Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework
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Journal of Financial Regulation, 2022, 00, 1–16
https://doi.org/10.1093/jfr/fjac007
Advance access publication date 5 October 2022
Article
Reset Required: The Euro-area Crisis
Downloaded from https://academic.oup.com/jfr/advance-article/doi/10.1093/jfr/fjac007/6603416 by guest on 13 August 2022
Management and Deposit Insurance
Framework
Thomas F Huertas∗
ABSTR ACT
The crisis management and deposit insurance (CMDI) framework in the euro area requires a reset.
This article explains why and proposes a new framework. This could start as early as 1 January 2024
when significant institutions in the euro area will have met requirements to have enough subordinated
obligations outstanding to recapitalize the bank if it were to fail. The proposed framework has four
components: a single lender of last resort (the European Central Bank); a single presumptive path for
resolution (exit via the use of bail-in to facilitate orderly liquidation of the failed bank by the Single
Resolution Board under a solvent wind-down strategy); an investor of last resort in a bank’s gone-
concern capital (its national deposit guarantee scheme); and a Single Deposit Guarantee Scheme (the
Single Resolution Fund with a backstop from the European Stability Mechanism). Together, these
measures would limit forbearance, assure bail-in did not touch deposits, promote competition, limit
recourse to taxpayer money, standardize resolution procedures for all banks, complete Banking Union
and guarantee that a euro of covered deposits would remain a euro, all without forcing national deposit
guarantee schemes to reinsure one another. Last but not least the proposed framework would promote
financial stability.
KE Y WO R DS: banking, resolution, banking union, crisis management, deposit insurance, euro area
1 INTRODUCTION
Crisis management and deposit insurance (CMDI) frameworks aim to enhance financial sta-
bility, limit recourse to taxpayer money, promote competition, and protect depositors. Those
are the aims of the euro-area CMDI framework as well. However, in the euro area, the current
CMDI framework neither promotes financial stability nor limits the use of taxpayer money. Nor
* Thomas F Huertas, Senior Policy Fellow, Leibniz Institute SAFE at the Goethe University Frankfurt 60323 Germany;
Adjunct professor, Institute for Law and Finance, Goethe University Frankfurt; Senior Fellow, Center for Financial Studies,
Goethe University Frankfurt, Germany; Non-Executive Director and Chair Board Risk Committee, Barclays Bank Ireland;
Chair, RISC Financing Platform Services; Alternate Chair, European Banking Authority (2011). Tel: + 49 157 7506 0026;
E-mail: huertas@ifk-cfs.de. The author is grateful to the anonymous reviewers for this journal as well as to Ignazio Angeloni,
Charles Goodhart, Jan-Pieter Krahnen, Karel Lannoo, Edith Rigler, and Nicolas Véron for comments on earlier versions.
© The Author(s) 2022. Published by Oxford University Press.
This is an Open Access article distributed under the terms of the Creative Commons Attribution NonCommercial-NoDerivs
licence (http://creativecommons.org/licenses/by-nc-nd/4.0/), which permits non-commercial reproduction and distribution of
the work, in any medium, provided the original work is not altered or transformed in any way, and that the work properly cited. For
commercial re-use, please contact journals.permissions@oup.com2 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
does the framework necessarily protect deposits. There is no guarantee that a euro in covered
deposits will remain a euro. This makes the playing field uneven, restricts competition, hampers
capital mobility, and restricts growth.
The euro-area CMDI framework therefore requires a reset, and the EU has initiated a review.1
The reset proposed here is consistent with recommendations from various stakeholders that any
reset should (i) improve and harmonize deposit insurance, ideally through the introduction of a
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European scheme which would complete Banking Union; (ii) unite responsibility for resolution
and deposit insurance, as is the case in the United States; (iii) improve and harmonize liquidation
procedures for small and medium sized banks; (iv) retain and implement the principle that
investors, not taxpayers should bear the costs of bank failures, and do all of the above in a manner
that (v) promotes financial stability and (vi) retains national autonomy, especially of certain
national deposit guarantee schemes.2 The reset proposal advanced here attempts to do all of
the above.
2 CRISIS MANAGEMENT AND DEPOSIT INSURANCE
FRAMEWORKS
CDMI frameworks establish the principles that authorities should follow as well as setting
out the options that authorities may employ to deal with troubled banks. At the trough of
the Great Recession the G-20 heads of state mandated the Financial Stability Board (FSB),
in collaboration with national policymakers and international organizations such as the Basel
Committee on Banking Supervision and the International Association of Deposit Insurers
(IADI), to develop a global template for CDMI frameworks. This centred on the creation of
efficient resolution regimes. These would reduce the adverse impact that the failure of a bank
could cause and complement reforms in regulation and supervision designed to reduce the
probability that a bank could fail.3
1 European Commission. Directorate General for Financial Stability, Financial Services and Capital Markets Union (FISMA),
Targeted Consultation: Review of the Crisis Management and Deposit Insurance Framework ( January 2021) . The review encompasses Directive 2014/59/EU
of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution
of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC,
2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations
(EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council [2014] OJ L173/190
(BRRD); Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing
uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework
of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010 [2014]
OJ L225/1 (SRMR); Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on deposit
guarantee schemes [2014] OJ L173/149 (DGSD) and the Banking Communication regarding state aid [2013] OJ C216/1
(BC). All websites accessed at 9 May 2022.
