Germany’s plans to put senior creditors in line for losses when banks fail would disqualify some of their debt from being used as collateral at the European Central Bank, adding to pressure on lawmakers to consider tweaks of the draft law.

Germany plans to subordinate senior unsecured bonds to currently equal-ranking liabilities, such as unsecured deposits and derivatives, to make it easier to share the costs of bank failures with creditors. That goal would be achieved with the draft law discussed by the parliament in Berlin, the ECB said in a legal opinion on the bill published Tuesday, but only at the price of senior bonds’ eligibility for its monetary-policy operations.

“The ECB notes that the proposed statutory subordination of certain senior unsecured debt instruments of credit institutions to other senior debt of those institutions is expected to facilitate resolution action,” said the ECB. “Bank debt instruments subject to a statutory subordination of the kind proposed in the draft law would currently no longer be eligible as collateral for Eurosystem credit operations.”

Germany is taking part in a global effort to ensure that future bank rescues aren’t funded by taxpayers, after a string of government bailouts during the financial crisis raised voters’ ire. The bill before German lawmakers, which helps implement EU law on the resolution of lenders, aims to make that possible by amending the order in which creditors take losses when a bank becomes insolvent.

Subordination Concerns

That law would clear the way for writedowns in a crisis and immediately create a stock of debt that can share losses, as it would apply to outstanding debts, not just newly issued ones.

The current draft also subordinates so-called Schuldschein loans -- promissory notes issued privately under German law -- as well as registered bonds, to the senior liabilities that are more likely to cause contagion.

The ECB’s comments confirm concerns by some German regional public-sector banks, or Landesbanken, who’ve warned before that the law’s approach puts collateral eligibility at risk. To assuage them, a possible tweak to that bill has been proposed by the Finance Ministry in Berlin.

The amendment would remove the language on subordination while retaining their place in a revised insolvency ranking between subordinated and operative debt, according to a draft ministry document seen by Bloomberg.

The rephrasing “makes clear that the relevant debt securities aren’t part of the subordinated debt,” the Finance Ministry document states. “It doesn’t entail a change in substance of the relative rankings.”

The changes will be discussed by lawmakers in the governing coalition this week.

Landesbanken Exposure

The Landesbanken, owned by Germany’s regional governments and savings banks, rely on significant amounts of senior bank debt to obtain ECB liquidity when needed, according to the German Savings Banks Association, DSGV. The state banks are critical to channeling loans to small and medium-sized companies.

Overall, the ECB said the German law achieves its goal of easing the bail-in of creditors. The German bill is intended to accommodate EU 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.

While Germany already implemented the law last year, the new bill would remove inconsistencies with the country’s insolvency code, the Finance Ministry has said.

The ECB also said the bill should facilitate German banks’ implementation of the Financial Stability Board’s proposed rules on total loss-absorbing capacity, or TLAC.

Still, the EU should find a “common framework” on the degree of senior bond subordination, to “avoid fragmentation of the market within the Union market for these instruments and to avoid complicating the tasks of the ECB both with regard to monetary policy and to supervision within the SSM,” the legal opinion said.