Keynote speech by Anneli Tuominen, Member of the Supervisory Board of the ECB, at the SRB-ECB CMDI Seminar
Brussels, 16 October 2023
Thank you to the Single Resolution Board (SRB) for hosting this important event here in Brussels. I am very happy to be presenting at today’s joint ECB-SRB seminar and grateful that you could all join us. I look forward to today’s discussions.
Let me start by stressing the significance – both for the ECB and for the banking union as a whole – of the current review of the EU’s crisis management and deposit insurance (CMDI) framework. Indeed, the market turmoil following events in the United States and Switzerland this spring served as another reminder of the importance of having a proper crisis management framework in place. Within the banking union, we have already made substantial progress on crisis management. At the same time, we have learnt valuable lessons from the experience of the past decade, standing us in good stead to further improve the framework. And time is of the essence at this critical phase of the legislative process, especially with the end of the legislative tenure fast approaching.
I will now highlight some relevant supervisory aspects of the European Commission’s CMDI package, which seeks to make improvements across all the different stages of the CMDI framework, including pre-resolution. I will then focus on how deposit guarantee schemes (DGSs) could provide a wider range of crisis management options to address possible or actual failures of banks of all sizes in a more cost-efficient way.
The role of supervisors in crisis management
As the European banking supervisor, the ECB plays a central role in crisis management within the European banking system, working closely with all relevant stakeholders, including the SRB, the Commission and the national supervisory and resolution authorities.
As part of our ongoing supervision, we assess banks’ recovery plans, which serve as an important crisis prevention tool. When a bank does not meet or is unlikely to meet its supervisory requirements, we are also empowered to take supervisory and early intervention measures aimed at keeping it viable and preserving financial stability.
In that regard, we welcome the Commission’s proposal to enhance the early intervention framework, which is an important step towards addressing the practical challenges that we have faced in applying it.
There are three main problems with the early intervention framework as it currently stands. The Commission’s proposal provides adequate solutions to these problems. First, the proposal removes the overlap between early intervention measures and other supervisory measures and generally aligns the conditions for applying them, both of which are very welcome changes. Second, it includes the power to adopt all early intervention measures under a single provision, subject to the same conditions, without including an escalation ladder. This removes the sequencing problem that we face under the current regime. Third, the proposal provides a direct legal basis for the ECB’s exercise of early intervention measures.
These changes will help us to swiftly adopt the necessary and most appropriate measure for any given situation, and therefore we wholeheartedly support them.
The CMDI package also improves the framework for collaboration and exchange of information between supervisors and resolution authorities. As you probably know, the ECB and the SRB already cooperate very closely and exchange information based on a bilateral Memorandum of Understanding (MoU). So it will come as no surprise that the ECB supports the proposals to further enhance cooperation and information exchange between supervisory and resolution authorities and to provide for this closer cooperation directly in the legislation.
The draft text also includes the proposal for a new “early warning” procedure, which would be activated when supervisors see a material risk that one or more of the conditions for an institution to be considered failing or likely to fail would be met. In such cases, our close cooperation would become even closer. Importantly, the new procedure will stimulate further dialogue about alternative solutions and their potential impact on the SRB’s resolution preparations. The CMDI proposal strikes the right balance here. Indeed, as noted by the Commission, it is important that this new early warning process does not affect the well-established resolution procedure. Moreover, to maintain the necessary supervisory flexibility, the process should not become a precondition for a bank to be assessed as failing or likely to fail. For example, in fast-evolving crises, we may have to jump straight to such an assessment without first being able to issue an early warning – but you can be sure that we will involve the SRB, and other stakeholders, immediately in such situations. That much is very clear from our bilateral MoU.
Ensuring optionality in crisis situations
Let me now move to my next point: the need to ensure optionality in crisis situations.
Crisis management needs to be understood as a continuum. As part of our day-to-day supervision, we help banks strengthen their resilience to all kinds of risk. However, the specific circumstances leading to difficulties may still be unexpected, for example with respect to a bank’s capital and/or liquidity position – as was the case with Sberbank, which suffered a deterioration in its liquidity position as a result of the reputational impact of geopolitical tensions. From a banking supervision perspective, it is indispensable to have a broad toolkit and a certain degree of flexibility in such situations, ideally within a fully harmonised crisis management framework. Equally, it is important to have confidence that there are sufficient options to handle the situations of banks in distressed conditions, even those assessed as failing, swiftly and effectively.
