A new perspective of banking crisis

by Matteo Manocchio


In response to the financial crisis that emerged in 2008, the European Commission pursued a number of initiatives to create a safer and sounder financial sector. These initiatives, which include stronger prudential requirements for banks, improved depositor protection and rules for managing failing banks, form a single rulebook for all financial actors in the 28 Member States of the European Union. This single rulebook is formed by the Capital Requirements Regulation (CRR), the Capital Requirements Directive IV (CRDIV), the Bank Recovery and Resolution Directive (BRRD) and the Deposit Guarantee Schemes Directive (DGSD). This gruop of European legislation regulatory frame work provides the regulatory framework of European banking union (Ebu).

The European Banking Union (EBU) is an important project born out of compromises and shaped to fit into the legal system of the EU. The study of this subject is important to better understand the importance of european legal framework in the administrative activity. In particulary the new European Banking Union shows a new perpective depending on how the “effectiveness” of its activity is to be understood and evaluated. Whilst international standards establish in general terms the attributes of effective supervisory and resolution regimes, this regulatory system suggests that the concept of effectiveness will change with the EBU evolution.

The purpose of policy makers is not only to cope with the financial difficulties which appeared after the global crisis with a new institutional project but i salso to identify and prevent crisis phenomena of systemic character. With the EBU, we have a reinforcement of the physiological steps of crisis prevention through more strict prudential rules and a piercing centralized supervisory mechanism, but also of the pathological step of banking crisis, with a new recovery and resolution mechanism.

In particular, The European Banking Union was born out of a perceived need for a stronger and more centralized system of financial supervision and resolution to restore credibility and stability to the euro area banking system, to break the vicious circle (or doom loop) between banks and sovereign states, and thereby to help address the fundamental problems of the euro area and of the EU. In the new insitutional model the banking superviosry and crisis management take place on the same level: the european one. Otherwise, infact, there would be a dichotomy between the responsability of supervision, at european level, and crisis management at national level, with serious distortion in decision-making and administrative action: as Michael Barnier, memebr of European Commission, explains “Banks will no longer be European in life but national in death”.

More specifically, the institutional components of EBU are: the single supervisory mechanism (SSM); the single bank resolution mechanism (SRM), wich includes a single bank fund (SRF); and a form of common system for deposit protection called european deposit insurance scheme (EDIS).

The Single Supervisory Mechanism (SSM) places the European Central Bank (ECB) as the central prudential supervisor of financial institutions in the euro area (including approximately 6000 banks) and in those non-euro EU countries that choose to join the SSM. The ECB directly supervises the largest banks, while the national supervisors continue to monitor the remaining banks. The main task of the ECB and the national supervisors, working closely together within an integrated system, is to check that banks comply with the EU banking rules and to tackle problems early on. Design the SSM has been an exercise in sophisticated legal gynmastics to fit withinthe existing Treaty frame work: the legal base of SSM is the article 127(6) of TFEU saying that The Council,acting by means of regulations in accordante with a special legislative procedure, may unanimously, and after consulting the European Parliament and the European Central Bank, confer specific tasks upon the European Central Bank concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings.

The position with regard to the distribution of competences and powers between the ECB and the national competent authorities (NCAs) requires a more complex assessment. Under Articles 4 and 6 of the SSM Regulation, the ECB has exclusive competence within a prescribed framework to carry out a specified list of tasks for prudential supervisory purposes in relation to all banks established in participating Member States. Tasks not specifically conferred on the ECB, including conduct of business and consumer protection matters, remain with NCAs. As regards the list of prudential tasks for which the ECB has exclusive competence under Article 4, the ECB is responsible, regardless of the size or systemic significance of the institution, for the granting and withdrawal of banking licences, and for assessing the suitability of bank owners. This particolar relationship is called “asymmetrical cooperation” because it indicates the ECB as a governing-central body and the NCAs as, not mere executors of ECB’s orders, but are integrated in a cooperation view with the ECB, wich, however, depend.

The second important point of EBU is the single resolution mechanism. The Single Resolution Mechanism (SRM) applies to banks covered by the SSM. In the cases when banks fail despite stronger supervision, the mechanism will allow bank resolution to be managed effectively through Single Resolution Board and a Single Resolution Fund, financed by the banking secor. Its purpose i sto ensure an orderly resolution of failing banks with minimal costs for taxpayers and to real economy.

The legal bases for the SRM is TFEU, article 114 wich allows for the adoption of measures for the approximation of the provisions laid down by law, regulation or administrative action in member states wich have as their object the establishment and functiong of the internal market.

The focus point in this area is the banking recovery and resolution Directive (BRRD) which orders the creation of a resolution Authority and give a series of new instruments to regulate the banking crisis. In particolar, “resolution” is a specialized process for dealing with distressed banks and ideally other systemically important financial actors as well. Resolution, infact, is an alternative to conventional corporate insolvency regimes. So, BRRD include an important and central principle: “no creditor worse off” (NCWO principle) safeguard whereby no creditor shall incur greater lossess than would have been incurred in normal insolvency proceedings.

