agreed to join forces for setting-up an orderly
banking resolution mechanism.
Of course, there would be no need for a banking union or an Srm to
handle major banking crises in Member States if the Emu were an Oca or a
well-functioning union. In my view, calling the members ‘Contracting
Parties’ is more correct than calling them ‘Member States’ because the Ebu
agreements are open to other States of the Eu not belonging to the Emu.
There is general agreement on this point among economists10. Also, as
suggested above, the initial readings and interpretations of the Maastricht
Treaty indicate that even banking resolution operations at the national level
are barely allowed because they entail state aid and they interfere with the
proper workings of a monetary union.
However, «the world is what it is» as V.S. Naipaul admonishes us from
the very first line of his Nobel Prize winning novel, A Bend in the River11. The
Oca theorem12 is a useful tool to assess whether and how monetary unions can
last and grow in strength and depth. As explained above, the Emu lacks many
fundamental elements of an Oca. Rather, it is an «on-the-brink-union» as
beautifully and skilfully defined by Bergsten and Kirkegaard in a recent
brief13. An on-the–brink-union is like a house built on sand, not on stone,
therefore always at high risk of collapsing at the first storm. Bergsten and
Kirkegaard (as well as several other economists) have consistently
maintained for a quarter of a century that «the European Commission (Ec)
locomotive theory is empirically wrong: the introduction of the common
currency itself did not facilitate any increase in economic and political
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8 Jennifer Payne, Elisabeth Howell, The Creation of a European Capital Market, in Panos Koutrakos and
Jukka Snell (edited by) «Research Handbook on the Law of the Eu’s Internal Market», Oxford
University Press, 2015.
9 Giuseppe Pennisi, Muddling Through, on the brink: the Single Resolution Mechanism, in Emilio Barucci
and Marcello Messori (edited by), «Towards the European Banking Union: Achievements and Open
Problems», Firenze, Passigli Editori, Astrid, 2014, pp. 109-116.
10 For a review see, Michael Artis, The UK and the Eurozone, in «Cesifo Economic Studies», 2006, Vol.
52, No.1; Hyiung Kew Chey, A Political Economic Critique on the Theory of Optimum Areas, and the
Implications for East Asia, in «The World Economy», 2014, No. 12; John Horvarth, Optimum Currency
Area Theory, A Selective Review, in «Bofit Discussion Paper», 2003, No. 15.
11 Vidiadhar Surajprasad Naipaul, A Bend in the River, New York, Vintage Press, 1979.
12 Robert Mundell, A Theory of Optimal Currency Area, in «The American Economic Review», 1961, Vol.
61, No. 4.
13 C. Fred Bergsten, Jacob Funk Kirkegaard, The Coming Resolution of the European Crisis: An Update,
in «Peterson Institute of International Economics, Policy Brief», 2012, No. 12-18.
integration in the Euro area, but produced the opposite result». Nonetheless,
Bergsten and Kirkegaard’s on-the-brink union is quite similar to the current
state of the Emu as described in the 28 March 2014 Ec memorandum14. This
memorandum states that the financial crisis highlighted the need for better
regulation and supervision of the financial sector. Also the memorandum
provides a good account of all the steps foreseen and actually implemented in
the few years before 2014 to move toward a banking union built on three legs
in order to minimize, if not avoid, contagion15.
The rationale for the Single Resolution Mechanism (Srm)
Repeated bank bailouts have created a situation of deep unfairness,
increased public debt, and imposed a heavy burden on taxpayers16. In short, to
ensure that the taxpayers 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
and the European Council of Ministers reached agreement on this framework
on 11 December 2013, subject to technical finalization and formal approval
of the ensuing directive by both institutions. The Directive of the European
Parliament and of the European Council, generally called the Bank Recovery
and Resolution Directive (Brrd), is a 333-p. document which sets uniform
rules, which entered into force on 1st January 2015. The Brrd establishes a
framework for the recovery and resolution of credit institutions and
investment firms17. These rules aim at providing 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
recovery and/or resolution process (for example in case a temporary
administrator is appointed for a limited period to deal with the problems).
Briefly put, the intention is to create a culture of early intervention18.
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14 European Commission, A comprehensive EU response to the financial crisis: substantial progress
towards a strong financial framework for Europe and a banking union for the Eurozone, Brussels,
Memo 14-244, 28 March 2014.
15 Olympia Bover, Eva Sierminska, Jose Maria Casado, Panagiota Tzamourani, Sonia Costa, Ernesto
Villanueva, Philip Du Caju, Tibor Zavadil, Yvonne McCarthy, The Distribution of Debt Across Euro
Area Countries. The Role of Individual Characteristics, Institutions and Credit Conditions, 2014,
Frankfurt am Main, European Central Bank Working Paper, No. 1639.
16 For an effective summary, Nikolaos Papanikolaou, The Road Towards the Establishment of the
European Banking Union, in «Munich Personal Repec Archive Paper», 2015, No. 62463.
