Elke König of SRB on EU Liquidation Regime and Gaps in Banking Union

Why we need an EU liquidation regime for banks. The resolution of banks is a specific insolvency procedure, introduced as an alternative to liquidation under national laws. The lack of an EU liquidation regime is a major obstacle toward full-fledged Banking Union. With nineteen different insolvency frameworks in the Banking Union, the analysis of the insolvency counterfactual for a cross-border bank in resolution is a challenge and results in diverging outcomes depending on the home country of the institution. Bank insolvency procedures should be subject to common standards and practices at the EU level. The ideal solution would be EU-wide rules on insolvency proceedings for the banking sector. SRB is working within the Single Resolution Mechanism on National Handbooks to define how to implement resolution schemes in each country as well as national implementation steps for a decision not to adopt resolution. This is a step in the right direction, but is only a “second best” option and not comparable to a harmonization of bank insolvency procedures—something only legislators can deliver. Proposals for harmonization will inevitably be fraught with political perils and resistance. An incremental approach—such as the one exemplified by the recent harmonization of the ranking of unsecured debt instruments in insolvency—may be a more palatable solution. The ultimate goal, however, must be to have in place an EU liquidation regime alongside an EU resolution regime.

Gaps in the Banking Union regarding funding in resolution and how to close them. By definition a recapitalized bank that has absorbed losses will be solvent and have better access to funding. However, given that analysts and creditors will likely require time to re-assess the financial position, the return to market funding will be a process rather than a one-off fix. Addressing the risk of banks having insufficient liquidity following resolution action, therefore, presents a crucial task in resolution planning. FSB guidance recommends establishing temporary public backstop funding mechanisms. Such a tool does not exist in the Banking Union, which is a missing piece in the overall framework. A credible tool would address open issues in the current system and put the Banking Union framework at equal footing with other jurisdictions such as the US or UK. A credible temporary public solution will provide markets with the needed confidence and allow fast return to private funding. When designing a credible tool some fundamentals must be fulfilled:

• First, all pre-conditions must be clear and resolution authorities should have certainty they can rely on the tool for finalizing all features of the resolution scheme, including funding, that is, liquidity on day one.
• Second, the scale must be sizable and flexible enough to support the effective implementation of any resolution strategy. It goes without saying, that only viable and solvent institutions in resolution should be supported with funding.
• Finally, the creation of a new sovereign-bank nexus should be avoided.

Related Links

• Article on Liquidation Regime
• Article on Gaps in Banking Union

Keywords: Europe, EU, Banking, Resolution Planning, Liquidation Regime, Banking Union, SRB