This is a key issue within the ongoing reflection in the European Union on how to improve the current arrangements for bank failure management and, in particular, on how to best adjust the existing funding mechanisms.
It is a pleasure to participate in this event organised by IADI.*
This research conference provides a great opportunity to scholars in
the field to share, among other contributions, analytical work on the
interaction of crisis management frameworks with deposit insurance.
It is unlikely that authorities will be able to achieve consensus
quickly on what to change and how to do it. But the ongoing discussions
already show that an agreement may be emerging on the diagnosis of a few
relevant flaws of the current framework
First, at present the banking union lacks an efficient and
sufficiently harmonised framework to deal with bank insolvency. Second,
the combination of a common resolution framework with a constellation of
heterogeneous insolvency regimes generates inconsistencies that can
severely damage authorities' ability to deal with the failure of
systemic banks without relying on taxpayers' support. And third, some
banks are too large for their failure and market exit to be managed
through conventional insolvency regimes, but still do not qualify, or
cannot meet requirements for, resolution under the Bank Recovery and
Resolution Directive (BRRD). These banks are what I have referred to
elsewhere as the "middle-class".2
Some of us have long been suggesting that the above deficiencies
could be largely corrected by putting in place harmonised mechanisms to
facilitate transfer transactions – such as the sale of a suitable
combination of deposits and assets from the failing entity to an
acquirer – for small and medium-sized banks under both resolution and
insolvency. Under the EU resolution framework, such transactions are
labelled "sale of business" (SoB). In that regard, a helpful reference –
although not a full solution – can be found in the US regime
administered by the Federal Deposit Insurance Corporation (FDIC).3
Those mechanisms would entail adjustments in the institutional
framework at the EU and national levels. However, the most important
modifications affect the available funding arrangements for relevant
crisis management strategies. Money is, as always, key. In crisis
situations, sufficient funds are required to protect the public interest
when resolving banks (ie the continuation of critical functions). In
addition, they may be needed to preserve banks' net asset value and
therefore to protect the interest of the deposit guarantee scheme (DGS)
and other creditors under insolvency.
The amount of funding needed crucially depends on the chosen bank
failure management strategy. The market exit of a failed bank – even
when its critical functions are preserved through an SoB transaction –
typically requires fewer resources than its restoration through
In what follows, I will review the existing funding mechanism and
propose a few concrete modifications that could help address the main
drawbacks of the current setup.
The existing funding mechanisms
In principle, there are three different sources of funding for the
orderly management of bank failures under resolution or insolvency:
public funding, a bank's internal loss-absorbing capacity and
industry-funded sources such as a deposit guarantee scheme or resolution
The most direct form of funding is government bailout. That has been,
in practice, the most relevant funding source for managing the failure
of significant banks to date. The new resolution framework, however, is
built with the objective of avoiding recourse to government funds to
maintain the critical functions of failing banks. Yet, as recent
experience shows, taxpayer funds are still available to fund banks' exit
from the market under national insolvency regimes.
At the other extreme, a core source of funding is banks' own internal
resources. Creditor bail-in – ie the writedown or conversion into
equity of debt instruments for loss absorption and recapitalisation –
could fund the continuation of critical functions by failing banks. This
is the cornerstone of the new resolution framework.4
In order to make this strategy feasible, banks that may be resolved are
typically asked to issue a sufficiently large amount of debt
instruments that could be bailed-in in resolution. In the EU, that takes
the form of a minimum requirement for own funds and eligible
The current SRB approach to setting MREL aims at ensuring that all
banks whose failure may have public interest implications should have a
credible resolution strategy that entails no need for external support,
from either the government or industry-funded sources, such as a
resolution fund or a DGS. To meet that objective, banks subject to a
preferred resolution strategy based on open bank bail-in must satisfy
MREL requirements that are consistent with their estimated needs for
loss absorption and recapitalisation in resolution, so that the entity
can continue to operate immediately after resolution, pending
For banks with a credible SoB transaction as a preferred strategy,
MREL needs could, in principle, be lower as the bank will cease
operating after resolution. However, given the uncertainty about the
availability of a suitable buyer at the point of resolution, the SRB
also develops a variant strategy for such banks that is less dependent
on third parties and market conditions. In most cases, that is open bank
bail-in. The SRB then calibrates MREL at the level needed to implement
that variant strategy.5
As a consequence, significant banks in the banking union are generally
asked, in practice, to satisfy stringent MREL requirements regardless of
their preferred strategy. In other words, MREL is effectively
calibrated so as to primarily accommodate a restoration strategy.
