German Senior Bond Bill Puts More Debt in Line of Losses

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Germany is pushing ahead with plans to put senior creditors in line for losses when banks fail, expanding the list of eligible debt in a draft law intended to prevent public bailouts.

The German bill obtained by Bloomberg News amends the order in which creditors are served when a bank becomes insolvent, according to the document sent to Chancellor Angela Merkel’s Cabinet by Finance Minister Wolfgang Schaeuble.

In a previous draft of the legislation, only senior unsecured bonds were subordinated to other senior liabilities such as unsecured deposits and derivatives, clearing the way for writedowns in a crisis. The revised bill, dated April 21, adds Schuldschein loans, promissory notes issued privately under German law, and registered bonds to the list.

“The subordination in insolvency makes it possible for the resolution authority to bail in those debt securities ahead of others, which are pari passu under current law,” Schaeuble wrote in a letter that accompanied the bill. “The bail-in of those securities is thereby made easier.”

After the European debt crisis turned German taxpayers into bailout masters, the country is trying to make sure more parties are on the hook for losses at failing institutions. The bill is intended to facilitate European Union resolution law, which requires creditors to bear losses equivalent to 8 percent of a bank’s liabilities, including senior debt if necessary, before recourse can be made to rescue funds.

Insolvency Code

The law, which would apply retroactively to outstanding debt, would bring Germany’s insolvency code into line with the authorities’ intention to spread losses more widely. Under the EU’s Bank Recovery and Resolution Directive, the bail-in of creditors mustn’t leave them worse off than they would have been in an insolvency.

Under the existing code, stability could have been put at risk by forcing losses on large or corporate depositors or on complex instruments. Authorities could also have been discouraged from resolving banks for fear of the consequences. The law effectively introduces another layer of loss buffers for instruments that are more complicated to handle.

“To put it in a nutshell, the German law is considering a juniorizing of senior debt for financial institutions,” Elke Koenig, the head of the euro-area bank resolution fund, said in Brussels on April 27. “It could be one element to really make the BRRD not just credible, but feasible in short instance.”

‘German Solution’

The law could also help European banks to meet requirements for total loss-absorbing capacity currently under discussion at the Financial Stability Board. The FSB, which brings together regulators from the Group of 20 nations, has proposed that the world’s 30 biggest banks have subordinated debt and other loss-absorbing liabilities equivalent to as much as a fifth of their assets weighted for risk.

European banks have the largest gap to fill to meet those criteria, and the German law, if adopted in other European countries in a similar fashion, could help address that, Credit Suisse Group AG’s Wilson Ervin said in an interview.

“If the German solution comes through, and reads across to France, Italy, and Spain, you could have a pretty clean solution for much of continental Europe,” Ervin, Credit Suisse’s vice chairman of the Group Executive Office, said last week in Riga, Latvia.

Koenig warned that extending the German solution beyond the country’s borders might not be possible. “What works for one jurisdiction might not work in another with a different legal environment,” she said.

Derivatives, Deposits

The first draft of the law, released by the Finance Ministry last month, left Schuldschein loans and registered bonds, privately issued debt instruments that are popular in Germany and can’t be traded easily, on the same level as derivatives and deposits from companies or banks.

Bringing them in the line of losses along with regular senior unsecured bonds was a suggestion made by the lobby groups for Germany’s savings and cooperative banks. They rely more heavily on those instruments for their own borrowing, while they are significant owners of the bonds of other banks.

The draft law to be discussed by the government on April 29 has been agreed on by all relevant German ministries, and reflects feedback from the Bundesbank, the banking industry and the German states, Schaeuble said in his letter.

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