17 Council of the European Union, Directive of the European Parliament and of the Council establishing
a framework for the recovery and resolution of credit institutions and investment firms and amending
Council Directives 77/91/EEC and 82/891/EC, Directives 2001/24/EC, 2002/47/EC, 2004/25/EC,
2005/56/EC, 2007/36/EC and 2011/35/EC and Regulation (EU) No 1093/2010 of the European
Parliament and of the Council, Brussels, 18 December 2013 - 17958/13, EF 276, ECOFIN 1174, DRS
227, CODEC 3011.
18 Alan Edwards Bavies, Bank Resolution in the UK: Creating a Culture of Early Intervention, University
of Bristol, 2013.
The recovery and resolution plans have 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. If, despite these
preventive measures, the financial situation of a bank deteriorates beyond
repair, the new rules ensure through a ‘bail-in’ mechanism that shareholders
and creditors of the banks have to pay their share of the costs. If additional
resources are needed, these must be taken from the national, prefunded
resolution fund that each Contracting Party must establish and build up within
10 years, so that it reaches a level of 1% of covered deposits. All banks must
pay into this fund but banks which take more risks will have to pay more.
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 to be bailed-out by public funds. Recapitalization through the writedown
of liabilities and/or their conversion to equity will allow the institution
to continue as a going concern, avoids the disruption to the financial system
caused by stopping or interrupting its critical services, and gives the
authorities time to reorganize the bank 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 a ‘bail-in’, authorities first ‘bail-in’ all those
who have invested in the bank in an order: common shareholders, certain
categories of preferred shareholders and the creditors whose bonds are
convertible to common shares. Individual depositors whose accounts contain
less than 100,000 Euro are entirely protected at all times. Deposits of
individual persons and small and medium size enterprises exceeding 100,000
Euro: a) benefit from preferential treatment (depositor preference) ensuring
that they do not suffer any loss before other unsecured creditors do, and b)
Contracting Parties can choose to use certain flexibility to exclude them fully
from the ‘bail-in’ process. In order to preserve the recovery prospects of a
bank and general economic stability, ‘bailing in’ applies at least up 8% of a
bank’s total assets. After this threshold, the resolution authority might grant
the bank the use of the resolution fund, accessing funds up to a maximum of
5% of that bank’s assets. Thus, the rules support an approach with the view of
avoiding, or at least minimizing moral hazard because it places the
responsibility of covering bank losses on private investors in banks and the
banking sector as a whole to the greatest extent possible.
In events such as a systemic crisis, it may be necessary to allow the use
of public funds to finance bank resolutions. Recourse to government funds is
possible after the 8% ‘bail-in’. However, this is subject to prior assessment by
the Ec of whether the economic disturbance and potential threat to the
functioning of the Emu justify it.
The Brrd is not a single one-for-all document but the most recent and
most significant step to set a single ‘rulebook’ for banking and finance in the
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Emu, a ‘rulebook’ open to other Eu States that intend to become Contracting
Parties to the Ebu. It includes: a) stricter rules on hedge funds, short selling
and derivatives, including credit default swaps; b) a comprehensive set of
rules for derivatives; c) a framework for a reliable, high quality credit rating;
and, d) a reform of the rules for market abuse. An assessment of the Srm’s
effectiveness as well as of possible fine tuning and/or revisions can only be
credibly carried-out after several years of operations.
The Brrd is quite clear and provides for realistic timing when successive
steps are called for an action or for a decision. However, on the assumption
that the Emu’s initial aim was to eventually become an Oca, the Brrd
represents a further departure from the path towards this objective.
The main issue is whether and how the ‘rule book ’ moulds the practices
of countries with drastically different and deep-rooted cultures, especially in
finance and banking as shown by a recent quantitative research19, focusing on
the cases of Germany and Greece. This, of course, applies to other Ebu
Contracting Parties, as well as more specifically to the moulding of the
cultures of the staff newly recruited by the Ecb to handle the supervision
functions.
The design of the Single Resolution Mechanism (Srm)
As approved on April 2014 by a very large majority of the European
Parliament (570 members approved, 88 voted no, and 13 abstained), the Srm
has three main actors: a) the Ecb, b) a distinct Single Resolution Board (Srb)
and, c) a Single Resolution Fund (Srf) with resources gradually reaching 55
billion Euro. The Srm is governed by two texts: an Srm regulation covering
the main aspects of the mechanism and an intergovernmental agreement
about some specific aspects of Srf. Centralized decision-making involves an
Srb with permanent members, the Ecb, the Ec, the European Council of
Ministers, and the national resolution authorities. In most cases, when a bank
needs to be resolved in the Euro area or established in a Eu Member State
participating in the Ebu, the Ecb notifies the case to the Srb, the Ec, and the
relevant national resolution authorities. The Srb meets in two types of
sessions. In its plenary sessions, the Srb takes all decisions of a general
nature, while in its executive sessions, it takes decisions with respect to
individual entities or to banking groups, if their use of the Srf is below a 5
billion Euro threshold.
