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18 March 2014

Graham Bishop: SRM – Deal cobbled together?

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The SRM decision is coming about in a very unsatisfactory way for a matter that is said by all concerned to be crucial to the continuing stability of the euro. What is all the sound and fury actually about?

In reality, the Commission already controls bank resolution until the SRM comes into force to the extent that any state aid is involved – and that function continues. So what will actually change - in all probability - for any significant cases? The complexity of the proposal, and the rush, is a bad way to make law but it can still be done – and then the scheduled review in 2016 can sweep up any nasty failings that do crystallise in the interim. 

Bloomberg reported German Finance Minister Schäuble as saying “I can say the European Parliament has to make a lot of moves, otherwise we will not get a decision …and then we will have no regulation". Council has given the Greek Presidency some latitude in negotiations but there is little evidence yet that it has given sufficient. The pressure on the negotiators is being ratcheted up by the deadline of the Parliament’s dissolution, but several factors should be put into the equation of whether a deal should be done tomorrow:

  • The run of reports about banks raising capital, passing national stress tests, etc. continues unabated. Though the losses now being reported look daunting, the shares seem to go up afterwards so bank shareholders continue their insouciance about the risk of the 'huge losses' that seem to haunt the politicians. If shareholders are right, the risk of major resolutions is quite modest.
  • Last August, the Commission amended State aid crisis rules for banks. In principle, a bank needs to work out a restructuring plan, including a capital raising plan, which convincingly demonstrates how it will become profitable in the long term before it can receive recapitalisation measures. If the viability of the bank cannot be restored, an orderly winding down plan needs to be submitted instead. This announcement did not generate much political heat at the time but in practice is very far-reaching, as it changed instantly the ability of governments to contribute to the re-capitalisation of banks.

Normally this is a crucial element of a rescue plan so, in reality, the Commission controls bank resolution until the SRM comes into force. In fact, the Commission proposal explicitly states that “the State aid competences of the Commission will be preserved in all resolution cases involving support which qualifies as State aid". If there are any major bank resolutions in the near future, it is almost inevitable that State aid will have a role until 'bail-in’ comes into force in 2016. So the Commission will run the procedure anyway. This could deal with the Parliament’s wish to have a Union body run the resolution process. The Parliament called for this to be the ECB but the Commission formally taking the decision should be acceptable as there will be no problem of delegated powers being challenged (under the famous Meroni doctrine)

  • Finally, the proposal calls for a complete “review by 31 December 2016, and subsequently every five years thereafter, the Commission shall publish a report on the application of this Regulation, with a special emphasis on monitoring the potential impact on the smooth functioning of the internal market". Assuming the AQR does not reveal a swathe of banks that need resolution during 2015, the SRM may hardly be used except for small banks.

If the detractors of the complex procedure turn out to be right, then the SRM will be subject to a root and branch review almost immediately.  With the benefit of hindsight, a calmer approach should result in a much improved, and thus credible, mechanism. So perhaps Parliament should hold its nose and let this through tomorrow.

There are two distinct strands to the argument between Council and Parliament that make it so intractable: (i) the issue of political power between the Member States (or at least some of them, and especially Germany) and the European Parliament just ahead of elections for the next Parliament; and (ii) the sheer complexity of the mechanics to operate the system in the heat of a crisis – unless the Commission takes the lead under the ordinary procedure when state aid is involved.

The Parliament’s powers shifted once the Lisbon Treaty gave it co-decision powers with Council in 2009. It has used these powers skilfully to embed its influence as the EU responded to the crisis since then. Indeed, in his last hearing with the current ECON, ECB President Draghi paid tribute to the Committee, saying “the hearings have always been a welcome occasion to discuss the state of Economic and Monetary Union between two genuinely European institutions and to debate about what is the right way forward". But he also said “Delivering on past commitments also means keeping the promise made by Heads of States or Governments in June 2012 to complete Banking Union… It also means that a strong second pillar of Banking Union, a Single Resolution Mechanism, needs to be agreed before the end of this legislature.”

The political problem for the Parliament is the proposal that the Single Resolution Fund – the means to provide emergency funding for banks that need to be resolved – should be created by an Inter-governmental Agreement (IGA) amongst the relevant Member States rather than by a body run by the 28 Members of the European Union.  The heart of the argument is that Parliament has set its face against actions outside the EU-28 – unless absolutely necessary. ECON’s negotiating position was clear: “The EP still questions the need for an IGA and waits for its legal justifications. The Council must show that the IGA doesn't encroach upon the competences of the Union.” 

So that is not an absolute red line, but is one that should only be crossed if the legal opinions are rock solid. Without a doubt, German sceptics will appeal to their Constitutional Court if there is any chink in the analysis. That could well result in the paradoxical situation that Germany – one of the strongest proponents of Banking Union - would be unable to sign on the dotted line for the IGA. If the German Court then delivered an OMT-style judgement that passed the ball to the European Court of Justice, then the SRM might not be able to come into operation for a long time. How would that chime with ECB Executive Board member Mersch’s comment that not having the SRM “would be very close to suicide”?

The second problem that must be resolved is the sheer complexity of the decision-making process. The ECON red lines are that “the ECB must be the only authority to decide whether a bank is “failing or likely to fail... A mechanism could however be envisaged to ensure that others can effectively voice their concerns; Resolution actions concerning a specific bank should be decided only at the executive board level to avoid political power-games and ensure that banks receive equal treatment, irrespective of their country of origin. A role for the Council in decisions on a bank’s resolution must be avoided;”

This author has yet to meet any market participant who thinks the Council’s proposed structure is realistic in a crisis. On the one hand, there is the issue of the number of bodies needed to reach agreement, and thus the necessary time. That might be capable of some sort of solution. But at the heart of it all is the issue of sharing sovereignty: will Council agree to an EU system that permits “Europe” to shut down crucial national banks? Logically, the answer should be Yes, as the bank would have to be in such grave difficulties that the only alternative to resolution might be nationalisation. But that would bring in the risk that the relevant State would breach other commitments on public finances – even to the point of being sanctioned and then possibly losing access to financial markets. The ECB’s Comprehensive Analysis is designed to uncover just how big these risks are.

© Graham Bishop

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