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European Commission

MEMO

Brussels, 6 June 2012

Bank recovery and resolution proposal: Frequently Asked Questions

I. CONTEXT

1. Why is the Commission proposing a framework for bank recovery and resolution?

The financial crisis has seen a number of large banks bailed out with public funds because they were considered "too big to fail". The level of state support has been unprecedented1. While this may have been necessary to prevent widespread disruption to the markets, it is clearly undesirable for public funds to be used in this way at the expense of other public objectives. In future, the financial system must be more stable so that government bail-outs are not needed.

The high profile banking failures which have occurred during the crisis (Fortis, Lehman Brothers, Icelandic banks, Anglo Irish Bank, Dexia) have revealed serious shortcomings in the existing tools available to authorities for tackling bank failures. They have also demonstrated that supporting banks which are too big to fail with squeezed public finances is becoming increasingly unsustainable.

2. Why is this framework needed?

A clear and comprehensive bank resolution regime is crucial for ensuring long term financial stability and for reducing the potential public cost of possible future financial crises. 'Resolution' means the restructuring of an institution in order to ensure the continuity of its essential functions, preserve financial stability and restore the viability of all or part of that institution.

The EU crisis management framework provides both more comprehensive and effective arrangements to deal with failing banks at national level, as well as complete arrangements to tackle cross-border banking failures.

Effective resolution will also address moral hazard as it will function as a strong element of discipline for the markets. Resolution is thus a vital complement to other work streams designed to make the financial system sounder, i.e. making banks stronger with higher levels of and better quality capital, greater protection of depositors, safer and more transparent market structures and practices, and better supervision.

3. What is the relationship between today's proposal and the Commission's announcement of 30 May 2012 on moving towards a banking union?

The two work-streams are complementary. Today's proposal is a necessary first step to improve efficiency and cohesion in ensuring that failing banks in the EU single market can be resolved in a way which preserves financial stability and minimises costs for taxpayers. It completes the roadmap of financial sector reforms launched since 2009.

The reflection towards a more integrated banking union signalled by the Commission on 30 May is an essential subsequent step. It will look into key measures which need to be taken to ensure closer integration.

With today's proposal on banking resolution, the Commission is completing the roadmap for financial sector reforms launched in 2009. A more integrated banking union is the logical next step.

Such a banking union will rest on the following 4 pillars:

  • a single EU deposit guarantee scheme covering all EU banks;

  • a common resolution authority and a common resolution fund for the resolution of, at least, systemic and cross-border banks;

  • a single EU supervisor with ultimate decision-making powers, in relation to systemic and cross border banks;

  • a uniform single rule book for the prudential supervision of all banks.

4. Why are normal insolvency proceedings unsuitable for banks?

Banks perform critical functions which are essential for economic activity to take place. They collect funds (deposits and other forms of debt) from private persons and businesses. They provide loans for households and businesses allowing savings to be allocated for investment. They also manage payment systems that are crucial for various sectors of the economy and society.

Banks operate on the basis of trust. If confidence in them is lost, depositors and other creditors may withdraw their funds. As well as depriving their customers of access to the socially valuable banking functions above, the failure of a large bank may undermine confidence in other banks, affect their finances and create instability across the financial system as a whole. This can rapidly erode the value and viability of other banks, thereby reducing the likelihood of a recovery.

Insolvency procedures may take years, with the objective of maximising the value of assets of the failed firm in the interest of creditors. In contrast, the primary objective of bank resolution is to maintain financial stability and minimise losses for society, and in particular taxpayers, while ensuring similar results to those of normal insolvency proceedings in terms of allocation of losses to shareholders and creditors.

Resolution thus protects certain critical stakeholders and functions (such as depositors and payment systems) and maintains them as operational, while other parts, which are not considered key to financial stability, may be allowed to fail in the normal way. In order to avoid moral hazard and the use of taxpayers' money to support failing banks, shareholders and debt holders need to know that they will bear an appropriate share of the losses in the event of a failure and to attribute a suitable price to this risk. Bank resolution also ensures that decisions are taken rapidly in order to avoid contagion.

5. Why didn't the EU have this framework in place before the crisis? Why is action at EU level needed?

Until the crisis, many felt that crisis management was best dealt with at national level (especially if there was a risk that there would be budgetary implications and in view of the close connection of crisis measures with national insolvency regimes). Measures in place and taken during the crisis varied greatly between Member States.

However, the crisis has strengthened the case for action at EU level, since it clearly demonstrated that the absence of arrangements at European level could result in diverging national solutions, which might be less effective in resolving the situation and ultimately prove more costly for national taxpayers. Furthermore, the crisis highlighted the fact that there were no mechanisms in place to deal with failing banks that operate in more than one Member State and that greater EU financial integration and inter-connection between institutions needs to be matched by a common framework of intervention powers and rules. The alternative is fragmentation and inefficiency in EU banking and financial services, something which would harm the single market and would impair its advantages for consumers, investors and businesses.

