European crisis management framework: ripe for reform?

Tue 19 Apr 2022

Since the European crisis management framework was established in 2014, there have not been many failing banks in Europe. However, the recent global health pandemic, combined with the ongoing conflict in Europe between Russia and Ukraine, could easily change this.

The EU crisis management framework was established in response to the global financial crisis and the sovereign debt crisis in Europe. The European authorities created the Single Resolution Mechanism (SRM), which, together with the Single Supervisory Mechanism (SSM), are the first two pillars of the EU Banking Union. The SRM governs the orderly resolution of failing banks directly supervised by the SSM and cross-border banks while trying to ensure minimum impact on the real economy and the public finance in the EU. Through the existence of a single resolution board (SRB), the SRM also manages a single resolution fund (SRF), which is financed by the banking sector.

The third pillar of the EU banking union, a common deposit insurance – the European Deposit Insurance Scheme (EDIS) – is still pending. In this context, the European bank crisis management and deposit insurance framework consists of the following regulations: the Bank Recovery and Resolution Directive (BRRD), the Single Resolution Mechanism Regulation (SRMR) and the Deposit Guarantee Scheme Directive (DGSD).

However, as the Sberbank AG case in Europe demonstrates, recent global events present banks with new challenges. Hence, all legislative texts mentioned above are expected to be reviewed by the regulators later this year, following a previous consultation of the Commission in 2021.

Differences to be addressed

The existing significant differences in national insolvency regimes are the cause for EU level playing field concerns that defer market integration. The EU resolution framework presently exists alongside countries’ domestic insolvency regimes. When the failing banks do not meet the public interest criteria required for resolution, the national insolvency regimes are applied^[1]. In addition, liquidation aid is usually less restricted than support under resolution. Hence, the current framework fails to provide a sturdy plan of action for managing the failure of a large part of the institutions in the banking union.

The bail-in tool, which is provided by the BRRD, is a key part of the EU resolution framework. The directive requires banks to keep a minimum amount of equity and subordinated debt – Minimum Required Eligible Liabilities (MREL) – determined on a bank-by-bank basis by the resolution authorities. The tool allows for losses to be absorbed by the shareholders and junior creditors before reaching out to taxpayers’ money (bail-out). Medium-sized banks in Europe are funded mainly by deposits and cannot issue large amounts of subordinated bonds required for resolution. Hence, their liabilities cannot be used for recapitalisation or loss absorption when failing.

Such banks resort to national insolvency regimes and utilise public funds to exit the market. They have not passed the public interest test for resolution, but, at the same time, their failure would harmfully impact the financial system, and taxpayer funds would need to be deployed. The national insolvency rules and procedures which apply to these less significant institutions vary among member states. There are differences in the hierarchy of liabilities in insolvency among different countries, which complicate the management of a cross-border banking crisis even further and prevent consistency in the Eurozone insolvency approach.

One of the reasons behind establishing the banking union was to minimise the connection between domestic financial risks and sovereign risks. The existence of 21 insolvency regimes presently in the Eurozone, including Bulgaria and Croatia, and funded with domestic resources works just the opposite. The member state’s deposit guarantee schemes (DGS) remain at a national level with operational and regulatory differences. At the same time, we have the SRF, which is funded and managed centrally, but it is only available for institutions meeting the public interest condition. To provide European banks with equal resources, complete regulatory harmonisation of the DGS, combined with administrative tools to liquidate banks of all sizes, is needed.

Expected impacts for banks

Depending on the measures taken, the review of the crisis management and deposit insurance (CMDI) framework could have operational consequences in terms of reporting, which is already a significant burden for institutions. From an operational perspective, reforms affecting the bail-in and the MREL eligibility could have an impact on the issuances of certain instruments and the clauses determining them.

In particular, MREL and Liability Data Reporting (LDR) reports could be affected by this reform. If insolvency procedures and the conditions or scope of deposit protection are modified, the granularity and breakdown of these reports could be adapted accordingly. Similarly, changes affecting bail-in or resolvability would require restructuring the LDR and MREL reporting, especially if they involve new identification and classification requirements of eligible instruments or deposits. These impacts would then have repercussions on the quality, granularity and amount of data in banks’ information systems.

More details will follow once the Commission unveils its proposal to review the BRRD, SRMR and DGSD, expected in the second half of 2022.

^[1] For instance, Sberbank AG in Austria was wound down whereas two of its subsidiaries, those from Croatia and Slovenia, have been put in resolution, following the public interest assessment made by the SRB.