13 October 2013

FT: Brussels warns on bank bailout loophole

Brussels has warned EU states that they will not be able to circumvent competition rules and shield all creditors from losses in failed banks, even if provisions allowing taxpayer bailouts are included in law.

Some European officials fear bailout clauses will be included in a proposed EU rulebook for handling distressed banks that could create a loophole undermining the aim of making investors, not taxpayers, pay for bank rescues. But a European Commission paper addressing the issue, seen by the Financial Times, states that any public support to banks will still be subject to state aid rules, which require at least junior bondholders to suffer losses before a bailout is approved.

In its “non-paper” – an informal statement of its position – the commission notes that markets have taken heed of recent creditor bail-ins in Spain and Cyprus and “funding costs for banks in countries with sovereigns perceived to be weaker have increased”. With flexible resolution rules, officials fear only poor countries will be forced to bail in while rich countries bail banks out with taxpayer funds rather than scare off investors.

The European Parliament is pressing for governments to be given an option to temporarily renationalise or recapitalise banks during a systemic crisis. These are “likely to constitute state aid” and under existing rules “would imply that the beneficiary bank has to implement burden-sharing measures [on its creditors]", the commission says.

Similarly, EU Member States are allowed “precautionary recapitalisation” of solvent banks without any requirement to bail in creditors, as long as the terms of support “do not confer advantage”. Here, the commission makes clear that it will police such interventions and require them to be “fully subject to the state aid rules and therefore the burden-sharing requirements”. This would involve, at a minimum, converting junior debt into equity and if necessary wiping out bondholders and shareholders before state funds can be used.

The resolution directive as drafted makes senior bondholders subject to bail-in from 2018. The Commission says it will review its guidelines on state support in light of regulations, suggesting it may eventually tighten the “burden-sharing” rules further.

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