Banking: Throwing the bail-in out with the bath water
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Banking: Throwing the bail-in out with the bath water

A textbook case, a long-inevitable state bailout and a brazen political fudge: Europe’s BRRD has had something of a rough ride this summer. As the region’s banks brace themselves for the capital-raising marathon that is MREL, are the new resolution regulations actually doing more harm than good?

Illustration: Britt Spencer

What was supposed to have brought clarity is in danger of only adding to the confusion. That is the lesson of a summer of European bank bail-ins and bailouts in the shadow of the region’s Bank Recovery and Resolution Directive (BRRD), which came into effect last year. The resolution of Spain’s Banco Popular ticked all the BRRD boxes regarding private capital and the absence of the state but is now subject to numerous legal challenges. 

The rescue of Monte dei Paschi di Siena (MPS) was finally made possible by the use of a precautionary recapitalization under BRRD. But the liquidations of two other long-troubled Italian banks, Veneto Banca and Banca Popolare di Vicenza, depended on them being exempted from BRRD rules altogether and their good assets essentially gifted to Banca Intesa Sanpaolo in a fudge of spectacular scale and audacity. 

What is clear is that the goal of a ‘single’ resolution mechanism for Europe’s banks is far from being met. Maybe European banks are simply too different for a pattern to ever emerge. Imposing BRRD on Europe’s wide and diverse array of banks was always going to be messy. 

“What we witness today in Spain and Italy suggests a system that is half built, with all the problems of a half-built system,” says Carmen Bell, practice lead at advisory firm Global Counsel in Brussels. 

There is no doubt in the mind of Giovanni Sabatini, the general director of the Italian Bank Association (ABI), as to why this is. 

“The original sin of the BRRD is that they made a major mistake in the sequencing of the measure for the resolution of banks,” he says. “Resolution is a completely new methodology. These are new tools for dealing with a banking crisis, and it is required that banks are ready to deal with these new procedures. They should have first allowed banks to adapt their liability side – BRRD should have been implemented the other way around.” 

This is why the first few resolutions have been so unpredictable. What is driving this disparity is the desperate desire of national governments to avoid imposing new bail-in rules on investors in their troubled lenders. 

Emil Petrov,

“It is not helpful that Banco Popular remains the single example of a bank resolution under BRRD,” says Emil Petrov, head of capital solutions at Nomura in London. 

“We need to see a little bit of a trend. We want to see a consistent approach to the imposition of losses on investors in failed banks. There are noises coming from the [European] Commission suggesting that what happened in Italy [with the Veneto banks] is the last time that this will happen. It is probably the last time that we will see such an obvious attempt by the political establishment to avoid the imposition of losses on investors in failed banks.” 

Lorenzo Codogno, visiting professor at the European Institute of the London School of Economics and Political Science, lays the blame for such fudges squarely on the decision to put the BRRD cart before the horse. 

“BRRD was driven by political motivations and not technical motivations,” he says. “This resulted in its immediate implementation. Italy had very specific domestic issues that were not highlighted at this time in the proper way. I was pushing for this to be recognized when I was at the Italian treasury. Europe decided not to allow for a transition period, which was a policy mistake. There is a tendency in Europe to say that we should take advantage of windows of opportunity, so the decision was to introduce a harsh, quick transition.”

Others argue that recent events have clearly shown that there is enough flexibility built into the regulations to cope with the region’s idiosyncrasies. 

“Every bank resolution is different, but BRRD provides enough flexibility to deal with different banks in different ways,” says Petrov. “Writing off securities is just one of several resolution tools available under the directive.” 

That is a good thing as the European regulators will need them. Recent research published by Bain & Co shows that of 110 European banks it examined, 31 are in the weakest category for profitability and balance-sheet strength, a jump to 28% from 21% in 2016. 

Codogno concedes that pan-regional rules are needed, but reckons that the kind of regulatory gymnastics that have characterized resolutions so far will be the name of the game for some time to come. 

“With regard to BRRD, we have to have something – particularly in the context of banking union,” he says. “It was a matter of finding a good transition. Given that there was no transition, we now have to find loopholes. There is still a lot of fragmentation in the way that different sectors are treated. It is not a level playing field. We need to be a little bit pragmatic here.” 


