7.4.2.1 Burden-sharing cascade

While the resolution authorities have discretion to select the most appropriate method of resolution and to apply any of the resolution tools, including the bail-in tool, the resolution framework does not afford discretion as to the application of the burden-sharing cascade when exercising the PONV conversion power and applying the bail-in tool.1

The burden-sharing cascade entails that losses are sequentially allocated through write-down and conversion of claims of (a) holders of CET 1 instruments, followed by (b) holders of AT 1 instruments, and (c) holders of Tier 2 instruments, followed by (d) other subordinated creditors in accordance with the hierarchy of claims in normal insolvency proceedings, and (e) the rest of eligible liabilities in accordance with the hierarchy of claims in normal insolvency proceedings.2

Within eligible liabilities, a further distinction should be made on the basis of the BRRD. Deposits of natural persons and micro, small and medium-sized enterprises exceeding coverage levels of the deposit guarantee schemes and deposits that would be eligible deposits if they were not made through branches outside the EU of banks established within the EU, enjoy priority over ordinary liabilities, but are subordinated to covered deposits and deposit guarantee schemes subrogating in their position.

The burden-sharing cascade can be influenced by means of subordination. Subordination of instruments issued by banks can take place in several ways, such as contractual subordination (including a subordination clause in contractual documentation governing the issuance of debt) or statutory subordination (subordination by law).3BRRD II bis has provided for further harmonization in that respect by introducing a new type of ‘senior’, unsecured, non-preferred debt, which is subordinated to other types of ordinary senior debt in the insolvency hierarchy, but preferred to subordinated debt, following the French Tier-3 approach.4

As a result of BRRD II bis, banks can structure their liabilities in such a way, that they consist of (a) regulatory capital, (b) subordinated debt that does not qualify as regulatory capital, (c) ‘senior’, unsecured, non-preferred debt, which is subordinated to ordinary senior debt but preferred to subordinated debt (senior non-preferred debt), and (d) other bail-inable debt that is in scope of the bail-in tool, but preferably not bailed-in (ordinary senior debt). By including extra layers of subordinated and senior non-preferred debt, ordinary senior debt holders are protected, as it is less likely that a bail-in will extend to this senior debt.