Although the EU’s crisis management framework is well established, experience has shown that improvements need to be made, particularly with regard to medium-sized banks. It can be very difficult to apply resolution tools to some of these banks – especially those that are primarily financed with deposits – without causing losses for deposits that are not protected by a DGS. Imposing such losses on deposits can cause contagion effects and affect financial stability, exacerbating the risk of broader bank runs. In turn, this may lead to serious adverse effects on the real economy. Such effects should be considered on a case-by-case basis, having regard to the specific details of the crisis situation, before deciding how to address it.
In this context, stakeholders other than the supervisory and resolution authorities can and will have to play an important role in crisis management. The CMDI proposal therefore further calibrates some of the existing tools of different stakeholders, including preventive and alternative measures of DGSs and the possibility of precautionary recapitalisations. In line with our stance on ensuring adequate optionality for decision-makers in crisis management, we welcome the fact that these other tools are retained and further elaborated in the Commission’s proposal. Having more options may open the door to cheaper solutions and thus a more efficient use of limited resources.
Before going into more detail on the role of DGSs in crisis management, I would like to say a few words on precautionary recapitalisation. We consider precautionary recapitalisation to be an exceptional but useful tool within the current crisis management framework, albeit one reserved for extraordinary circumstances. It is – and should remain – subject to strict conditions. Past experience and the limited use of the instrument thus far indeed indicate that the current conditionality is appropriate. We therefore welcome the clarifications included in the Commission’s proposal that support a quick and effective implementation of the tool in very exceptional cases. At the same time, the ability of the relevant authorities to take the specific circumstances of each case into account should not be further constrained. For example, setting a fixed timeline for an exit strategy and linking possible delays to an automatic assessment of failing or likely to fail may limit the scope for taking into account unexpected developments.
Let me now focus on another aspect of ensuring optionality, which is the use of DGSs. We can all agree that DGSs are essential to mitigate the risk of bank runs and are thus also key for ensuring financial stability. In some countries, their role is narrowly circumscribed to being that of a paybox with the sole ability to compensate covered deposits through ex ante payouts and then collect the proceeds during insolvency. But there may be other ways in which they can help to achieve financial stability objectives and avoid bank-runs than through this liquidity intensive paybox function.
In fact, in its 2021 annual survey the International Association of Deposit Insurers reported that 80% of its member DGSs had the power to use their funds for purposes other than payouts. The international trend points towards a growing role for DGSs, going beyond a mere paybox function. Many countries – including outside Europe – have found it worthwhile to be more flexible when it comes to the role of their DGSs.
Aside from their payout function, DGSs can be enabled to act at various stages along the crisis management continuum. They can broaden optionality pre-resolution, by expanding the toolkit available to prevent a crisis, in the form of what is called “DGS preventive measures”. They can also broaden optionality in liquidation – which are dubbed “DGS alternative measures”. Finally, they can further enhance the operationalisation of resolution tools, by which we mean the role DGSs can play in helping to fund resolution actions, in particular for transfer strategies.
I will now zoom in on those three areas, starting with DGS preventive measures, before moving on to DGS alternative measures in insolvency and concluding with transfer strategies in resolution.
DGS preventive measures
DGS preventive measures can be a useful crisis prevention tool. They can help banks to ensure or restore compliance with the prudential requirements in going concern situations. However, financing such measures could mean another burden on the DGS and might be perceived as a rescue measure, thereby undermining market discipline. The proposed legislative package seeks to put in place adequate safeguards to ensure that the use of these measures is adequately safeguarded, and timely, so neither too late nor too early. There are also safeguards to ensure that these measures are cost-effective and applied consistently across Member States. However, under the proposal, using DGSs to finance preventive interventions is still just an option for Member States. Although we fully acknowledge the related challenges, we encourage legislators to further harmonisation and ensure a level playing field by making these preventive measures available across the EU.