However, the SRB may need to adjust this approach somewhat as the new
Single Resolution Mechanism Regulation (SRMR) explicitly links possible
adjustments to MREL requirements to the needs of the preferred
A third source of funding is the national DGS. Those funds can
contribute to supporting transfer transactions in both resolution and
insolvency. However, there is a tight limit on that contribution (a
financial cap): funds provided by the DGS cannot exceed the net costs
for the DGS of paying out deposits if the bank in question is wound up
under the national insolvency procedures. "Net costs" in this context
refers to net of the recoveries the DGS would have made in a liquidation
following a payout of insured deposits. In the EU, DGS claims rank
senior to other deposits and securities issued by banks (they are
"super-preferred"), so expected losses for the DGS in liquidation and,
therefore, the available support for a SoB transaction are typically
small when not negligible. Therefore, while a financial cap is a
necessary protection for DGS funds that prevents excessive expenditure
in a single bank failure, the way in which the cap currently applies
makes DGS support for SoB transactions largely irrelevant in practice.
Finally, another source of possible funding for bank failure
management in the banking union is the Single Resolution Fund. The SRF
is only available for banks meeting the positive public interest
assessment required for resolution. Available SRF support is capped at
5% of total liabilities and, more importantly, requires the prior
writedown of at least 8% of total liabilities.
Minimum bail-in requirements ensure that the SRF funds are available
only when the liabilities that can realistically absorb losses – ie
without undermining the effectiveness of the resolution or the
resolution objectives – have done so.7
The 8% minimum bail-in condition for SRF access is imposed across the
board regardless of the failing bank's preferred resolution strategy.
It does not therefore accommodate the situation of banks with a large
amount of deposits relative to other liabilities that can absorb losses
without unintended effects. Imposing the same minimum bail-in conditions
for SRF access by any bank further reinforces the SRB's approach of
imposing stringent MREL requirements on all significant banks
irrespective of their preferred resolution strategy.
The current framework is therefore internally consistent:
restrictions on the use of DGS and SRF funds to facilitate an SoB
transaction justifies requiring all banks to satisfy large MREL
requirements. Banks that can meet those conditions may credibly be
subject to open bank bail-in (as the preferred or a backup strategy) and
may also satisfy the conditions required to obtain SRF support if that
is needed. The problem, of course, is that a relatively large subset of
banks under the SRB remit run business models that could not easily cope
with the conditions imposed (MREL requirements) for their resolution
On the basis of the new provisions of the SRMR, the SRB will need to
adjust downwards MREL requirements for all banks whose preferred
resolution strategy is SoB. However, under current arrangements that
adjustment cannot realistically be far reaching.9
Without further reforms that would increase the feasibility of SoB for a
failing bank, the lack of sufficient loss-absorbing liabilities could
severely jeopardise the orderly resolution of that bank. Absent a
suitable buyer, the bank might only be able to continue operating and
have access to the SRF if sensitive liabilities – such as deposits –
Therefore, solving the middle-class issue requires a comprehensive
approach that could lead to a new internally consistent setup that would
be less disruptive than the current one. That might be achieved by
adopting three main reforms: (i) first, make DGS funding less
restrictive by replacing the current super-preference of covered
deposits by a general depositor preference rule; (ii) second, redefine
the methodology for calculating MREL requirements for banks with a
resolution plan based on SoB transactions to accommodate a higher
likelihood of success of that strategy; and (iii) replace the currently
universal 8% minimum bail-in conditions for SRF access by a case by case
calibration linked to MREL requirements. Let me review each of those
Remove super-preference of deposits
In order to change the status quo, the first step would be to explore
sensible ways to facilitate the DGS funding of SoB transactions without
altering the core principles of the current framework. The most obvious
way to do that is by eliminating the super-preference of DGS claims or,
more specifically, to replace the seniority of covered over uncovered
deposits by a general depositor preference rule.
