Eurofi Article by Elke König - Why we need an EU liquidation regime for banks

The resolution of banks is a specific insolvency procedure, introduced as an alternative to liquidation under national laws. Under the EU regulatory framework, resolution only applies where resolving a failing bank is in the public interest – be it out of financial stability concerns or because of the critical functions performed by the bank. Resolution is for the few, not the many: insolvency remains the primary route for failing banks, even for those that are under SSM and SRB remit. However, while the legal framework for resolution has been harmonised and developed to be suitable for the specific challenges of banking failures at EU level, insolvency regimes remain national.

The lack of an EU liquidation regime is a major obstacle towards a fully-fledged Banking Union. The SRB’s assessment of the no-creditor-worse-off principle seeks to ensure that the treatment of creditors in resolution is not worse than the one they would have received under normal insolvency proceedings. Currently, with nineteen different insolvency frameworks in the Banking Union, the analysis of the insolvency counterfactual for a cross-border bank in resolution is a challenge, and results in diverging outcomes depending on the home country of the institution. Moreover, the ‘failing or likely to fail’ assessment is not always aligned to the criteria for liquidation at national level and may similarly lead to different conclusions.

Bank insolvency procedures should be subject to common standards and practices at EU level. The ideal solution would be EU-wide rules on insolvency proceedings for the banking sector. This harmonisation would have a number of advantages: it would facilitate resolution planning for cross-border banking groups; level the playing field and eliminate wrong incentives; and provide the industry and investors with the same level of certainty in liquidation as in resolution. An efficient and effective insolvency framework also contributes to addressing legacy assets and avoiding the build-up of new non-performing loans. Furthermore, a harmonised system would also benefit the Capital Markets Union, by providing investors with greater clarity.

These ideas are not new. Already in 2010, the European Commission’s Communication on an EU Framework for Crisis Management called in the medium term for “further harmonisation of bank insolvency regimes, with the aim of resolving and liquidating banks under the same procedural and substantive insolvency rules.”

The SRB is currently working within the Single Resolution Mechanism on National Handbooks to define how to implement resolution schemes in each country, as well as national implementation steps for a decision not to adopt resolution. This is a step in the right direction, but is only a ‘second best’ option and not comparable to a harmonisation of bank insolvency procedures – something only legislators can deliver.

Proposals for harmonisation across the board will inevitably be fraught with political perils and resistance. An incremental approach – such as the one exemplified by the recent harmonisation of the ranking of unsecured debt instruments in insolvency – may be a more palatable solution. The ultimate goal, however, must be to have in place an EU liquidation regime alongside an EU resolution regime.