UCD/Whelan: Principles for recapitalising Europe’s banks [prepared for ECON MD]

13 December 2013

Before public money is used to bail out insolvent banks after the comprehensive assessment over the next year, senior bond liabilities should be written down or converted to equity. Ultimately, there is a strong shared public interest argument for using the ESM to recapitalise banks.

This briefing paper was prepared for the ECON Committee's Monetary Dialogue on 16.12.13.

Whelan argues that:

• Europe’s banking sector is objectively under-capitalised, both relative to the tougher capital standards required by Basel 3 and relative to what is necessary to re-assure creditors that their investments with banks throughout Europe are safe despite the likely problems in coming years with bad loans.

• The upcoming comprehensive assessment of the banking sector, followed by mandated recapitalising, is an essential step in strengthening Europe’s banks and pulling the economy out of its slump.

• Public money should only be considered for the purposes of bank recapitalisation when all options that do not threaten financial instability have been exhausted.

• In the case where a bank is clearly insolvent, liabilities to bond-holders should be written down or converted to equity. This includes senior bonds. The current European policy of delaying bail-in of senior bonds until 2018 is counter-productive and may cost the European governments a lot of money.

• Where a bank is declared solvent but is unable to raise funds to reach the capital ratios required by regulators, the EU’s new state aid rules are correct to insist on conversion of subordinated debt to equity as a condition for state aid.

• When a Member State is not able to recapitalise its banks, there are strong European public interest arguments for using the ESM to do this task. While ESM investments should be structured so as to protect the taxpayer as far as possible, there is also a strong common public interest in maintaining financial stability in the euro area.

• At a minimum, deposits of households and SMEs should be protected as a matter of priority in line with the hierarchy of creditors set out in the draft recovery and resolution directive.

Full paper

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