In response to the recent turmoil, and as a part of a series of proposals, the European Commission has proposed the amendment of rules under the current Bank Recovery and Resolution Directive to facilitate resolution of small and medium banks operating in Europe. Our Financial Regulation team examines the rationale for this extension and assess the likely impact for in-scope institutions.
Yet again a bank collapse is at front and centre of our collective attention. We previously discussed the write-down of Credit Suisse’s AT1 bonds and the Silicon Valley and Signature Bank collapses in some detail. We have also recently witnessed the takeover of First Republic Bank by JP Morgan, which is just the latest US regional bank to become a victim of banking market turmoil caused by inflation and rising interest rates.
Crisis management reform
European dealmakers have observed that tough new accounting rules seem to have set bank consolidation activity in Europe back by several years. Weaker European banks cannot therefore expect to be rescued by acquisition in the coming years, increasing the need for regulators to ensure that the crisis management framework is up to scratch. Shortly after the SVB and Signature Bank collapses, and right on cue, the European Commission published a proposal to reform the EU’s crisis management and deposit insurance frameworks. The Commission was quick to point out that these proposals had been under discussion for several years, well ahead of the US and Swiss bank regulatory interventions.
One size fits all?
The Commission’s premise is that the post global financial crisis (GFC) regime for managing bank resolution under the EU Bank Recovery and Resolution Recovery Directive (BRRD) has been effective in major financial institutions. However, the Commission sees gaps in the framework for small and medium sized banks. These are generally subject to resolution action by national resolution authorities - NRAs, and in Ireland’s case the Central Bank - rather than by the Single Resolution Board (SRB). According to the Commission, experience has shown that these have mostly been resolved by using taxpayers’ funds or by using private, industry-funded safety nets rather than Bank Recovery and Resolution Directive (BRRD) methodologies and instruments.
The Commission no doubt has cases like Banca Popolare di Vicenza and Veneto Banca in Italy in mind when it points to the use of taxpayers’ funds in Europe to address smaller bank failures. Its April 2023 legislative proposal now seeks to amend the BRRD, the Single Resolution Mechanism Regulation (SRMR) and the Deposit Guarantee Schemes Directive (DGSD) to promote greater alignment with the guiding principle of post-GFC bank resolutions: minimising the use of taxpayers’ funds.
Public interest scenarios
The Commission proposes reforms to EU law to clarify the public interest assessment that needs to be conducted by national resolution authorities to determine whether to invoke bank crisis management tools, such as bail-in, or whether to opt for liquidation/insolvency proceedings under national law. The Commission argued that the lack of clarity and predictability in this regard had led to market fragmentation, with variation among member states in their approaches. The overall effect of the proposed reforms will be to further tilt the balance of the public interest assessment in favour of resolution and against liquidation/insolvency proceedings. Further restrictions will also be introduced on the ability of Member States to deploy public funds in resolution scenarios.
The proposal also emphasises the need, in the case of small and medium banks, for efficient use of deposit guarantee schemes (DGS) in crisis situations. The amendments are designed to clarify the ability of national resolution authorities to use DGS funds in support of transfer and market exit resolution strategies thereby avoiding the risk of bail-in of deposits above the DGS coverage level.
The Commission is concerned that the current BRRD preference rules for depositors are not robust enough. Currently, the BRRD only mandates preference for depositors that are covered under the DGS and for the DGS itself where it has paid out. However, deposit amounts over €100,000 and excluded deposits, under BRRD, rank as general unsecured liabilities. The Commission proposes to create a single, generalised preference for all deposit amounts under BRRD, to remove possible incentives for larger depositors and excluded depositors to pull their deposits and cause a bank run.
Calibrating MREL
Regarding the minimum requirement for own funds and eligible liabilities, or MREL, the Commission says that the current rules assume that bank resolution will always occur via bail-in. However, in scenarios involving small and medium banks, a transfer strategy with market exit is more likely. Therefore, the Commission is proposing revised methodology for calibrating MREL where resolution strategies other than bail-in are proposed.
Expanded coverage for high balances
Finally, and importantly, the Commission proposes amendments to the DGSD to increase the coverage limit for temporary high balances held by covered depositors and for deposits linked to real estate transactions. The scope of DGS coverage is also to be expanded, with safeguarding accounts held by payments firms and e-money firms to come within scope, along with certain formerly excluded public authority depositors.
Conclusion
The Commission proposals, if adopted, will require small and medium banks to revise their resolution planning frameworks in several respects. If a transfer with market exit is a preferred resolution strategy, they will need to consider the interplay of this with the revised DGS coverage and usage terms. They will need to recalibrate their MREL requirements and may need to issue fresh MREL.
Most obviously from a consumer perspective, banks will need to facilitate expanded DGS coverage for their depositors, allowing depositors to benefit from enhanced status, even for uncovered deposits, in a resolution scenario. Whether all of this can, in practice, stem a future EU bank run remains to be seen.
For more information, contact a member of our Financial Regulation team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.
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