DGS alternative measures
The second area concerns DGS alternative measures. Even with a broader scope of resolution, a significant number of smaller banks are likely to remain outside the scope of resolution. Applying the resolution framework to these banks would simply not be proportionate. In these cases, DGS alternative measures can be a useful tool in liquidation, as they may facilitate transfers of assets and liabilities to an acquiring bank.
Let me briefly explain why such transfers can be such a useful option in the toolkit and why they are being used extensively in key non-EU countries. First, they can improve value recovery, which is a critical objective when dealing with a failing bank. Second, they can reduce strains on DGS liquidity by avoiding payouts. Third, they can improve depositor protection by preserving the uninterrupted access of depositors to their funds and by often allowing to broaden the scope of depositor protection beyond covered deposits. This is becoming more and more important as depositors turn to digital means of payment instead of cash. Finally, by making it possible to address bank failures in a much less disruptive way, they support financial stability and minimise the need for government support.
I would like focus on the first two points in a little more detail.
Why are transfers often better able to preserve value? Some seem to think that a quick transfer is basically a fire-sale. That is a misconception. In the US system, a transfer is typically the result of weeks of due diligence by the acquiring bank, which can then benefit from the franchise value of the failed bank, its customer relationships, its staff and its deposit base. Transferring the whole bank also minimises administrative costs by avoiding a drawn-out liquidation process. This was the case with Banco Popular: according to Deloitte’s Valuation 3 report, had the bank been liquidated, the losses for shareholders and creditors would have been two to three times higher than they were after the transfer in resolution.
By avoiding a payout, alternative measures can also limit liquidity strains on DGSs. Payouts can be a heavy burden for DGSs, even in the case of smaller banks. As a recent ECB Occasional Paper shows, in each Member State in the banking union there is at least one less significant bank that could deplete its fully filled DGS with a single payout. In most Member States there are several. In normal times, DGSs can obviously refund themselves, but this comes at a cost. In periods of systemic stress, several smaller banks may fail in one country, subjecting the DGS to greater liquidity stress at a time when refunding could be more expensive.
Some countries counter this by citing their positive experience of quickly recouping DGS funds. But we should be mindful that, even in a best-case scenario where a DGS is fully repaid within a few years, the actual payout ties up significant resources, and at a considerable cost, especially in an environment of higher interest rates like the one we are currently facing. There are significant opportunity costs associated with payouts. Simply put, in crisis management, time is money. And transfer strategies, by virtue of being a lot more time-efficient than payouts, can entail significant savings.
So, alternative measures can serve to contain DGSs’ upfront outlays, administrative costs and the loss of asset value caused by the winding-up process. They can improve depositor protection and help to safeguard financial stability. We therefore think it would be useful to make DGS alternative measures in liquidation available across all Member States in a harmonised way.
Role of DGSs in resolution funding
The third area where DGSs can play a valuable role is in helping to provide funding in resolution. As the Chair of the Supervisory Board, Andrea Enria, said earlier, ensuring adequate funding in resolution is an important precondition for the proposed expansion of resolution to medium-sized banks.
We welcome that the CMDI proposal facilitates an enhanced application of transfer tools in resolution, supported by DGS interventions where needed. The contribution from the DGS will count towards the minimum loss absorption requirement to access the Single Resolution Fund (SRF), namely 8% of total liabilities and own funds (TLOF). This DGS bridge mechanism will thus ensure that a larger number of medium-sized banks can potentially access the SRF. We also welcome that the proposed legislative package includes options for the DGS – in the context of the bridge mechanism – to protect non-covered depositors when needed.
However, the DGS bridge comes with a lot of strings attached – which we fully support. To use an analogy, think of it as a narrow footbridge with selective entry criteria rather than a Golden Gate-style road bridge accessible to all. You would only walk the footbridge if there was no way to avoid it. The DGS bridge is limited to banks earmarked for resolution, to transfer strategies leading to market exit, and to the amount necessary to meet the 8% TLOF requirement to access the SRF.
