Bank Resolution Funds – Frequently Asked Questions
European Commission - MEMO/10/214 26/05/2010
Other available languages: none
Brussels, 26 May 2010
Bank Resolution Funds – Frequently Asked Questions
Why is the Commission adopting a Communication at this time?
There is broad global agreement that taxpayers should not again be expected to foot the bill of future financial crises, but the debate is still open as to how best such an objective might be achieved.
The G20, at its Pittsburgh summit in September 2009, agreed to address the issues surrounding cross-border resolutions and systemically important financial institutions by the end of this year.
The Commission believes that crisis prevention and management needs to be tackled holistically , and will set out its concrete proposals for a comprehensive set of measures, including future legislative proposals, in October1. The Commission's work is fully in line with the broader international agenda agreed by the G20 in Pittsburgh.
The framework needed for crisis prevention needs to be global and integrated. A number of lines of defence are necessary, including:
Today's Communication sets out the Commission's vision for resolution funds, as part of the broader set of initiatives designed to strengthen crisis management arrangements. We hope broad agreement at EU level can be found on the necessity to establish national funds, as a coordinated approach is necessary to avoid competitive distortions and to facilitate cross-border crisis management.
Consensus at European level will also allow us to shape the agenda when the G20 meets at the end of June in Toronto.
Why do we need Resolution Funds?
A principal objective of developing an EU crisis management framework, including resolution funds, is to ensure that banks that are no longer viable can be wound up, governments are not forced to provide 'bail outs', and costs to the public purse are minimised.
Funds should be used to finance operations under a new EU crisis management framework. That framework would include inter alia powers to effect private sector acquisitions, transfer business to a temporary structure (such as a "bridge bank") or to separate clean and toxic assets between "good" and "bad" banks through a partial transfer of assets and liabilities. Crisis management operations may entail costs, if it is necessary to maintain parts of the bank's operations for a transitional period before a buyer can be found or before the operations can be wound down in an orderly manner.
It needs to be clear that the purpose is to facilitate an orderly failure of an insolvent bank, not to bail it out. This is very important in order to combat the moral hazard that might arise with the creation of a large fund.
When would resolution funds be used?
The chart below explains in a simplified way when the funds would be used. The first box covers a period when the firm is still going concern (i.e. operating) and under normal supervision. The focus at that time is on prevention and contingency planning. Should the firm encounter problems which are picked up by the supervisor, box 2 covers the phase of early intervention, involving close collaboration between the authority and the bank's management to recover the situation and return the firm to a going concern situation. At that stage, there are no implications for the use of the fund. However, should the supervisory authority determine that the institution is not recoverable, resolution measures would be needed, and the fund may need to be called upon to finance those measures. If the institution, or parts of it, are placed into liquidation under normal insolvency, there should be no further implications for recourse to the resolution fund.
Figures and graphics available in PDF and WORD PROCESSED
Won't the existence of large amounts of private money create expectations that banks will be saved and raise moral hazard concerns? Should the money not go to the State budget?
The current situation – where the expectation now is that the state will bail out failing banks – certainly creates moral hazard. The new system should avoid that problem as long as the the rules are clear and well known in advance.
Use of resolution funds should bring no benefits to the failed institution – in particular its management and shareholders. Activation of the fund should be strictly limited to the use of resolution tools set out in a harmonised EU legal framework (which the Commission will propose in early 2011). Use of the funds would bring no benefits to risk takers whose risks have turned bad – as they would be the first in line to take any losses. Creating a certainty for the market that an institution will be failed in an orderly manner as opposed to bailed out should on the contrary introduce an important new market discipline which reduces moral hazard.
A further way of avoiding moral hazard is to ensure that the level does not go straight to the national budget. If it did, there could be a reasonable expectation from institutions contributing that they could expect to be bailed-out.
Should a resolution fund be global, European or national?
Establishing a single pan EU fund, although it could present a number of advantages, would seem very difficult at this stage given the de-centralised nature of EU supervision. Setting up an EU fund would require putting in place clear and comprehensive governance arrangements to determine how and when the money should be used. For the moment therefore, the most realistic approach is to coordinate the setting up of funds at national level, ensure that all Member States are in a position to secure equivalent levels of funding from the private sector for resolution purposes, using equivalent crisis management tools, and to put in place efficient coordination mechanisms between authorities.
It is desirable to develop a coordinated global approach with respect to the establishment of bank resolution funds. That is why the work at G20 level is so important. And it is the position the Commission will support at the G20.
What kinds of financial institution would be covered by an EU regime?
At this stage, the Commission believes that a crisis management framework should cover deposit-taking banks and investment firms. We will consider at a later stage whether and how the framework could be extended to other classes of financial institution the failure of which is capable of having a systemic effect.
How big should resolution funds be?
The size of funds depends on what resolution funds are expected to do. The Commission has not taken a definitive view on what the ultimate target size of funds should be. However, as the Commission does not favour their use to bail out banks, the costs will be considerably lower than the cost of measures taken by Member States during the current crisis. Building up resolution funds will take a number of years and it will be important to measure the overall cost of new requirements on banks. The Commission recognises that it will be necessary to ensure that the costs are calibrated in such a way as to avoid stifling the economic recovery and the increase to the cost of credit to the real economy. Resolution funds need to be part of a holistic and appropriate response to the crisis.
Is it realistic to believe that resolution funds would ever be useful in the case of failure of a very large bank?
It is important that a system is designed that ensures that even large insolvent banks can fail. Resolution funds will be one of a range of the tools that will help to achieve that goal. They will not be the only element: there is other work ongoing which should see the development of resolution plans (living wills which will oblige banks to make contingent plans which could be implemented in case of failure), creditor haircuts (involving powers to authorities or contractual clauses for re-structuring of debt conversion of debt to equity)and more effective resolution tools , that together with resolution funds should contribute to ensuring even large banks can fail.
Why do you need resolution funds when you already have deposit guarantee schemes?
Resolution funds serve a different purpose than Deposit Guarantee schemes. The latter ensure that depositors (i.e. any citizen putting money into a regular bank account) will be reimbursed up to the amount guaranteed whilst resolution funds ensure that the bank can be wound up and cover different costs (paying for continuity of certain key services, covering administrative costs, fees, etc.) than those related to the reimbursement of depositors.
Who will decide on the use of resolution funds?
Resolution funds will need to be designed to fit closely into the new crisis management framework that the Commission intends to propose in early 2011. This framework will include arrangements for the coordination of cross-border crisis management between resolution authorities. The use of funds will need to be governed by the same strict conditions which determine how crisis resolution tools can be used. The new European Banking Authority will, once the supervision package is finally agreed and in place, also have an important role to play in the coordination of cross-border crisis management.
The Commission already published a Communication on crisis management in October 2009: IP/09/1549