The special measures, or resolution tool, that can be applied to an istitution in distress are the heart of any resolution regime. Four tools are specified in the BRRD, namely, sale of business, bridge institution, asset separation, and bail-in. The sale of business tool enables resolution authorities to sell on commercial terms all or part of a bank’s business without obtaining shareholder consent or complying with other procedural requirements that would otherwise apply. The bridge institution tool enables resolution authorities to transfer all or part of the business o fan institution to a publicly-controlled entity pending a future return of the business back to the private sector when market conditions improve. The asset separation tool enables resolution authrities to transfer imparied or problematic assets to an asset mangement vehicle to allow them to be managed and worked out over time. The bail-in tool gives resolution authorities wide power to write down or to cancel the claims of the unsecured creditors of a failing institution, to convert debt claims to equità, and to change the terms of debts instruments. The usual order of priority as between shareholders and creditors whereby the shareholders bear first losses is a general principle governing resolution. In addition creditors are to bear losses in accordante with the order of priority of their claims under normal insolvency proceedings except where otherwise provided in BRRD. The aim of bail-in, so, is to recapitalize an institution to restore its ability to comply with authorization requirements, to provide capital for a bridge institution or to reduce the debt that is transferredunder the sale of business or asset separation tool. As such, the bail-in mechanism should function as an alternative to taxpayer-funded bailouts. The bail-in is the most important tool in the BRRD because it subverts the normal regime of intervention in banking crises: it is not the government to intervene, there isn’t the figure of the State-savior but are the same people who invested in the bank (shareholders and bondholders) to face the injection of capital; so many respected authors of law speak about bail-in like a “socialization of losses”.

At the end we have the European Deposit insurance Guarantee (EDIS). It would apply to deposits below 100.000 euros of all banks in the euro area. When a bank is placed into insolvency or in resolution and it is necessary to pay out deposits or to finace their transfer to another bank, the national deposit guarantee schemes and EDIS will intervene. Given that national DGS may remain vulnerable to large local shocks, the purpose of EDIS is to ensure equal protection of deposits through the banking union regardless of the Member State where the deposit is located.

From this overall regulatory frame work, through the analysis of what has beeen called the phase of physiological administration and the phase strictly linked to a banking crisis phenomena, we can track dwn some distintive features to how its usually apply the european administrative law.

The first new element is represented “by the reversal of the usual relationship between European law and national law.” European law in fact has always sought a solid foundation for national, finding most of the time very difficulties to build from scratch a European administrative apparatus. With European Banking Union this mechanism is reversed. It is widely analyzed as the ECB is entrusted with a leading function of direction: it has the task of applying the national implementing rules of the European directives and regulations. This single entity applies, therefore, different rules and, in the usual European administrative context, it has had in general a system where many national authorities shall apply the same European rules. We can not say for sure whether such a reversal will lead to greater uniformity in the rules, in force of the uniqueness of the subject, but it is certain that this centralization in the hands of the ECB will inevitably create a dystonia compared the application of rules of law corporate and national bankruptcy laws, which are still the preserve of states and therefore different from country to country.

Tightly connected to this aspect is the general implemantation procedure of the new system rules, particullary refer to the SSM.

This process is divided into three stages: the decision, it is for the ECB and the investigation and application phases, which are characterized instead by a strong cooperation with the national authorities, from which descends the definition of “asymmetric cooperation”.

To analyze this relationship on a practical level is taken as example the demand for credit granting. When prompted, the same is taught by the national authority, which shall adopt a draft decision, on the basis of which the ECB proposes to proceed to the authorization (competence entrusted to the ECB ex art. 4 of the Regulation). The domestic authority is obliged to establish the existence of the necessary requirements, in the absence of which directly rejects the request, without the decision comes in the hands of the ECB. If, however, where the national authority has proposed the ECB to be issued, the ECB must rule within ten days and in the absence of express will is presumed tacit assent.

Is interesting to note that the decision-making relations between the ECB and the domestic authority are to be based, in some cases, on a procedure called mixed top-down, different from the bottom up so. The acts and the most important measures of the national authorities, in fact, can only be adopted after consultation of the ECB.

The various elements that integrate the concept of a banking union constitute a solid and consistent framework that will foster financial integration and be supportive of Economic and Monetary Union. They would overcome a shortcoming of the initial design of the monetary union that allowed financial supervision to lag behind monetary and financial integration. Their implementation will also contribute to address the current crisis by helping to separate banks from the sovereigns and reverse the on-going fragmentation of markets along national borders. This in turn will help to restore the proper functioning of the monetary policy transmission mechanism. In particular, the new structure of the supervisory framework would reflect and complement the single market in financial services. To the ECB is given a major role, specially in the supervisory framework. It is with an acute sense of responsibility and awareness of the involved risks that we have to look to the new competences about to be bestowed on the ECB, confident that our Institution will continue to serve well the inspiring goals of our European Union.