The new European Single Resolution Mechanism (SRM), intended to rescue failing banks, has received further implementation. The SRM was designed as part of a larger initiative adopted by the European Union after the financial crisis to guarantee the stability of financial institutions and banks. This initiative, known as the Bank Recovery and Resolution Drive (BRRD), was adopted in Spring 2014 and was intended to be introduced across all member states on 1 January 2015.
Under the BRRD, banks are required to prepare recovery plans, and national and EU-level authorities have powers to intervene to prevent a bank from failing and to restructure them if they do fail, allocating losses to shareholders and creditors in a defined hierarchy. This restructuring is known as the ‘bail-in” mechanism. It is this mechanism that the SRM has finally implemented. The BRRD mandates that 8 percent of a bank’s total liabilities must be wiped out before any taxpayer support can be provided. The hierarchy of loss allocation is:
shareholders of the institution under resolution shall bear losses first;
creditors of the institution under resolution bear losses after the shareholders in accordance with the normal order of priority subject to certain exceptions;
creditors of the same class are treated in an equitable manner;
no creditor shall incur greater losses than would have been incurred had the institution under resolution been wound up under normal insolvency proceedings; and
covered deposits are fully protected.
One note: This hierarchy differs in different member states for smaller banks, as was allowed under the BRRD, but the full text of the original directive can be found here.
In addition to the SRM’s advancement, arrangements have been set in place for cross-border rescues—with the European Banking Authority playing a central role. Also, national rescue funds were established and replaced on 1 January 2016 by the Single Resolution Fund (SRF). Under the SRF, SRM-covered banks need to provide $59 billion in funding over the next eight years to create the SRF.
All of these changes are playing out under the BRRD’s two legislative levels. The largest banks, 129 of them, are governed by the European Central Bank (ECB), while smaller institutions are governed by what are known as “national competent authorities.” In the United Kingdom, for example, that national competent authority is the Bank of England, while in Holland it is the Dutch Central Bank. Beginning on 1 January 2016, the Single Resolution Board (SRB) was established to oversee the rescue of both banks directly supervised by the ECB and cross-border groups, while national resolution authorities continue to be responsible for all other banks and financial institutions.
While the BRRD was supposed to be introduced at the national level on 1 January last year, only a few countries actually did so; Britain among them. Italy, however, only introduced the regulations in November last year. The slight has not gone unnoticed; on 22 October, the European Commission said it was suing six EU countries¾the Czech Republic, Luxembourg, the Netherlands, Poland, Romania, and Sweden¾for not introducing the BRRD at the national level.
Some have attributed the recent stock price volatility among European banks, particularly Deutsche Bank in Germany, to the final introduction of the SRM, and there have already been calls to dial back the regulations. However, Eurogroup President and Chair of the Economic and Financial Affairs Council (ECOFIN) Jeroen Dijsselbloem has been widely quoted as dismissing these concerns and has said that there will be no diminution to the regulations.
The Portuguese central bank already applied the BRRD in December 2015 and wrote down €2 billion in bonds at Portuguese bank Novo Banco. And the ECB announced in October last year that there was an estimated €826 billion in non-performing loans on the balance sheets of banks governed by the Single Supervisory Mechanism (SSM), many in Italy, making it likely that the BRRD will be invoked again in the near future.
Also beginning on 1 January 2016, member states are required to implement Article 55 of the BRRD, which requires banks and other financial institutions to include language in relevant contracts, especially those covering loans or other credit instruments from outside the European Union, which states the possibility that the institution’s liabilities may be subject to “bail-in.”
The final step in the introduction of the SRM is a common deposit guarantee similar to the U.S.’s Federal Deposit Insurance Corporation. In 2016, a European Commission proposal to establish a European Deposit Insurance Scheme that will be the subject of debate. Its aim will be to guarantee individual deposits up to €100,000 at all EU banks. Quite a laundry list; looks like the SRM has its work cut out for it.