Earlier this summer, when Euromoney caught up with the genial Sabatini at the Italian Bank Association, the sound of the two massive state bank bailouts in Italy was still ringing in our ears. Some €6.6 billion of taxpayer money was being poured into MPS and up to €17 billion had been pledged to persuade Banca Intesa Sanpaolo to take the long-troubled Veneto Banca and Banca Popolare di Vicenza off the table. 

Sabatini was thrilled. 

“The solution of MPS and the Veneto banks has finally cleared the horizon of the Italian banking sector from the dark clouds from last year,” he enthused. “It is a positive solution. The European resolution framework has proved to be flexible enough to deal with different cases in a manner able to minimize the impact of the financial crisis.” 

That may be true, but wasn’t BRRD supposed to stop this kind of thing? Isn’t the whole point of it that taxpayers do not get involved? 

Robin Creswell,
Payden & Rygel

“On the face of it, there didn’t seem to be much ambiguity with BRRD,” says Robin Creswell, managing principal at Payden & Rygel in London. “There was some discussion about the level of bail-in for deposits, but everyone thought that the rules were very clear.” With over $110 billion in assets under management, Payden & Rygel is one of the largest privately owned investment managers in the US. 

“BRRD meant that we could, if we chose to, strategize about how much of a corporate’s cash could be at risk in a bail-in, and therefore how many counterparties you should give your cash to,” Creswell points out. “However, the two recent situations have raised the caveat of non-systemic risk allowing for state bailout and showed that bail-in occurred without any adverse consequence for cash and senior unsecured bonds.”

Europe’s summer of bank failures also saw the long-anticipated collapse of Banco Popular. Its resolution on Wednesday June 7 was the first time that the BRRD framework had been used for this purpose. 

The Single Resolution Board (SRB) pushed the bank into the arms of rival Santander in just 24 hours – prompted by a run on the bank that had seen €20 billion leave its coffers between the end of March and June 5. This was also the first time that the Single Supervisory Mechanism (SSM) had determined that a bank had reached the point of non-viability, failing or likely to fail (FOLTF). 

The ECB had placed a value of between negative €2 billion and negative €8 billion on the bank before the sale, which saw Santander take it on for €1 plus a capital increase of €7 billion. Equity and subordinated debt to the tune of €4 billion was wiped out while senior bondholders were left untouched.

The move took many by surprise and has spawned inevitable legal challenges. By the August 17 deadline, 51 lawsuits had reportedly been filed with the EU General Court against both the SRB and the European Commission over the Spanish lender’s demise. 

Europe’s regulators were pretty smug about the outcome, however. SSM chair Daniele Nouy declared on June 19 that “modestly… I would say we have passed the test.” 

Elke König, SRB

On July 11, Elke König, SRB chair at an Econ public hearing said that while the Popular resolution benefited greatly from the close cooperation of both European and national authorities, the commitment of the bank itself and the ongoing private sale process, the SRB had identified some areas for improvement. She said that there are strong advantages to a moratorium tool covering all liabilities to buy time if need be or to take the process to the weekend in the case that a bank is declared FOLTF mid-week again. 

“Until Banco Popular we hadn’t really seen BRRD in action,” says Petrov at Nomura. “Afterwards, we thought we are now over with bank failures being dealt with on a case-by-case basis – it was a good example of how efficiently banks could be resolved under the new rules.” 

If only. What looked like it might be a triumph for Europe’s regulators is quickly looking to be anything but. There is a terrible irony in the fact that the Popular bail-in that followed the rules is now the subject of multiple legal challenges; whereas the Italian bank rescues, which clearly flouted both the letter and the spirit of the regulations, appear to have progressed relatively smoothly. 

Why such a level of disquiet over what is supposed to have been Popular’s textbook resolution? In late June, MEPs also raised questions about how Popular had passed the European Banking Authority’s (EBA) stress tests in 2016, when and for how long its liquidity threshold had been violated and whether the ECB had knowledge of widespread rumours that privileged insiders had withdrawn large volumes of deposits prior to June 7. 

Investors also allege that König’s public comments about Popular’s position contributed to the bank run and claim that a valuation report previously produced by Deloitte was based on incomplete information. Their prospects are, however, somewhat slim. 

“Any legal challenge to the Popular resolution that will have a remote chance of success will have to rely on failure of process not a violation of the rules,” reckons one expert close to the situation. “It will have to demonstrate that the ECB or the SRB were negligent or acted with malicious intent. This will be difficult to prove, and I would be surprised if they succeed.”

