Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.5.2.4:5.5.2.4 Member States are still the ultimate backstop

Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.5.2.4

5.5.2.4 Member States are still the ultimate backstop

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The standing of a banking system depends on the strength and credibility of the backstop of the available resources, especially in the case of a full-blown systemic crisis.1 As long as this backstop is provided by the Member States, it will still be the Member States that ultimately carry the burden of failing banks. While the BRRD has introduced additional public funding resources in the form of national resolution funds, funding through these funds is capped at certain maxima. If the amount of aid available within these limits is not sufficient, the Member States will still act as the ultimate backstop. The same applies to the use of deposit guarantee schemes.

In addition, while the introduction of the SRF and ESM DRI may have lifted the decision to use these forms of EPFS to the Eurozone level, thereby breaking the direct link between Member States and banks, this is still suboptimal, because both funding resources are capped at 55 billion and 60 billion, respectively.

Should aid be required from the SRF that exceeds the threshold of EUR 55 billion, the Member States will still have to act as the capital backstop. They provide a national individual credit line to the SRB to back their national compartments in the SRF in case of possible funding shortfalls following resolution cases of banks in the Eurozone.

As discussed, the ESM Treaty will be amended to provide the ESM with the new task to act as a common backstop to the SRF.

In case of the ESM DRI, any losses arising will be charged on, firstly, the reserve fund,2 secondly, against the paid-in capital and thirdly, through a capital call. The paid-in capital is provided by the participating Member States and the callable capital is committed by the same Member States. Although the Member States are ultimately the backstop, this is a contingent liability. The Member States share the burden of bank failure in their jurisdictions.3 Although the backstop to the ESM DRI is a contingent liability of the Member States, the ESM DRI may only be applied, if the Member State in which the failing bank is established also contributes to the funding gap of the failing bank. As a result, there still is a link between the failing bank and the Member State in which it is established when the ESM DRI is used.

Table 9 shows the different sources of public funding available in resolution, other than direct Member State support, their target level, resources and ultimate backstop.

Table 9: Resources and backstop of public funding in resolution

Source of public funding in resolution, other than Member State support

Target level

Resources

Ultimate backstop

DGS support

At least 0.8% of covered deposits by 2024 (in specific cases the adjusted target level may be 0.5%).4

The deposit guarantee schemes are funded by their members, which are the banks in the respective Member States.5

Deposit guarantee schemes should have adequate alternative funding arrangements in place to enable them to obtain short-term funding to meet claims against them.6 These arrangements could involve support from Member States.

NRF

1% of covered deposits by 2024.7

Contributions from the banking sector outside the Eurozone, BRRD investment firms and Union branches

Alternative funding means (including Member State support) raised in accordance with Article 105 BRRD8

SRF

1% of covered deposits by 2024.9

Contributions from the banking sector within the Eurozone

Alternative funding means raised in accordance with Articles 73 and 74 SRMR.10

As of 2016, all participating Member States have entered into a harmonised Loan Facility Agreement for a maximum aggregate amount of EUR 55 billion with the SRB, providing a national individual credit line to the SRB to back their national compartments in the SRF in case of possible funding shortfalls following resolution cases of banks in the Eurozone. The banking sector of the Member State concerned will be liable for repayment of the amounts drawn under the credit line.11

ESM DRI

EUR 60 billion

The ESM raises money it needs in financial markets by issuing bills and bonds and through other funding tools12

Losses arising in the ESM operations shall be charged on, firstly, the reserve fund, secondly, against the paid-in capital and thirdly, through a capital call.13

The ESM has a total capital of nearly EUR 705 billion. This consists of over EUR 80 billion in paid-in capital provided by the participating Member States and approximately EUR 624 billion in committed callable capital.14

Although central bank support is, at the time of writing this dissertation, not (yet) available in resolution – unless the bank can be considered solvent –, it is also interesting to look at the resources of central banks. The main liabilities of central banks are issued banknotes and commercial bank reserves as a result of their monetary operations. Central banks also carry capital on their balance sheet. This capital comes from the Member States for most central banks, but it can also come from the public.15 The Bank of Greece is, for example, listed on the Athens Exchange.16

According to Schoenmaker, a central bank can provide unlimited liquidity by expanding its balance sheet, but its capacity to bear losses is limited to its capital which is normally provided by the Member States.17 He also notes that, taking into account that the national central banks of all Member States are the shareholders of the ECB,18 any losses of the ECB, are transferred to these national central banks. This makes the Member States the ultimate backstop of the ECB.19

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