EU Commission hits a snag with its proposal for a revised bank crisis management and deposit insurance framework

On 18 April 2023, the EU Commission has adopted a proposal to amend and further strengthen the existing EU framework for bank crisis management and deposit insurance (CMDI), thereby intending to take a further step towards the completion of the Banking Union. The proposed package includes amendments to the

• Bank Recovery and Resolution Directive 2014/59/EU (BRRD);
• SRM Regulation (EU) No 806/2014 (SRMR); 
• Deposit Guarantee Schemes Directive 2014/49/EU (DGSD), and
• Daisy Chain Act.

Following the collapse of Silicon Valley Bank and Credit Suisse, whose impact on the global banking sector still remains to be assessed, including the measures to be taken to prevent a similar crisis, the CMDI proposal seems to come at the right time. While the overall impression is that the events surrounding Silicon Valley Bank and Credit Suisse are of less concern for the EU banking sector since its resilience has improved significantly over the last few years in light of the Banking Union reforms, the legislative focus is now on dealing with the failure of medium-sized or smaller banks that were wound-up under national (insolvency) regimes outside the resolution framework in the past years. This is a concern of the EU Commission since this often led to a situation where taxpayer's money was used instead of industry-funded safety nets. The review of the CMDI framework and its interaction with national resolution regimes is intended to ensure that the framework meets its objectives and is fit-for-purpose for all banks in the EU, irrespective of size, business model and liability regime. In future, the European resolution authority, the Single Resolution Board (SRB), is to have a greater influence on these decisions concerning resolution.

The proposed amendments are controversially discussed, not least, because national ideas on when a bank should be rescued or wound up are different. The German government, for example, is of the opinion that cooperative and saving banks should not be covered by the European resolution regime. In the view of the Federal Association of German Cooperative Banks (Bundesverband der Deutschen Volksbanken und Raiffeisenbanken, BVR) and the German Banking Industry Committee (Deutsche Kreditwirtschaft, DK), the proposal jeopardises the functioning of the institutional protection systems in Germany and, therefore, they reject the general paradigm shift according to which bank resolution is to take precedence over deposit insurance. The BVR emphasized on behalf of the DK that “an approach that consciously endangers the protection provided by existing national deposit guarantee schemes in order to expand a resolution mechanism that was specifically designed for large banks so that it covers all banks and savings banks is unacceptable to us.”

Also, back in December 2022, Germany, France, Netherlands and Finland set out in a joint opinion statement to the EU Commission that the new proposal would weaken the creditor hierarchy for DGS and endanger national or industry safety nets.

But let’s take one step at a time. We have summarised below what you can expect from the proposed changes in the BRRD, SRMR and DGSD – if they survive the trilogue negotiations – which introduce a load of new requirements aiming to preserve financial stability, protect taxpayers, increase the efficiency of the CMDI framework and harmonise the EU deposit protection standards:

I. BRRD

1. Overview

The BRRD sets out the powers, rules and procedures for the recovery and resolution of banks, including cross-border cooperation arrangements to deal with cross-border bank failures. The aim of the reform is to ensure that any bank in crisis can exit the market in an orderly manner. In doing so, the preservation of financial stability, taxpayers' money and depositors' trust confidence should be ensured. According to the EU Commission, the existing resolution framework for small and medium-sized banks must be improved in terms of its design, implementation and, most importantly, the incentives for its application, so that it can be applied more credibly to these banks. 

2. What will change?

So, in a nutshell, the EU Commission proposes, among others, the following changes:

