• Bank supervisors should coordinate across borders, study says
  • Authorities should consider if resolution is act of default

European regulators need to be transparent about how they’ll handle bank failures case-by-case for new resolution rules to work, according to a new study from a task force of big lenders and other market participants.

Now that the European Union has passed new laws on how to dismantle banks safely, regulators need to follow through with proper planning, according to the study presented by Centre for European Policy Studies, a Brussels-based EU policy think tank. If investors know what will happen for each and every bank, they are more likely to take steps that might prevent authorities from having to step in, the study said.

“There is much to be said for communicating that preferred path not only to the banking group concerned but to markets more generally,” the study said. “That will serve to put investors on notice that they will in fact be bailed in and are therefore at risk, if the bank does enter resolution.”

Under EU laws that took full effect this year, banks must create resolution plans and bondholders must face losses -- known as a bail-in -- before failing institutions can tap taxpayer-funded backstops such as the Single Resolution Mechanism. The Bank Recovery and Resolution Directive makes most categories of liabilities subject to losses, and requires that creditors not be worse off than they were if a bank were liquidated under standard procedure.

Failing Subsidiaries

Plans will need to address what happens to parent companies when their subsidiaries fail, and also what the resolution process would be for holding companies, the study said. Regulators will also have to decide if groups can limit their liability for an entity that enters resolution -- particularly if a bank only owns part of the affected firm -- and whether a holding company would only fail based on its own capital shortfalls or based on what happens to its units.

Regulators need to make clear what will happen to repurchase agreements and derivatives contracts when banks fail, the study said. If resolution is a default event, the holders of those claims might liquidate collateral immediately, which could make the rest of the wind-down process harder, it said.

“Perhaps the simplest way to overcome the barriers to resolution posed by qualified financial contracts is to exclude the entry into resolution as an event of default and to limit the right to terminate to the actual failure by the bank-in-resolution to meet a cash obligation due in full and on time,” the report said. “In any event, steps should be taken to eliminate the ability to terminate contracts at the bank level, unless there is a default at the bank level.”

The CEPS task force that wrote the report was led by EY’s Thomas Huertas and included executives from Societe Generale SA, Commerzbank AG, Intesa Sanpaolo SpA and other European banks.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE