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EU banking union ushers in new era

Bail-in uncertainties remain; Portugal and Italy mark tough start for BRRD.

Daniele Nouy-600

Danièle Nouy: 'Non-performing exposures are also still a serious prudential challenge in some countries, including Italy.'

The EU’s banking union – the most ambitious integration project since the euro – hit a watershed as the Bank Resolution and Recovery Directive and Single Resolution Mechanism came into force on January 1.

These bodies now operate alongside the Single Supervisory Mechanism, headed by Danièle Nouy, which assumed prudential control of eurozone bank supervision in November 2014. The common aim is to end taxpayer-financed bank bailouts, by bailing in bank equity and bondholders – relying on creditors for at least 8% of a lender’s liabilities – alongside a bank-financed resolution scheme and a harmonized deposit guarantee programme. 

But events in Italy and Portugal at the end of last year, before the BRRD came into force, raised questions about both governments’ commitment to new bailout rules and, by extension, the credibility of the new resolution authority.

In November, Italy used an industry-financed bailout fund – which was provided with a short-term loan guaranteed by a state-owned postal savings bank Cassa Depositi e Prestiti (CDP) – to inject €3.6 billion into four small banks. The intervention wiped out shareholders and junior creditors, while senior bondholders and depositors were protected. Italian officials deny fiscal backing, but there are questions over whether or not the bailout structure would have complied with BRRD rules against discretionary state backing. 


More controversially, leading lawyers and bank investors argue that the bail-in of senior bondholders of Novo Banco in December breaches BRRD norms on the equal treatment of senior creditors and on the transfer of bonds to a third party.

Nicolas Véron, senior fellow at Bruegel, a European think-tank, says: “BRRD defines the future stance on bail-in in theory, but it remains to be seen how it will play out in practice. While Novo Banco is no precedent for the future, it does underline the massive uncertainties that remain in that area, as do the recent cases in Italy.”

Dan Davies at Frontline Analysts, a bank equity-research house, and a former investment banker, adds: “Politicians wanted to get the Italian rescues done before year-end, precisely because they knew that once BRRD kicked in, they lost all powers to a supervisory architecture that’s run from Frankfurt, with very little national discretion. At the end of the day, everything got done, and everyone who did anything had to get the ECB’s blessing first.”

Policymakers claim that the recent leg of the eurozone crisis and negative bank-sovereign feedback are now over. The bond spread between Portugal and Germany, for example, is only 230 basis points. While this is, in part, thanks to the ECB’s monetary actions, the SSM’s market credibility has helped.

None of the banks included in the 2014 Comprehensive Assessment have collapsed, “in sharp contrast to the ill-fated EU stress tests of 2010 and 2011”, Véron says. Greek banks raised equity from private-sector investors, vindicating the SSM’s earlier assessment of their solvency, while analysts say the new supervisory regime imposes tougher capital and liquidity requirements than the national supervisors it has replaced. 


Reform advocates call for further harmonization to complete the banking union, including efforts to reduce the home bias of banks’ sovereign debt portfolios, and a specific, pan-European insolvency regime. 

Véron explains: “Bank insolvency law remains national, and so is the insolvency court system. Since bank resolution is defined as an alternative to court-ordered insolvency (‘no creditor worse off’), this means that we are still far from a genuine single resolution mechanism. Taxation, consumer protection, housing finance, pensions, accounting and auditing are among the other areas that are still entirely or significantly national. We are still very far from a pure, complete banking union.”

In a speech last November, Nouy stressed: “There are still a lot of challenges ahead, most notably in terms of achieving the main goal of the SSM: ensuring fully harmonised prudential banking supervision in the euro area.” 

She added: “Non-performing exposures are also still a serious prudential challenge in some countries, including Italy.”

ECB board member Benoît Cœuré concluded in a speech in January that external and internal rebalancing was a prerequisite for further eurozone integration, as recommended by the Five Presidents’ Report, authored by heads of key European financial and political institutions. 

Of immediate concern is Germany’s resistance, citing fears over debt mutualization, to the European Commission’s European Deposit Insurance Scheme (EDIS), which EC officials say would complete the banking-union project, in the absence of fiscal integration.

Davies backs Berlin. “This is a pretty daft idea because deposit insurance can’t help with system-wide crises. It’s also politically toxic because the German savings banks see it, correctly, as either a raid on their massive and massively solvent fund, or, also correctly, as an attack on their practice of bailing each other out to avoid washing any dirty linen in public.”

For now, supervisory officials are content with focusing on more prosaic matters: to bolster the quality and transparency of data-sets and to harmonize audits while streamlining and centralizing decision-making. 

On that front, Italian banks seemed to get a pass after the SSM clarified it would not be undertaking a new asset-quality review of the country’s lenders and didn’t foresee new provisions or unexpected requests for additional capital. 

The statement came after news of an SSM questionnaire sent to several banks in Italy fed fears over additional provisioning. Italian bank stocks sold off heavily last month. But the SSM’s very exercise – to understand “the governance of the NPL process management” – underscores a more-fundamental point: it has the power to investigate NPLs on a granular, bank-by-bank basis, to audit the auditor and to harmonize valuation-practices, says Davies.

Aside from NPL supervision, there’s an argument that regulators should now play second fiddle to the market in solving banks’ capital problems. 

As Euromoney has reported in recent months, a lack of bank M&A and belated decisions on retooling business-models are key constraints on credit growth and bank earnings, rather than weak capital ratios per se.

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