29 June 2017

ECB's Angeloni: Crisis management in the banking union: overview and early experience

The member of the Supervisory Board of the ECB outlined the features of the existing framework in the banking union and practical experience had so far with the handling of troubled banks in the EU.

3. Crisis management for banks in the euro area

3.1 – Features of the existing framework

Let me turn to examining the crisis management framework in the banking union and start by looking at some of its specific features. As I outlined earlier, the BRRD lays down a comprehensive regime for the recovery and resolution of banks both in a domestic as well as in a cross-border context. During a bank’s normal course of business, the BRRD contains rules for preparing for and preventing crisis situations. Banks are required to prepare recovery plans which contain options to be taken in case of stress in order to restore their financial position. In addition, resolution authorities have to draw up resolution plans outlining the course of action in case of failure of the bank. If the resolution authority identifies obstacles to resolvability during the course of the planning process, it requires the bank to take appropriate measures to remove such obstacles. Recovery plans for significant banks are assessed by the ECB, after consulting the Single Resolution Board (SRB), and resolution plans are prepared by the SRB after consulting the ECB.

If the bank’s financial position is deteriorating, the ECB as supervisor has an expanded set of powers to intervene via so-called early intervention measures to prevent the bank from failing. These powers include, for example, the ability to dismiss the management and appoint a temporary administrator, as well as to convene a meeting of shareholders and require the bank to draw up a plan for the restructuring of debt with its creditors. Once the ECB adopts early intervention measures, the SRM is entitled to receive full information about the bank’s developments and acquires additional powers to prepare for resolution. This includes the power to require the bank to contact potential purchasers or to require the relevant national resolution authority to draft a preliminary resolution scheme.

Once a bank’s failure is deemed to be inevitable, the BRRD requires the ECB, as supervisory authority for all significant banks, to determine that it is “failing or likely to fail” (FOLTF). If a significant bank is deemed FOLTF, the SRB has to assess whether there are any measures other than resolution which could prevent the failure of the institution in a reasonable time frame and whether resolution is in the public interest by assessing the bank’s critical functions and risks to financial stability. If there are no alternative measures and resolution is found to be in the public interest, the resolution authority will apply resolution measures to the bank, which may include selling the business to another bank, setting up a temporary bridge bank to operate critical functions, separating good assets from bad assets and writing down debt or converting it to shares (bail-in). The assessment of the other resolution conditions and the resolution procedure is handled by the SRB in close cooperation with the national resolution authorities.

The interaction between the SRB and the ECB is underpinned by the SRM Regulation, which stipulates that both institutions must cooperate closely during all phases of recovery and resolution and provide each other with all information necessary for the performance of the other’s tasks. The SRB and the ECB have concluded a Memorandum of Understanding (MoU) to articulate this mandatory cooperation in practical terms. This MoU covers the cooperation and the exchange of information with respect to all banks that are directly supervised by the ECB. In addition, the MoU covers all other cross-border groups under direct responsibility of the SRB insofar as the ECB is exclusively competent to carry out so-called common procedures (e.g. authorisations).

In addition to the ECB and the SRB, there is another actor which is central to the crisis management framework in the banking union, namely the Commission, given its responsibility for competition and State aid. In particular, the Commission’s DG Competition is responsible for authorising cases in which State aid is involved, whether in the context of a FOLTF declaration or not.

3.2 – Bail-in, burden-sharing and safeguarding financial stability

The BRRD establishes the EU framework for managing bank failures in a way that avoids financial instability and minimises costs for taxpayers. The Directive achieves the latter purpose by stipulating that public funds may be used to support a bank’s resolution only after its creditors and shareholders have endured losses equivalent to 8% of the bank’s liabilities. Using resolution financing arrangements – in the case of the banking union, the Single Resolution Fund – is also possible, but only to cover up to 5% of the bank’s liabilities.

We can thus consider bail-in as the baseline case in resolution matters. However, this does not imply that it is applicable always and everywhere, since the BRRD also includes a number of provisos for deviating from this principle in specific and well-defined circumstances.

The best known among these – and certainly the one which has received most attention recently – is the option for banks to undergo a precautionary recapitalisation. As a general rule, extraordinary public financial support is among the conditions triggering FOLTF. However, precautionary recapitalisation is explicitly considered as an exception to this general rule under the BRRD in cases where financial stability needs to be preserved and a serious disturbance in the economy of a Member State needs to be remedied. There are three conditions which need to be fulfilled for banks to make use of this option.

First, precautionary recapitalisation is only available to solvent banks. The ECB, the direct supervisor for significant banks in the banking union, makes this assessment. The ECB operationalises this requirement by assessing compliance with the minimum capital (Pillar 1) requirements.

Second, precautionary recapitalisation is limited to the capital injections needed to address a capital shortfall under the adverse scenario of a stress test. For significant banks in the banking union, the ECB is asked to confirm that there is no shortfall under the baseline scenario and the extent of the capital shortfall under the adverse scenario of the most relevant (recent) stress test exercise.

