The institutional framework for banking resolution in Europe

The institutional framework in Europe is based on the Single Rulebook which removes any national biases – harmonization – or supervisory forbearance. The new regulation introduces the ‘bail-in’ principle which puts some resolution costs on creditors of the stressed bank. Consequently, ‘bail-out’ is replaced as resolution mechanism.
The Directive 2014/59/EU – Banking Recovery and Resolution Directive (BRRD) – transposes the Financial Stability Board (FSB) Key Attributes into EU law (FSB, 2014). The BRRD entered into force on the 1^st January 2016^[1] and put in place a set of common tools and powers to the national regulators which would enable them to avert the failure of a bank and, if necessary, resolve branches of banks based in other countries and circumstances. (FSB, 2016a).^[1]The BRRD requires each member state to designate a national resolution authority, and practically the whole member states had done so as of 30 September 2015. The package of measures is aimed at reducing the probability the G-SIIs may fail. The FSB indeed proposed a new international standard for resolution regimes to address possible differences amongst jurisdiction and allow them to promptly intervene without disrupting in the overall financial system.
The European resolution framework is advancing to implement a bank-specific requirement for own funds and eligible liabilities (MREL) that will be applicable to all banks. The European Union is working to transpose the FRB’s total loss-absorbing capacity (TLAC) standards into EU directives in manner consistent with MREL, which shares the same regulatory features with TLAC (FSB, 2016a). The proposal of the Commission of 23 November 2016 implements the TLAC standards issued by FSB in November 2015 (after the approval of BRRD) and integrates the TLAC requirement with the MREL rules avoiding redundancy. Among other novelties, the proposal contemplates harmonization of MREL across countries, as it is the case for TLAC, but only for G-SIIs as it was expected. The proposal also harmonizes creditors’ hierarchy keeping the existing class of senior debt and reacting a new asset class of non-preferred senior debt bailnable after other capital instruments, but before other senior liabilities. Institutions remain free to issue debt in both classes while only the non-preferred senior class will be eligible for the minimum TLAC requirement.
The BRRD also requires each bank to draw up a resolution plan, or Living Wills, along with supervisory authorities, with the purpose of using it in the event of bank’s failure. The resolution plan shall include, where applicable, an analysis on how and when the bank may apply for central banks facilities and identify those assets which would be expected to be used as collateral (Avgouleas et al., 2013). Furthermore, institutions should put in place recovery plans for critical resources to enable them to return to ordinary business procedures in a reasonable timeframe (EBA, 2016).
The Single Resolution Mechanism (SRM) was established by the Regulation (EU) 806/2014. The SRM envisages the centralized European-decision making and financing mechanism for resolution. The Single Resolution Board (SRB) is its executive board. The SRM is a coordinated system in which the SRB and the European Central Bank (ECB) work as the single resolution authority. The resolution process is organized as follows. Firstly, the European Central Bank (ECB) determines whether the bank is “failing or likely to fail” (EBA, 2015). Then, the SRB determines the resolution scheme, i.e. resolution tool the bank should be liquidated or resolved in combination with national resolution authorities and the Living Wills (Huertas, 2016)^[2]Article 32 of BRRD. , which may be validated by the ECB in the following 24 hours. Finally, the resolution scheme enters into force if no objection has been expressed by the Council or the European Commission (FSB, 2016b).
The Single Resolution Fund (SRF) is an essential part of the SRM which harmonizes resolution of the European financial institutions within its 19 Member States. The SRF will be built between 2016 and 2023 and shall reach the 1% of covered deposits, estimated at roughly 55 billion euros. To estimate ex-ante contributions of the banks to the Fund, the SRB applies the methodology set out in the Commission Delegated Regulation (EU) 2015/63 and the Council Implementing Regulation (EU) 2015/81. Accordingly, the SRB takes into consideration the size and the risk of each financial institution to estimate its ‘risk factor adjustment’; otherwise, a lump-sum treatment is applied to small or low-risk banks (SRB, 2016). Table 1 displays the annual contributions of banks computed based on Euro area level estimations (SRM level) and national level (BRRD level) estimations (Hadjiemmanuil, 2015).

