Keynote speech by Anneli Tuominen, Member of the Supervisory Board of the ECB, at the 22nd European Banking Institute Policy Series
I am delighted to be speaking at today’s EBI Policy Series on crisis management and deposit insurance (CMDI).
The Chair of the Single Resolution Board (SRB), Dominique Laboureix, has just told us why we need the crisis management reform. Let me now give you the ECB’s perspective on the significance of the current review of the CMDI framework. Implementing the CMDI proposal will increase the EU banking sector’s resilience and make crisis management in the EU more efficient. Improving resilience will reduce the risk that a bank failure leads to contagion. The CMDI proposal aims to improve the way we resolve crisis situations at mid-sized banks. But let’s not forget that this is a coherent package which hinges on having adequate funding in resolution. I will come back to this issue later. In brief, our key objective is to maintain stability; we should not fall back on taxpayers’ funds or let contagion spread across the financial markets.
I will first look at some of the most relevant changes to the pre-resolution phase set out in the European Commission’s CMDI package. I will then focus on how the package will ensure optionality to the crisis management toolkit. Finally, I will discuss the crucial point of resolution funding, and conclude by recalling the elements that are still missing in the EU’s crisis management framework.
I am also looking forward to our panel discussion when we will hear views − from a broad range of perspectives − on the reform of the EU’s CMDI framework.
Pre-resolution phase
We welcome the Commission’s proposal to enhance the existing early intervention framework. The proposed changes will help us to swiftly adopt the necessary and most appropriate measure for any given situation. In particular, the proposal removes the overlap between early intervention and other supervisory measures and generally aligns the conditions for applying them. In addition, it gives 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 we have to deal with under the current regime. Finally, the proposal provides a direct legal basis for the ECB’s use of early intervention measures.
Besides the improvements in the early intervention framework, the Commission’s proposal includes changes that will further deepen the cooperation between supervisory and resolution authorities. It goes without saying that good cooperation and communication are vital, for example when we need to act fast to prevent or address crisis situations. The ECB and the SRB already closely cooperate based on a bilateral Memorandum of Understanding. We therefore support the proposals to further enhance cooperation and information exchange between the supervisory authority and the resolution authority in the legislation.
Under the proposal, a new early warning procedure would be activated if supervisors see a material risk of one or more of the conditions for a bank to be considered failing or likely to fail being met. In practice, the supervisory authority and the resolution authority would exchange views on measures that could prevent the bank from failing and discuss their potential impact on the preparation for resolution. The authorities could then closely assess the emergence of a crisis situation and react in the most appropriate way.
At the same time, the Commission’s proposal rightly ensures that this new process would neither affect the well-established existing resolution procedure nor become a precondition for a bank to be assessed as failing or likely to fail. For example, in a fast-moving crisis − if the situation is severe and there are no measures that could prevent failure − we may have to immediately make a failing or likely to fail assessment. Imagine for instance a bank which becomes subject to sanctions and sees all its third-party providers walk away, thus effectively freezing its capacity to operate. In such situations, we should be able to act fast and declare the bank failing or likely to fail.
Optionality in crisis management
Our experience has shown that some shortcomings in the current crisis management framework need to be addressed.
From a supervisory perspective, we consider it very important to have a robust toolkit that ensures optionality to deal effectively with banks in distressed conditions. What do I mean with optionality? At every point in time the relevant authorities should be able to choose the most appropriate tool for the situation at hand amongst a range of tools and be able to effectively make use of that tool. We are glad that the Commission’s proposal ensures that the various stakeholders involved in crisis management keep the tools that are available to them today, and we would even support their further harmonisation.
Let me now look at some of these important tools.
First, the precautionary recapitalisation tool. The Commission’s proposal maintains this tool, and it rightly remains subject to strict conditions. Hence, it would continue to be used only in extraordinary circumstances. The Commission’s proposal includes clarifications that support the tool being deployed effectively. This matches our experience thus far. Though exceptional, the precautionary recapitalisation tool is useful within the current crisis management framework and its current conditionality appears appropriate. At the same time, the discretion provided to relevant authorities to take specific circumstances into account should not be constrained. In this regard, we are concerned about some ideas out there that would constrain the recourse to what is already a very exceptional – but useful - safety valve. For example, we consider the proposed definition of solvency too stringent. An institution or entity receiving such support should be solvent at the time the measures are applied. According to the Commission’s proposal it needs to be assessed by the competent authority as not being in breach and not likely to breach the applicable capital requirements in the next 12 months. We would prefer providing the competent authority with a little more flexibility and allow us to deem an entity solvent also where we determine that a breach of these requirements is temporary in nature. Such flexibility would allow us to consider the specific circumstances of each case.
Second, other tools build on the use of deposit guarantee schemes (DGSs), such as DGS preventive measure and DGS alternative measures.
In some countries, DGSs solely compensate covered deposits through ex ante payouts and then collect the proceeds during insolvency. However, the international trend points towards a growing role for DGSs going beyond this “paybox” function.[1] Instead of simply paying out covered depositors, this entails using the DGS funds to facilitate transfers of assets and liabilities to an acquiring bank. In the EU, we refer to this as DGS alternative measures. We see merit in such measures, as they can serve to contain upfront outlays from DGSs, administrative costs and the loss of asset value caused by the liquidation process. Moreover, they can improve depositor protection and help to safeguard financial stability. Therefore, making DGS alternative measures available across all Member States in a harmonised way would be very useful from our perspective. These measures may be particularly relevant for smaller banks. These banks would still not fall inside the broader net of resolution, as applying the resolution framework to these banks would not be proportionate.
