EU’s Bank Resolution Plan Questioned as Denmark Joins Doubters

As Italy argues with Germany over a plan to provide support to its struggling banks, the first country in the European Union to rule out government bailouts says its experience suggests balance sheets should be repaired before aid is pulled.

“If one could do it differently, it would have been smarter to have implemented the bail-in rules after you had cleaned up the non-performing loans,” said Jesper Berg, director general of Denmark’s Financial Supervisory Authority.

Italy’s banks are saddled with some 360 billion euros ($400 billion) in soured loans and a flailing economy. This week, their shares got hammered after the U.K.’s vote to secede from the bloc. Now, Prime Minister Matteo Renzi is considering efforts to recapitalize struggling banks, putting the country at loggerheads with Germany.

Denmark prohibited such measures in 2010, after the government was forced over a three-year period starting in 2008 to take over six banks and one subsidiary. The country’s resolution agency continues to seek buyers for the assets put under its control.

German Chancellor Angela Merkel insisted earlier this week that all EU countries must abide by the Bank Recovery and Resolution Directive. It was designed after the financial crisis to prevent taxpayer bailouts and took full effect this year. That means investors and some depositors must take losses before state aid can be given.

Renzi, who’s faulted his predecessor for failing to involve the government in overhauling banks while it was still allowed under EU rules, shot back on Wednesday, saying Italy will respect EU rules and didn’t need “a lesson by the school teacher.”

That tempers are flaring is understandable, Berg said. “These countries are in a very difficult spot,” caught between complying with BRRD and limitations on state aid on the one hand and “the general population’s lack of understanding of the risks in bank claims as well as the stability of the financial system.”

Denmark executed its first bail-in more than 20 years ago, when a banking crisis led to losses among Tier 2 debt holders. But until 2010, senior unsecured debt holders had been protected. A year after Denmark pioneered the bail-in law, Amagerbanken A/S became Europe’s first lender to test it, with senior bondholders and some depositors suffering losses.

The move earned the Nordic country international renown. But the cost was high: ratings companies downgraded banks, leaving them pariahs cut off from capital markets. Lawmakers moved to stem the damage, offering banks incentives to take over failing rivals. Ultimately only one other bank was subjected to the bail-in law.

“There are countries in the EU who at present are discovering that this is not a walk in the park,” Berg said. “The one really important lesson is that we have a gigantic communication problem to make people aware that the risks are now in their private pockets, not their pocket as a taxpayer. That message cannot be under-communicated.”

Italy has been sounding out other countries and the European Commission, the bloc’s executive arm, on a plan to inject as much as 40 billion euros into banks, according to a person with knowledge of the planning.

“The lesson we can offer is that, to the extent one can build buffers into the system, to avoid getting into the situation, that is the much preferable route. Lesson two: be aware of state aid rules,” Berg said. “It has taken us 20 years and two crises to get to where we are in terms of public acceptance of these things. It’s a long ride.”

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