8.2 Moving towards resolvable banks

Chapter 2 started with taking a closer look at the definition of ‘credit institution’ in banking regulation in order to better understand the term ‘bank’. Interestingly, this term is not as clear as one might expect. Due to a lack of clarification of certain elements of the definition of ‘credit institution’ at the EU level, there remains a degree of divergence between the Member States as to the interpretation of this term. A further complicating factor in understanding what a bank is, is the variety of activities and business models of banks within the EU. Although, ultimately, the purpose of bank ing intermediation is transforming short-term deposits into a stable and sustainable supply of long-term credit to the real economy, banks are involved in all kinds of activities. Some banks have such high amounts of total assets that they qualify as being global systemically important. Other banks have a more modest balance sheet.

While the business models and balance sheets of banks differ, they have in common that they all need to comply with the regulatory capital requirements and the MREL. As a result, each bank needs to maintain a certain composition of its balance sheet. This should guarantee that the reliance of banks on short-term wholesale funding to finance the expansion of their balance sheets, together with the use of high leverage, supports economically useful banking activities that serve the general interest, while banks are resolvable when they are failing. The balance sheets of banks may, however, not be quite ready for that, because of challenges relating both to the MREL amount and the MREL composition. Banks have a financing need to meet the MREL. In addition, certain banks are characterized by the predominance of deposits covered by a deposit guarantee scheme or preferred retail deposits in the funding structure and limited or non-existent experience in issuing debt instruments. This affects these banks’ abilities to meet the MREL and, in the end, also affects their resolvability.

If the level of own capital and eligible liabilities is insufficient to absorb losses and recapitalise a failing bank, other funding resources will be necessary to resolve the bank. These may involve public funding provided by Member States, national central banks, deposit guarantee schemes, national resolution funds, the SRF and/or the ESM. Taking into account that banks are currently still in the initial stage of implementing the MREL, it may be realistic to assume that it will be necessary to use alternative public funding resources in the resolution of banks – in any event, as long as the MREL has not been fully implemented. This brings us to the State aid regime.

Chapter 3 discussed that the EU is unique in having a State aid regime, under which Member States give up part of their sovereignty by requiring the Commission’s approval of State aid awards. Not all public funding qualifies as State aid: public funding only comes within the remit of State aid control if it is assessed to be an intervention by a Member State or through Member State resources in any form whatsoever, which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods, and that affects trade between Member States. This assessment is made by the Commission and is subject to judicial review by the EU Courts.

The assessment by the Commission normally starts with the request of a Member State for approval of a State aid award. It remains for each Member State to determine the circumstances in which it wishes to grant State aid and the beneficiaries to whom this aid is to be granted. The Member States design the aid measure in liaison with the bank. In the end, however, it is the Commission that has to approve the aid as being compatible with the internal market, which makes the process of designing the aid measure more of a trialogue. Third parties, such as the shareholders and creditors of a bank, also play their part when State aid is awarded. Sometimes far-reaching restructuring of the bank is necessary, which may include the dilution, cancellation or conversion of capital instruments, the write-off of debts, the replacement of management and/or divestment. Shareholders’ and creditors’ rights do not remain untouched in that case.

The Commission makes use of soft law instruments to inform Member States how it assesses State aid awards. The urgency, the interdependence of financial markets and the extraordinary size of the subsidies committed by Member States to save national banks during the GFC, led the Commission to modify its ordinary decision-making practices and to adopt a new set of soft laws for the banking sector, consisting of the Crisis Communications, on the basis of Article 107(3)(b) TFEU. While the contours of the European Banking Union were given shape, the Commission started with its review of the Crisis Communications This led to the publication of the 2013 Banking Communication on 13 July 2013, still on the basis of Article 107(3)(b) TFEU. The 2013 Banking Communication forms the basis of the State aid regime for the banking sector as we know it today. The Commission continues to assess whether State aid awards in the banking sector are appropriate for remedying a serious disturbance in the economy of a Member State. The temporality of this regime, although advocated by the Commission, therefore seems to no longer be a reality.

With the introduction of the resolution framework, as described in Chapter 4, the question whether the State aid regime for the banking sector is still fit for the purpose of identifying and controlling State aid to banks have become more imperative. The resolution framework was introduced because the GFC showed that general corporate insolvency procedures may not always be appropriate for banks, as they may not always ensure sufficient speed of intervention, the continuation of the critical functions of institutions and the preservation of financial stability. This formed the justification to take away the power to determine resolution from courts and confer this on administrative authorities, the resolution authorities. With the introduction of the BRRD, procedures for resolving banks were harmonised at EU level, in order to submit resolution authorities to the same principles and to provide them with the same set of tools in order to achieve the resolution objectives. With the introduction of the SRM, not only harmonisation, but also centralisation of the resolution process at supranational level took place within the European Banking Union, with the introduction of the SRB and the SRF.

Although the resolution framework has successfully been established, the devil is – as always – in the detail. The resolution framework is, mainly due to its dual structure, both on Eurozone and national level, at some points hard to read and fathom. In addition, the complexity of resolution, both in terms of involvement of the number of actors, and the procedural outline of resolution, renders the concept of resolution difficult to grasp, not only for the bank itself, but also for its shareholders and creditors. At the same time, this resolution can have far-reaching consequences. The case of Banco Popular, the first resolution case in which the SRB took the lead, shows that shareholders and subordinated debt holders can be confronted with a situation in which their shares and other capital instruments are written down without any compensation.

The resolution framework has already been subject to revision, although it has barely seen its first practical applications. With the further development of its practicalities over the coming years, there will undoubtedly be many more causes for revisions of this framework. Any amendments have to be carefully considered, however, in light of the cohesion with other legal frameworks, including the State aid regime for the banking sector.