Public funding of failing banks in the European Union (LBF vol. 19) 2020/7.5.4.1:7.5.4.1 Undesirable outcomes of burden-sharing allocation

Public funding of failing banks in the European Union (LBF vol. 19) 2020/7.5.4.1

7.5.4.1 Undesirable outcomes of burden-sharing allocation

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Section 7.4 described the concept of burden-sharing and the development thereof after the introduction of the resolution framework. Although burden-sharing takes place in the bankruptcy or liquidation of each and every corporation, burden-sharing is special in relation to failing banks, taking into account the specific role they play in our society.1 The burden is therefore not shared by the usual suspects in a normal insolvency situation. Moreover, with the introduction of a range of new funding resources, answering the question of who has to bear the losses has become even more complex.2 These funding resources may range from the bank itself, its shareholders, creditors, and the whole banking sector (through contributions from the national resolution funds or the SRF and the deposit guarantee schemes), to the national central banks and the Member States.

With the introduction of new parties that can assist when a bank fails (such as the national resolution funds or SRF, but also senior debt holders), the burden-sharing allocation among the parties that carry the burden has also been impacted.3 Burden-sharing allocation seems unavoidable without favouring one party over another party. If a Member State does not provide the necessary means to ensure the return to long-term viability of a bank or to protect the critical functions, these means must be provided by another party, be it a shareholder, creditor, or the banking sector through contributions from the national resolution fund or the SRF.4

De Serière notes that burden-sharing has been an issue that has never been resolved due to politics and the complexities surrounding the issue.5 Although it seems fair that investors in a bank are exposed to investment risks, the nature of these investors can make it a – socially and politically – unacceptable decision to have them contribute to the losses of a failing bank. See, for example, section 7.5.4.2 in respect of the treatment of retail investors. A disadvantage of a taxpayer bailout is, however, that this allocates the costs of a bank failure in one Member State, while the bank is most likely active in multiple Member States and even outside the EU. This issue can be solved by the introduction of supranational funding instruments, but this comes at the cost of giving up fiscal sovereignty.

In addition, Schoenmaker states that burden-sharing may have a different effect depending on the bank to which it is applied. He states that bail-in of large banks might add to–instead of dampen– financial panic.6 Wojcik also states that bail-ins will be most effective when applied to non-systemic, smaller domestic banks.7 Binder, however, sees a risk in the application of the resolution toolbox (including the bail-in tool) to small or even medium-sized institutions taking into account that the resolution action should be proportionate to one or more resolution objectives and winding up of the bank in normal insolvency proceedings would not meet the resolution objectives to the same extent. He takes the stance that this could normally not be said about cases involving smaller or even medium-sized institutions.8

In the author’s view, there is no ‘one size fits all’ approach when it comes to burden-sharing allocation when a bank fails. The resolution framework however defines a standard burden-sharing cascade, which may include senior debt, and a mandatory bail-in threshold when certain public funding sources are used. This has already led to artifices of Member States to deal with an (both financial and political) undesirable outcome thereof. As a result, burden-sharing has not only become controversial, but also conveys the impression of arbitrariness. This is pressing, as Wojcik mentions the predictability and the stability of the legal result produced by a bail-in as two of the most important criteria to make bail-in effective.9

According to Nicolaides, special consideration should be given to the fact that many banks that have received State aid since 2007 and have not been liquidated are partly or even wholly owned by a Member State. This means that in case these banks need extra capital and cannot raise it on the market, the State as a shareholder will have to be bailed-in. As a result, tax payers will still ultimately bear the burden. This could – and should, in the author’s view – be changed by requiring the SRF or the national resolution funds to step in when a Member State has to be bailed-in.10 This, however, requires amending the resolution framework.

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