The Ecb supervisors trigger the whole process, being responsible for
deciding whether a bank is on the brink of failing. The Srb may ask that the
Ecb takes the pertinent decision. If the Ecb declines to do so, then the Srb
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19 Luigi Guiso, Helios Herrera, Massimo Morelli, A Cultural Clash View of the EU Crisis, Brussels, Cepr,
2013.
itself may take the decision. The Ec adopts the draft resolution schemes and
the plans drawn up to address the specific case of a failing bank. The
European Council of Ministers gets involved only at the Ec’s express request.
This is expected to avoid pervasive political interference in individual
resolution cases, a key concern for the European Parliament.
It is hoped that the time for decisions to be taken on a resolution scheme
will be very short. The European Parliament estimates that following the
inter-institutional compromise reached in March 2014, the decision-making
process will be greatly streamlined. As a consequence, a resolution scheme
could therefore be approved within a weekend, from the closing of the Us
markets to their opening in Asia. A regulation will enable the Srf to borrow in
order to increase ‘its firepower’ (in the Eu jargon), an ability which would be
particularly crucial in the first years when the Srf will only have a small
capitalization. A rapid mutualisation of the ‘national compartments’ of the Srf
is foreseen: 40% is to be mutualised in the first year, 20% in the second year,
the rest equally over a further six years. Rapid mutualisation was a
requirement for the European Parliament.
According to the European Parliament, these preventive and curative
mechanisms as well as the Sss should ensure that taxpayers shoulder only
negligible bank risk. On the other hand, banks, like any other business, may
make profits but are also first in line to bear their losses and, in the worst-case
scenario, can be wound-up without risking a general financial meltdown.
Will the Srm work speedily and efficiently? In summary terms, the
decision-making process can be represented as in the figure below.
The figure, here in Appendix, is drawn by the Cato Institute, a free
market ‘think tank’ which of course has little consideration for an Emu
increasingly more distant from an Oca. The process still looks like as an
Elizabethan garden maze. About a hundred individuals from nearly ten
different institutions are involved in the decision-making process to ask for
Srf relief, and on how to make use of it.
Altogether, as Daniel Gros pointed out: «the decision-making
mechanism of the Resolution Board is so complex that in practice it will work
quite differently from what one would imagine by looking at the formal rules.
In an emergency, the people with the necessary information will decide and
all the others who are formally also involved will probably just have to
agree»20.
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20 Daniel Gros, The Bank Resolution Compromise: Incomplete, but workable? in «CEPS Commentary»,
19 December 2013; after the European Parliament approval of the SRM, comments were not
enthusiastic, for example, Greg Ford of Financial Watch stressed that the authorities will get jammed
when there is a crisis involving very large and very interconnected banks; Reinhart Close of Ubs said
that the decision making process is still rather complicated; Guntram B. Wolff, Director of Bruegel
underlined that the Ecb must be as tough with a bank in Germany as with a bank in Greece, but that the
sizeable amount of money that the banks will have to pay toward their own rescue offer greater
assurance of stability than in the recent past.
This baroque decision making process is unlikely to be handled within
the short time span of a week-end, when markets are closed. More
significantly, together with the ‘bail-in’ clause, the Srb and its procedures are
more likely to act as a deterrent or 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.
Conclusion
In Spring 2014, an overview of the Srm stated that it «is a further
indication that the Emu is an on-the-brink union muddling through current
problems and issues as they come». It also added that «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 to update the Treaty to circumstances (such
as banking crisis) not envisaged when it was prepared?»21.
Developments over the last fifteen months certainly strengthen this point.
The negotiations brought about a set of financial institutions and instruments,
but their adequacy is of particular concern as concluded in a recent legal
analysis of the Srm22. Even more significantly, the available mechanisms have
not been utilized in cases when a bank resolution could have had adverse
effects on the Emu financial integration.
A case in point is the difficult situation of the Italian bank, Monte dei
Paschi di Siena (Mps)23. In short, this major Italian bank was about to go
bankrupt with Europe-wide consequences. Instead, a wholly national solution
was chosen by issuing convertible bonds to be purchased by the Italian
Treasury. After about one year, the Italian Treasury became the major
shareholder of Mps – a path quite different from that foreseen by the
“founding fathers” of the Emu and of the negotiators of the Maastricht Treaty.
However, this is only one aspect. The Ebu, as seen in the introduction,
has as its main and highest objective to prevent the fragmentation of the
European capital market and of the banking sector and to increase integration.
Developments over the last year or so show that the Ebu, the Sss, and the Srm
have not had any significant positive impact in facilitating the reaching of
these goals.
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21 Giuseppe Pennisi, op. cit., p.116.
22 Christos Hadjemmanuel, Bank Resolution Financing in the Banking Union, in «Lse Legal Studies
Working Paper», 2015, No. 6.
23 For details and analysis see Kenjoro Hori, Jorgen Martin Ceron, Agency Cost of Bail in, in «Birkbeck
University of London Department of Economics, Mathematics and Statistics Working Paper», No.