Nevertheless, Bell at Global Counsel sees real problems ahead for the ECB in resolution situations. 

“The ECB is accruing formal responsibility for banks in death, but it may often be hard to disentangle that from the decisions that are taken (or not taken) as they slide into failure or before,” she says. “So long as the ECB remains limited in its ability to deal with issues of fraud, money laundering or insider information, it will face questions about its role in enforcing standards at the banks it ultimately has to resolve.” 

She suggests a closer partnership, or even merger, between the SSM and the EBA as a solution to align day-to-day supervision and resolution.

The valuation of Popular in resolution does raise questions – marrying as it does almost exactly with the volume of equity and subordinated debt available to be bailed in. 

“The Banco Popular price of €1 was somewhat miraculous, but no one can blame the SRB for that as it was driven by the bid from Santander,” argues one banker. 

Santander’s bid was the only one on the table and the ECB desperately needed a buyer. However, disgruntled investors are proving harder to convince of this miracle. 

“It is hard to escape the conclusion that the SSM got lucky with Banco Popular because a buyer was available,” Bell points out. “Things could have looked less seamless – and Nouy perhaps less optimistic – if it had not been; or if a solution closer to the compromise for Monte dei Paschi had been required.” 

The inevitable

Compromise is a polite description of the fate of Italian lender MPS. 

Having become a byword for Europe’s broader non-performing loan problems over a number of years, the bank was finally granted a precautionary recapitalization under BRRD on June 4, following the failure of protracted attempts at a private-sector restructuring. 

The €6.6 billion of state funds pumped into the ailing bank is the largest such injection since Benito Mussolini nationalized the sector in 1933. 

Many, including Euromoney, have long pointed out that state intervention for MPS was inevitable, but precautionary recapitalization under BRRD is only permissible if it can be proven that it is essential to avoid a serious disturbance in the economy of a member state and preserve financial stability. 

“MPS was the fifth-largest Italian bank,” says Samrat Kanodia, European credit director at Payden & Rygel. “The fourth- or fifth-largest bank in a country should not be a risk to the system. But if things had not resolved in the MPS case, it would clearly have affected the whole Italian banking system.” MPS lost 87% of its market value in 2016. 

There is no doubt that the length of time it has taken to get any fresh capital – be it private or state sector – into MPS has been hugely damaging to Italy’s banking sector. 

“The lesson from Banco Popular is that when there is a bank in crisis, it is important to fix it quickly,” says Codogno, who was chief economist and director general at the treasury department of the Italian ministry of economy and finance from May 2006 to February 2015 and now runs his own firm, LC Macro Advisors. 

“Italy lost a full year in 2016, and all that we ended up with are public guarantees that nobody uses,” he says. 

Codogno argues that it would have simply been too risky to impose BRRD resolutions in Italy before now. 

“These problems could not be addressed in the summer of last year because systemic risk in Italy was very high,” he says. “There was clearly the risk of a bank run because of MPS. It was not appropriate to allow Italy – and indeed Europe – to run such a big risk. Now the Italian government has found loopholes: precautionary recapitalization in the case of MPS and a second loophole in the form of the fudge for the Venetian banks in that they were not deemed to be systemic.”

The resolution of Veneto Banca and Banca Popolare di Vicenza (known as the Veneto banks) could necessitate €17 billion of public money being pumped into entities that were recapitalized by the country’s Atlante rescue fund in April last year. Not only has the €2.5 billion then committed to the banks been wiped out, but the Italian government is also paying Banca Intesa €5.2 billion to take on just their good assets for, again, the princely sum of €1 – €3.5 billion to protect its own capital ratios and €1.5 billion protection against claims on the banks. There are also €12 billion of state guarantees to cover the wind down of the bad banks that remain. 

“When the Veneto banks’ capital increases failed [in the spring of 2016], it would have been much better at that stage to have had one bank come forward and buy them,” says Codogno. “As no buyer candidate came forward, Atlante was forced to intervene and its investment was completely wiped out. Instead, the government should have said that they would guarantee the assets of the banks. In the intervening period so much value has been destroyed.”

