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Eurofi Article by Elke König - Banking Union: CMDI can build further on solid ground | Prague, September 2022

Wednesday, 14 September 2022

“Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity”.

These words, from the 1950 Schuman declaration, are still very pertinent today. As Chair of the Single Resolution Board (SRB), I have long wished to see the third pillar of the Banking Union, the common deposit insurance, EDIS becomes a reality. However, that plan is now on hold.

It seems as though Schuman could have been talking about the Banking Union way back in 1950 – for it appears that it will not be completed “all at once, nor according to a single plan”. The Eurogroup President, Paschal Donohoe, did his utmost to deliver a single Work Plan, yet the political dynamics meant that we will proceed one-step at a time, beginning with the review of crisis management and deposit insurance framework (CMDI).

As a premise to those steps, we should recognise that the Banking Union has already delivered much for financial stability.

In the past decade, the EU has faced several crises: most recently, Covid-19, and the Russian war in Ukraine. It is not by chance that our banks largely weathered the economic consequences well. The swift and coordinated fiscal and monetary response by the EU, national governments and central banks was key. Having the Banking Union and the Single Rule Book in place was an additional layer of comfort at this time.

In less than a decade, we have made significant steps with the first pillar of the Banking Union, the Single Supervisory Mechanism (SSM) established high supervisory standards right across the Banking Union, and enhanced the banks’ positions. [The latest stress test confirms this increased resilience].The second pillar, the Single Resolution Mechanism (SRM), led to banks becoming not only more resilient, but also more resolvable. The progress is clear: at the end of 2021, nearly all banks under our remit met their intermediate MREL targets. It is key that those resources can be reliably mobilized in a crisis.

The Single Resolution Mechanism was designed to deal with bank failures as efficiently as possible. The Sberbank and Banco Popular cases showed that, the SRB - in cooperation with the other authorities - could devise a solution that successfully achieved all resolution objectives including the protection of the taxpayer.

These are remarkable achievements for a relatively young Banking Union. However, we must be on our guard and make sure we don’t slide back on what we have already achieved. It took the U.S. over 80 years and multiple crises in order to arrive at its well-functioning bank failure management regime. Let us try and learn from them and others rather than try and go down the route of making every mistake for ourselves.

This does not make us complacent, but it should give enough confidence to legislators to use the upcoming CMDI review to take steps forward in enhancing the Banking Union tools and foster market integration while working towards an agreement on EDIS.

The tools to deal with failing or likely to fail banks are resolution, when it is assessed to be in the public interest, and normal insolvency proceedings (NIPs). While the former is harmonised at European level and centrally managed by the SRB for the Banking Union, the latter is subject to different national legal frameworks, systems and authorities.

In line with the legislators’ expectations, the SRB has expanded its public interest assessment (PIA) over time. As of today, the SRB plans for resolution for almost all banks under its remit.

Resolution tools have proven their value for so-called midsize banks. The sales of Banco Popular and Sberbank’s subsidiaries are a testament to that. Resolution is not a free lunch. The MREL necessary to ensure an orderly resolution as well as an operational for resolution must be met. High quality debt instruments are important, particularly as equity is loss-absorbing and might not be available anymore at the time a bank is failing. Only after bailing in the banks’ MREL and eligible liabilities, can one consider external sources. The law already provides for the Single Resolution Fund (SRF) and the DGS as external resources. Yet, the use of DGS funds in resolution is de facto extremely restricted due to their super-priority in the creditors’ hierarchy. If this was removed, and a general depositor preference was introduced, the DGS could still be protected by their position in the hierarchy, but they would also be able to step in in lieu of deposits and DGS funds could be used to support market exits, after bail-in and before the SRF, where needed.

The funding cascade is unchanged: first the funds of the bank, then the funds from the industry. DGS funds would be used in resolution only when this costs the DGS less than their pay-out to depositors, according to the international best practice.

The safeguards need to be clearly stated, but the potential benefits, too. Stronger resolution transfer tools would facilitate timely market exits of unviable banks, ultimately making both the banking sector and the economy healthier. This could help to make a decisive step away from the use of public funds. Compared to national solutions, and in the absence of EDIS, the use of DGS in resolution also ensures a harmonised and predictable framework. Lastly, the possibility of cross-border sales (even if partial), and having the SRF in the background, would give scale effects and result in more efficient crisis solutions.

This is not to say that DGS should be used only in resolution, or that no bank should be wound down at national level anymore. On the contrary, national NIPs will remain the sensible solution for smaller banks that fail. There are many examples in recent years where banks have been wound down in a swift and effective way under national insolvency procedures, without using public funds. Yet, the system can be improved taking lessons from the successful examples. If a full harmonisation of those procedures is unlikely (however desirable) in the short term, targeted changes would still help. These should be aligned with the framework of the SRB to the greatest extent possible to avoid target conflicts.

In conclusion, I would note that if –regrettably- not all interests have yet aligned on the third pillar, a more fragmented second pillar is certainly in nobody’s interest. Recalling the optimistic but pragmatic quote of the Schuman declaration, I would encourage legislators to reflect on the concrete achievements of the Banking Union, build on them, and take pragmatic steps forward with the CMDI.

Our “ceterum censeo” is and remains EDIS.

Let us hope it won’t be put in place only in a moment of crisis.

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