Bwpef 1407 and Francesco Capriglione, The EU-Wide Stress Tests: A Storm Before a New Order of the
Financial Market. The Italian Case, in «Open Review of Management, Banking and Finance», 2015,
No. 20/2.
The main indicator is the lack of cross-national and Europe-wide mergers
and acquisitions (M&As). They are few and far between, while the ‘home
bias’ remains very strong. There has been a real flurry of M&As but very few
that are cross-national. Moreover, the most important cross-national M&A –
the purchase of Tsb, a British bank operating mostly on line, by the Banco
Sabadell, Spain’s fifth biggest lender, had the primary purpose to set a foot in
the United Kingdom – viz. outside the Emu. Banco Sabadell’s main
challenger was another Spanish bank, Caixa Bank, also aiming at finding a
way to operate outside the rules and regulations of Emu. There are other
examples. In Portugal, after a severe cure, the Novo Bank, the successor of
the Banco de Espìrito Santo, is up for sale but does not appear to elicit interest
by major banks of other Emu countries though several might find it
interesting to have business in the western-most continental European
country.
The Deutsche Bank, the largest of the Federal Republic of Germany, is
thinking of selling part or all its retail operations in order to consolidate and
improve its profits, but it made it known that it is seeking German purchasers.
Other examples could be mentioned. As a matter of fact in 2013-2014, only
the major French bank Bnp-Paribas increased its international foothold. At
some stage, it appeared interested in acquiring a significant participation in
the Italian bank Mps or in the German Commerzbank. However, high
transaction costs reportedly prevented Bnb-Paribas from going any further.
Within the Emu, a domestic M&A costs about half of what it would cost to
acquire or merge with a bank of another Emu country. Thus, policy
instruments other than the Ebu’s desire to integrate financial and banking
markets may be more efficient in bringing about these lofty goals24.
Unfortunately, the way appears to be all uphill.
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24 André Sapir and Guntram B. Wolff, Euro area governance :what to reform and how to do it, in «Bruegel
Policy Brief», 2015, 27 February 2015, No. 1.
APPENDIX*
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* The Cato Institute, The EU’s New Banking “Single Resolution Board”, posted in «Cato’s Domain» on
December 28, 2013 by Cato The Eldest.
Single Resolution Mechanism (Srm)
of the European Banking Union (Ebu)
Giuseppe Pennisi
Introduction
Way back in the Spring 1992, a team of specialists from various
disciplines was preparing the program of the would-be-government expected
to result from the forthcoming political elections. A well known senior
economist from the Rome University La Sapienza joined the meeting with a
slight delay but with a thick book in his hand: the Maastricht Treaty which
had not yet been ratified by the required number of Member States. With a
sweet and sour smile, he told the others: «When this Treaty is effective, what
the government is doing with the Banco di Napoli and Banco di Sicilia will
not be allowed». At that time, in fact the Banco di Napoli and the Banco di
Sicilia were both about to file for bankruptcy and were being rescued by
other financial institutions with the support of the Italian Treasury and the
Bank of Italy as well as (for the Banco di Sicilia) of the Regione Siciliana1.
As a matter of fact, the Maastricht Treaty does not allow government support
to banks in trouble and considers it State aid, which distorts competition. If
the Euro Zone were an Optimal Currency Area (Oca)2, such interventions
would not be allowed. The Euro ‘founding fathers’ were well aware that
structural differences between the countries seeking to join the European
Monetary Union (Emu) would not have allowed the Euro area to become an
Oca for several years or even decades. They designed a path with specific
targets that would eventually turn the Emu into an Oca. However, actual
developments have been quite different than foreseen when the Maastricht
Treaty was negotiated in the 1990s. As a matter of fact, during the financial
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1 For a summary of these developments, see Riccardo De Bonis, Tre temi di politica monetaria, in «Studi
e note di economia», 1996, No. 2 and Mario Sarcinelli, La politica monetaria italiana negli anni ’80 e
’90; la revisione del modus operandi, in «Moneta e credito», 1995, No. 192. For similar and more recent
examples, W. Scott Frame, Andreas Fuster, JosephTracy, James Vickery, The rescue of Fannie Mae and
Freddie Mac, in «Federal Reserve Bank of New York Staff Report», 2015, No. 719 and Rosalind
Wiggins, Natalia Tente, Andrew Metrick, European Banking Union, D: Cross Border Resolution –
Dexia Group, in «Yale Program on Financial Stability Case Studies», 2014, 5D-V1».
2 Mario Sarcinelli, L’unione bancaria europea è sufficiente per stabilizzare l’eurozona?, in «Moneta e
Credito», 2013, No. 261.
The impervious road to the
Single Resolution Mechanism (Srm)
of the European Banking Union (Ebu)
GIUSEPPE PENNISI
crisis which started in 2008, there have been major government interventions
to rescue financial institutions; and there has been an increased fragmentation
of financial and banking markets. Also and as a consequence, special, ad hoc
European authorities and agencies have been created. Finally, increasing
divergences within the countries of the area are raising issues that touch on
the very survival of the single currency3. Within this context, the European
Banking Union (Ebu) was designed in 2012 to prevent crises, help to solve
them, and facilitate a better integration of European financial and banking
markets.
