Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.3.5.7:5.3.5.7 Access to the ESM DRI within the SRM

Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.3.5.7

5.3.5.7 Access to the ESM DRI within the SRM

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Even if the GFST are not available within the SRM, this would not mean that recapitalisation of a bank in resolution cannot take place with the use of EPFS. From 8 December 2014, the ESM can apply the ESM DRI to systemic banks that are put in resolution, if these are found in need of additional recapitalisation funds. The ESM only provides for direct bank recapitalisation for banks established in the participating Member States of the SSM and that are therefore in scope of the SRM. The ESM Board of Governors decides on the application of the ESM DRI.1 Decisions of the ESM Board of Governors in that respect should be taken by unanimity.2

It has been argued that the instrument of direct recapitalisation would no longer be needed once the SRF is fully established, as in that case the ESM will provide a back-up directly to the SRF.3 It is currently foreseen as part of the ESM reform that the ESM DRI will no longer be available for recapitalisation of a bank.4 This is an interesting development, because the ESM DRI is available on request of a participating Member State and approval from the Board of Governors, while the SRF is available depending on a decision by the SRB, which acts independently from the Member States and in the general interest.5 Replacing the ESM DRI by the backstop to the SRF will therefore have the impact that participating Member States will be more dependent on the SRB for the funding of a bank in resolution, unless Member States are given a say in the use of the backstop.

As a general rule, the ESM will acquire common shares (CET 1) in the bank through the application of the ESM DRI.6 The ESM Board of Governors may however also decide to authorise the acquisition of other capital instruments, the issuance of guarantees or, in exceptional circumstances, to provide financial assistance to any bridge institution or asset management vehicle.7

The ESM Board of Directors may only apply the ESM DRI, if the following ‘access criteria’ are met as set out in the ESM DRI Guideline.

Access criterion 1: Breach of capital requirements

The bank is, or is likely to be in the near future, in breach of the capital requirements established by the ECB in its capacity as supervisor, it is unable to attract sufficient capital from private sector sources to resolve its capital problems and the bail-in conducted in accordance with Article 8 of the ESM DRI Guideline (see access criterion 6) is not expected to fully address the capital shortfall. Private sector sources include tapping new market investors or existing shareholders. 8

The ESM DRI is thus not available for precautionary recapitalisation. Some authors have argued that the ESM should be allowed to participate in precautionary recapitalisations.9 It seems, however, that this is not intended to be part of the ESM Treaty amendment in relation to the common backstop function.

Access criterion 2: Systemic relevance

The bank concerned should have a systemic relevance or pose a serious threat to the financial stability of the Eurozone as a whole or of the requesting participating Member State. In establishing the systemic relevance of a bank, the systemic dimension of the bank will be assessed, taking primarily, its size, interconnectedness, complexity, and substitutability into account.10

Systemic relevance can refer to: (i) systemically important institutions that fall into the main criteria enclosed in the ESM DRI Guideline (size, interconnectedness, complexity, and substitutability); or (ii) other institutions, not necessarily cross-border, whose insolvency could have a significant negative impact on the financial system because of adverse market circumstances or financial stress. 11

Access criterion 3: Direct supervision by the ECB

The bank should be directly supervised by the ECB.12 It can be expected that this will normally be the case when taking the access criterion of systemic relevance into account. However, if the bank is not directly supervised by the ECB, the ESM Board of Governors will request the ECB to take over its direct supervision.

Access criterion 4: Use of ESM DRI is indispensable to safeguard financial stability

The use of the ESM DRI should be indispensable to safeguard the financial stability of the Eurozone as a whole or of its Member States. 13

Access criterion 5: Member State is unable to provide financial assistance in full itself

The requesting participating Member State of the SSM should be unable to provide financial assistance to the bank in full without very adverse effects on its own fiscal sustainability, including via the instrument of indirect recapitalisation. The use of the ESM DRI can also be considered if it is established that other alternatives would have the effect of endangering the continuous market access of the requesting participating Member State and consequently require the financing of its sovereign needs via the ESM. 14

Access criterion 6: Contribution by the Member State

Although the requesting participating Member State should not be able to provide the financial assistance in full by itself, it should contribute a level of capital alongside the ESM. The exact contribution depends on the bank’s equity level. If a participating Member State is unable to fully provide its contribution, the Board of Governors may decide to partially or fully suspend the contribution.15

If the beneficiary bank has insufficient equity to reach the legal minimum CET 1 of 4.5%, the requesting participating Member State will be required to make a capital injection to reach this level. Only then will the ESM participate in the recapitalisation. If the beneficiary bank already meets the capital ratio mentioned above, the requesting participating Member State will be obliged to make a capital contribution alongside the ESM. This contribution will be equivalent to 20% of the total amount of public contribution in the first two years after the ESM DRI is applied.

Access criterion 7: Bail-in

The ESM DRI may only be used provided that, (a) a contribution to loss absorption and recapitalisation equal to an amount not less than 8% of the total liabilities including own funds of the bank in resolution, measured at the time of resolution action, has been made by shareholders, the holders of relevant capital instruments, and other eligible liabilities through write down, conversion or otherwise, (b) a contribution by the SRF of 5% of the total liabilities including own funds of the bank in resolution, measured at the time of resolution action has been made, and (c) all unsecured, non-preferred liabilities, other than eligible deposits, have been written down or converted in full. 16

The conditions set out under (b) and (c) concur with the conditions set out in Article 27(9) SRMR that provides that, in extraordinary circumstances, further funding may be sought from alternative financing sources. It can be derived from Article 30(6) SRMR that such alternative financing sources specifically include the ESM DRI, as this article states that the SRB will cooperate closely with any public financial assistance facility, including the ESM, in particular in the extraordinary circumstances referred to in Article 27(9) SRMR.

Access criterion 8: Approval under the State aid regime

The ESM DRI may only be used after receiving final approval under the Union State aid framework.17

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