30 November 2013

Stefano Micossi: The new Single Bank Resolution Mechanism of the European Union

Of the three pillars of the nascent European Banking Union, establishing a unified bank resolution mechanism is the most pressing issue, says Micossi, suggesting some changes to the existing SRM proposals.

The proposed system appears to be generally well-designed, and respectful of the institutional balance of powers dictated by the Treaty. However, some specific aspects may be improved with a view to increasing the effectiveness and legal strength of the Single Resolution Mechanism. In particular, the following changes appear desirable.

In order to streamline and speed up the initiation of resolution, the assessment that a bank is failing or likely to fail, and that no private or supervisory alternative is available, should be left to the ECB (in its supervisory role) and national resolution authorities, as the last act of early intervention. Accordingly, the Commission should in practice focus its intervention on verifying the existence of the public interest conditions that are required to open resolution. The decision to start resolution should normally be initiated after the close of business on Friday afternoon, and be completed before markets reopen.

On bail-in, the authors have proposed that the requirement for banks to have sufficient liabilities subject to bail-in could in part be translated into an obligation to issue debentures automatically convertible into equity when capital (evaluated at market prices) falls below certain thresholds. This would greatly strengthen market discipline on shareholders and management. They have also underscored the need for flexibility in the application of bail-in where there is an injection of public funds into a solvent financial institution – be that by national authorities or the European Stability Mechanism – so as to avoid unwanted destabilising effects when a capital shortfall becomes known to the public. This will be especially important in view of the comprehensive and ambitious asset quality review that the ECB and European Banking Authority will launch in the coming months – possibly leading to the conclusion that a major ‘precautionary’ injection of funds is needed in parts of the EU banking system.

On the Resolution Fund, the authors' main proposition is that it must be supranational, since a collection of national funds would not eliminate national forbearance, and without a fiscal backup the entire scheme would lack credibility (on this, see also Gros 2013 - link). The Fund would be paid for by financial institutions participating in the Single Resolution Mechanism, and would not require any support from national budgetary resources. However, this does not eliminate – for the sake of the very credibility of the Single Resolution Mechanism – the need to establish a last-resort fiscal backup for the Fund, to be activated in exceptional circumstances such as a systemic shock affecting large parts of the EU banking system. In this regard, the first line of defence can be provided by the European Stability Mechanism – with appropriate changes in its membership – and subsequently, in extreme cases of systemic banking crisis, by national budgets.

The rules for tapping these backstops and the contribution keys by the Member States should be agreed in advance, lest they become the subject of frantic and divisive negotiations should a major financial shock materialise. These funds should be repaid by financial institutions as soon as the crisis subsides. The credibility of the Single Resolution Mechanism requires that the system be completed by a fiscal backstop, which may be guaranteed in the first place by the European Stability Mechanism and as a last resort by national budgets.

Finally, the authors have discussed two legal aspects of the Single Resolution Mechanism’s design – its legal basis and the balance of powers between the different bodies involved in the resolution procedures. On the first aspect, were Article 114 to prove an inadequate legal basis for the exercise of centralised resolution powers deeply impinging on individual property rights, it might be necessary to consider, only in this respect, the joint resort also to Article 352. On the second aspect, the authors have stressed the critical role of the Commission, which must take the key decisions affecting property rights in the procedure, thus better underpinning their legality and political accountability under the Treaty.

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