II. INTERNATIONAL LEVEL PLAYING FIELD

6. How does the draft proposal relate to work undertaken at international level?

The Commission's initiative follows international developments in this area. In November 2008, G20 leaders called for a “review of resolution regimes and bankruptcy laws in light of recent experience to ensure that they permit an orderly wind-down of large complex cross-border institutions"2.

At the G20 Pittsburgh summit3 (September 2009), they committed to act together to "...create more powerful tools to hold large global firms to account for the risks they take" and, more specifically, to "develop resolution tools and frameworks for the effective resolution of financial groups to help mitigate the disruption of financial institution failures and reduce moral hazard in the future."

In Seoul (November 2010) the G20 endorsed the Financial Stability Board (FSB) Report on "Reducing the moral hazard posed by systemically important financial institutions"4 which recommended that “all jurisdictions should undertake the necessary legal reforms to ensure that they have in place a resolution regime which would make feasible the resolution of any financial institution without taxpayer exposure to loss from solvency support while protecting vital economic functions through mechanisms which make it possible for shareholders and unsecured and uninsured creditors to absorb losses in their order of seniority”.

Most recently, in Cannes (November 2011), the G20 endorsed5 the FSB's core recommendations for effective resolution ("Key Attributes of Effective Resolution Regimes for Financial Institutions"6) which jurisdictions should implement to achieve these outcomes.

7. Is the EU the first jurisdiction that is proposing a crisis management framework for the banking sector? What are other countries doing on crisis management?

Numerous countries around the world are working on various aspects of crisis management, largely depending on the nature and scale of recent developments in their banking systems.

The recent work of the Financial Stability Board (FSB) provides guidance on the "Key Attributes of Effective Resolution Regimes for Financial Institutions"7, agreed by the authorities of all major financial centres. The proposed EU approach is fully in line with the FSB recommendations, including a number of elements where the specificities and divergences in Europe's markets and regulatory structures require particular solutions (e.g. resolution colleges, role of the European Banking Authority).

8. What are the main differences between what the EU is proposing and the US approach?

In the US, the Dodd-Frank Act8 has established a resolution framework for systemic financial institutions. The US approach intends to address systemic banks by taking failing institutions into receivership by the Federal Deposit Insurance Corporation (FDIC), under which their business will be transferred to a new entity or wound down.

The EU framework would also allow authorities to put banks into an orderly resolution in which their essential services could be preserved, for example via a sale to a third party or the creation of a bridge bank, while the failed institution itself would ultimately be wound down. However, in cases where an institution could be restored to financial viability and this would better serve the maintenance of critical functions and the public interest, the Commission also proposes equipping authorities with the power to write down some of its liabilities (bail-in) and allow the bank to remain in business. This would include dilution of shareholders, changes to management, haircutting of creditors and other restructuring so as to ensure that the surviving entity was viable. All resolution operations would also need to adhere to EU state aid rules.

III. STRUCTURE OF PROPOSAL

9. What are the key elements of today's proposal?

The proposal lays out a comprehensive set of measures which aim to ensure that:

  • national authorities are equipped with the necessary tools to intervene in a troubled institution at a sufficiently early stage to address developing problems;

  • firms and authorities make adequate preparation for crises;

  • national authorities have harmonised resolution tools and powers to take rapid and effective action when bank failure cannot be avoided;

  • authorities cooperate effectively when dealing with the failure of a cross-border bank.

The framework takes into account the global nature of several banks. It provides for strong coordination between national authorities under the leadership of the group resolution authority in order to ensure that resolution tools are applied to a cross-border group in a coherent manner across different jurisdictions.

Key elements

  • The framework will be based first on prevention and preparation. In particular banks and resolution authorities will be required to draw up recovery and resolution plans on how to deal with financial stress or failure at group level but also for the individual entities in the group. If authorities identify obstacles to resolvability in the course of this planning process, they can require a bank to take appropriate measures including changes to corporate and legal structures to ensure that it can be resolved with the available tools in a way that does not threaten financial stability and does not involve costs to taxpayers.

  • Another key element will be early intervention. The powers of authorities will be expanded in order to intervene at an early stage (before the problems become critical and its financial situation deteriorates irreparably) when a bank is in breach of, or is about to breach, regulatory capital requirements. These powers will include the possibility of dismissing the management and appointing a special manager even before a bank is failing, as well as convening a meeting of shareholders to adopt urgent reforms, and requiring the bank to draw up a plan for the restructuring of debt with its creditors.

