The European Banking Union

Supervision and Resolution

Giuseppe Boccuzzi

• Publisher: Palgrave Macmillan
• Year: 2016
• Print ISBN: 9781349575251, 9781137555649
• eBook ISBN: 9781137555656
• Topic: Business
• Subtopic: Business General
• Index: Business

The 2008 financial crisis all but brought down the financial system and real economies of industrial countries. The Banking Union took a broad approach to resolve the structural fragmentation and distortions in the European banking system which were major obstacles to a working single market for financial services. This book examines the numerous changes happening to European legislations for the prevention and management of banking crises. What emerges is a changing picture of regulations and institutions, of goals, tools and opinions, public and private, European and national all involved in the task. The book focuses on the new framework for banking crisis management, starting from the foundations of banking regulation and supervision. It explores the institutional architecture of banking supervision and crisis management, the powers of the authorities, the tools for administrative actions, the complexities of business and bankruptcy laws, individual rights and their legal guarantees.

1

The Financial Crisis and the Banking Union Project

1 The weakness of the institutional framework for managing banking crises before the financial crisis

The financial crisis of 2008–09 originated in the US subprime mortgage crash and then spread to Europe. It was an important test for the rules and institutional framework of banking supervision and crisis management in Europe. The high number of bank failures that occurred revealed serious deficiencies in risk management by financial institutions, a low level of preparedness for dealing with difficult situations and serious gaps in financial sector regulation and supervision, significant deficiencies and a lack of homogeneity in the institutional arrangements and tool kit for dealing with pathological situations.¹

The problems that emerged in the treatment of banking insolvencies were particularly significant, specifically:

(i)	the different characteristics of the legal models for crisis management (administrative vs. judicial);
(ii)	the different range (or lack of in some cases) of tools to treat the various stages of a banking crisis and varying degrees of supervisor involvement;
(iii)	the absence of specific legislation on banking group crises, and consequent difficulties in ensuring a global and unified perspective on the analysis of the problems affecting both the parent company and the subsidiaries and the search for solutions. In the case of crises that affected internationally active banks (financial intermediaries) or groups, the procedures for coordination between the authorities involved in crisis management were inadequate; this was also a result of a lack of discipline in the allocation of insolvency costs (burden sharing), which prompted authorities to give protection to the assets settled within their own national borders (ring-fencing).

In most countries, systemic bank crisis was usually resolved through public financial interventions (bail-outs) for fear that significant negative externalities could affect multiple stakeholders; the cost of the failures, thus, was carried by taxpayers. The too big to fail principle, that is, that banks too complex and interconnected should not fail, was almost taken for granted, even though never formally established. It was a practice of constructive ambiguity that until then the authorities had always followed that left investors in uncertainty about State intervention and thus reduced the scope for moral hazard. Public interventions significantly affect public budgets. Recent such interventions contributed to forming a vicious circle between bank risk and sovereign risk, especially in weaker economies where public debt and budget deficits were already significant.

The turmoil unveiled gaps and inefficiencies in the whole financial structure. European Union (EU) authorities intervened time and time again, setting down institutional arrangements and more effective rules and, especially, boosting cross-border co-operation and coordination. The process accelerated in 2013–14. The result was a new regulatory framework and new procedures and tools for banking crisis management that moved consistently with the general innovations in prudential regulation and supervisory activities evolving at the European level. These initiatives are part of the wider Banking Union project, which is characterised by the centralisation of decisions in the hands of the European authorities, although in co-operation with the national resolution authorities. A single set of EU rules has been established, the Single Rulebook.

2 First timid (and difficult) attempts to regulate banking insolvency

The need for greater convergence between European countries in the discipline and practice of managing banking crises has been felt for some decades, but not consistently. The level of sensitivity to this issue has increased when significant insolvencies have threatenened but has diminished in times of relative bank stability.²

Several initiatives were taken towards convergence at EU level but they lacked any substantial support. In some cases, there was even strong opposition to the creation of a common framework for crisis management, largely because of profound differences between different countries’ regulatory and institutional frameworks and a reluctance to surrender national individualities in an area as sensitive and complex as banking crisis management. There were even arguments – both theoretical and from a practical point of view – as to whether or not a special regime for managing banking crises – different from that generally applicable to other commercial enterprises – would be valid.

Consensus on the need for a common set of rules for the treatment of cross-border banking crises began to emerge after the serious events of the 1990s. The aim was to reach a system based on minimum harmonisation, mutual recognition of national procedures and co-operation between authorities. There followed a long and difficult legislative process and approval was finally met on an EU directive for the reorganisation and winding-up of credit institutions (Directive 2001/24/EC of 4 April 2001).³ This was a significant step forwards in the climate of the time, but the new legislation was still anchored to a vision of minimalist intervention and continued to be heavily centred on the preservation of the peculiarities of national legislation. The Directive did not provide a definition for common insolvency rules but left each country free to keep the institutional arrangements and procedures enshrined in its own national legislations. The Directive did not go beyond the definition of which country had competence to open reorganisation or liquidation proceedings and the laws applicable.