This conditionality is crucial, as it means that any possible DGS support only forms a second line of defence and, importantly, will always lead the failing bank to exit the market. The cardinal principle that losses in a credit institution failure should be borne first and foremost by shareholders and creditors also applies in these cases, and rightly so. Banks earmarked for resolution will be required to have a minimum loss absorption capacity as a first line of defence, adequately calibrated in line with the resolution strategy, thereby ensuring market discipline and minimising reliance on external funding sources. This is an important safeguard. In addition, resolution authorities will continuously assess banks’ resolvability and their compliance with the minimum requirement for own funds and eligible liabilities (MREL). The new MREL disclosure requirements will also help to support market discipline and MREL compliance.
For non-covered deposits, resolution authorities must also demonstrate that the reasons for their protection are met. Therefore, it will not be automatic – these new DGS interventions will only be possible if the protection of non-covered deposits is fully justified.
Of course, the ECB is aware of the concerns expressed about a greater recourse to DGS funds. These concerns are understandable, especially as the fundamental role of a DGS is to prevent bank runs and support financial stability. However, we also need to be mindful of the important benefits that a transfer strategy can bring in this regard. And we should not forget that the Commission’s proposal includes a range of safeguards.
One key safeguard is the least-cost test. The amount of DGS contributions in resolution and in preventive and alternative measures is always limited by this least cost test. It compares the cost of a DGS intervention to prevent a bank’s financial situation deteriorating further or the cost to the DGS of transferring business to another bank with the hypothetical cost of paying out covered deposits in the event of liquidation. We welcome the intention to further harmonise this least-cost test. In terms of governance, the DGS remains responsible for performing the least-cost test and assessing the possible DGS resources, which are also capped by the amount of covered deposits held at the respective credit institution.
We also welcome that the European Banking Authority will be mandated to develop draft regulatory technical standards specifying the methodology for the least-cost test calculation. The methodology for calculating costs will be a sensitive topic and an important factor influencing the scope of DGS funding available for non-payout measures. According to a study by the Bank for International Settlements, the elements taken into account when calculating the cost of a payout vary significantly across jurisdictions.
The creditor hierarchy is another key factor in estimating the cost of a DGS payout and thus the outcome of the least-cost test and the DGS funds available. The higher the DGS’s claims rank in the creditor hierarchy, the less likely it is that the least-cost test will allow for preventive or alternative DGS measures or a DGS contribution in resolution. The current super-preferred ranking of DGS claims greatly limits the availability of DGS funds for measures other than payouts in Europe. Therefore, the Commission’s CMDI proposal seeks to introduce a single-tier depositor preference, meaning that all deposits rank pari passu and above ordinary unsecured claims.
In addition to improved access to DGS funding and measures, the proposal will also further harmonise the creditor hierarchy across the EU. Sebastiano Laviola, SRB Board Member, will shortly be presenting an analysis by the SRB of the different benefits and implications of the proposal. But it is important to keep in mind that the single-tier depositor preference and the DGS bridge are closely interdependent. In short, without changes to the creditor hierarchy, the DGS bridge risks becoming a bridge to nowhere.
To conclude, this review is an important opportunity to further enhance the existing EU crisis management framework using the lessons learnt during the first years of its application.
Changes envisaged during the legislative process need to consider that the key elements of the Commission’s proposal together form a cohesive whole. Any changes should not alter the existing balance. They should enable the more efficient use of the existing industry funded safety nets like the SRF and national DGSs in order to further support financial stability, enhance depositor protection and to foster optionality in crisis management.
A swift legislative process is of the essence, as the CMDI package is a crucial intermediate step towards a more resilient and more integrated European banking sector, ultimately benefitting the European citizens. I therefore greatly appreciate the incredibly strong support and commitment shown by all legislative bodies for an enhanced CMDI framework.
International Association of Deposit Insurers (2022), 2021/2022 Annual Report, October.
Deloitte (2018), “Valuation of difference in treatment – Banco Popular Español”, SRB, August.
Eule, J., Kastelein, W. and Sala, E. (2022), “Protecting depositors and saving money – why deposit guarantee schemes in the EU should be able to support transfers of assets and liabilities when a bank fails”, Occasional Paper Series, No 308, ECB, Frankfurt am Main (revised June 2023).
Costa, N., Van Roosebeke, B., Vrbaski, R. and Walters, R. (2022), “Counting the cost of payout: constraints for deposit insurers in funding bank failure management”, FSI Insights, No 45, Bank for International Settlements, July.