  • The framework will provide for credible resolution tools when a bank is about to fail. These tools will include the power to sell or merge the business, to set up a temporary bridge bank to operate critical functions, to separate good assets from bad ones and to convert to shares or write down the debt of failing banks (the so called bail–in). The objective is to minimise the extent to which the cost of a bank failure is borne by the State and its taxpayers. The resolution tools will ensure that essential functions are preserved without the need to bail out the institution, and that shareholders and creditors bear an appropriate part of the losses. They will also prevent the precipitous loss of value in a failing bank associated with bankruptcy, for example by quickly recapitalizing it and allowing it to be restructured.

  • The framework also establishes the mechanisms for cooperation between national authorities so that where a cross-border banking group fails, national authorities will coordinate resolution measures to protect financial stability in all affected Member States and achieve the most effective outcome for the group as a whole.

10. What will the role of the European Banking Authority (EBA) be?

The EBA will play a strong coordination role both during the prevention and early intervention stages (in particular in resolution planning) as well as in facilitating the taking of joint decisions with respect to cross-border firms undergoing resolution. The proposals vest the EBA with clear and decisive powers in areas where harmonisation and consistency in rules and practices is key, while avoiding any duplication in the tasks of national authorities responsible for day-to-day oversight.

11. What are the objectives of resolution and the conditions to trigger it?

Resolution would have to: 1) safeguard the continuity of essential banking operations, 2) protect depositors, client assets and public funds, 3) minimise risks to financial stability, and 4) avoid the unnecessary destruction of value.

A bank would become subject to resolution when:

  • it has reached a point of distress such that there are no realistic prospects of recovery over an appropriate timeframe,

  • all other intervention measures above have been exhausted, and

  • winding up the institution under normal insolvency proceedings would risk prolonged uncertainty or financial instability.

Entry into resolution will thus always occur at a point close to insolvency. Authorities nonetheless need to have a degree of discretion to ensure that they can intervene before it is too late for resolution to meet its objectives.

12. What resolution tools will be needed?

With a view to the aforementioned objectives, resolution authorities should be able to employ clear-cut measures to resolve the situation of the bank when it meets the three conditions for resolution mentioned above.

The choice of tools will depend on the specific circumstances of each case and build on options laid out in the resolution plan prepared for the bank. They should consist of powers to:

(i) effect private sector acquisitions (parts of the bank can be sold to one or more purchasers without the consent of shareholders);

(ii) transfer business to a temporary structure (such as a "bridge bank") to preserve essential banking functions or facilitate continuous access to deposits;

(iii) separate clean and toxic assets between "good" and "bad" banks through a partial transfer of assets and liabilities; and/or

(iv) bail in creditors (mechanism to cancel or reduce the liabilities of a failing bank, or to convert debt to equity, as a means of restoring the institution's capital position).

These tools would allow an institution to be restructured as a going concern or wound down in an orderly manner without recourse to public funds and minimising destruction of value.

13. What kinds of financial institutions would be covered by the EU regime?

The framework covers deposit-taking banks and some investment firms (e.g. institutions like Lehman Brothers), because this is where action is needed most urgently.

However, the Commission will, in forthcoming work, consider whether and how the framework could be extended to other classes of financial institutions such as market infrastructures, the failure of which are capable of having a systemic effect.

14. How will the regime apply to the failure of a cross-border group?

The first step is to equip national authorities with a set of harmonised tools and to establish a robust framework for information sharing, consultation and cooperation between them. Resolution colleges built around existing supervisory colleges will be at the centre of this.

In order to better deal with large and more complex cross-border groups, the group resolution authority (the authority in the Member State in which the consolidating supervisor under EU banking rules is situated) would play a leading role in approving a recovery plan and designing a resolution plan for the whole group. The resolution plans could allow for intervention both at the level of the parent or holding or of the subsidiaries, depending on the nature of the group. Coordination would be ensured through resolution colleges and binding mediation by the EBA. The plans will not dictate how the group operates internally (separated subsidiaries, integrated liquidity and risk management, etc.) but would ensure that the legal structure does not constitute an obstacle to resolvability. The EBA would also coordinate any joint decisions by national authorities at the stage of early intervention.

Groups may also enter into arrangements, approved by regulators and shareholders, of financial support between constituent entities for restoring the group's financial health efficiently (see below).

The exercise of any resolution powers in relation to various entities of the group would thus be prepared in advance and take place as far as possible in a coordinated and consistent manner.

15. How would financial support within groups work?

The proposals allow entities in a group to enter agreements to provide help to other parts of the group (parent company or subsidiary) if it faces difficulties. This provision works both ways so a parent company can help the subsidiary and the subsidiary can help the parent company.

