Bailouts for banks by owners and creditors, not taxpayers

Per Heister
20.05.2013 - 16:00
Bank sign on building

The Bank Recovery and Resolution Directive (RRD) is a cornerstone of the legislative initiatives on financial services currently being processed by the EU institutions. It seeks to correct the long-lasting problem of banks being too big to fail by establishing a framework of measures that would allow public authorities to resolve a bank without destabilising financial markets or the economy in a wider sense. In a nutshell, the purpose of the directive is to set up an alternative to the standard insolvency procedure, as that process is generally considered to be too slow for an institution as interlinked as a big bank (the Lehman Brothers bankruptcy, for example, is still not concluded).

Restructuring banks and holding shareholders responsible

By taking the bank into resolution instead, the idea is that its critical operations and functions can be maintained whilst the bank is restructured to a viable form through a number of resolution tools, such as separating bad and good assets or setting up a temporary bridge bank. Whereas the bank as such is kept alive, previous shareholders will not be saved by the government but rather lose their investment so as to mitigate moral hazard effects (where investors take bigger risks in the knowlegde that the government will come to the rescue in the event of trouble).

"Bail-in tool"

Another main component of the proposal is what is referred to as the “bail-in tool”, which means that those who have lent money to a bank could have their claims written down or converted into equity if the bank faces a large amount of losses. In doing so, the liabilities of the bank are reduced and its capital increased thereby restoring its balance sheet.

Apart from its “repairing” quality, the bail-in tool is important in the sense that it will instill a larger degree of scrutiny and discipline among bank creditors as they will know there is a risk they will lose the money they have lent unless they ensure the bank is operating in a prudent manner.

EPP Group in favour of RRD

From the EPP Group’s perspective, a recovery and resolution framework is to be warmly welcomed. Designed properly, it will improve the functioning of financial markets and reinstate fundamental market economy rules of the game in the banking sector, i.e. that bank owners and creditors should not only be entitled to the profits from their investments but also be the ones to bear the losses when things go bad.

Among the changes the EPP Group has successfully made to the proposal are a more clear division between the recovery and resolution phases, where a blurred line would risk creating the perception that authorities have taken over the bank when owners in fact should still be those held responsible, a more balanced distribution of influence between home and host countries and a deletion of the original proposal for mandatory lending between the resolution funds of different Member States (lending is now to be strictly voluntary).

What's next?

Following the adoption of the report in the European Parliament’s Economic and Monetary Affairs Committee in May and an agreement among Member States in Council, trialogue negotiations between the Parliament, the Council and the Commission are to be initiated with the aim of reaching a final agreement on the legislative text before the summer recess.


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