The European Union proposed legislation for dealing with failing banks that aims to shift the cost of future bank collapses away from taxpayers and onto investors.
The plan, drafted by the European Commission, the EU’s executive arm, is the latest effort to ensure that the massive government-funded bank bailouts of recent years aren’t repeated. It includes a controversial idea that delayed the proposal for months: forcing bank shareholders and even bank creditors to absorb losses if a firm runs into trouble.
The proposals made Wednesday have been under discussion for years and cede only limited powers to the European Banking Authority in cases where governments can’t reach agreement over the collapse of a bank with important operations in several countries.
These proposals are much more limited in scope than the “banking union” idea recently raised by European leaders. The banking union, which would cover only the 17 members of the euro zone rather than the 27 of the entire EU, is a long-term project that foresees creating a common bank-rescue and deposit-guarantee fund.
“The financial crisis has cost taxpayers a lot of money,” said Michel Barnier, the commissioner in charge of financial regulation, in addressing Wednesday’s proposal. “We must equip public authorities so that they can deal adequately with future bank crises. Otherwise citizens will once again be left to pay the bill, while the rescued banks continue as before knowing that they will be bailed out again.”
The commission says a bank failure—like the collapse of any other business—should potentially result in losses to creditors. The rules aim to preserve a failing bank’s vital operations, such as payment systems and retail deposit-taking, while injecting new capital by turning bank creditors into shareholders. Most governments during the crisis lacked the legal powers to engineer this process; instead they guaranteed creditors and used public funds to inject capital into banks.
But setting rules on how bank creditors could book losses is sensitive, given the dire problems many European banks now face borrowing money in financial markets. Some policy makers still worry that putting creditors on the hook for losses could inject more uncertainty into markets reeling from fears about the euro-zone debt crisis.
The commission’s proposal aims to ease these worries. Certain liabilities will be exempted from the so-called bail-ins, including secured debt, liabilities with maturity of less than a month and guaranteed deposits. While most of the legislation’s provisions must be put in place by 2015, the mechanism for imposing losses wouldn’t come into effect until January 2018.
The commission acknowledged that the impact of forcing creditors to share a greater burden of bank crises in the future could raise the cost of bank funding between 0.05 and 0.15 percentage point. But over the long term, the commission said, the proposals would cut the risk of a systemic crisis that could be hugely expensive for taxpayers.
In order to have funds available to help with future banking crises, the commission is also proposing creating national resolution funds, which would force banks to set aside cash to be used were they to fail. The commission recommends an EU country would have to lend funds to another state in case of a crisis elsewhere in the EU.
German banks criticized this proposed burden-sharing. “It’s not justified that the costs for restructuring a bank—which could for instance be caused by the failure of a national supervisor—should be passed on to banks in other EU member states,” said Michael Kemmer, who heads the BdB German association of commercial banks. that represents banks including Deutsche Bank AG and Commerzbank AG.
The legislation would require banks to draw up “resolution plans”—often referred to as living wills—that would set out how a bank could be quickly wound up if it runs into trouble.
National authorities would be given greater powers to intervene when a bank is on the verge of collapse, including by forcing out management.
Only when these measures have failed will resolution—which aims to protect depositors and maintain certain critical functions of the banks operation—come into force.
The proposal still has to pass the usual prolonged approval process, which requires consent from the European Parliament and member states before becoming law.