Such help is subject to approval by the supervisor of each subsidiary/parent company which is asked to help and by the shareholders of each entity. It must aim to restore or ensure the viability of the group as a whole, must not damage the solvency of any entity providing support, and must not cause a breach of regulatory capital requirements.

It might be in the interest of a subsidiary to help the group because the overall group will be stronger and continue for example to be able to provide services to the subsidiary. But this cannot be done against the subsidiary's will.

IV. FINANCING OF RESOLUTION

16. How will the cost of bank resolution be financed?

In order to be effective the resolution tools require a certain amount of funding. For example, if the authorities create a bridge bank, it will need capital or short term loans to be able to operate.

These costs should be borne by the banking sector rather than taxpayers.

This is why every Member State will have to set up financing arrangements funded with contributions from banks and investment firms in proportion to their liabilities and risk profile.

Banks will contribute in relation to their share of specific liabilities of the total size of the national financial sector so that those who contribute most would potentially benefit most in case they enter resolution.

Each national fund will finance the resolution of the entities established on its own territory. For cross-border groups, various relevant national arrangements will be required to contribute to a financing plan pre-determined between the competent resolution authorities.

The national financing arrangements should be sufficiently financed ex-ante. To that end contributions will be raised from banks at least annually in order to reach a target funding level of at least 1% of covered deposits over a 10-year transitional period9 (likely to end in 2023 or 2024, depending on the date of entry into force of this proposed Directive).

If the ex-ante funds are insufficient to deal with the resolution of an institution, further contributions will be raised (ex post).

In case of need, national financing schemes will also be able to borrow from one another. Other schemes will be obliged to provide support unless they consider that such lending would leave them without sufficient funds to deal with any imminent resolution action in their own national market. In any event, no national fund could be asked to lend more than half of their fund's value.

For an optimal use of resources, the resolution Directive takes advantage of the funding already available in the 27 Deposit Guarantee Schemes (DGS). When an institution has to be resolved, the DGS will have to make a contribution equivalent to the burden they already assume in normal insolvency procedures (i.e. to protect each retail depositor up to EUR 100 000), while the new resolution funds meet the other financing needs required by the resolution. This reflects the burden which DGS currently already assume in order to avoid retail depositors from losing money in the event a bank goes bankrupt.

Member States will also have the option, instead of creating separate resolution funds, to merge the DGS and the resolution financing arrangement. If Member States decide to have a single fund for both functions, the "DGS-resolution fund" will have to respect all the conditions for resolution funds, notably in terms of funding and responsibilities. In the event that the DGS has to meet several claims at the same time, a priority rule is introduced so that depositors are protected before other claims can be honoured.

17. What purpose should resolution funds serve?

It is very important to ensure clear objectives for resolution funds, namely to serve the objectives of resolution outlined above. In particular it needs to be clear that the purpose is to facilitate an orderly restructuring or failure of an insolvent bank, not to bail it out or confer an unfair competitive advantage. This is very important in order to combat the moral hazard that might arise with the creation of a large fund. Consequently, resolution funds could only be used, for example, to provide loans to a bridge institution, to purchase specific assets of an institution under resolution, or to guarantee certain assets or liabilities of the institution under resolution.

18. Should there be a single European resolution fund?

Yes. However for now, setting up a single pan-EU fund would be difficult. Ideally a pan-EU resolution authority would manage its disbursal but the absence of a single European banking supervisor and insolvency regime make this unworkable at this stage. Nonetheless, the importance of obtaining adequate financing for resolution should not be compromised by the difficulties associated with reaching agreement on a single EU authority to determine how and when the money should be used.

As indicated above, in this proposal the Commission therefore proposes the setting up of funds at national level which would interact and lend to one another when necessary, notably in the case of cross-border groups, to constitute a European system of resolution funds. Banks would contribute in relation to their share of specific liabilities of the total size of the national financial sector so that those who contribute most, would potentially benefit most in case they enter resolution. Furthermore, the closer integration of supervisory and resolution arrangements for cross-border institutions will be explored further in the context of the reflection on moving towards a banking union (see question 3 above).

V. BAIL-IN

19. What is the proposal to write down creditors ('bail in') and how would it work?

The mechanism would stabilise a failing institution so that it can continue to provide essential services, without the need for bail-out by public funds. Recapitalisation through the write-down of liabilities and/or their conversion to equity would allow the institution to continue as a going concern, avoid the disruption to the financial system that would be caused by stopping or interrupting its critical services, and give the authorities time to reorganise it or wind down parts of its business in an orderly manner – an 'open bank resolution'. In the process, shareholders should be severely diluted or wiped out, and culpable management should be replaced.

Open bank bail-in would be helpful in cases where other resolution tools may not deliver the best outcome as regards financial stability (e.g. banks where it may not be possible to find a private sector acquirer and transfer of systemically important functions to a bridge bank may be complex or destabilising).