The main features of the European Banking Union (Ebu)
The Ebu, as originally designed, was expected to have three main legs.
The first leg is a Single Supervisory – or Surveillance – System (Sss)
whereby: a) surveillance of major financial institutions is to be carried out
directly by the European Central Bank (Ecb), and, b) agreed criteria and
methods are to be followed in surveillance of the other banks by the national
supervisory authorities of individual member States. The second leg is a
Single Resolution Mechanism (Srm) to handle major banking crises. The
third leg is a Single Deposit Guarantee Scheme (Sdgs) as a safeguard to
savers and depositors. In 2014, the Sss appeared to be well set to begin
operations so that the Ecb planned to hire nearly a thousand new employees
for this purpose and to build new headquarters in Frankfurt4. The Srm had
been designed, and its main elements had been agreed upon. But the Sdgs still
has a long way to go.
A preliminary assessment, however, can be formulated at this time. In
early 2015, the fledgling Sss started to operate, apparently to the satisfaction
of all the concerned parties5. The Srm has yet to be experienced and, thus,
proven. There have been no major developments on the Sdgs and there are
increasing doubts about the need for its establishment6. Nonetheless, there has
been a significant evolution, especially in relation to the Greek debt crisis
which made quite obvious the possibility of contagion to the entire financial
system of the area, and even to the rest of the world7. This article focuses on
the Srm because it is the essential and most original element for a well-
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3 Jamal Ibrahim Haidar, Can the euro survive?, in «The World Economy», 2015, Vol. 38, Issue 3.
4 Luis M. Hinojosa-Martinez, The Role of the ECB in Supervising of Credit Institutions, in Luis M.
Hinojosa-Martinez and Jose M. Beneyto (edited by), «European Banking Union - The New Regime»,
Kluwer, 2015.
5 Rosalind Z. Wiggins, Michael Wedow, Andrew Metrick, European Banking Union - The Single
Supervisory Mechanism, in «Yale Program on Financial Stability Case Study», 2014, 5A-VI.
6 Veerle Colaret, Deposit Guarantee Schemes in Europe. Is the Banking Union in Need of a Third Pillar?,
in «European Company and Financial Law Review», 2015, Vol. No. 2.
7 Sotiris Serbos, Eurozone’s Debt Crisis and US Strategy: A Return of Geopolitics for Europe, in Center
for Transatlantic Relations, School of Advanced International Studies, Johns Hopkins University,
forthcoming 2015.
functioning and well-integrated European capital market which is a pre -
requisite for a return to growth and development in the European Union (Eu)8.
Thus, this article expands and updates the contribution to the 2014 Astrid
publication9, taking recent evolution into account, as well as examining
several aspects of the Srm in greater depth. This is the real innovation in
international relations because, if memory serves, it has never happened
before that several countries agreed to join forces for setting-up an orderly
banking resolution mechanism.
Of course, there would be no need for a banking union or an Srm to
handle major banking crises in Member States if the Emu were an Oca or a
well-functioning union. In my view, calling the members ‘Contracting
Parties’ is more correct than calling them ‘Member States’ because the Ebu
agreements are open to other States of the Eu not belonging to the Emu.
There is general agreement on this point among economists10. Also, as
suggested above, the initial readings and interpretations of the Maastricht
Treaty indicate that even banking resolution operations at the national level
are barely allowed because they entail state aid and they interfere with the
proper workings of a monetary union.
However, «the world is what it is» as V.S. Naipaul admonishes us from
the very first line of his Nobel Prize winning novel, A Bend in the River11. The
Oca theorem12 is a useful tool to assess whether and how monetary unions can
last and grow in strength and depth. As explained above, the Emu lacks many
fundamental elements of an Oca. Rather, it is an «on-the-brink-union» as
beautifully and skilfully defined by Bergsten and Kirkegaard in a recent
brief13. An on-the–brink-union is like a house built on sand, not on stone,
therefore always at high risk of collapsing at the first storm. Bergsten and
Kirkegaard (as well as several other economists) have consistently
maintained for a quarter of a century that «the European Commission (Ec)
locomotive theory is empirically wrong: the introduction of the common
currency itself did not facilitate any increase in economic and political
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8 Jennifer Payne, Elisabeth Howell, The Creation of a European Capital Market, in Panos Koutrakos and
Jukka Snell (edited by) «Research Handbook on the Law of the Eu’s Internal Market», Oxford
University Press, 2015.
9 Giuseppe Pennisi, Muddling Through, on the brink: the Single Resolution Mechanism, in Emilio Barucci
and Marcello Messori (edited by), «Towards the European Banking Union: Achievements and Open
Problems», Firenze, Passigli Editori, Astrid, 2014, pp. 109-116.