Would that have been allowed under BRRD? State aid is now finally being thrown at the problem only because the fate of the Veneto banks was deemed not to be a threat to the wider Italian economy. Because they were deemed non-systemic by the SRB, they were therefore not held to the state-aid rules under BRRD. 

“The deterioration of the two banks over the last two years meant that they have shrunk significantly in terms of size and interconnectedness, and at the same time their only remaining critical function – taking deposits – was also available from almost 30 other banks in the region,” explained König in the July 11 public hearing, defending the decision to deem the banks non-systemic. “The SRB therefore concluded that resolution action was not warranted in the public interest for these banks individually, but also taken together and that they could instead enter into the normal Italian insolvency proceedings without measurable risks to financial markets or the real economy.” 

Amelie Champsaur,
Cleary Gottlieb

Amelie Champsaur, partner at law firm Cleary Gottlieb in Paris, has little time for such explanations. “The fact that these banks are under the ECB’s supervision and subject to the resolution powers of the SRB rather than the Italian authorities means that they are deemed systemic at EU level,” she points out. Despite this, their fate was deemed the purview of national insolvency proceedings and an emergency decree was passed by the Italian authorities on June 25 that permitted the sale of their good assets to Banca Intesa Sanpaolo. 

“In the case of the Veneto banks, the decision by the SRB appears to have circumvented the EU rules,” claims Champsaur. “There is a possibility, and even an obligation, to place banks into normal insolvency if the conditions for resolution are not met. However, the emergency decree of June 25 is not a normal insolvency regime. It is an ad hoc resolution regime. It was called a liquidation, but the two banks were actually placed in resolution.”

Coming unstuck

Before June 23, the Veneto banks were in negotiations with the European regulators over precautionary recapitalizations of their own. Those talks had come unstuck over the issue of how much private money would be needed alongside state funding, not whether the banks were eligible for such a resolution – only available to lenders deemed to be a systemic risk and whose collapse would pose a threat to the wider economy – in the first place. 

Indeed, just weeks before they collapsed Banca Popolare di Vicenza chief executive Fabrizio Viola, who had been parachuted in to the Veneto banks from MPS after it failed its EBA stress test in 2016 (hardly the most auspicious qualification for the job), warned that: “The effects of not solving the crisis at the two banks would not be smaller than those created by a default by Greece.” 

The key claim here was the limited geographic scope of the banks’ activities. The impact of their resolution would not be as great as it would be for MPS as they only operate domestically and regionally. The SRB used this as justification for there being no public interest in resolving them, despite the fact that there is nothing in the application of public-interest rules that refers to domestic versus international activities to determine whether public-interest requirements have been met.

Sabatini, who has been general director of the Italian Bank Association (ABI) since 2009, is in no doubt as to the legitimacy of the resolutions. 

“The European rules were fully respected on the single closure of each entity,” he tells Euromoney. “Frankly speaking, only a few voices have raised the problem of a breach of the rules. Some, such as the chairman of the SRB, said that the Commission should review the state aid discipline, but that is not her realm of authority.”

On August 8, König criticized the Veneto bank solution, saying that: “We need to make sure we are not putting wrong incentives into the system. I think the commission would agree that there has to come a point where it needs to be changed.” 

So far, however, the EU’s competition commissioner, Margrethe Vestager, does not seem to agree, saying in July that she had no concrete plan to change the rules. 


“Rules should leave some leeway for governments to grant liquidation aid to their banks as fully recognized by the 2013 communication of the EU Commission,” Sabatini insists. He points out that the liquidation of the banks makes the situation more straightforward. “State aid is potentially subject to less strict conditions because it is a liquidation – it is the end of the two entities, so there is no risk that state aid can distort the competitive environment.” 

Despite strenuous denials, it is hard to believe that the decision on the Veneto banks was not at all influenced by the need to find money to prop up MPS. Interviewed by Euromoney in July, Paolo Petrignani, CEO of Quaestio Asset Management, which manages the Atlante fund, declared the impact of the former on the latter to be fortuitous. 

“Ironically, the liquidation of the Veneto banks allowed the investment in MPS,” he said. “It wasn’t planned that way; it was pure coincidence. If it [the Veneto bailout] had happened a week later, it would have been a problem… Banking crises are by definition a chaotic process.” 

The banks were wound up after the government intervened to suspend an €86 million payment on Veneto Banca subordinated debt that was due to mature on June 21. 

