12 November 2012

Gunnar Hökmark MEP: Europe needs better bank rules

In my proposal for the Bank Recovery and Resolution Directive, currently up for consideration in the Parliament, I have laid out the set of principles that I believe should be followed.

First, recovery and resolution need to restore the basic rule of capitalism that owners should not only be entitled to profits but also bear potential losses. That means not using public money to rescue bank owners when the authorities are trying to protect the financial system or its critical functions. Shareholders must risk losses, and failing banks must run the risk of liquidation.

Second, management of distressed banks must be designed in a way that forces creditors to scrutinise the creditworthiness of those to whom they lend. Credits should not be granted on the basis that a public backup system for rescuing failing institutions exists, but because of trust in the bank’s ability to repay its debt on commercial terms.

The Commission’s proposal states that regulatory authorities -- whether national or supranational -- should intervene and force banks that get too close to solvency and liquidity problems to change direction or management. In my report, I set out explicit rules for when authorities should be allowed to intervene in order to reduce the risk of arbitrary or premature intrusion.

I have also excluded liquidity as a trigger for intervention and instead sought to provide quantitative criteria on the basis of the EU’s future rules on capital requirements. Liquidity-related triggers could further systemic risk, as the mere expectation that an institution may end up in resolution might provoke a liquidity crisis and thus be self-fulfilling. Equally, severe liquidity problems often rapidly develop into capital problems and would then be covered anyway.

The commission has also proposed that the resolution authorities should be able to intervene when a bank is in a crisis by: forcing the institution’s sale to a third party; separating good and bad assets; setting up a bridge bank and bailing in long-term creditors, for example by converting bonds they hold to equity; or writing down the notional value of bank liabilities.

Systemic Differences

Each of these tools is relevant for the management of individual banks in crisis, but they may not be sufficient if an economic and financial crisis were to hit the banking system. So, I’ve proposed a clear distinction between what is required when an individual bank is in trouble, and what might be needed when a crisis threatens the banking system.

In the first example, it is often bad management or an inferior business model that has led to excessive risk-taking. In such cases, lost asset and collateral values will probably not be possible to restore. Public money should not be spent and the institution should be wound down.

In the case of a systemic crisis, by contrast, banks will have ended up in smaller or bigger difficulties depending on how their managements responded to challenges in the macroeconomy. In most cases external factors, such as an overall economic shock or the bursting of an asset price bubble, will have caused the banking system’s crisis.

Asset values that deteriorate and undermine collateral as a result of such a situation will probably revive as time goes on and the economy recovers. The risk of an eventual taxpayer loss associated with public intervention will therefore be smaller than in the case of a bank that fails due to its flawed business performance. At the same time, public intervention will protect the economy and prevent a deepening of the crisis.

This is why I’ve proposed the possibility for EU Member States to intervene with a blanket guarantee, capital injection or temporary public ownership of banks to ensure the maintenance of critical functions in the financial system -- provided that the shareholders of affected banks, as well as long-term debt holders to an appropriate extent, have taken the associated losses. I shall also work to ensure that national resolution funds are pre-financed, thereby contributing to stability when a crisis hits.

We can tighten the rules for the supervision and monitoring of cross-border banks and systematically important banks. This can be done by giving the European Banking Authority, which is based in London and covers all EU countries, a further mandate to monitor and follow up on the supervision that’s performed by national authorities.

Full article

Presentation to ECON-Committee

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