Third, the BRRD stipulates that public support must be of a precautionary and temporary nature, be proportionate to remedy the consequences of the serious disturbance and not be used to offset losses that the institution has incurred or is likely to incur in the near future. These losses should be covered by private capital. Compliance with these overall conditions needs to be approved by the European Commission (DG Competition) under the Union State aid framework.

While precautionary recapitalisation does not require use of the bail-in tool, the State aid rules foresee the application of burden-sharing. According to the 2013 Banking Communication, burden-sharing will normally entail, after losses are first absorbed by equity, contributions by hybrid and subordinated debtholders. A contribution by senior debtholders is not required. This represents an important difference with bail-in, where senior debt is also included. In addition, exceptions to burden-sharing can be made where the implementation of such measures would endanger financial stability or have disproportionate results.

Burden-sharing ensures that the link between a bank’s failure and the responsibility of shareholders and creditors is not entirely diluted. However, precautionary recapitalisation may still entail the use of a large amount of public funds. The EU State aid rules aim to limit the fallout by stipulating that public funds may only be injected into a bank that is expected to be profitable in the long term. This requires the bank to undergo in-depth restructuring with the purpose of restoring long-term viability without State aid as soon as possible, based on a restructuring plan which should not last more than five years. Under precautionary recapitalisation, the restructuring plan is assessed by the Commission and should identify the causes of the bank’s difficulties and weaknesses and outline how the proposed restructuring measures remedy the bank’s underlying problems. According to the Commission Restructuring Communication, “long-term viability is achieved when a bank is able to cover all its costs including depreciation and financial charges and provide an appropriate return on equity, taking into account the risk profile of the bank”. In assessing this, collaboration with the supervisory authority is essential.

While protecting taxpayers’ money, the State aid framework also tries to minimise the competitive distortions resulting from banks which successfully qualify for precautionary recapitalisation. This implies that the receipt of public funds needs to be balanced with proportionate remedies (for instance, by making sure that the aided banks close or sell parts of their businesses, or by ensuring that they do not use the aid to undercut their competitors). The nature and form of such measures will depend on the amount of aid and the conditions and circumstances under which it was granted, as well as on the characteristics of the market or markets in which the beneficiary bank operates.

Another proviso in the BRRD allows for an exclusion in full or in part of certain liabilities from bail-in. This is left at the discretion of resolution authorities but needs to be justified on account of either time pressure, continuity of critical functions, avoidance of widespread contagion or avoidance of destruction of value (higher losses to other creditors than if those liabilities were excluded from the bail-in). In order to tap resolution financing resources, 8% of banks’ liabilities still need to be bailed-in even if some instruments are left out.

In addition, the state may inject “liquidation aid” for banks in the context of an orderly wind-down process, an option provided for in the Commission’s Banking Communication. This case materialises if the SRM establishes that the conditions of resolution are not fulfilled (i.e. resolution is not in the public interest). In this case, EU Member States must submit a plan for the orderly liquidation of the bank and the Commission would need to assess the conditions for State aid. In this situation, a bail-in is not required, but the State aid rules need to be followed, notably including burden-sharing. [...]

The first and most evident observation is that the crisis management framework, from a purely operational viewpoint, has worked. The various authorities involved (ECB, SRB, Commission and national authorities at various levels) have been able to put in place effective and rapid coordination modalities that have performed well under stress. Our experience includes also the overnight resolution of a medium-sized bank. This result was not granted ex-ante: many observers had expressed concern about the fact that the complexity of the norms and the high number of actors involved would impede efficiency and create risks.

A second observation concerns the timing of the decision that a bank has reached the point of non-viability. The ECB is obliged to declare a bank to be “failing or likely to fail” if it is certain or probable that it will be unable to settle its debt or meet its obligations within a short period of time. This circumstance may arise because of a loss of solvency (capital ratios fall below the minimum regulatory requirements) or because of a liquidity shortage linked to deposit withdrawals. Both situations have occurred recently, but the timing is normally different: very quick in the case of outflows of deposits and often slower in the case of insolvency, particularly if liquidity support is provided in the form of public guarantees for bond issuance (a type of assistance that has to be authorised by the Commission). In the latter case, it is crucial that the declaration of insolvency is timed correctly.

Thirdly, it is important to note that the danger of contagion has not materialised in the cases seen thus far. Some observers had feared that the new European rules, which impose tighter constraints to bail-outs, could weaken market confidence and become an inherent source of systemic stress. What we have observed instead is that the loss of confidence of depositors and investors in the banks that were perceived as weak was accompanied by a strengthening, not a weakening, of the competitors that were perceived to be stronger. This was very clear in the deposit flows across banks, which are monitored daily in crisis situations. In the financial markets (for listed stocks, CDS spreads, AT1 and T2 instruments) the impact was selective, not generalised. The tentative evidence suggests that under the new rules the market mechanism is working, leading to the strongest institutions being identified and indirectly contributing to the strengthening of the system as a whole. [...]

Full remarks

© ECB - European Central Bank