Keith Mullin
IFR Editor at Large
SO THERE YOU have it. The European Parliament and European Council negotiators ended up pushing a relatively hard line on bank resolution and recovery. There were no great surprises in the draft, and even though the directive is almost through its multiple stages, it’s still too early for market participants to focus properly on full and lasting impacts – or remedies. Don’t hold your breath on full clarity any time soon, either.
The recovery and resolution directive now proceeds to its technical phase and will still need to be approved by the Council and the European Parliament plenary. But even assuming it gets through those phases unchanged, lawmakers have inserted a series of get-outs and suck-it-and-see review dates. And most importantly, the elephant in the room – the moral hazard of taxpayer-funded bailouts – is still on the agenda.
We still don’t know yet how the wind-up mechanism will work as lawmakers will only unveil their positions regarding the single resolution authority and fund in the coming week at the earliest. Negotiations won’t even start until January 2014.
All of that notwithstanding, the draft on resolution reached on December 11 enshrines the wonky concept of creditor default on a going-concern basis that will see large depositors, senior and subordinated creditors (and of course shareholders) wiped out or full or partially bailed in ahead of recourse to resolution funds and before the bank declares insolvency or bankruptcy. It turns the current system on its head.
The directive’s early go-live date of January 1 2015 albeit with a one-year grace period before bail-in kicks in in 2016 (presumably so the machinery will be in place to deal in principle with any fallout from the ECB’s stress tests) underscores the pushy nature of the lawmakers marshalling this through the system. As does the fact that large unsecured depositors can be whacked even after the resolution fund and relevant deposit guarantee fund have been activated.
SETTING THE BAR at 8% of assets before in-country resolution funds are able to step in to cover an additional 5% maximum (to finance bridge banks, asset transfers, or establishment of good bank/bad banks) basically means curtains for shareholders and most creditors – although I’m keen to understand how the “no creditor worse off” principle where resolution funds can compensate shareholders or creditors if their bail-in losses exceed losses they would have suffered under insolvency proceedings will work in practice.
There is some slightly odd chronological asynchronicity in the directive. Bail-in kicks in at the beginning of 2016 but the in-country resolution funds won’t need to hit the required 1% of system-wide covered deposits until 2025. That means sliding-scale interim arrangements for nine years. And there’s some pretty wide latitude regarding the establishment and funding of resolution funds, too.
There is a potential (but not really) ”Get out of Jail Free” card in the directive in that a member state can ask the EC to exempt certain creditors from bail-in on an exceptional and case-by-case basis. But it’s unclear on what grounds the exemption will be granted. And even if it is, the troubled bank will still need to hit the 8% of assets bail-in target before accessing other funds. In that respect, it won’t help.
Beyond all the noise around the setting of triggers and targets and the gnashing of teeth around creditor bail-ins, taxpayers aren’t spared. The resolution directive still makes allowances for taxpayer bail-outs via ”government stabilisation tools” leading to ”precautionary recapitalisations”. And while the European Banking Authority is scheduled to issue guidelines in mid-2015 on the nature of those recaps, the EC won’t pass final judgement on whether they’ll be allowed until 2018.
Even though these tools will only be used as a last resort, it suggests that no matter how strict the conditionality, too big to fail has won the day. If the point of the massive body of legislation is designed to kill the bete noire of systemic risk, hasn’t it – by dint of the get-outs and last-resort measures – failed?
The market for senior bank debt will have to undergo a process of adaptation to the emerging new realities
AT A PRACTICAL level, officials and lawmakers have disregarded some serious unintended consequences of the bail-in regime. In June 2012, I wrote a column entitled: “Farewell senior debt, it’s been fun”. I wrote then, and I stand by it now, that EU authorities “are taking a potentially fatal step toward bank capital that will cause far more harm than good to the invest-ability and stability of the European banking sector”.
The market for senior bank debt will have to undergo a process of adaptation to the emerging new realities. Senior debt will cease to be the low-cost bread-and-butter funding tool it is, for perhaps all but the most robust national champions. It will end up carrying a bail-in premium. Secured debt and covered bonds (exempt from bail-in) will remain preferred funding tools, particularly for second-tier banks and below, but of course asset encumbrance will limit their possibilities.
The impact of bail-in will raise bank funding costs just at a time when returns on equity are under huge pressure and banks are scrutinising businesses and recalibrating strategies. For some banks, the impact of the new regime will be to render the business model uneconomic. In that case, it’s not a case of throwing the baby out with the bathwater; it’s chucking out the bath as well.