10 For a review see, Michael Artis, The UK and the Eurozone, in «Cesifo Economic Studies», 2006, Vol.
52, No.1; Hyiung Kew Chey, A Political Economic Critique on the Theory of Optimum Areas, and the
Implications for East Asia, in «The World Economy», 2014, No. 12; John Horvarth, Optimum Currency
Area Theory, A Selective Review, in «Bofit Discussion Paper», 2003, No. 15.
11 Vidiadhar Surajprasad Naipaul, A Bend in the River, New York, Vintage Press, 1979.
12 Robert Mundell, A Theory of Optimal Currency Area, in «The American Economic Review», 1961, Vol.
61, No. 4.
13 C. Fred Bergsten, Jacob Funk Kirkegaard, The Coming Resolution of the European Crisis: An Update,
in «Peterson Institute of International Economics, Policy Brief», 2012, No. 12-18.
integration in the Euro area, but produced the opposite result». Nonetheless,
Bergsten and Kirkegaard’s on-the-brink union is quite similar to the current
state of the Emu as described in the 28 March 2014 Ec memorandum14. This
memorandum states that the financial crisis highlighted the need for better
regulation and supervision of the financial sector. Also the memorandum
provides a good account of all the steps foreseen and actually implemented in
the few years before 2014 to move toward a banking union built on three legs
in order to minimize, if not avoid, contagion15.
The rationale for the Single Resolution Mechanism (Srm)
Repeated bank bailouts have created a situation of deep unfairness,
increased public debt, and imposed a heavy burden on taxpayers16. In short, to
ensure that the taxpayers 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
and the European Council of Ministers reached agreement on this framework
on 11 December 2013, subject to technical finalization and formal approval
of the ensuing directive by both institutions. The Directive of the European
Parliament and of the European Council, generally called the Bank Recovery
and Resolution Directive (Brrd), is a 333-p. document which sets uniform
rules, which entered into force on 1st January 2015. The Brrd establishes a
framework for the recovery and resolution of credit institutions and
investment firms17. These rules aim at providing 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
recovery and/or resolution process (for example in case a temporary
administrator is appointed for a limited period to deal with the problems).
Briefly put, the intention is to create a culture of early intervention18.
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14 European Commission, A comprehensive EU response to the financial crisis: substantial progress
towards a strong financial framework for Europe and a banking union for the Eurozone, Brussels,
Memo 14-244, 28 March 2014.
15 Olympia Bover, Eva Sierminska, Jose Maria Casado, Panagiota Tzamourani, Sonia Costa, Ernesto
Villanueva, Philip Du Caju, Tibor Zavadil, Yvonne McCarthy, The Distribution of Debt Across Euro
Area Countries. The Role of Individual Characteristics, Institutions and Credit Conditions, 2014,
Frankfurt am Main, European Central Bank Working Paper, No. 1639.
16 For an effective summary, Nikolaos Papanikolaou, The Road Towards the Establishment of the
European Banking Union, in «Munich Personal Repec Archive Paper», 2015, No. 62463.
17 Council of the European Union, Directive of the European Parliament and of the Council establishing
a framework for the recovery and resolution of credit institutions and investment firms and amending
Council Directives 77/91/EEC and 82/891/EC, Directives 2001/24/EC, 2002/47/EC, 2004/25/EC,
2005/56/EC, 2007/36/EC and 2011/35/EC and Regulation (EU) No 1093/2010 of the European
Parliament and of the Council, Brussels, 18 December 2013 - 17958/13, EF 276, ECOFIN 1174, DRS
227, CODEC 3011.
18 Alan Edwards Bavies, Bank Resolution in the UK: Creating a Culture of Early Intervention, University
of Bristol, 2013.
The recovery and resolution plans have 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. If, despite these
preventive measures, the financial situation of a bank deteriorates beyond
repair, the new rules ensure through a ‘bail-in’ mechanism that shareholders
and creditors of the banks have to pay their share of the costs. If additional
resources are needed, these must be taken from the national, prefunded
resolution fund that each Contracting Party must establish and build up within
10 years, so that it reaches a level of 1% of covered deposits. All banks must
pay into this fund but banks which take more risks will have to pay more.
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 to be bailed-out by public funds. Recapitalization through the writedown
of liabilities and/or their conversion to equity will allow the institution
to continue as a going concern, avoids the disruption to the financial system
caused by stopping or interrupting its critical services, and gives the
authorities time to reorganize the bank 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 a ‘bail-in’, authorities first ‘bail-in’ all those
who have invested in the bank in an order: common shareholders, certain
categories of preferred shareholders and the creditors whose bonds are
convertible to common shares. Individual depositors whose accounts contain
less than 100,000 Euro are entirely protected at all times. Deposits of
individual persons and small and medium size enterprises exceeding 100,000
Euro: a) benefit from preferential treatment (depositor preference) ensuring
that they do not suffer any loss before other unsecured creditors do, and b)
Contracting Parties can choose to use certain flexibility to exclude them fully
from the ‘bail-in’ process. In order to preserve the recovery prospects of a
bank and general economic stability, ‘bailing in’ applies at least up 8% of a
bank’s total assets. After this threshold, the resolution authority might grant
the bank the use of the resolution fund, accessing funds up to a maximum of
5% of that bank’s assets. Thus, the rules support an approach with the view of
avoiding, or at least minimizing moral hazard because it places the
responsibility of covering bank losses on private investors in banks and the
banking sector as a whole to the greatest extent possible.