Indeed, the super-preference of DGS claims is at odds with the
prevailing regime in other jurisdictions (such as the United States)
where DGS funds have been successfully used for bank failure management.10
More importantly, it does not have a clear policy rationale. DGS are
created to serve a specific public objective: to prevent bank runs that
could be destabilising for the system. Making DGS exposures senior to
other deposits in case of insolvency in fact provides incentives for
runs by uninsured depositors, and thus jeopardises the very objective of
the DGS. In addition, from a social point of view, it is not
straightforward to justify protecting the interest of banks contributing
to the DGS more than deposits held by firms, or by households for
amounts that exceed the established threshold for DGS coverage.11
In recent work conducted at the FSI, we show that replacing the
existing super-preference of covered deposits by a general depositor
preference would have a material impact on available funding. In
particular, for banks holding large amounts of non-covered deposits,
removing the super-preference would substantially amplify the support
that the DGS could provide, thereby making the transfer transactions
much more feasible under either resolution or insolvency.
However, even with a less restrictive financial cap linked to a
general depositor preference rule, the available DGS support will not
always be sufficient to ensure the success of SoB. That strategy
crucially requires banks to be able to absorb losses stemming from a
shortfall of transferred assets relative to transferred liabilities.
Redefine MREL requirements
In a typical SoB transaction, acquirers assume sensitive liabilities
(in particular covered and uncovered deposits) and receive, as a
counterpart, a subset of a bank's assets. If the assets are
insufficient, the shortfall may be made up by DGS funding, if available.
Quite often, though, the accounting value of the assets required by the
acquirer would be larger, despite the DGS support, than that of
transferred liabilities. As a counterpart to those additional assets,
the bank would need to have in its pre-resolution balance sheet a set of
subordinated liabilities that would not be transferred and would
therefore be liquidated, as part of the residual entity, once the SoB
transaction was performed. Those liabilities would need to be able to
absorb losses after failure, thereby acting as gone-concern capital.
Therefore, in order to accept a resolution plan based on an SoB
strategy, authorities should ensure that the bank has sufficient
loss-absorbing liabilities – beyond regulatory capital – to effectively
fund, together with the available DGS support, the transfer transaction.
In principle, that should be the main criterion used to specify MREL
requirements for banks with a sufficiently credible SoB resolution
strategy. The current approach, under which MREL for an SoB bank is
determined by the need to prepare for a variant open bank bail-in
strategy is only warranted when, as happens now, the transfer
transaction is highly uncertain due to the lack of proper funding.
Analytical work at the FSI (Restoy et al (2021)) provides some ideas
on the calibration of MREL requirements for banks pursuing credible SoB
resolution strategies. Assuming that deposits are the only liabilities
that need to be transferred to the acquirer, the study shows that the
amount of required gone-concern capital for SoB banks can be calculated
as a function of the amount of non-covered deposits and the estimated
value of the franchise. The latter is expressed as the difference
between the value of the assets for the acquirer and the expected
recoveries in a piecemeal liquidation.
Note, however, that with super-preference of covered deposits, the
sensitivity of required gone-concern capital to non-covered deposits
would be greater than it would be with general depositor preference. In
the latter case, the net costs for the DGS in liquidation, and,
therefore, the available support for the SoB transaction, increases with
the proportion of non-covered deposits, Therefore, for the same amount
of non-covered deposits, a feasible SoB strategy would require the
transfer of more assets (and therefore more MREL) with super-preference
than with general depositor preference.
Recalibrate minimum bail-conditions for SRF access
A third ingredient of the new funding strategy would be the revision
of the 8% minimum bail-in requirement for banks, with an SoB strategy,
that meet the public interest threshold for resolution. Once the funding
strategy is substantially improved by combining the relaxation of the
financial cap for DGS funding and the establishment of sensible MREL
requirements, the feasibility of an SoB transaction for banks with
traditional business models would be substantially enhanced. Therefore,
it would no longer necessarily be the case that those banks should also
be prepared for open bank bail-in when their preferred resolution
strategy is a transfer transaction.
In order to preserve the consistency of the framework, minimum
bail-in requirements for access to the SRF should be calibrated for each
bank on the basis of its specific MREL requirements. The latter would
already reflect how many losses should, in principle, be allocated to
creditors (other than depositors) to facilitate the transaction. For
banks with a preferred open bank bail-in strategy, that approach may not
lead to substantially different minimum bail-in requirements as MREL
obligations should normally suffice to meet the required 8% threshold.
