Limits on State-Funded Bailouts in the EU Bank Resolution Regime

Abstract

In the post-crisis environment, the new European policy orthodoxy insists on avoiding state-funded bailouts of banks in distress under all but the most exacting circumstances. This is reflected in the two distinct but interrelated sets of norms governing bank resolution actions: the Commission’s norms on state aids in the banking sector as reflected in the Banking Communication of July 2013; and the new special resolution regime for credit institutions and investment firms adopted in May 2014 in the form of the Bank Recovery and Resolution Directive. The paper discusses the anti-bailout objective of the two frameworks, the way in which this is reflected in their operative provisions, and the degree to which the latter result in a truly binding regime, or admit exceptions and variations. It is shown that the overall effect of the provisions is to render outright bailouts almost impossible. Even when an intervention is permitted, this may take place only in prescribed forms and at a late stage within the resolution system’s financing cascade, which insists on substantial bail-in of ailing banks’ private claimholders, amounting to at least 8% of total liabilities, as a prior condition. The only exception is precautionary recapitalization; but this applies only to solvent institutions and cannot cover past losses. It may be wondered, however, whether a policy of strict insistence on bail-in in all cases of undercapitalization is wise. The problem has recently come to a head due to the troubles of the Italian banking system, with its huge pile of bad assets and numerous weak banks, including the NPL-infested Monte dei Paschi di Siena. The Italian banking system has a sufficient volume of bail-inable junior debt, thus making bail-in technically feasible. But at what cost?

JEL Classification: E44; E59; G01; G21; G28; G33; H81