By Michalis Zaouras on April 19, 2013

Banks bail-in a template or not?

EU officials and Member States' representatives (national governments) have been discussing whether a bail-in approach to banks resolution is a template or not. I provide below some evidence that it might be a template after all. In 06/06/2012 the Bank recovery and resolution proposal is clearly suggesting a shift of EU's policy from bail-out to bail-in. To cite:

"What resolution tools will be needed?

...
(iv) bail in creditors (mechanism to cancel or reduce the liabilities of a failing bank, or to convert debt to equity, as a means of restoring the institution's capital position)."

The proposal also suggest the protection of secured depositors. See below for reference:

http://europa.eu/rapid/press-release_MEMO-12-416_en.htm?locale=en

Interestingly, the proposal does not exclude a bail-out approach but rather allows a bail-in within a European context. Worryingly, a bail-out can be used in order to safeguard the big banks from failing (too big to fail) in the context of systematic risk while a bail-in approach can be used for smaller non-systematic banks. The problem with such an approach is how you define a big bank (or systematic). Consider the case of Cyprus, Laike-Marfin is definitely a small bank (and non-systematic) in the European context and as a result it can be bailed-in. However, this bank is "big" within Cyprus therefore generating systematic risks within Cyprus (but potentially not within EU). As a result, someone would expect big banks in large economies within EU to be bailed-out while "small" banks in small economies to be bailed-in. So is this a step forward for EU integration or not?

Please note though that the above analysis is based on a proposal. This has not been put as a directive (not yet at least), which means that it is not legalized as a template. Therefore, it is not a template (yet) but it is included in the proposal of Monetary and Fiscal Integration of the EU (and seen as a necessary tool).

Most interestingly I have found an EU discussion paper that proposes the bail-in approach (see below for reference) and suggests that this idea should be tested first. Guess where they have tested the bail-in approach? Hmm... wait a minute I know, Cyprus!

http://ec.europa.eu/internal_market/bank/docs/crisis-management/discussion_paper_bail_in_en.pdf

Finally, the above documents suggest that political parties (which take part in the EU Parliament) and the Government  of Cyprus (participating in the initiatives for Monetary and Fiscal Integration) were (or should have been) aware of what the bail-in and bank resolution within that context corresponds to. Therefore, I believe that the blaming game currently taking place in Cyprus is just ridiculous (everyone is responsible, maybe some of them to a lesser degree) and unproductive.  Most importantly, the root of the problem was not how we handled the crisis (though it has amplified the crisis) but rather the failure of the banking sector and the banks overexposure to risky assets.

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