In a 'closed bank resolution' the bank would be split in two, a good bank or bridge bank and a bad bank. The good bank-bridge bank is a newly created legal entity which continues to operate, while the old bad bank is liquidated. Bank creditors that are not systemic can either be left with the old bank and participate in the liquidation or be transferred to the new bank either reducing their claims or converting them into equity.

20. What instruments would bail-in apply to and in what order?

Bail-in would potentially apply to any liabilities of the institution not backed by assets or collateral, and not to deposits protected by a deposit guarantee scheme, short-term (e.g. inter-bank) lending, client assets, or liabilities such as salaries, pensions, or taxes. Member States can also choose to exclude other liabilities on a case-by-case basis if necessary to ensure the continuity of critical services.

The write down would follow the ordinary allocation of losses and ranking in insolvency. Equity should absorb losses in full before any debt claim is subject to write-down. After shares and other similar instruments, it would first, if necessary, impose losses evenly on holders of subordinated debt and then evenly on senior debt-holders.

The Deposit Guarantee Scheme (but not covered depositors who would remain unaffected) to which the institution is affiliated would rank alongside other unsecured creditors and be liable to assume losses, up to the amount of covered deposits, for the amount that it would have had to bear if the bank had been wound up under normal insolvency proceedings.

21. Are you proposing to require institutions to maintain a minimum level of liabilities that is subject to write down?

If debt write-down is to be a credible resolution tool, it is necessary to ensure that there are sufficient 'in-scope' liabilities when a resolution authority determines that an institution meets the conditions for resolution and that writing down the debt of an institution would be in line with the objectives of resolution. In other words, sufficient bail-in capacity should be provided for in all cases when the insolvency of a distressed institution would be detrimental for financial stability and taxpayers.

By definition, this will only be likely in the case of systemic institutions. Still, depending on their risk profile, complexity, size, interconnectedness etc., all banks should maintain (subject to on-going verification by supervisors), a percentage of their liabilities in the form of shares, contingent capital and other liabilities not explicitly excluded from bail-in. In this context, institutions could issue specific subordinated debt instruments which would absorb losses after regulatory capital but before any senior debt. The Commission would specify criteria to ensure similar banks are subject to the same standards.

The crisis has shown that a level of loss-absorbing capacity (own funds, subordinated debt and senior liabilities) at 10% of total liabilities (exclusive of regulatory capital) could broadly represent a threshold at which most recent bank failures could have been resolved with bail-in, and one which is largely consistent with the composition of banks' liabilities today. This is indicative however, and is not a proposed legal requirement.

22. Would the bail-in tool apply immediately to all outstanding debt or only after a transitional period?

The proposal states that the tool should apply as of 1 January 2018 to all outstanding and newly issued debt. This provides the relevant institutions and resolution authorities with a period of time (additional to the entry into force of the rest of the framework) during which to ensure required levels of eligible liabilities.

23. How much would bail-in cost banks, and ultimately the real economy?

The costs should be moderate, and by far outweighed by the expected macro-economic benefits associated with a far-reduced likelihood of systemic financial crises and economic disruption. The average increase in funding costs for banks is expected to be around 5-15 basis points. Subtracted from the expected benefit in terms of GDP of a lower probability of systemic crises, this translates into a net yearly benefit of 0.34-0.62% of EU GDP.

This is set out in the impact assessment accompanying this proposal. This assessment is based on the fact that: (i) bail-in would be better for creditors than normal insolvency, (ii) it would principally apply only to cross-border and other systemic institutions, (iii) these could satisfy the minimum requirement with new subordinated debt instruments if cheaper for them, and (iv) that there would be a sufficient degree of ex-ante funding for supporting the costs of resolution (whether via the Deposit Guarantee Scheme or a separate Resolution Fund).

VI. EU-LEVEL SUPERVISION AND RESOLUTION

24. How does the Commission propose to strengthen cross-border supervision and resolution in the future?

Regulations, no matter how good, cannot overcome poor supervision. The EU has already taken steps to strengthen supervision, notably with the creation of the three European Supervisory Authorities and the European System Risk Board (MEMO/10/434). This proposal strengthens banking oversight further by introducing a common framework for preventing and managing crises affecting the financial viability of all types of banks. As a rule, it establishes a high degree of cooperation and consistency as regards the preventive measures and resolution actions foreseen in relation to cross border banks and other systemically relevant institutions. This lays the foundations for a more integrated EU-level treatment of these entities.

However, especially for cross-border institutions, there is a need to go further to ensure successful resolution. As stated in the European Commission's Communication of 20 October 201010, "in principle, an integrated framework for resolution of cross border entities by a single European body would deliver a rapid, decisive and equitable resolution process for European financial groups, and better reflect the pan EU nature of banking markets." However, this is currently difficult to pursue within the existing Treaties, and would be hampered by the lack of a common insolvency regime and single supervisory authority.

