EU Ministers to Grapple Over Bank Creditor Loss Rules

Finance ministers will hold talks next week on proposed European Union rules for writing down failing banks’ creditors, amid splits over the status of insured depositors and the powers that should be handed to national regulators.

“The treatment of uninsured depositors remains a key issue particularly after recent events,” according to a document prepared by Ireland, which holds the rotating presidency of the EU. Options being weighed by national officials include granting these deposits a preferred status compared with other senior creditors, meaning that “in many instances,” they would not face losses.

EU leaders have set a June deadline for governments and the European Parliament to agree on the text of a bank-failure law, aimed at taking taxpayers off the hook for rescues. In the absence of such a system, nations have injected 1.7 trillion euros ($2.2 trillion) into their banking systems since the 2008 collapse of Lehman Brothers Holdings Inc., according to European Commission data.

Under the plans, unsecured creditors at a crisis-hit bank would face losses in order of seniority before recourse is made to public funds.

Ministers will also discuss whether state-guarantee systems used to protect insured depositors should be expected to contribute funds at the same time that unsecured senior creditors face writedowns, according to the document, dated May 6 and obtained by Bloomberg News.

Insured Depositors

EU law requires nations to put in place programs, known as deposit-guarantee schemes or DGS, to protect savings of as much as 100,000 euros. Depending of the final design of the EU rules, these programs may be asked to take losses in a bail-in situation, effectively standing in place of the insured depositors.

Nations are split over whether the deposit protection programs should only be tapped after other senior creditors, according to the document.

The bail-in rules may be potentially “unusable” if the protection programs aren’t granted preferred status, Ireland said in the paper.

“The low size of DGS funds compared to insured depositors balances means that the funds would not be able to cover the losses in the event of a bail-in of a large bank,” if they are tapped at the same time as senior creditors, according to the document.

‘Harmonized Approach’

National officials clashed on the design of the writedown rules at a meeting of ambassadors last week, according to a European official.

While governments including the U.K. and France argue that the writedown rules will be ineffective unless regulators have the power to adjust them according to circumstances, some other nations are concerned that this discretion could fuel uncertainty and lead to a patchwork of approaches across the 27-nation bloc.

“Many member states consider that the major drawback to the harmonized approach is the inability to deal with unforeseen events and that the absence of flexibility may result in the resolution authority avoiding or being unable to use the bail-in tool,” according to the document.

Ireland is also seeking guidance from governments on what rules should govern the use of national, bank-financed funds, which would be set up under the law to help cover costs at failing lenders.

While provisional versions of the legislation would only allow these so-called resolution funds to be tapped after creditors have been written down, “there are a small number of member states who would like a greater flexibility in the use of the resolution fund to allow it to be used for direct solvency support,” according to the document.

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