The Five Presidents’ Report (EC, 2015a) indicated as a priority to set up a credible common backstop to the SRF during the transition period. The SRM will serve as a transitional backstop until the fund has reached its full target size. However, the current version of the SRF is allowed to borrow from external markets, but not to have the backing from the Member States. This limitation has been criticized for lack of credibility of enough financial backstop. The combination of a well-endowed resolution fund and ECB liquidity may fulfil the credibility for resolution mechanism, shielding the ECB for potential losses. Finally, under the current ESM Treaty, the SRF is unable to provide funds to non-Eurozone countries which opted to join the Banking Union (Gordon and Ringe, 2015).
The current Deposit Guarantee Scheme (DGS) is regulated by the Directive (EU) 2014/49/EU. The Directive allows for coverage of deposits up to EUR 100,000. However, this feature allows compensations in excess of this amount in case of qualifying deposits.^[3]Deposits resulting from real estate transactions relating to private residential properties; deposits that serves social purposes, and deposits that serve purposes laid down in national law … Continue reading) Importantly, the SRB and the European Commission are involved in designing the European Deposit Insurance Scheme (EDIS) to complete the Banking Union. The political discussion on the EDIS is conditional on bank risk reduction measures prior to achieving the full mutualisation of deposit insurance. Preconditioning EDIS on them would result in a delay for the third pillar. However, if the Council decides granting a veto power to individual member States, i.e. via Intergovernmental Agreements, the EDIS might be further delayed.^[4]The Intergovernmental Agreement was signed by representatives of all Member States, except Sweden and the United Kingdom. The scheme should include a series of strong safeguards against ‘moral hazard’ and inappropriate use, in order to give incentives to national schemes to manage their potential risks in a prudent way. In particular, a national scheme should only be able to access EDIS if it fully complies with relevant Union law (Gross and Schenmaker, 2014). As for EDIS funding, the initial target level of the Fund will be progressively reached until 20% of four ninth of the minimum target levels of the DGS of the whole Member states. Banks’ ex-ante contributions to EDIS would be calculated based on covered deposits, adjusted to take into account the risk attributes of each bank, to meet a target level of 0.8% of covered deposits of all banks in the SSM by 2024. Table 2 displays the funding path of EDIS and participating national DGS (EC, 2015b).

Challenges for bank resolution in the United States

Title II of the Dodd-Frank Act introduces the Orderly Liquidation Authority (OLA) as a new resolution mechanism for G-SIIs. The central challenge posted by the Title II is to adapt the Federal Deposit Insurance Company (FDIC) receivership to carry out the liquidation and wind-up from small and medium sized banks to G-SIIs. A central element of quickly FDIC resolution is the Purchase and Assumption (P&A), by which a healthy bank purchases assets and assumes liabilities of the troubled bank. Then, the Resolution Trust Company – a special and temporary government entity – proposes the branch breakup to improve upon P&A transactions. (Capponi et al., 2016).
The US legislation is still uncertain as to whether a G-SII will be resolved under OLA or Chapter 11 bankruptcy procedure (11US Code), potentially increased by banks’ resolution plans. In fact, the US legislation takes on three challenges for the near future. Firstly, OLA is seen by US regulators as a backstop which would be activated if the organizational complexity of G-SIIs makes difficult to invoke Chapter 11. Secondly, the exemption of qualified financial contracts (QFC) from the automatic stay under Chapter 11 – but under OLA the resolution authority may impose a stay – introduces uncertainty when the derivative and repo counterparties are free to cancel their contracts with the bank. Finally, a carefully designed liquidity provision facility that can be tapped during resolution is another key issue in case TLAC at the holding level could not be ensured. Under OLA, such liquidity may be provided through the orderly liquidation fund.