It did, however, set down important principles, namely the unity and universality of procedures in the EU. Based on these principles, the administrative or judicial authorities of the “home Member State” were the only authorities competent to decide the opening of reorganisation and liquidation procedures. Proceedings opened in the home State would be recognised by, and fully effective in, all Member States without further formalities and they would operate in accordance with the law of the home Member State (lex concursus). This solution was consistent with the general principle on regulation in the banking sector (Directive 2006/48/EC of 14 June 2006), under which banks and their EU subsidiaries were considered to be a single entity and were subject to the supervision of the competent authorities of the State in which they had been granted authorisation (the so-called Single European Licence).⁴

Given the significant national differences, especially in the discipline of certain rights and legal relations, the Directive permitted flexibility in many areas through a specific derogation to the lex concursus, based on a system of referrals to the laws of another Member State for the regulation of certain contracts and rights. The European regulation on banking crises set out by the Directive moved with a “territorial” logic. It applied the reorganisation and liquidation legislation of the parent home country only to foreign branches, and not to the foreign subsidiaries of a banking group or to investment firms.

In 1994, Directive 94/19/EC set the discipline and rules for deposit guarantee systems (DGSs). This was a milestone in bank depositor protection regulation: it enshrines the principle of mandatory membership of banks in deposit guarantee schemes, making it a requirement for the conduct of banking activity. The 1994 Directive, however, was still only at a minimum harmonisation level, in line with what was typical of European banking legislation at the time.

The points of convergence were limited to a few key elements in national systems. Member States were left free to adapt the structural and functional aspects of the guarantee schemes. The following were harmonised: (1) banks’ mandatory membership of a deposit guarantee scheme; (2) liability of the home deposit guarantee scheme for repayment to depositors of branches established inside the European Community and (3) minimum level of coverage (20,000 Euros), with the possibility of depositors sharing part of the losses (co-insurance) up to a maximum of 10% of covered deposits.

In the wake of the severe bank failures in 2008–09 and “bank runs” in some banking systems (for example, Northern Rock in the United Kingdom (UK)), policymakers saw the necessity to reinforce deposit guarantee systems. The first step towards a comprehensive reform was Directive 2009/14/EC of 11 March 2009. This remedied some critical aspects of Directive 94/19/EC and achieved greater convergence between DGSs. The level of coverage was gradually raised to 100,000 Euros and the payout time frame was significantly reduced to 20 working days.

The worsening financial crisis made it clear that the 2009 regulatory intervention was insufficient to deal with the problems arising. It triggered international debate on a further strengthening of deposit guarantee schemes. In June 2009, the Basel Committee and the International Association of Deposit Insurers (IADI) issued jointly 18 Core Principles (CPs).⁵ They brought together international best practices and followed the directions given by the Financial Stability Forum (FSF) in 2008.⁶ The Core Principles are a set of guidelines for policymakers for the design or improvement of national deposit guarantee schemes, aimed at increasing the effectiveness of the systems while leaving countries enough leeway to introduce additional measures to take account of national peculiarities.

To assist an effective application of Core Principles, a methodology was designed to assess compliance of individual systems with the principles.⁷ They enjoy high credibility in the international financial environment and have been used by the International Monetary Fund (IMF) in the Financial Sector Assessment Program (FSAP). Following a period of public consultation, the CPs were revisited. Work is still underway on a handbook for conducting self-assessments.

The European Commission, in July 2010, issued a legislative proposal for a new directive amending the 1994 Directive.⁸ This followed on recommendations by the Financial Stability Board (FSB) and the Basel Committee. The aim was to reinforce further consumer protection and confidence in financial services. The proposal put forward: (1) simplification and harmonisation of coverage and depositor payout; (2) further reduction of the payout time frame; (3) improvement in DGSs’s access to information on member banks and (4) making deposit guarantee systems more solid and credible via a wider funding mechanism (a mixed approach of ex ante plus ex post) including mutual borrowing between DGSs.

At the end of the 1990s and beginning of the 2000s, the European Commission issued a number of directives to bolster the EU legislative framework on crisis management in the financial sector.

Specifically:

i)

Directive 2001/17/EC on the reorganisation and winding-up of insurance undertakings.

ii)

Directive 1998/26/EC on settlement finality in payment and securities settlement systems. Its aim is to ensure stability in payment, clearing and transfer carried out in official systems of payment and securities settlement systems, even in the case of insolvency proceedings of a participant in the system. This results in a reduction of risks deriving from the situations of participants and from the individual contracts.

It lays down specific rules for the protection of settlement systems, specifically, (1) the “final” nature of payment, transfer and clearing orders, even if insolvency proceedings are opened against the participants, the effects of insolvency proceedings will not be retroactive on the rights and obligations of the participants themselves; (2) the ability of the systems to dispose directly of the participant’s cash and securities subject to insolvency proceedings and (3) the isolation of the rights to collateral in securities, received by a participant in the system or central banks, from the effects of insolvency proceedings on the party giving the collateral.

iii)	Directive 2002/47/EC on financial c...

Table of contents

• Cover
• Title
• Introduction
• 1  The Financial Crisis and the Banking Union Project
• 2  The First Pillar of the Banking Union: The Single Supervisory Mechanism
• 3  The European Reform of the Rules for Banking Crisis Management: The Bank Recovery and Resolution Directive
• 4  The Second Pillar of the Banking Union: From the National Resolution Authorities to the Single Resolution Mechanism
• 5  The Third Pillar of the Banking Union: The Pan-European Deposit Guarantee Scheme
• 6  Banking Crises and State Aid Discipline
• 7  Conclusions
• Notes
• Bibliography
• Index