7.5.4.3 The (in)compatibility of burden-sharing and financial stability

Burden-sharing has been developed as a general principle of State aid control that contributes, in particular, to limiting distortions of competition between banks and across Member States in the internal market, and to addressing moral hazard.1 An exception to the burden-sharing principle can be made where implementing burden-sharing measures would endanger financial stability or lead to disproportionate results. Under the resolution framework the objective of burden-sharing is explained as ensuring that systemic banks can be resolved without jeopardising financial stability. In addition, the application of the burden-sharing requirement should give shareholders and creditors of banks a stronger incentive to monitor the health of a bank under normal circumstances.2

While the resolution framework therefore starts from the premise that burden-sharing contributes to financial stability, the State aid regime allows deviation from the burden-sharing principle if applying this principle endangers financial stability. This difference in approach in relation to the contribution of burden-sharing towards financial stability, can perhaps be explained taking into account that the resolution framework is more focused on the failure of an individual bank (idiosyncratic shock), while the State aid regime for the banking sector is developed in the midst of a systemic crisis.3 Idiosyncratic shocks and systemic crises can call for different approaches. It should be acknowledged that the GFC created exceptional circumstances in which the bankruptcy of one bank, even a bank of small size, could undermine trust in the financial system at large, both at national and international level.4

Avgouleas and Goodhart conclude that imposing haircuts on general bank creditors during a systemic event is a sure way to accelerate the panic. In fact, contagion: a flight of creditors from other institutions may be uncontainable.5 They therefore focus on the clean-up of bank balance sheets, for example through setting up a Euro-AMC. Cleaning up bank balance sheets from NPLs would free up capital for new lending which would boost economic recovery in the periphery of the Eurozone.6 Tröger also states that bank resolution without injection of public funds poses a problem if it occurs in the middle of a systemic crisis. In fact, he notes that financial history teaches us that a tough stance of governments who refuse to backstop the financial system aggravates the impact of the event.7 While burden-sharing may hence contribute to financial stability in case of an idiosyncratic shock, this may be different when the whole banking sector fails. Requiring a bail-in of 8% of total liabilities and own funds of the bank to have access to public funding may not be realistic in that situation.