22 November 2018

European Parliament: Financing bank resolution: An alternative solution for arranging the liquidity required

This paper proposes an ECB liquidity facility with an SRF guarantee as an alternative solution for banks in resolution. The funds available should be broadly sufficient to address potential liquidity needs for resolution tools.

The introduction of the Single Resolution Mechanism has shifted de facto the function of lender of last resort from central banks to the Single Resolution Fund (SRF). Indeed, when the bank in resolution cannot obtain liquidity from the central bank, the SRF is the last remaining option. This is unlikely to be a purely theoretical possibility witnessing the up to EUR 900 billion in guarantees that euro area governments provided to banks in the aftermath of the global financial crisis.

However, the limited funds available and time required to mobilise sufficient liquidity make the SRF unsuitable for taking this role. Even when the ESM backstop to the SRF – that still needs to be finally agreed by euro area countries – is taken into account, the total amount available would only reach around EUR 142.5 billion. This is likely to be grossly inadequate to offer liquidity support in a systemic crisis and potentially even if a large systemically important bank were to fail.

There are several solutions under consideration for addressing the liquidity needs of banks that have just been through resolution and need to regain market confidence. For example, providing a government guarantee to the Eurosystem, providing ESM claims as collateral for Eurosystem liquidity support, or increasing the size of the backstop beyond the levels currently foreseen. These solutions would involve taxpayers’ money and intensify the sovereign-bank nexus, both of which are contrary to the primary objectives of the resolution mechanism. Moreover, the lengthy political discussions regarding the backstop serve to illustrate the resistance to potential mutualisation of losses.

As alternative, this paper proposes to introduce a Transitional Liquidity Assistance (TLA). This would provide ECB liquidity support for resolved banks based on an SRF-guarantee. This SRF-guarantee would be based on potential further commitments from banks to the fund. These commitments would be maximum 0.125% of covered deposits per year. Such annual contributions are similar to the current contributions during the build-up of the fund and would only be required at the moment that the guarantees are called on. The TLA should only be provided under strict conditions to lower the risk of the funds being called on.

TLA returns the lender of last resort function to the ECB. The total amount available for the TLA depends very much on the Marginal Lending Rate (MLR) of the ECB, potential anticipated adjustment to compensate for reductions arising from future increases in the MLR and whether the SRF is used for other purposes than this guarantee (capital support, AMCs, etc.). Based on the current MLR (0.25%) the SRF guarantee could be up to EUR 3,150 billion, which should be more than enough to cover potential liquidity shortages in resolution.

In addition, there might also be a need for liquidity support for the use of the resolution tools. This is important in particular for non-bank resolution tools such as AMCs. The total amounts of liquidity support required for this tool are expected to be substantially lower than for banks in resolution, but might still involve the public backstop facility.

Full draft report

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