In events such as a systemic crisis, it may be necessary to allow the use
of public funds to finance bank resolutions. Recourse to government funds is
possible after the 8% ‘bail-in’. However, this is subject to prior assessment by
the Ec of whether the economic disturbance and potential threat to the
functioning of the Emu justify it.
The Brrd is not a single one-for-all document but the most recent and
most significant step to set a single ‘rulebook’ for banking and finance in the
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Emu, a ‘rulebook’ open to other Eu States that intend to become Contracting
Parties to the Ebu. It includes: a) stricter rules on hedge funds, short selling
and derivatives, including credit default swaps; b) a comprehensive set of
rules for derivatives; c) a framework for a reliable, high quality credit rating;
and, d) a reform of the rules for market abuse. An assessment of the Srm’s
effectiveness as well as of possible fine tuning and/or revisions can only be
credibly carried-out after several years of operations.
The Brrd is quite clear and provides for realistic timing when successive
steps are called for an action or for a decision. However, on the assumption
that the Emu’s initial aim was to eventually become an Oca, the Brrd
represents a further departure from the path towards this objective.
The main issue is whether and how the ‘rule book ’ moulds the practices
of countries with drastically different and deep-rooted cultures, especially in
finance and banking as shown by a recent quantitative research19, focusing on
the cases of Germany and Greece. This, of course, applies to other Ebu
Contracting Parties, as well as more specifically to the moulding of the
cultures of the staff newly recruited by the Ecb to handle the supervision
functions.
The design of the Single Resolution Mechanism (Srm)
As approved on April 2014 by a very large majority of the European
Parliament (570 members approved, 88 voted no, and 13 abstained), the Srm
has three main actors: a) the Ecb, b) a distinct Single Resolution Board (Srb)
and, c) a Single Resolution Fund (Srf) with resources gradually reaching 55
billion Euro. The Srm is governed by two texts: an Srm regulation covering
the main aspects of the mechanism and an intergovernmental agreement
about some specific aspects of Srf. Centralized decision-making involves an
Srb with permanent members, the Ecb, the Ec, the European Council of
Ministers, and the national resolution authorities. In most cases, when a bank
needs to be resolved in the Euro area or established in a Eu Member State
participating in the Ebu, the Ecb notifies the case to the Srb, the Ec, and the
relevant national resolution authorities. The Srb meets in two types of
sessions. In its plenary sessions, the Srb takes all decisions of a general
nature, while in its executive sessions, it takes decisions with respect to
individual entities or to banking groups, if their use of the Srf is below a 5
billion Euro threshold.
The Ecb supervisors trigger the whole process, being responsible for
deciding whether a bank is on the brink of failing. The Srb may ask that the
Ecb takes the pertinent decision. If the Ecb declines to do so, then the Srb
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19 Luigi Guiso, Helios Herrera, Massimo Morelli, A Cultural Clash View of the EU Crisis, Brussels, Cepr,
2013.
itself may take the decision. The Ec adopts the draft resolution schemes and
the plans drawn up to address the specific case of a failing bank. The
European Council of Ministers gets involved only at the Ec’s express request.
This is expected to avoid pervasive political interference in individual
resolution cases, a key concern for the European Parliament.
It is hoped that the time for decisions to be taken on a resolution scheme
will be very short. The European Parliament estimates that following the
inter-institutional compromise reached in March 2014, the decision-making
process will be greatly streamlined. As a consequence, a resolution scheme
could therefore be approved within a weekend, from the closing of the Us
markets to their opening in Asia. A regulation will enable the Srf to borrow in
order to increase ‘its firepower’ (in the Eu jargon), an ability which would be
particularly crucial in the first years when the Srf will only have a small
capitalization. A rapid mutualisation of the ‘national compartments’ of the Srf
is foreseen: 40% is to be mutualised in the first year, 20% in the second year,
the rest equally over a further six years. Rapid mutualisation was a
requirement for the European Parliament.
According to the European Parliament, these preventive and curative
mechanisms as well as the Sss should ensure that taxpayers shoulder only
negligible bank risk. On the other hand, banks, like any other business, may
make profits but are also first in line to bear their losses and, in the worst-case
scenario, can be wound-up without risking a general financial meltdown.
Will the Srm work speedily and efficiently? In summary terms, the
decision-making process can be represented as in the figure below.
The figure, here in Appendix, is drawn by the Cato Institute, a free
market ‘think tank’ which of course has little consideration for an Emu
increasingly more distant from an Oca. The process still looks like as an
Elizabethan garden maze. About a hundred individuals from nearly ten
different institutions are involved in the decision-making process to ask for
Srf relief, and on how to make use of it.
Altogether, as Daniel Gros pointed out: «the decision-making
mechanism of the Resolution Board is so complex that in practice it will work
quite differently from what one would imagine by looking at the formal rules.
