European Union policy makers need to standardize insolvency laws across the bloc if new bank-failure rules are to work effectively. The euro area’s central resolution authority needs to consider that insolvency law is the basis for their work.
New EU bail-in rules, that are a key part of the EU’s attempts to tackle too-big-to-fail banks, state that shareholders and creditors must bear losses equivalent to 8 percent of a failing bank’s total liabilities including own funds before rescue funds can be tapped. However, the success of such a bail-in procedure depends a lot on the creditor hierarchies in national insolvency laws.
There is no a harmonized insolvency law in the EU, there are 19 versions within the banking union. The worst thing to happen in a banking crisis is a lack of clarity, transparency and certainty about where within a creditor hierarchy institutions could stay.
Regulators worldwide have taken measures to keep taxpayers off the hook when banks fail. EU rules in the the Bank Recovery and Resolution Directive make most categories of liabilities subject to losses, and require that creditors be no worse off than they would be if a bank were liquidated in a normal procedure.
The credibility of the EU’s bank-failure system has been questioned recently by top Italian officials. Finance Minister Pier Carlo Padoan and Bank of Italy Governor Ignazio Visco have said that using the bail-in tool mustn’t be allowed to put financial stability at risk.
“It doesn’t look good to say that we have bail-in in place when everyone knows that it can’t be used because of these systemic and contagion risks,” Visco said last week. “We need to have a backstop in case of systemic crises, but this must be discussed very calmly and carefully.”
The Single Resolution Board, the resolution authority for around 143 significant banking groups as well as any cross border banking group established within participating EU Member States, has to set a minimum requirement for loss-absorbing liabilities and own funds for the banks under its purview by the end of the year, and said it would give banks enough time to meet the requirement. Only if banks have enough liabilities to fulfill the 8 percent bail-in requirement will the euro area’s industry-financed rescue fund be sufficient.
One of the challenges it faces is that nations such as Germany, Italy, France and Spain have tweaked their insolvency rules in different ways to make sure those losses can be imposed.