VII OTHER ISSUES

25. What is the purpose of appointing a special manger and wouldn't this appointment lead to loss of confidence in and consequent runs on the firm in question?

As part of the early intervention measures, the special manager could be appointed by the authorities to replace or assist the management of a troubled institution for a one-year period, renewable in case the problems persist. Under the close oversight of the banking supervisor, his/her primary function would be to restore the financial situation and the sound management of the bank. To this end, the special manager would have all the powers of the managers of the company, and could take decisions to, for example, implement any part of the recovery plan, recapitalise the institution, or reorganise its ownership or business structure, including by selling off parts to other healthy banks.

This tool already exists in some Member States, and has been used successfully in the past. It has been proven to create confidence (e.g. there have been no depositor runs in Italy on the appointment of a special manager).

Its inclusion in the EU framework should enhance the tools available to supervisors to prevent failure. National supervisors will have discretion as to which tools to apply. If a supervisor has legitimate concerns that the use of this tool would, in the circumstances, undermine confidence or financial stability, it would not be required to use it.

26. Resolution measures may interfere with the rights of shareholders and creditors. How does the Commission propose to deal with this?

The new EU resolution framework incorporates adequate safeguards to protect the interests of stakeholders affected by resolution measures. Appropriate safeguards include notably the principle that no creditor should be worse off under resolution than it would have been had the bank been wound up under the applicable insolvency law.

Rights of shareholders need also to be recognised by appropriate mechanisms for judicial redress and compensation. However, a balance needs to be struck between protecting the legitimate interests of shareholders and enabling resolution authorities to intervene quickly and decisively to restructure a failing institution or group to minimise contagion and ensure the stability of the banking system in the affected Member States. Therefore, remedies for wrongful decisions should be limited to compensation for damages suffered and not affect any administrative acts and/or transactions concluded as part of the resolution.

27. Would "living wills" help authorities to manage a cross-border banking crisis?

'Living wills' in the shape of ex-ante plans for handling a bank in crisis will be an important part of resolution planning. They will help authorities to better understand group structures, intra-group dependencies, and separate critical functions, and will mitigate the risk that banks are either too big or too complex to fail. They will ensure that in the event of a crisis, authorities will have all the necessary information for rapid decision-making and intervention. In addition, they should help groups to streamline their operations and foster more integrated approaches to risk management.

28. How does the EU framework square with the resolution regime adopted in some Member States?

Some Member States already have in place or have recently introduced mechanisms at national level to resolve failing banks (e.g. the UK, Germany, Denmark, Ireland, Greece, Portugal, the Netherlands, France, Italy). These regimes pursue the same objectives and are generally compatible with the Commission proposal.

In any event, the Commission proposes a minimum harmonised set of tools and powers, so that Member States would be able to introduce additional tools at national level (such as taking a bank into temporary State ownership) to deal with crises, as long as they are compatible with the state aid rules provided for at EU level.

29. How does the EU Framework square with the EU State Aid rules?

Although the EU proposal aims to minimise losses for society, in particular to avoid as far as possible the use of taxpayers' money, the framework does not prohibit the use of public funds to finance bank resolution. The granting of rescue aid in systemic crises is governed by the EU framework for State Aid11. The proposal on bank resolution will not prejudice these rules. They will continue to apply in the context of a bank resolution, if a form of financing that is supplied qualifies as State aid according to the existing rules.

30. How does this proposal relate to the Capital Requirements Directive IV (CRD IV) proposal tabled in summer 2011?

The two proposals complement each other. The CRD IV proposal (IP/11/915) strengthens the prudential requirements and supervision related to banks and investment firms. Today's proposal contains measures on how to address a banking crisis at an early stage and, if the crisis develops further, how to resolve a failing bank in an orderly manner without damaging the financial system and by extension, the real economy.

While the CRD IV proposal reduces the probability of banks failing, the current proposal reduces the impact of such failures and will therefore work as a backstop for bank failures. It contains legislative provisions related to preparatory measures, early intervention measures and resolution powers and tools.

31. What link is there between resolution and deposit guarantee schemes (DGS)?

Despite the different scope and purpose of deposit guarantee schemes (IP/10/918), which guarantee deposits up to a certain amount, and resolution, there are a number of synergies. For example, when a resolution framework that stops contagion is in place, the DGS fund would only finance a few banks (pay out depositors) that would potentially default. In contrast, when no resolution measures are available and contagion spreads through the financial system, the amount of money that the DGS needs to pay out in a Member State is considerably higher.