However, for banks subject to an SoB strategy, minimum bail-in would be
smaller as MREL requirements would also be smaller as they only need to
facilitate orderly market exit.
A final comment
Note, finally, that a scheme in which SoB transactions become more
feasible, owing to the availability of internal and external funding,
may be, under some conditions, consistent with a more integrated
approach to bank failure management. If SoB could often be used in both
insolvency and resolution, in both cases with the support of the
relevant DGS, the dividing line between the two frameworks is to some
In that context, the natural way forward would be to centralise
decision-making for all entities, whether significant or
non-significant, within the same body (the SRB) and to make available a
single (European) DGS (a European deposit insurance scheme (EDIS)) that
could – beyond paying out covered deposits – fund SoB transactions with a
sensible financial cap.
Of course, other less ambitious options – which do not require the
creation of an EDIS with all the desirable powers and tools – could also
be considered. For example, the alleviation of the financial cap for
the deployment of national DGS funds, without further reforms, could
facilitate by itself SoB transactions for national insolvency
procedures. That would help make failure management procedures for
smaller banks more efficient. Yet that option would fall short of
providing sufficient relief for mid-sized banks which – while meeting
the public interest test – could not easily satisfy the current
minimum-bail-in conditions for access to the SRF.
An alternative option would be to relax the minimum-bail-in
conditions for SRF access for banks with a credible SoB strategy without
modifying the financial cap for national DGS. That option would
increase the SRF's ability to facilitate – using European funds –
transfer transactions and could therefore help reduce MREL requirements
for mid-sized banks that satisfy the public interest test. However, that
option would not help improve the efficiency of insolvency procedures
for all banks that do not satisfy the public interest test and therefore
need to be subject to domestic insolvency procedures.
Those options could prove helpful in achieving a complex political
compromise. However, any option to improve the crisis management
procedures without completing the banking union with an EDIS would
intrinsically be subject to the vulnerabilities associated with the
remaining links between bank risks and the availability of domestic
funds to address them once they materialise
European Commission (EC) (2021): Targeted consultation on the review of the crisis management and deposit insurance framework, January.
Federal Deposit Insurance Corporation (FDIC) (2017): Crisis and response: an FDIC history, 2008–2013.
Garicano, L (2020): "Two proposals to resurrect the Banking Union: the Safe Portfolio Approach and SRB", paper prepared for ECB conference on "Fiscal policy and EMU governance", Frankfurt, 19 December.
Gelpern, N and N Véron (2020): "A European FDIC: what it means and how to do it", forthcoming.
König, E (2021): "The crisis management framework for banks in the EU: what can be done with small and medium-sized banks", keynote speech at the Banca d'Italia workshop on the crisis management framework for banks in the EU, 15 January.
Restoy, F (2016): "The challenges of the European resolution framework", closing address at the conference "Corporate governance and credit institutions' crises", organised by the Mercantile Law Department, UCM (Complutense University of Madrid), Madrid 3 November.
--- (2018) "Bail-in in the new bank resolution framework: is there an issue with the middle class?",
March, speech at the IADI-ERC International Conference "Resolution and
deposit guarantee schemes in Europe: incomplete processes and uncertain
outcomes", Naples, 23 March.
--- (2019): "How to improve crisis management in the banking union: a European FDIC?",
speech at the CIRSF Annual International Conference 2019 on "Financial
supervision and financial stability 10 years after the crisis:
achievements and next steps", Lisbon, 4 July.
Restoy, F, R Vrbaski and R Walters (2020): "Bank failure management in the European banking union: what's wrong and how to fix it", FSI Occasional Paper, no 15, July.
--- (2021): "How much MREL for mid-sized banks?", forthcoming.
Single Resolution Board (SRB) (2020): "Minimum requirements for eligible liabilities (MREL). SRB policies under the banking package", December.
Visco, I (2021): "The crisis management framework for banks in the EU. How can we deal with the crisis of small and medium-sized banks?" Welcome address at the Banca d'Italia workshop on the crisis management framework for banks in the EU, 15 January.
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