Sabatini at the ABI supports this view. 

“The two decision processes for MPS and the Veneto banks were quite disentangled,” he says. 

However, the Veneto collapse just happened to free up €450 million to add to Atlante’s purchase of MPS’s €26 billion bad-debt securitization and enable the precautionary recapitalization to go through.

The Veneto bank resolutions run counter to everything that the BRRD is trying to achieve due to the shocking outcome for Italy’s taxpayers. 

“The MPS situation is a recapitalization and the taxpayers will benefit from the upside, if any,” points out Champsaur. “The Veneto bank situation involved a cash contribution by the state to Intesa Sanpaolo – a straight loss for the taxpayer, with no possibility of upside benefit.”

Banco Intesa Sanpaolo chief executive Carlo Messina has reacted angrily to suggestions that the Veneto banks were handed to him on a plate. 

“The idea of a gift is completely wrong, we are intervening to safeguard savings, employment and businesses,” he declared in late June, adding that any redundancies at the failed banks would be voluntary. 

His public comments since the resolutions have done little, however, to cement the case that the banks were not of systemic importance. 

“Our intervention saved the entire banking system from very high costs, estimated at €12 billion, related to guarantees of client deposits at the two banks,” he declared in a public statement on August 1. “And it avoided very high costs for the Italian state, of about €10 billion, related to public guarantees of bonds issued by the two Veneto banking groups. Without our intervention, the impact of the failure of the two banks would have affected the local economies of these very dynamic regions and would have hurt the entire domestic economy.” 

That sounds pretty systemic to us.

Turning a blind eye

To paraphrase, bank resolutions are like sausages, better not to see them being made (particularly when it is salami and chorizo). The markets certainly seem to have turned a blind eye and have barely reacted to the rush of activity over the summer. 

“The reaction of the financial markets and investors to any circumstances depends on how they differ from what they expect,” says Nigel Jenkins, managing principal at Payden & Rygel in London. “The average investor is not expecting the exact implementation of BRRD. Investors have had some healthy scepticism and that is why the market reaction has been muted.” 

Nevertheless, investors like predictability, and the implementation of this particular set of rules has been anything but. The problems at Banco Popular had been flagged up for a long time, and once a bank run starts it can be impossible to stop. But when the resolution came, it was still a surprise to many (although not to many more if allegations of insider prior knowledge are to be believed). 

“The decision on non-viability can be very random – what does the regulator use?” asks Kanodia at Payden & Rygel. “The capital ratio, liquidity ratio, funding ratio? It is very hard to predict the PONV [point of non-viability]. However, non-viability is not as much of a cliff edge as it seems, given that a bank in the vicinity of its PONV will highly likely already be trading at very stressed levels.” 

Before June 23 some Veneto Banca subordinated debt was trading at 5 cents on the euro.

The two striking similarities between the Spanish and Italian resolutions are that tier-1 and tier-2 bondholders met exactly the same fate and that, despite the new rules on burden sharing, seniors were left untouched across the board. 

“With BRRD you have burden sharing,” says Kanodia, “if you touch one part of the capital structure, you should in principle touch other parts of the balance sheet. However, the market didn’t react when senior bondholders were not touched in the Popular rescue. It is interesting to point out that a large chunk of the senior bonds were held by local investors in Spain – the largest insurance companies and pension funds.” 

The desire to protect your own was also behind the decision to leave Italian senior bondholders unscathed as well. 

“The Italian solution is a pragmatic one, reflecting the wish to protect senior debt, much of which is owned by private individuals,” noted CreditSights analysts when the Veneto banks were wound up. “Both this story and that of Banco Popular cement our view that there is no ‘one size fits all’ when it comes to bank failures.” 

But isn’t that exactly what BRRD sets out to be?

Other than those involved in the array of legal proceedings that Popular’s resolution has triggered, subordinated investors seem remarkably sanguine about the absence of senior bail-in so far. 