In countries where the interbank market (lending between banks) is more developed the synergies between the two are higher (as contagion risk is higher). In addition if DGS finances resolution measures (e.g. deposits transferred to a healthy bank), its payment obligation would mostly likely be smaller than the payout of all eligible deposits if the bank is liquidated.

Currently, in several Member States (e.g. Austria, Belgium, Bulgaria, Germany, Spain, France, Italy, Lithuania, Poland, Portugal, Romania, United Kingdom) DGS have varying powers beyond the mere payout of depositors such as liquidity support, restructuring support or a liquidation role. DGS would be used to finance such measures if it is less costly than paying out depositors.

32. If we had had this proposal already in place, would this have saved banks like Dexia, Lehman Brothers, or BayernLB?

When banks like Fortis, Icelandic banks, Lehman Brothers, Anglo Irish Bank, Dexia, CajaSur, HBOS, RBS, Lloyds, Société Générale or BayernLB were hit by the financial crisis, they faced potential collapse and posed a threat to their national financial systems, and threats to the economy. These banks were rescued by public money or supported by state guarantees.

In the case of the Icelandic banks, the absence of early intervention prevented an early and less costly resolution, while the lack of adequate cooperation between relevant authorities resulted in banks' assets being ring-fenced. The country's deposit guarantee scheme was not adequately financed, and could not sustain pay-outs for insured depositors.

In the case of Fortis, for example, the absence of burden-sharing arrangements between parts of the group located in different countries ultimately resulted in the group being split along national lines.

The chaotic way in which Lehman Brothers was placed into bankruptcy led to a significant loss of value for unsecured creditors and caused uncertainties about the location and return of client assets. This case reveals a clear failure of cooperation and information-sharing at a critical moment: insolvency. This case illustrates how difficult it can be to ring-fence assets in practice.

The lack of effective resolution tools in the case of the Anglo-Irish and Icelandic banks shows how the problems of one bank can drag the whole country into recession. The losses incurred by banks, like Dexia for example, could have been covered by bailing in shareholders and creditors along the lines of today's proposal, rather than employing public funds.

At the time that banks like Fortis, Lehman Brothers, Dexia, etc. were rescued by the taxpayer, state support was the only prompt and credible solution that was available.  However, what we now see is that bailed-out banks – "zombie banks" – do not lend.  The framework proposed today would not only provide the tools and the financial means to act decisively, but it will also empower an independent authority (the resolution authority) to resolve any bank in difficulties.  This authority will indeed be obliged to act in those circumstances.

All of these cases illustrate the fact that there were no effective tools in place to monitor and deal with problems at an early stage, nor were there effective solutions to be applied once problems materialised. The measures in today's proposal could limit the spill-over effect of bank crises on the country and its economy. Today's proposal addresses all of these shortcomings.  Had these powers and tools been available to the relevant authorities in the recent cases of banks that were bailed out with public money, we would have seen more cooperation and preventive actions in cross-border banking groups. Today's proposal means that governments would have to examine the use of resolution tools other than a simple bail-out using taxpayer's money.

The case of Bradford & Bingley illustrates such an alternative. When in 2008 the FSA determined that the bank no longer met threshold conditions, UK authorities took Bradford & Bingley into temporary public ownership. Thanks to extensive prior contingency planning, the UK was able over the space of a single weekend to auction off Bradford & Bingley’s retail deposits, branches and associated systems. The Bradford & Bingley branches opened for business as usual on Monday morning with no interruption in service. Another example is Denmark's Amagerbanken. Early in 2011, the Danish authorities demonstrated both their willingness and capacity to use the recently created bank resolution framework, imposing a 41% write-down of senior debt and unguaranteed deposits, and in so doing sent a strong signal that they may do so again in the future. Until this time the Danish authorities had supported the unguaranteed depositors and senior creditors of failing banks via blanket guarantees, guarantees on debt issuance by the banks, and hybrid capital injections.

33. Is there a link to the plan for the recapitalisation of banks?12

There is no direct link. The steps announced regarding recapitalisation are immediate measures to address capital shortfalls in the EU banking sector, whereas the present proposal is for a comprehensive and permanent framework for bank recovery and resolution, regardless of prevailing market conditions. However, there are overlaps, notably as regards how banks should recapitalise, e.g. by bailing in creditors.

34. What is the link between this proposal and the work of the High-level Expert Group on structural aspects of the EU banking sector?13

The two are complementary. The High-level group will determine whether, in addition to ongoing regulatory reforms such as today's proposal on bank recovery and resolution, structural reforms of EU banks would strengthen financial stability and improve efficiency and consumer protection. Recovery and resolution may entail changes to the structure of individual banks on a case-by-case basis, but the mandate of the High-level group is to examine whether specific reforms ought to be carried out across the board.

