EU Wants Bank Failure to Look the Same From Germany to Malta

  • Mock says German, French, Italian laws may create distortions
  • Commission considering whether an EU approach makes sense

The European Union is pushing to unify rules for imposing losses on the bondholders of failing banks, as the divergent insolvency laws adopted by member states could distort markets and make it harder to keep taxpayers off the hook.

The European Commission, the EU’s executive arm, plans to meet with national experts on Thursday to discuss how to adapt EU laws to make sure creditors share the cost of bank failures in the same way across the 28-nation bloc.

Germany, France and Italy have recently put in place laws on the ranking of creditors “and these are quite different from each other,” commission spokeswoman Vanessa Mock said by e-mail. “This could create competitive distortions in the single market and complicate the execution of the bail-in tool, in particular for cross-border banks.”

The Group of 20 nations last year approved a minimum total loss-absorbing capacity, or TLAC, requirement for the world’s biggest lenders with the goal of allowing them to fail in an orderly fashion and without recourse to public funds. The TLAC rules require global banking giants to issue ordinary shares, subordinated debt and other potentially loss-absorbing securities equivalent to 18 percent of risk-weighted assets and 6.75 percent of leverage exposure by 2022.

Different Approaches

As the EU is debating how to incorporate TLAC, which will be phased in from 2019, into its own bank-failure rules, Germany, Italy and France have chosen different approaches to make sure securities available for “bail-in” are subordinated to liabilities that should remain intact.

Germany’s law subordinates plain-vanilla senior unsecured debt to deposits, derivatives and structured notes to make it TLAC-eligible, and it applies retroactively, making a pool of liabilities available in January, when the rule kicks in.

The German model has been praised for its simplicity by banks and investors, but the commission says it may drive up banks’ funding costs and provide few options for them to fine-tune the liability structure. German banks’ bond spreads widened by 30 basis points after the bill was published, according to a commission discussion paper prepared for a June 23 meeting of national experts and obtained by Bloomberg.

‘Senior Unpreferred’

France created a new class of “senior unpreferred” debt earmarked to play that role. Italy chose an approach similar to Germany’s, but it left liabilities other than deposits on the same level as senior unsecured bonds in the insolvency ranking.

“Commission services are considering whether an EU approach to this issue makes sense and are seeking the views of experts with a view of elaborating a harmonized approach on the ranking of bondholders in the creditors’ hierarchy in case of bank insolvency and resolution,” Mock said.

U.K. and Swiss banks are relying on so-called structural subordination, which works by way of a holding company that would absorb the losses if necessary, and didn’t adapt laws.

Under a common approach, other forms of subordination, such as “structural subordination where bail-in is made operational through a particular holding structure,” should “continue to exist and still be considered appropriate to meet the subordination requirement,” the document states.

The document “cannot be understood as representing the European Commission’s position on these issues and does not bind the Commission in any way,” according to a disclaimer. The Financial Times reported previously on the paper.

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