“The implementation of BRRD regulations within the European banking system has unequivocally made them much safer institutions,” declares Marc Stacey, portfolio manager at BlueBay Asset Management in London. “Additionally, the combination of having a Single Resolution Board and bail in-able instruments means banks that are failing or likely to fail can be successfully resolved. Contrast the recent examples in Spain with Banco Popular, as well as Vincenza and Veneto bank in Italy, with Novo Banco in Portugal where some investors were haircut and some weren’t. That was a particularly poor outcome in Portugal. We are in a far better environment now, where banks like Banco Popular can be resolved and the rest of the sector can rally with a weaker bank having been removed from the system. Equally important is that investors know there is no ambiguity that equity and subordinated debt will be haircut if they invest in a failing bank.” 

Stacey has little sympathy for the treatment of tier-2 in these resolutions. “Our bank capital strategy is almost exclusively invested in additional tier-1 rather than tier-2. The reason is that you are getting paid more for taking similar risk. As we saw in the Banco Popular example both AT1 and LT2 recovered close to zero.” 

Disincentivizing buyers

The wind up of the Veneto banks follows the blueprint of an earlier liquidation under national insolvency rules, that of Banca Romagna Cooperativa (BRC), which was sold to Banca Sviluppo, part of the ICCREA Group, in July 2015. In that case, BRC equity and subordinated debt were left behind in the liquidation estate, but junior bondholders were reimbursed by the Italian mutual sector’s institutional guarantee fund. 

The extent of retail investment in subordinated debt in Italy has long dogged the country’s attempts to deal with its failing banks, but steps have been taken to disincentivize retail buyers in future. The tax incentives that attracted them to subordinated bank bonds in the first place (a 27% rate on deposits but a 12.5% rate on bonds) were scrapped in 2015, and the industry is trying to stamp out further mis-selling. 

“We have entered into an agreement with the unions to check that there is not undue pressure on bank employees to sell products to retail investors,” Sabatini explains. “We at the ABI are putting all possible efforts to avoid mis-selling practices. In some cases – limited cases under investigation by administrative and judiciary authorities – mis-selling was the problem, but it was not a generalized problem.” 

If, as these resolutions suggest, all subordinated investors are going to be treated like AT1. In resolution, why buy tier-2? Many investors might be asking themselves that question. 

“It is very well understood that if you are a tier-2 bondholder, then you are highly exposed to losses,” says Kanodia. “MPS and Popular have made it clear that you will be bailed in. Tier-2 bonds have a clear provision in their prospectus about PONV. The regulators can write down principal without the bank getting into default.” 

So will these resolutions drive investors out of tier-2 and into tier-1? Many buyers simply cannot buy the latter because it is not in the indices, so they form a relatively solid base for tier-2 demand. Indeed, Stacey at BlueBay argues that AT1 is unfairly mispriced because of this. 

“One of the reasons that AT1 is mispriced is because it does not have a natural home within any traditional fixed income indices like high yield or investment grade,” he says. “For example, Bank of America Merrill Lynch have a specific index (COCO) which includes all the contingent capital debt: if CoCos were included within the high yield indices there would be a far bigger natural investor base.” 

Indeed, aside from certain well-documented examples such as that of Spain’s Liberbank, tier-2 spreads across Europe seem to have held up well since the resolutions. So has there been no impact? 

“There has been a lot of talk about the impact on tier-2 after Popular,” says Petrov at Nomura. “The theory is that T2 spreads might move closer to T1. In reality, the subordinated spreads of certain Spanish banks widened significantly, but there was no wider systemic shift in spreads. This lack of contagion has been attributed to the relative illiquidity of the affected instruments and the generally positive tone of the market.” 

Whether that should be the case, or will remain the case, is another matter. 

“I think investors are being a little bit complacent,” warns one FIG specialist. “People are trying to explain this away by market sentiment, but investors couldn’t sell off because of a lack of liquidity. This could be storing up trouble for the future. 

“It could be a latent excuse for another sell-off at a later date. Third-tier banks and below cannot issue T2 anymore – if they were to do a new issue, they couldn’t get it done. This has exacerbated the bifurcation of the market and is an undesired side effect of BRRD.” 

It is a very different story for senior debt. Veneto Banca senior bonds, which had been trading at 73.8c in early June, shot up to 91.4c on news of the Intesa deal. One investor that Euromoney spoke to for this article says that, after these recent resolutions: “We believe that unless the bank is very small, the senior bondholders won’t be touched in a resolution.” 

The regulators have been at pains to emphasize that this is not the case, but are yet to put this to the test. 