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References
Avgoluleas, E., Goodhart, C., and Schoenmaker, D. (2013). Bank Resolution Plans as a catalyst for global financial reform. Journal of Financial Stability, 9, 201-218.
Benczur, P., Cannas, G., Cariboni, J., Di Girolamo, F., Maccaferri, S., and Giudici, M.P. (2016). Evaluating the effectiveness of the new EU bank regulatory framework: A farewell to bail-out. Journal of Financial Stability, forthcoming.
Bolton, P., and Oemkhe, M. (2016). Bank Resolution and the structure of global banks. Columbia Business School Working Paper. Available at: https://www0.gsb.columbia.edu/faculty/moehmke/papers/BoltonOehmke_BankResolution.pdf
Capponi, A., Dooley, J., Oet, M., Ong, S. (2016). Capital and resolution policies: the US interbank markets. Journal of Banking and Finance, forthcoming
European Banking Association (EBA) (2015). Guidelines on the interpretation of the different circumstances when an institution shall be considered as failing or likely to fail under Article 32(6) of Directive 2014/59/EU. EBA/GL/2015/07. Available at: https://www.eba.europa.eu/documents/10180/1085517/EBA-GL-2015-07+GL+on+failing+or+likely+to+fail.pdf/02539533-27ed-4467-b442-7d2fa6fcb3d3
European Banking Association (EBA) (2016). Draft Guidelines on internal governance. Available at: https://www.eba.europa.eu/documents/10180/1639914/Consultation+Paper+on+Guidelines+on+internal+governance+%28EBA-CP-2016-16%29.pdf
Financial Stability Board (FSB) (2016a). Resilience through resolvability – moving from policy design to implementation. 5th Report to the G20 on progress in resolution. Available at: http://www.fsb.org/wp-content/uploads/Resilience-through-resolvability-%E2%80%93-moving-from-policy-design-to-implementation.pdf
Financial Stability Board (FSB) (2016b). Second thematic review on resolution regimes. Peer Review Report. Available at: http://www.fsb.org/wp-content/uploads/Second-peer-review-report-on-resolution-regimes.pdf
Financial Stability Board (FSB) (2014). Key attributes of effective resolution regimes for financial institutions. Policy Documents. Available at: http://www.fsb.org/2014/10/r_141015/
European Commission (EC) (2015a). Completing Europe’s Economic and Monetary Union. Five President Reports Series. Available at: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf
Gordon, J.N., and Ringe, W.G. (2015). Bank resolution in the European Banking Union: A transatlantic perspective on what it could take. Columbia Law Review, 115, 1297-1370.
Hadjiemmanuil, C. (2015). Bank resolution financing in the Banking Union. LSE Law, Society and Economy Working Papers 6/2015. Available at: https://www.lse.ac.uk/collections/law/wps/WPS2015-06_Hadjiemmanuil.pdf
Huertas, T.F. (2016). European bank resolution: Making it works! CEPS Task Force Report. Available at: https://www.ceps.eu/system/files/TFR%20Bank%20Resolution.pdf
Hryckiewicz, A. (2014). What do we know about the impact of government interventions in the banking sector? An assessment of various bailout programs on bank behaviour. Journal of Banking and Finance, 46, 246-265.
Single Resolution Board (SRB) (2016). Annual Report 2015. Available at: https://srb.europa.eu/sites/srbsite/files/srb_annual_report_2015_en_0.pdf

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Legislation cited
Chapter 11 of Title 11 of the United States Code. Available at: http://uscode.house.gov/browse/prelim@title11/chapter11/subchapter1&edition=prelim
Commission Delegated Regulation (EU) 2015/63 of 21 October 2014. Available at: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32015R0063
Council Implementing Regulation (EU) 2015/81 of 19 December 2014. Available at: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32015R0081
Directive 2014/49/EU (Deposit Guarantee Scheme Directive) of the European Parliament and of the Council of 16 April 2014. Available at: http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=celex:32014L0049
Directive 2014/59/EU (Banking Recovery and Resolution Directive, BRRD) of the European Parliament and of the Council of 15 May 2014. Available at: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32014L0059
Dodd-Frank Wall Street Reform and Consumer Protection of 2010. Senate and House of Representatives of the United States of America in Congress Available at: https://www.sec.gov/ about/laws/wallstreetreform-cpa.pdf
European Commission (2016a), COM (2016) 852, “Proposal for a Directive amending Directive 2014/59/EU of the European Parliament and the Council on Loss Absorption and Recapitalisation Capacity of credit Institutions and Investment Firms”.
European Commission (2016b), COM (2016) 853, “Proposal for a Directive amending Directive 2014/59/EU of the European Parliament and the Council as regards the Ranking of Unsecured Debt Instruments in Insolvency Hierarchy”.
European Commission (EC) (2015b). Proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme. Available at: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015PC0586
Regulation (EU) No 806/2014 (Single Resolution Mechanism and a Single Resolution Fund) of the European Parliament and of the Council of 15 July 2014. Available at: http://eur-lex.europa.eu/legal-content/en/TXT/?uri=celex%3A32014R0806