EU bank regulation may be in the process of coming full circle, meaning it won’t have gone anywhere at all.
The European Commission on Friday struck a provisional agreement with the Italian government to reimburse some investors who bought shares in failed banks in an unprecedented move that would significantly soften EU rules on bank rescues. The agreement was welcomed by the Italian government and Bank of Italy which both argue that the European Union’s bail-in rules are damaging and virtually impossible to apply.
Those rules represent the central plank of the EU’s post-crisis banking reform. They came into law in the wake of Europe’s sovereign debt crisis and were designed to make sure that collapsing banks in Europe would in future be “resolved” with the funds of shareholders, bondholders and other investors, including account holders with deposits of more than €100,000 euros — instead of classic bailouts that raid directly or indirectly taxpayer funds. Under the new legislation public funds should only be used after unsecured creditors who can absorb the losses have been bailed in.
One of the first test cases of the new bail-in regulation was Tercas, a small Italian bank that hit the wall in 2014 and whose rescue with money from the country’s deposit guarantee fund was blocked by the European Commission on competition grounds. But that decision was overturned by EU judges last month, prompting calls for compensation not only for Tercas’ bailed in savers but also the depositors of four small Italian regional banks that were resolved with creditors’ funds in 2015 as well as those of Monte dei Pacshi, which was rescued in a similar fashion just a year later.
“The Commission is in constructive contact with Italy on the proposed measures,” the EU commissioner for financial services Valdis Dombrovskis said. Under the terms of the agreement, shareholders with annual incomes below €35,000 ($39,280) and assets worth less than €100,000 would be automatically compensated for their losses in past bank rescues, the official said.
The anti establishment 5-Star Movement, which is currently in government with La Liga, wants even softer terms to compensate unsophisticated bank customers who were allegedly missold bank shares and bonds before the banks went belly up, Reuters reports. But critics of the new agreement argue that not all those entitled to claim compensation were duped.
More important still, the ECJ’s ruling and the new agreement between the Commission and Italy’s government could have major ramifications for the way the EU treats banking rescues that happen in the future or are already under way, such as those of Italy’s Carige and Germany’s NordLB, which have both been offered state-funded guarantees.
Mid-sized regional lender Nord LB almost collapsed in 2017 as a result of the more than €20 billion of loans it had made to shipping companies, many of which went bad in the wake of the global shipping meltdown. The bank, which performed worse than any other in the European Banking Authority’s stress tests last year, had already been bailed out in 2008, only to recollapse a short while later. It was then bailed out again, including with €10 billion in loan guarantees from the German states of Hamburg and Schleswig-Holstein, which are now its largest owners.
Now, it needs even more funds to keep it afloat. But EU regulators deemed the latest planned bailout to be illegal state aid and ordered the bank to be privatized by February 2018 or be liquidated. That didn’t happen. And now, thanks to last month’s ruling, it could get all the money it needs without falling foul of regulators or causing too many blushes to Germany’s government, which loves to berate others on the evils of moral hazard and the importance of forcing reckless creditors to clean up the banks instead of putting citizens on the hook.
The new ruling and agreement could also come in handy if the tabled merger between Germany’s two largest and most dangerous lenders, Deutsche Bank and partly state-owned Commerzbank, is consummated in the coming months, with the full support of the German government. The main goal of such a merger would be to open the door to ongoing state support of the country’s two biggest financial institutions, while also making sure that no rival European banking giant gets its hands on the assets of Deutsche Bank, Germany’s one and only global systemically important bank.
Italian regulators are, if anything, even more thrilled about the shifting regulatory landscape. Salvatore Maccarone, chairman of Italy’s state-owned deposit guarantee fund, said the ruling meant the fund could in the future pump money into ailing Italian banks before they risk being wound up by European authorities — something that could happen very shortly if BlackRock’s proposed acquisition of mid-sized lender Carige falls through.
If the Commission’s recent moves are any indication, it’s unlikely to kick up a fuss about such a development. The governments of other EU Member States are also unlikely to oppose a publicly funded bank bailout in Italy since they, too, may one day hope to do the same to resolve failing banks on their own turf.
That the EU appears to be backsliding on previous commitments not to bail out banks, at least without first bailing in creditors, shouldn’t come as much of a surprise. No EU country would allow an essential bank to collapse if it threatened to take down the economy regardless of what the EU regulations say. And even the collapse of a seemingly non-essential mid-sized lender like Spain’s Banco Popular, which was taken over at the last minute by Santander in 2017, was enough to shake the foundations of Spain’s banking system.
The EU’s long-coveted banking union, begun in 2012, is still far from complete, with no sign of an EU-wide deposit guarantee or a fiscal safety net for banking resolution on the horizon. Nonetheless, regulators in Europe regularly parrot the line that European lenders now have bigger buffers of disposable capital that can be bailed in before public funds are needed. But if that is the case, why is the Commission now backtracking on the central plank of its post-crisis banking reform, the bail-in directive?
Quietly but ominously, making taxpayers, rather than bank creditors, pay for bank failures is becoming acceptable policy in Europe once again as EU bank regulation appears to be in the process of coming full circle, meaning it won’t have gone anywhere at all.