Unsecured Creditors Face Losses in EU’s Plan for Failing Banks

The European Union will seek to give regulators the power to impose writedowns on senior unsecured creditors at failing banks as part of measures to prevent taxpayers from footing the bill for saving crisis-hit lenders.

The writedown powers would apply to senior unsecured debt and derivatives, while some other claims, including secured debt and deposits that are protected by government guarantee programs, would be shielded from the losses, according to draft plans obtained by Bloomberg News. Regulators would have the so-called bail-in powers from the start of 2018.

The cost of bank funding may increase as investors take on board the plans “but this is a natural process of getting taxpayers off the hook,” John Vickers, the chairman of the U.K.’s Independent Commission on Banking, said in a speech in Brussels yesterday. “It’s not sinister that funding costs go up if it’s for that reason.”

EU Financial Services Commissioner Michel Barnier had delayed proposing the law, which was originally scheduled to be released in September 2011, because of market turbulence. The Bloomberg Europe Banks and Financial Services Index has fallen

35.8 percent in the past year on concerns lenders have been weakened by the European sovereign-debt crisis.

Any bail-in of bank debt would “be accompanied by the removal of the management responsible for the problems of the institution,” according to the draft proposals, prepared by Barnier’s staff at the European Commission. The bank would face restructuring “in a way that addresses the reasons for its failure.”

Equity Conversion

The plans, scheduled to be published on June 6, will have to be agreed on by finance ministers from the EU’s 27 member states and members of the European Parliament before they become law.

The bail-in powers must be in place across the EU by the start of 2018, the commission’s draft proposal said. As well as writing down claims, national regulators would also have the power to convert them into equity, according to the draft rules.

“In order to reassure investors and market counterparties and to minimize its impact it is necessary not to apply the bail-in tool until Jan. 1, 2018,” the commission said in the document.

Such a delay would be a mistake, Karel Lannoo, chief executive officer of the Centre for European Policy Studies, a Brussels-based research institute, said in a phone interview.

‘Right Away’

“We need a shift to this system right away,” Lannoo said. Without the powers, the EU risks further fragmentation of its banking market along national lines, he said.

Barnier has cited the state-funded break up of Fortis AG along national lines as an example of the kinds of bank rescues that should be avoided in the future, both to protect taxpayers and to preserve the principle of cross-border banking in the bloc.

Under the plans, banks with “systemic relevance” would be required to issue a minimum amount of capital instruments, subordinated debt and other claims that could be written down in a crisis.

This minimum amount should be equivalent to 10 percent of a bank’s non-equity liabilities, the document says.

According to the document, the commission has dropped plans from last year to place longer-term unsecured debt in the firing line for writedowns ahead of shorter-term claims. The commission said in March that while such a measure would aid the interbank lending market, it could also encourage banks to rely on less stable funding sources.

Stefaan De Rynck, Barnier’s spokesman, declined to immediately comment on the document.


Barnier said today that national regulators would be left with some flexibility to decide when they enact a bail-in.

Anders Borg, Sweden’s finance minister, has called for governments to retain the option to rescue banks with taxpayer money if they think that is the best way to safeguard financial stability.

The Barnier plans call on national governments to ensure that a minimum amount of money is immediately available to stabilize a crisis-hit bank. Authorities would be free to decide on the “institutional setup of such arrangements,” which would allow regulators to buy time while other steps, such as creditor writedowns, are enacted.

The funds would be raised through annual contributions by banks. Lenders could be tapped for further financing in an emergency, while governments would be obliged to lend to each other as a last resort.

Bank Deposit Guarantees

Member states could merge these requirements with existing national arrangements to guarantee bank deposits, according to the EU document.

The draft plans also state that national authorities should be prepared to pool their financial resources when a cross-border bank is on the point of failure. The preparations should include the drawing up of a “financing plan” showing how each nation would contribute.

This requirement is “far too weak,” Lannoo said, as the pooling of resources would “take weeks” to activate. A standing EU-level bank resolution fund is needed, he said.

Under EU law, governments must guarantee bank deposits of 100,000 euros ($125,000) or less. Barnier proposed in July 2010 that lenders be forced to contribute to standing national funds that would help authorities honor their obligations to depositors.

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