Bank Resolution Funds
During the 2008 financial crisis, considerable amounts of public funds were made available to banks to support their activities. However, governments clearly indicated that this support could not be renewed. It is for this reason that the European Commission supports the creation of resolution funds which should allow the costs related to resolution in the event of new failures to be covered.
Communication of 26 May 2010 from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the European Central Bank - Bank Resolution Funds [COM(2010) 254 final – Not published in the Official Journal].
This Communication defines the European Commission's intentions concerning the establishment of Bank Resolution Funds.
What is the role of Bank Resolution Funds?
Resolution funds should contribute to financing the orderly resolution of distressed banks. In order to do this, they could implement measures such as:
- financing bridge banks;
- financing a total or partial transfer of assets and/or liabilities from the ailing entity;
- financing a good bank/bad bank split.
Resolution funds may also be used to cover administrative costs, legal and advisory fees.
However, they must not play the role of insurance against failure or be used to bail out failing banks.
How can Bank Resolution Funds be financed?
The Commission considers that financing arrangements for a fund should procure the necessary resources whilst incentivising appropriate behaviour.
Three points could form the basis for calculating contributions to Bank Resolution Funds:
- banks’ assets could represent an indicator of the amount which might need to be spent in handling the bank's resolution. A levy could be established based on the assets and could therefore amount to an additional capital requirement;
- banks’ liabilities could also represent indicators of the amount which might need to be spent in handling the bank's resolution. However, liabilities could be less effective proxies for the degree of risk;
- profits and bonuses could be used as a reference in order to determine the amount of levies.
Financing arrangements should meet the following criteria:
- avoid any possible arbitrage;
- reflect the appropriate risks;
- take into account the systemic nature of certain financial entities;
- be based on the possible amounts that could be spent if resolution becomes necessary;
- avoid competition distortions.
What means of governance should be used for Bank Resolution Funds?
Bank Resolution Funds should remain separate from the national budget and be dedicated only to resolution costs.
The management of these funds should be entrusted to the authorities responsible for the resolution of financial entities acting as independent executive bodies.
The use of resolution funds should also respect the EU State aid rules.
The Commission plans to adopt legislative proposals for crisis management and resolution funds by early 2011.
How can bank resolution funds be integrated into a new financial stability framework?
The Commission has proposed to strengthen capital requirements and to reform financial supervision within the EU. It intends to strengthen Deposit Guarantee Schemes and the corporate governance of financial institutions.
The Commission also intends to implement preventive measures in order to mitigate the risks of bank failures and to reduce the implicit guarantees associated with institutions deemed ‘too big to fail’.
The Commission has also planned to adopt in October 2010 a roadmap on a European framework for crisis management. The aim of the new proposed framework is to make common tools, which enable prompt and effective action to be taken in the event of banking failures, available to Member States. These measures should not lead to costs for taxpayers.
Tools are proposed to complement the action of resolution funds:
- Recovery and Resolution Plans;
- debt to equity conversions.
Defining a common approach to Bank Resolution Funds
A European and global approach should be defined as regards the creation of Bank Resolution Funds.
Under this new measure, national authorities will continue to be responsible for day to day supervision, and this should be underpinned by a solid cross-border framework which is ready to address possible crises.
The first step in this common approach lies in establishing a system based on a harmonised network of national funds linked to a set of coordinated crisis management arrangements. This system should be re-examined by 2014 with a view to creating EU integrated crisis management and supervisory arrangements, as well as an EU Resolution Fund in the longer term.
In order to mitigate the bank failures caused by the October 2008 financial crisis, the governments of Member States have provided State aid to assist the financial sector. This aid has considerably affected taxpayers and has increased Member States’ public debt. The creation of resolution funds should prevent future recourse to State aid to resolve financial institutions’ failures.