Finland Urges EU to Clarify Bail-In Rules After Cyprus

Bank of Finland Deputy Governor Pentti Hakkarainen is urging Europe’s policy makers to come up with a more predictable crisis-management rulebook after Cyprus’s bank creditor bail-in confused investors.

“We need good rules that are ex-ante and harmonized as widely as possible,” Hakkarainen said in an interview at his office in Helsinki on April 10. This should apply “at least in the euro area, and preferably within the European Union, so that when we do take action, everyone already knows what the order is in which creditors take part.”

As Europe’s three-year-old debt crisis claims its fifth nation, investors have watched policy makers invent rules along the way in an effort to deal with the turmoil. Losses forced on holders of Greek debt in February 2012 weren’t extended to securities held by the European Central Bank. Financial markets were left wondering again at last month’s decision to levy a tax on deposits in Cypriot banks that was later amended to leave out insured deposits.

The Cyprus bail-in of depositors with funds exceeding the EU deposit-guarantee limit of 100,000 euros ($131,000) “can’t be the template” for possible future sovereign rescues “because situations were different,” Hakkarainen said, reiterating comments by ECB President Mario Draghi.

Pecking Order

Europe is trying to break the link between banks and sovereigns after their interdependence exacerbated the region’s debt crisis. The new rules mean banks will have to amass more capital and match lending with funds raised on the market to help them withstand losses.

“There is a general perception that deposits under the deposit guarantee should have a better position,” said Hakkarainen, who bears responsibility for matters relating to financial market stability at the Bank of Finland. “Whether deposits exceeding the guarantee should have a better position than bondholders is a much harder question. Whatever the order is, it will impact markets, and that’s why everyone needs to know this as soon as possible.”

European leaders are working toward a June timetable to set minimum standards for individual deposit guarantee plans at the 27 member states. The deposit-insurance standards are on hold while the EU concentrates on parallel proposals to spell out which investors will absorb losses when a bank fails, also due in June. That’s due to be followed by plans for expanding the EU’s financial watchdogs’ toolkit with a way to wind down insolvent lenders.

Harmonized Rules

“Deposit guarantees should be further harmonized within the EU with regards to what they cover, how they’re funded and to what amount,” Hakkarainen said. “The idea at the current juncture is to harmonize national rules rather than create an EU-wide scheme.”

Michel Barnier, the EU’s financial services chief, said last night he would oppose attempts by some governments to dilute his plan to let regulators impose creditor writedowns at failing banks by 2018. Some governments have sought to give national authorities flexibility to decide which bank creditors should face forced losses in a crisis.

“We need to have one set of common, predictable rules,” Barnier said in prepared remarks for a speech in Dublin last night. “Authorities need some flexibility. But national discretion must be limited and properly framed.”

The ECB will encompass a joint mechanism to supervise the roughly 6,000 banks in 17 euro members to ensure adequate oversight for cross-border operations. The Basel Committee on Banking Supervision also requires that banks amass higher risk buffers and match lending and borrowing maturities more closely.

Quick Decisions

“It’s extremely important to create a resolution mechanism for financial institutions that allows quick decision-making,” Hakkarainen said. “The normal bankruptcy or reorganization proceedings aren’t suitable to financial institutions.” The Federal Deposit Insurance Corporation, which insures deposits and winds down failing banks in the U.S., is an example of what is needed in Europe, he said.

The EU shouldn’t rush this matter, Swedish Finance Minister Anders Borg told reporters in Dublin today. The plan needs to be designed carefully so that it doesn’t create “moral hazard,” he said.

Political Decision

“While we’re in the resolution and bail-in phase, it has to be done by civil servants,” Hakkarainen said. “It shouldn’t become political. If public funds need to be used for propping up a bank that would otherwise fail, that needs to be a political decision.”

European Commission data show the bloc’s governments have injected 1.7 trillion euros into their banking systems since 2008 as the fates of nations depended on the survival of their financial industries.

“The better the mechanism is designed, the smaller the bailout need becomes,” Hakkarainen said. “Adequate risk buffers and adequate amounts of bail-in-able items. The financial crisis taught us that that’s needed.”

In the future, he said, “resolution and bail-in in the industry should be the rule, bailout the rare exception.”

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