ANNEX

Key Numbers

  • Process and public consultations:

Two online public consultations were run between 2009 and 2011. In addition an informal discussion document was published in March 2012. Together, over 250 responses were received to the two online consultations and to the discussion document14. A public hearing was organised on 19 March 2010.

  • Crisis costs:

Crisis-related losses incurred by European banks between 2007 and 2010: almost €1 trillion or 8% of EU GDP (IMF). EU GDP contraction in 2009 due to the economic recession induced by the financial crisis: 6% (Eurostat). Approved state aid measures including guarantees between October 2008 and October 2011: €4.5 trillion or 37% of EU GDP (Commission). State aid measures effectively used including state guarantees between 2008 and 2010: €1.6 trillion or 13% of EU GDP (Commission), of which €409 billion of asset relief and recapitalisation aid.

Examples of companies where inadequate management of liquidity risk largely contributed to their failure: Northern Rock (UK), HBOS (UK), Bradford and Bingley (UK), Bear Sterns (US), Lehman Brothers (US)

Examples of companies whose (mostly hybrid) capital instruments did not live up to the expectations as regards their loss absorption, permanence and flexibility of payments capacity (which had to be reinforced through Commission state aid decisions): RBS (UK), Bradford and Bingley (UK), KBC Group (BE), Bayern LB (DE), Commerzbank (DE), Lloyds (UK), Allied Irish Banks (IR), Bank of Ireland (IR), Cajasur (ES)

  • Economic impact of the proposal (notably the bail-in tool and funding of the resolution framework)

The European Commission has analysed the costs and benefits of the proposal in the accompanying impact assessment.

The costs of the framework are taken to derive notably from the potential increase in the funding cost of banks due to the removal of the implicit state support and from the costs of setting up resolution funds. Such increases in banks' costs might have negative effects for GDP. On the other hand, the improved stability of the financial sector, and reduced likelihood of systemic crises and risks for taxpayers’ money to recapitalise failing banks, would have a positive effect on GDP.

The proposal seeks to design an approach which is both efficient and effective. In other words, new costs for banks should be minimal while the framework should work in a variety of crises of different magnitude (losses by EU banks during the recent crisis from 2008 to 2010 are taken as a key reference point).

The efficiency and effectiveness of the proposed framework is to be seen in the context of a joint calibration of Basel III rules, funding available under Deposit Guarantee Schemes (DGS) and the bail-in tool. The new capital requirements under the Basel III accord (which reduces the probability of bank failures) are expected to generate net benefits equal to 0.14 % of the EU’s GDP annually. The necessary funding of DGS or specific resolution funds are expected to bring positive net benefits equal to 0.2-0.3 % of the EU’s GDP annually. The bail-in tool could produce economic net benefits equal to 0.3-0.6 % of the EU’s GDP annually. Overall, these measures are expected to generate a cumulative net benefit equal to 0.7-1.0 % of the EU’s GDP annually.

Table 1. Cumulative impact of Basel III, RF/DGS and Debt Write Down tool (bail-in) (costs and benefits as % of annual GDP.)

Basel III

DGS/RF

Bail-in

Sum

Costs (% of EU GDP annually)

0.16%

0.04%

0.14% - 0.42%

0.34% - 0.62%

Benefits (% of EU GDP annually)

0.30%

0.32%

0.76%

1.38%

Net Benefits (% of EU GDP annually)

0.14%

0.28%

0.34% - 0.62%

0.76% - 1.04%

The costs (in terms GDP, investment, volume of loans, etc.) are estimated through a simple methodology also used by the Bank of England, and validated by the estimations of a dynamic general equilibrium macroeconomic model (QUEST III) that has been extended to incorporate financial intermediation by the banking sector.

The benefits are estimated using the SYMBOL model, developed by the European Commission. This model allows estimating the aggregated losses deriving from bank defaults, explicitly linking Basel capital requirements to the other key tools of the banking safety net (i.e. DGS). Macroeconomic benefits are calculated by multiplying the reduction in the probability of a systemic banking crisis (due to improved regulation) times its total (avoided) costs.

1 :

According to the IMF estimates, crisis-related losses incurred by European banks between 2007 and 2010 are close to €1 trillion or 8% of the EU GDP. Between October 2008 and October 2011, the Commission approved €4.5 trillion (equivalent to 37% of EU GDP) of state aid measures to financial institutions.

9 :

1% represents around €80 billion for the Union and €65 billion for the Euro area (as of March 2012, based on data from the European Commission, the European Central Bank and Bankscope).

10 :

COM(2010) 579

11 :

The State aid rules established in response to the financial crisis are available at http://ec.europa.eu/competition/state_aid/legislation/temporary.html

14 :

All documents (apart from submissions to the informal discussion document) are available at http://ec.europa.eu/internal_market/bank/crisis_management/index_en.htm


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