In an emergency, the people with the necessary information will decide and
all the others who are formally also involved will probably just have to
agree»20.
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20 Daniel Gros, The Bank Resolution Compromise: Incomplete, but workable? in «CEPS Commentary»,
19 December 2013; after the European Parliament approval of the SRM, comments were not
enthusiastic, for example, Greg Ford of Financial Watch stressed that the authorities will get jammed
when there is a crisis involving very large and very interconnected banks; Reinhart Close of Ubs said
that the decision making process is still rather complicated; Guntram B. Wolff, Director of Bruegel
underlined that the Ecb must be as tough with a bank in Germany as with a bank in Greece, but that the
sizeable amount of money that the banks will have to pay toward their own rescue offer greater
assurance of stability than in the recent past.
This baroque decision making process is unlikely to be handled within
the short time span of a week-end, when markets are closed. More
significantly, together with the ‘bail-in’ clause, the Srb and its procedures are
more likely to act as a deterrent or 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.
Conclusion
In Spring 2014, an overview of the Srm stated that it «is a further
indication that the Emu is an on-the-brink union muddling through current
problems and issues as they come». It also added that «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 to update the Treaty to circumstances (such
as banking crisis) not envisaged when it was prepared?»21.
Developments over the last fifteen months certainly strengthen this point.
The negotiations brought about a set of financial institutions and instruments,
but their adequacy is of particular concern as concluded in a recent legal
analysis of the Srm22. Even more significantly, the available mechanisms have
not been utilized in cases when a bank resolution could have had adverse
effects on the Emu financial integration.
A case in point is the difficult situation of the Italian bank, Monte dei
Paschi di Siena (Mps)23. In short, this major Italian bank was about to go
bankrupt with Europe-wide consequences. Instead, a wholly national solution
was chosen by issuing convertible bonds to be purchased by the Italian
Treasury. After about one year, the Italian Treasury became the major
shareholder of Mps – a path quite different from that foreseen by the
“founding fathers” of the Emu and of the negotiators of the Maastricht Treaty.
However, this is only one aspect. The Ebu, as seen in the introduction,
has as its main and highest objective to prevent the fragmentation of the
European capital market and of the banking sector and to increase integration.
Developments over the last year or so show that the Ebu, the Sss, and the Srm
have not had any significant positive impact in facilitating the reaching of
these goals.
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21 Giuseppe Pennisi, op. cit., p.116.
22 Christos Hadjemmanuel, Bank Resolution Financing in the Banking Union, in «Lse Legal Studies
Working Paper», 2015, No. 6.
23 For details and analysis see Kenjoro Hori, Jorgen Martin Ceron, Agency Cost of Bail in, in «Birkbeck
University of London Department of Economics, Mathematics and Statistics Working Paper», No.
Bwpef 1407 and Francesco Capriglione, The EU-Wide Stress Tests: A Storm Before a New Order of the
Financial Market. The Italian Case, in «Open Review of Management, Banking and Finance», 2015,
No. 20/2.
The main indicator is the lack of cross-national and Europe-wide mergers
and acquisitions (M&As). They are few and far between, while the ‘home
bias’ remains very strong. There has been a real flurry of M&As but very few
that are cross-national. Moreover, the most important cross-national M&A –
the purchase of Tsb, a British bank operating mostly on line, by the Banco
Sabadell, Spain’s fifth biggest lender, had the primary purpose to set a foot in
the United Kingdom – viz. outside the Emu. Banco Sabadell’s main
challenger was another Spanish bank, Caixa Bank, also aiming at finding a
way to operate outside the rules and regulations of Emu. There are other
examples. In Portugal, after a severe cure, the Novo Bank, the successor of
the Banco de Espìrito Santo, is up for sale but does not appear to elicit interest
by major banks of other Emu countries though several might find it
interesting to have business in the western-most continental European
country.
The Deutsche Bank, the largest of the Federal Republic of Germany, is
thinking of selling part or all its retail operations in order to consolidate and
improve its profits, but it made it known that it is seeking German purchasers.
Other examples could be mentioned. As a matter of fact in 2013-2014, only
the major French bank Bnp-Paribas increased its international foothold. At
some stage, it appeared interested in acquiring a significant participation in
the Italian bank Mps or in the German Commerzbank. However, high
transaction costs reportedly prevented Bnb-Paribas from going any further.
Within the Emu, a domestic M&A costs about half of what it would cost to
acquire or merge with a bank of another Emu country. Thus, policy
instruments other than the Ebu’s desire to integrate financial and banking
markets may be more efficient in bringing about these lofty goals24.
Unfortunately, the way appears to be all uphill.
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24 André Sapir and Guntram B. Wolff, Euro area governance :what to reform and how to do it, in «Bruegel
Policy Brief», 2015, 27 February 2015, No. 1.
APPENDIX*
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* The Cato Institute, The EU’s New Banking “Single Resolution Board”, posted in «Cato’s Domain» on
December 28, 2013 by Cato The Eldest.
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