“When BRRD was conceived, it was in the crucible of Europe-wide systemic risk,” says Creswell. “If we again found ourselves in a 2007-type situation, we would be saying to ourselves there is a very real risk of senior bondholders being bailed in. But we suspect that in non-crisis circumstances, the BRRD legislation has a certain amount of elasticity in it.” 

That could be putting it mildly. 

“Senior debt is immunized at this point,” claims one bank capital specialist. “BRRD is completely idealistic in thinking that bail-in of seniors could ever be applied. It is a bit disheartening that all this work has gone into building a framework that doesn’t work. We have the European authorities continuing to say that it is working well. This is just not true, and this type of denial damages their credibility.”

Kanodia points out that the market has made its own mind up: “The ratio between subordinated bank spreads and senior bank spreads is almost two. Subordinated spreads are now almost double senior unsecured spreads,” he points out. “The differential between the two used to be very small.” 


Investors piling into new-style bail-inable senior bank debt with gay abandon should take care. 

“The regulators have done the market a disservice by calling bail-inable senior debt ‘senior non-preferred’. This is capital and should be priced as such,” Stacey warns. “Investors in this debt should be under no illusions that they will be bailed in along with equity holders, AT1 and LT2 if they invest in a failing bank.” 

Many, it would seem, simply do not believe him. It would be rash to assume that treatment of certain classes of investors in resolution will follow a pattern after a small number of long-standing cases are finally pushed into insolvency. 

“Policymakers looking to promote the European Deposit Insurance Scheme and fiscal backstop to the Single Resolution Fund will look to Banco Popular for validation – arguing that these things are backstops that need never be touched, not bail-out funds,” says Bell at General Counsel. “But it is also the case that, in the absence of these things, the SSM is politically exposed and more liable to get pulled into compromises of the Monte dei Paschi kind.” 

Swinging in the wind

The hope must be that simply declaring future problem banks to be non-systemic and reverting to national insolvency rules does not form a regular part of that pragmatic approach. Any troubled bank will shrink to become non-systemic if it is left to swing in the wind long enough. 

“This has set a precedent of interpreting the public interest condition in a way that makes it easier for authorities to use the national insolvency route as an alternative to resolution, particularly for legacy situations,” reckons Champsaur.

Surely issuers and investors need to know that the rules are there and they know what will happen when things go wrong? 

“As fixed income managers we could rail against it, but BRRD does establish a framework that allows for delegation to the central bank of the country,” says Creswell. “Central banks are proving adept at managing the issues and banks in Europe are now much better capitalized. Genuine systemic risk is now much more off the table. National governments and central banks need these tools, but they also need to be able to shape them to their own circumstances. What happened in Italy does not mean that bail-in has been thrown out with the bath water.” 

Given that the market has hardly stirred, and that bank capital is a rare opportunity for yield, investor appetite does not seem to be too much of a worry right now. 

“Investing always has a practical side to it,” says Kanodia. “We always thought that applying BRRD would be very challenging. Banks can be very different – they can be retail, investment, commercial – but they are all governed by the same BRRD rules. We have always thought that banks are so diverse that you have to take that into account. And of course, national regulators will always want to save the banking system of their country.”

Banks in Europe now face a huge capital-raising challenge with the imposition of Minimum Requirements for Eligible Liabilities and Own Funds (MREL), and there is no getting away from the fact that the weaker players will struggle to issue subordinated debt now that the BRRD rules are there. They will therefore have to try to issue senior non-preferred and hope that there are enough investors out there that believe they will not get bailed in if things go wrong. 

Sabatini at the ABI argues that senior investors in Italian banks should be protected up to a point. 

“I hope that in the next revision of BRRD, some time will be devoted to excluding senior bonds up until €100,000 from bail-in, taking into account that, from an economic perspective, they are similar to time deposits. I think that would be advisable. We are witnessing a recomposition of the liability side, with deposits increasing and bonds decreasing because of the tax change and risk of bail-in.”

That may be a long shot, but Europe’s regulators have a tough balancing act on their hands as the region’s banks try to satisfy their new capital commitments at the same time as dealing with legacy problems – the combination of which can tip them close to non-viability. 

“The lessons for the regulator are, firstly, that if you want the regulations to be taken seriously, you need to apply them consistently,” advises Petrov. “Secondly, all this new loss-absorbing capital has to come from somewhere and they need to be more mindful of that.” 

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