Still on the subject of DGS tools, allow me to have another look at the pre-resolution phase and also mention DGS preventive measures. These can be used to broaden optionality at the pre-resolution phase, by helping banks to ensure or restore compliance with the prudential requirements in going concern situations. I understand that using DGSs to finance preventive measures could be perceived as a rescue measure, thereby undermining market discipline. In this respect, I would like to point out that the Commission’s proposal seeks to put in place adequate safeguards, for example to ensure that these measures are used in a timely and cost-effective manner and applied consistently across Member States. We encourage legislators to further harmonisation and ensure a level playing field by making these preventive measures available across the EU.
Resolution funding and the role of the DGSs
Now I come to my third topic for today, which relates to the strengthening of funding options in the event of resolution. DGSs can also play an important role in achieving this goal.
Of course, shareholders and creditors would still remain the first line of defence, but the CMDI proposal facilitates an enhanced application of transfer tools in resolution, supported by DGS interventions, where needed. The contribution from DGSs could be used to bridge the gap towards the 8% threshold of total liabilities and own funds for accessing the Single Resolution Fund (SRF). This mechanism will ensure that also smaller and more medium-sized banks can potentially access the SRF. The Commission’s proposal also includes the possibility for the DGSs to protect non-covered depositors, when needed. Resolution authorities should demonstrate that the reasons for their protection have been 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.
We welcome the fact that using the DGS to bridge gaps that might exist is subject to strict conditionality. It means that any DGS support would only form a second line of defence and, importantly, will always result in the failing bank exiting the market.
As I mentioned before, the ECB is aware of the concerns expressed regarding greater recourse to DGS funds, and the SRF. These concerns are understandable. But at the same time, we need keep in mind the important benefits a transfer strategy can offer and the many safeguards that have been included in the CMDI proposal.
In this context, we also welcome the intention to further harmonise the least-cost test. This test limits the amount of DGS contributions that can be used in the event of resolution and for preventive and alternative measures. 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.
Another important element to be taken into consideration is the creditor hierarchy. The higher the DGS’s claims rank in the creditor hierarchy, the less likely it will be that the least-cost test will allow for DGS preventive or alternative measures to be taken or a DGS contribution to be made in the event of resolution. The current “super-preferred” ranking of DGS claims greatly limits the availability of DGS funds for measures other than payouts. The CMDI proposal includes a single-tier depositor preference, meaning that all deposits are ranked pari passu and above ordinary unsecured claims. It seeks to ensure greater harmonisation of the creditor hierarchy across the Union and simultaneously improve access to DGS funding.
The proposal for a single-tier depositor preference has raised concerns and questions from various corners. In our ECB Opinion, we acknowledged these concerns and pointed at areas where further analysis could be warranted. We also signalled that alternatives could be explored – and consideration is indeed now being given to a two-tier hierarchy. But one thing should be very clear. If you move away from a single-tier depositor preference, then automatically also the ability of the DGS to contribute to crisis management measures declines. That is why we – in our opinion – stressed that any alternatives should also ensure that as much funding is available under such scenarios as would be possible with a single-tier depositor preference.
Conclusion
I would like to conclude by saying that we very much welcome the European Commission’s proposal. It contains very useful steps to improve the framework to both prevent and manage bank crises.
One thing that we deem crucial is to ensure “optionality”. In other words, policymakers should have at their disposal a solid toolkit with several tools. And they should be able to choose the most appropriate tool and have access to adequate funding to be able to use those tools. And for the latter the capacity to actually make use of the existing safety nets – SRF and DGSs – is obviously crucial.
When looking at the legislative discussions, I fear that this aspect of optionality is not always given the degree of attention that it deserves. Some want to make it more difficult for the relevant authorities to use certain tools. In the same vein, the question of ensuring adequate funding is also not always given due consideration. For instance, while I understand the concerns about the proposed creditor hierarchy, we should be very mindful of the impact a different hierarchy will have on the availability of funding.
The risk is that we end up with a sort of “capability-expectations gap”. With the banking union, the legislators have created the expectations and the ambition that the relevant authorities – including the SRB - will be able to resolve banks in an efficient harmonised way, without recourse to taxpayers. However, their capability to actually do this may fall short if these authorities are not given the adequate tools and adequate funding in resolution.
If I may use an analogy, it is a bit like setting up a new surgery unit in a hospital, but at same time not giving the surgeons the right tools and forcing them to do their operations in a straight-jacket. Obviously, the public health outcome would not be great.
Lastly, we should bear in mind that the CMDI proposal does not address some of the core elements of the broader crisis management architecture. The third pillar of the banking union, a European deposit insurance scheme, is still missing. Given its importance, we hope that this will be addressed in the next legislative term. Another issue that also needs a prompt solution is the question of liquidity in resolution. As the recent March turmoil in Switzerland has shown, having proper arrangements in place for liquidity in resolution is not a “nice-to-have”, it is an indispensable part of the toolkit.
International Association of Deposit Insurers (2022), 2021/2022 Annual Report, October.
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