20 July 2023

Finance Watch's Stiefmuller: 8% – We had a deal!

Europe’s “8% rule” requires bank shareholders to cover losses on up to 8% of the bank’s balance sheet. It is the embodiment of the EU’s promise that taxpayers would “never again” pay for banks’ under-capitalised risk-taking.

The European Commission’s latest proposal on crisis management and deposit insurance (CMDI) would effectively drop that rule from the statute book. This must not happen!

Remember the financial crisis? 

Fifteen years ago, EU taxpayers were asked to write a ‘blank cheque’ to shore up the financial sector, especially some of Europe’s biggest banks, when they ran into trouble following a decades-long run of deregulation and unbridled risk-taking. That cheque ultimately turned out to be for roughly one million million Euro – and that was barely enough to cover the direct cost, not to mention the final cost of the ensuing Eurozone debt crisis. A “lost decade” of low growth, zero-interest rates and ballooning central bank balance sheets may have permanently altered the political and economic stability of the continent.

What went wrong? 

It turned out that banks, in Europe and elsewhere, had been allowed to operate with levels of capital that were nowhere near sufficient to absorb the losses taken during the crisis. Especially the biggest banks had been happy to take on risk, safe in the knowledge that they were ‘too big to fail’ and would be rescued by their home-country governments – which means, in reality, the taxpayer.

Have policymakers addressed these risks?

When EU lawmakers went about fixing the legal framework it became clear that they had to firmly draw a line in the sand so that taxpayers would no longer have to shoulder such losses. Under the new rules, the Bank Recovery and Resolution Directive (BRRD), bank shareholders and other investors, usually bondholders, are now required to cover the bank’s losses up to 8% of its balance sheet total. Based on precedents from this and earlier banking crises, including Lehman Brothers, this was a level that regulators thought would be adequate to cover a bank’s losses in most instances and keep it afloat long enough to either put it back on an even keel or sell it to another, more stable institution.

What has happened since?

Not surprisingly, ever since the “8% rule” came into force lobbyists for the banking industry have been chipping away at it. And with some success: in 2016, the Commission decided – after a very public falling-out with the supervisors at the European Banking Authority (EBA) – that banks would not be required to meet the 8% requirement with equity capital and standard debt securities –  so-called eligible liabilities, which could be written off or readily converted into equity. It was left to the EU and Member-State authorities, notably the Single Resolution Board, to ensure, on a case-by-case basis, that banks had enough of the right types of equity and debt capital to ensure that the “8% rule” could be implemented...

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