• Early intervention measures: In general, supervisory authorities may use early intervention measures such as the removal of managers or the appointment of a temporary manager at an earlier stage.  Furthermore, the internal sequencing between early intervention measures is removed, and they are all subject to the same triggers, although authorities should apply the principle of proportionality. Early intervention measures in the BRRD that overlap with the supervisory powers under the Capital Requirements Directive or the Investment Firm Directive are removed from the BRRD.
• Early warning of failing or likely to fail: The proposal aims to intensify the cooperation and information exchange between the competent authority and the resolution authority which should closely evaluate together if an institution is considered to fail or likely to fail. For example, an obligation for the competent authority is introduced to inform the resolution authority as soon as it is of the opinion that such a risk is present.
• Public interest test: In general, under the current rules, if there is a public interest in the resolution of the relevant institution, the resolution authority should take action using the tools and powers granted under the BRRD unless there is an alternative private sector solution to avert failure. In the absence of a public interest, the failure of a bank should be resolved through a national orderly insolvency process, funded by the DGS or other sources as appropriate, and implemented by national authorities. In fact, when applying the public interest test, resolution authorities should compare the resolution against insolvency and in particular assess how each scenario achieves the resolution objectives, which has granted resolution authorities with broad discretion and, according to the EU Commission, led to divergent applications and interpretations. To minimise divergences and to allow a broader application of the resolution rules, certain resolution objectives shall now be amended, including the objective relating to depositor protection to clarify that resolution should aim at protecting depositors while minimising losses for DGS. In addition, it is clarified that national insolvency should be the preferred strategy only if it meets the objectives of the BRRD better than (and not only to the same extent as) a resolution – which would, in fact, make small and medium-sized institutions more likely to be subject to the resolution regime than before since the amendments lead to an increase in the burden of proof in demonstrating that resolution is not in the public interest.
• Wind up and exit market: Although the public interest test may lead to a broader application of resolution actions, there will still be banks whose resolution is not in the public interest and for which the national insolvency regime may generally be applicable. The insolvency of a bank is handled very differently in the Member States in terms of the triggers for initiation and the structure of the procedure itself. To address uncertainties arising from this, Member States were required to ensure the orderly winding up in accordance with the applicable national law of failing banks. The existing requirement has been considered insufficient because not all risks of failing banks that eventually do not exit the market are captured. In particular, it is not clear which procedure should apply on a national level beyond normal insolvency proceedings. Therefore, the proposed amendment emphasizes that the applicable national law should lead to the market exit of the bank which must terminate its banking activities in an appropriate timeframe. In addition, competent authorities should be able to withdraw a bank's license simply on the basis of its "failing or likely to fail" status.
• Extraordinary public financial support: Since the current rules on the provision of extraordinary public support are not deemed to be sufficiently precise, amendments are introduced to specifically provide when public funds may be used as financial support on an exceptional basis, which shall only be possible in the following circumstances: precautionary recapitalisation, preventive measures of the DGS aimed at preserving the financial soundness and long-term viability of credit institutions, measures taken by DGS to preserve the access of depositors and other forms of support granted in the context of winding up proceedings. In any other cases the provision of extraordinary public financial support is not permitted and entails that an entity is considered as failing or likely to fail.
• MREL: The EU Commission clarifies its understanding that for large and complex institutions, bail-in is expected to be the preferred resolution tool while smaller and medium-sized institutions may be candidates for transfer tool strategies – which is interesting since the SRB has recently requested large investment banks to describe their variant resolution strategies assuming that assets and liabilities would be transferred to a bridge institution. While the existing provision of Art. 45c BRRD has focused on MREL calibration for bail-in strategies, a new Art. 45ca BRRD sets out the principles to be taken into account when calibrating MREL for transfer tool strategies, i.e., for example, size, business model, risk profile or a transferability analysis should be relevant factors. Taking into account that due to the new approach concerning the public interest test, small and medium-sized banks may fall under the resolution regime more easily instead of being wound-up under national insolvency proceedings, they will increasingly be subject to MREL requirements.
• Depositor preference: Under the current Art. 108 (1) BRRD a three-tier depositor preference has been established, where covered deposits (i.e. deposits from natural persons below EUR 100,000) and DGS claims have “super preference” in the creditor ranking in the insolvency laws relative to non-covered preferred deposits (i.e. deposits from natural persons and SME exceeding EUR 100.000). The latter must rank above the claims of ordinary unsecured creditors. The BRRD is currently silent on the ranking of the remaining deposits, i.e. non-covered non preferred (i.e. corporate non-SME deposits exceeding EUR 100.000) and excluded deposits (i.e. deposits of public authorities, financial sector entities and pension funds). To facilitate the use of the DGS, the proposal intends to amend Art. 108 BRRD to remove the “super-preference” of covered deposits and DGS claims and introduce a general depositor preference with a single tier ranking. In fact, this means that all deposits (covered deposits, non-covered preferred deposits, non-covered non-preferred and excluded deposits) should rank pari passu above ordinary unsecured claims.
• Use of DGS: In the future it should also be possible to increasingly use funds from the national DGS to finance a resolution. Currently, funding in the event of resolution must first be provided by the bank's internal resources, which are used to cover its losses (bail-in) and primarily include equity and other liabilities. This funding can be supplemented with the resources from the Single Resolution Fund or national DGS under certain conditions, but only after at least 8% of the individual bank's total internal resources have been used. Since, according to the EU Commission, smaller and medium-sized banks, in particular those with many depositors, had difficulties to meet the 8% threshold, the proposal intends to allow the use of funds from national DGS in resolution as a "bridge" to fulfil the 8% condition. Art. 109 BRRD is therefore amended to enhance the application of transfer tools in resolution for smaller or medium-sized banks and facilitate DGS interventions in support of such tools.

