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Opinion 21 May 2019

To complete the Banking Union, it is also necessary to harmonize bank insolvency regimes

In this article, Javier Pablo García Tolonen, Financial Regulation BBVA, explains his vision about the need to harmonize insolvency regimes for banks in the EU.

The management of recent cases of bank failures has shown that it is necessary to improve the new resolution framework created in the wake of the financial crisis. Topics that are repeated over and over again (but that remain unresolved as of today) such as the need to establish a liquidity in resolution mechanism or to set up a backstop to the Single Resolution Fund are essential in order to increase the credibility of the banking crisis management framework. But there is another issue that has gone unnoticed but that is no less important: the need to harmonize insolvency regimes for banks in the EU.

But, why is this important? First of all, because the resolution framework and the insolvency regimes are intertwined in several aspects, most importantly through the principle that no bank creditor will receive worse treatment in resolution than in insolvency (No Creditor Worse Off - NCWO). The more the two regimes differ, the greater the likelihood of violating this principle. Actually, in some of the recent resolution / liquidation cases, the exact opposite has happened: some creditors received better treatment in insolvency than they would have received in a resolution. Furthermore, it does not make sense to have a single European bank resolution regime and a multitude of different national insolvency frameworks. This creates an unlevel playing field for banks in the EU, and therefore between their creditors and shareholders.

And how could we achieve this? First, let’s point out how not to achieve it. The harmonization of common insolvency regimes (for all types of companies and not only for banks) should be ruled out because, although it would represent a step forward to establish a capital markets union (CMU), it would be very difficult to achieve in political terms. Nor should the idea of ​​applying resolution to all banks (and not only to systemic entities) be on the table. This would eliminate the counterfactual analysis of what would have happened in a hypothetical scenario of liquidation, to verify compliance with the NCWO principle, and would leave investors at the mercy of an administrative authority without recourse to a more impartial opinion from a judicial authority.

An idea, in line with the opinion of international organizations such as the International Monetary Fund or the International Bank of Payments and that of European authorities such as the Single Resolution Board (SRB), would be to establish a single insolvency regime for banks in the EU. This framework could be led by an administrative authority (the SRB itself in the Eurozone), with the participation of judicial authorities. It should include a toolbox similar to that available in resolution processes (bridge bank, asset separation, etc.) and a common and unique hierarchy of creditors. Insolvency proceedings should be agile and efficient, guaranteeing market unity.

Also, it would be necessary to review the principle of universal succession by which the buyer in an insolvency process (also applicable in resolution) would avoid inheriting legal contingencies from the bankrupt bank. It is not fair that entities that have nothing to do with actions that are, or that may become subject to litigation, committed by third parties become responsible for the mere fact of buying their business, especially taking into account that the decision to buy is usually taken with limited information and time. On the contrary, the purchase of bankrupt banks should be encouraged, in order to guarantee the success of future resolution processes, protect financial stability and minimize the use of public resources.

Finally, it would be advisable to review the Commission's state aid communications in order to align the scope of burden sharing, which in insolvency proceedings only affects shareholders and subordinated creditors, with that of the bail-in tool of the bank recovery and resolution directive (BRRD). Indeed, bail-in can reach all types of creditors including holders of senior debt and some depositors not protected by the deposit guarantee fund.

It is now time for EU legislators to focus on this matter. In September 2018, the EU Commission initiated a process to evaluate the current insolvency regimes applicable in the EU. Its conclusions could well feed a legislative proposal to create a single and harmonized insolvency regime for banks in the EU during the next BRRD review.

Together with the establishment of a funding in resolution mechanism and the creation of the single deposit guarantee scheme (EDIS), a single insolvency regime for banks in Europe would be a decisive step towards finalizing the Banking Union.