Resolving banks with depositors’ money?

Press conference by Michel Barnier, Member of the European Commission, on the establishment of a Single Resolution Mechanism for the Banking Union. (EC Audiovisual Services).

Tomorrow’s Ecofin council, marking the last 2013 meeting of the 28 EU ministers of Finance, constitutes the final opportunity of the member states to strike an agreement in order to finalise the construction of the European Banking Union. What is still missing for the establishment of the EBU is of course the full Single Resolution Mechanism, which will accompany the Single Supervisory Mechanism in the smooth functioning of EBU. It’s imperative that the bank supervision activity is flanked by an effective resolution mechanism otherwise the stress tests on banks will be meaningless.

The supervision authorities, namely the European Central Bank and the national central banks must know in advance what will happen to the financial firms if they don’t pass the viability tests; how they are going to be recovered or resolved. Last June, the 28 EU leaders mandated the Ecofin council to reach an agreement on those matters before the end of the year, given that early in 2014 the ECB is expected to start its stress tests on banks and other financial firms.

Bank recovery and resolution

Despite the fact that the Single Supervision Mechanism is already in place under the roof of ECB, the second pillar of the banking union, that is the Single Resolution Mechanism, is always in the air. The key features of the SRM which are pending and have to be decided during tomorrow’s Ecofin are the authority under which it will function and the financial means it will use, in the recovery or the resolution of those banks which are singled out by the SSM as non-viable.

In the first question there are two possible answers. The authority under which the SRM is going to function can either be the European Commission or the Ecofin itself. In any case, the SRM will function centrally for the 130 ‘systemic’ Eurozone banks, while the recovery and the resolution of the smaller financial firms will be realised by the member states in a decentralised manner. As for the authority issue, it is much more probable that it will be the Commission rather than the Ecofin, on account of flexibility. On top of that, the Commission has a much more competent and adequate in numbers personnel to secure this function.

The key is who pays for the failing banks

No matter under who’s authority, recoveries and resolutions will be realised under the rules foreseen in the Bank Recovery and Resolution Directive, which has been voted for and will be in force at the beginning of next year. It provides for the pecking order of funds to be used for the recovery or the resolution of a non-viable bank. Those funds will be the bank’s own capital and if this is not enough it will be its unsecured obligations (uncovered bonds and deposits above the limit of €100,000) to be used in the bail-in.

The problem is what will happen if those funds are still not enough. The discussion so far on this question has focused on the need for a Bank Resolution Fund. The Fund will supposedly support the resolution mechanism and will be financed by a levy on all banks. Until it is fully capitalised it has to be able to borrow from the European Stability Mechanism, which has a dowry of about €500 billion paid by the European taxpayers. Theoretically, the Resolution Fund will return the money to the ESM after it has been fully capitalised.

However, the implication of ESM’s public money has been strongly contested by Germany, on the grounds that no taxpayers’ money should be used to resolve or bail out banks. Then a new idea appeared; the use of the deposit guarantee systems operating in various EU member states. Danièle Nouy, the ECB’s nominee for the new post of EU bank supervisor, while speaking at the EU Parliamentary hearing to approve of her nomination, said that “the EU supervisor would be hampered if the two other pillars of banking union (recovery and resolution mechanism and deposit guarantee system) were not set up”.

Pay depositors with their own money!

The use of the deposit guarantee systems of member states in possible bank resolutions was confirmed this morning with a Press release issued by the Lithuanian Presidency of the Council. It goes like this “The Ministers (of the Ecofin) will also consider key open issues on Bank Recovery and Resolution as well as Deposit Guarantee Schemes Directives to provide Presidency with a final mandate to conclude the negotiations with the European Parliament. Bank Recovery and Resolution Directive is to establish a framework for the recovery and resolution of banks and investment companies while safeguarding the taxpayers’ money. The aim of the revised Deposit Guarantee Schemes Directive is to ensure fast pay-outs to depositors and that each member state would have sufficient funds in the scheme”.

At this point it has to be reminded that the European Parliament has asked that no deposit guarantee scheme money will be used to bail out failing banks. This must change now and to this effect the Presidency is to ask for Ecofin’s mandate to renegotiate with the Parliament. It’s highly probable that the Parliament will agree not only on the reimbursement of the secured deposits of up to €100,000, by the deposit guarantee schemes. Since this is more than obvious, the Presidency is expected to ask the Parliament to agree that the deposit guarantee schemes ‘participate’ in the entire bail-out procedure.

As things stand now and given the depth and the length of the discussions so far and the urgency of the entire affair, it is very probable that tomorrow the Ecofin will decide on both those pending issues, namely the resolution authority and the funding. The question remains though, what will happen and who is going to pay for bank resolutions, if the entire capital of the deposit guarantee schemes will not be enough and up to which extend these funds will be used. Most probably everything will end up at paying depositors with their own money.