II. SRMR

Since the SRMR, mainly refers to the BRRD in terms of resolution triggers and resolution tools, the amendments on the SRMR logically follow the changes in the BRRD and therefore we refer to the above. However, to further harmonise the two legislative acts, the rules on early intervention are replaced by a new set of articles mirroring the BRRD provisions on early intervention to provide the ECB with a directly applicable legal basis to exercise those powers. Although the CMDI framework has considerable implications for small and medium-sized banks, it should be noted that the new proposal does not lead to any changes in the competences of the resolution authorities. The SRB remains the responsible resolution authority under the SRMR in particular for significant and cross-border banks and its competences are not extended to cover small and medium-sized institutions.

III. DGDS

1. Overview

The Banking Union is still incomplete and lacks its third pillar: a European Deposit Insurance Scheme (EDIS). In June 2022, the Eurogroup did not agree to a more comprehensive work plan to complete the Banking Union by including EDIS. The EU Commission does not make a new push for a pan-EU deposit protection scheme, but instead proposes new rules regarding the protection of depositors to harmonise and clarify the existing framework.

2. What will change?

The EU Commission aims to introduce a couple of changes to the existing regime, among others, in the following areas:

• Scope of application: The proposals suggests that branches of credit institutions established in third countries will be covered by the DGSD if they want to provide banking services and take eligible deposits in the EU under the condition that they join a DGS within a Member State. Also, it is clarified that the DGS protects depositors located in Member States where the credit institutions operate on the basis of the freedom to provide services. Specific provisions shall be introduced to enable the DGS in the home Member State to directly reimburse depositors of branches established in a host Member State and to allow DGS in a host member state to act as a point of contact for depositors of these branches. In addition, depositor protection is to be extended to certain public institutions, including schools, hospitals and municipalities (see also under I. above regarding ‘depositor preference’). It is now also clarified that client funds collected on behalf of investment firms, e-money institutions or payment institutions will be covered as well.
• Coverage level: The previous EUR 100,000 cover remains in place. However, in addition, the proposal intends to cover deposits temporarily exceeding the EUR 100,000 threshold. This should include high balances resulting from certain life events such as inheritances or insurance benefits. For such situations, deposits are to be temporarily protected for a period of six months up to EUR 500,000. Furthermore, the proposal also aims to improve the quality of information provided to depositors on the protection of their deposits by creating a harmonised information sheet across Europe.
• Recourse: Currently, where a DGS makes a payment to an institution under resolution, the DGS has a claim against the credit institution for an amount equal to its payments which ranks pari passu with covered deposits (see also under I. above under ‘depositor preference’). Art. 9 DGSD does not differentiate between a contribution of the DGS where the bail-in tool has been applied to the credit institution, which continues to operate, or where the credit institution has been subject to the transfer strategies. The provision should therefore be amended to specify that when DGS funds are used in the context of transfer tool strategies in resolution and as an alternative in insolvency proceedings, the DGS should have a claim against the residual institution or entity in its subsequent winding-up proceedings under national law, because the DGS funds are used in connection to losses that depositors would have otherwise borne.
• Simplifying administrative procedures: Among others, Art. 8 DGSD is amended to allow the DGS to apply a longer period of up to 20 working days in the case of repayment of deposits. The amended article also allows the DGS to set a threshold for the repayment of dormant accounts. Also, there will be alternative funding arrangements aiming to ensure the flexibility of the DGS.

IV. What’s next?

The Commission's efforts to optimize the CMDI framework have been broadly welcomed. However, that the reform will be implemented as presented is hardly realistic considering that many details of the package are controversially discussed where the resolution of small and medium-sized banks is concerned. Numerous stakeholders including Germany have already expressed concerns. It can be assumed that in Brussels the negotiations will likely be extremely tough and will drag on until the next legislative period after the European elections in 2024. In general, the transposition of the directives into national law should take place within 18 months of the entry into force of the amendments. So, until the package applies, and the Member States have transposed the new rules into national law, at lot of water will have flown under Europe’s bridges.