2 For example, the European Central Bank, ‘ECB contribution to the EuropeanCommission’s targeted consultation on the
review of the crisis management and deposit insurance framework’ (May 2021) supports points (i) to
(v). F Restoy, R Vrbaski and R Walters, ‘Bank failure management in the European banking union: What’s wrong and how to
fix it’ Financial Stability Institute Occasional Paper 15 ( July 2020) emphasizes (i) to (iv). I Angeloni, Beyond the Pandemic:
Reviving Europe’s Banking Union (CEPR Press 2020) also does so, but in addition gives recommendations for regulation
and supervision. A Gelpern and N Véron, An Effective Regime for Non-viable Banks: US Experience and Considerations for
EU Reform (European Parliament Economic Governance Support Unit 2019) focuses on (i) to (iii), while the German
Savings Bank Association stresses the importance of (vi). See KP Schackmann-Fallis, ‘Improving the crisis management
and deposit insurance framework while preserving the diversity of the EU banking system’ Eurofi Views Magazine (April
2021) . See also Institutional Protection Schemes in Europe, ‘Declaration of Institutional Protection Schemes
in Europe with regard to changes to the regulatory framework for Crisis Management and Deposit Insurance’ (6 April
2021) ; M Tümmler,‘Completing Banking Union? The Role of National Deposit Guarantee Schemes
in Shifting Member States’ Preferences on the European Deposit Insurance Scheme’ (2022) Journal of Common Market
Studies 1 .Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework • 3
Resolution reform introduced what amounts to a pre-pack bankruptcy procedure for banks.
This has three components: (i) the separation of operating liabilities, such as derivatives and
deposits, from investor obligations; (ii) the subordination of the latter to the former in the
creditor hierarchy; and (iii) the bail-in (write down or conversion into common equity Tier
1 (CET1) capital) of obligations of the failed bank in reverse order of seniority in an amount
sufficient to recapitalize it.
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To ensure that bail-in stops short of operating liabilities, resolution reform requires banks to
issue a minimum amount of investor obligations, to remove obstacles to resolvability, and to plan
for resolution. If authorities avoid forbearance, the bail-in of investor obligations recapitalizes
the failed bank and allows the resolution authority to restructure it without cost to the taxpayer,
without interrupting critical economic functions and without significant disruption to financial
markets or the economy at large.4
If bail-in works in this manner, it also protects deposits, illustrating the fact that the risk to any
scheme that insures deposits depends not only on the probability that a member of the scheme
may fail, but also on when and how the authorities resolve the failed bank as well as on changes
in the economic environment subsequent to the bank’s entry into resolution. Claims on the
deposit guarantee scheme (DGS) are likely to be higher if the authorities exercise forbearance
and delay starting resolution, and/or the resolution process itself generates additional losses.
But these details need not concern the holder of a covered deposit: she will not suffer a loss if
the bank in which she holds the covered deposit fails, regardless of when or how the authorities
resolve the failed bank. If necessary, the DGS will step into the shoes of the depositor. The DGS
assumes the obligation of the failed bank vis-à-vis the holder of the covered deposit. It either
repays the deposit or transfers it to another institution. In return, the DGS takes over the claim
of the depositor on the failed bank. Although deposit insurance removes the rationale for the
insured to monitor the bank (and thereby creates moral hazard), on balance deposit insurance
limits contagion and promotes financial stability.5
However, if deposit insurance is to create these benefits, the guarantee of covered deposits
must be unconditional. The guarantee cannot be subject to preconditions, contingent on the
scheme’s operational capabilities, or limited to the amount of assets in the scheme. A DGS must
therefore have a backstop (IADI Core Principle 9). Indeed, it is the strength of the backstop that
gives a DGS its credibility.6 The backstop must come from an entity that is unquestionably able
3 For an overall summary of the entire reform programme as well as an evaluation of its implementation see Financial Stability
Board, Implementation and Effects of the G20 Financial Regulatory Reforms: 2020 Annual Report (November 2020) . For a summary of reforms to resolution see Financial Stability Board,
2021 Resolution Report: ‘Glass half-full or still half-empty?’ (7 December 2020) ; to banking regulation
see Basel Committee on Banking Supervision, Implementation of Basel standards—A report to G20 Leaders on implementation
of the Basel III regulatory reforms (November 2020); and to deposit insurance see International Association of Deposit
Insurers, ‘IADI Core Principles for Effective Deposit Insurance Systems’ (November 2014).
4 For an evaluation of resolution reform as well as an overview of its implementation see S Gleeson and R Guynn, Bank
Resolution and Crisis Management: Law and Practice (Oxford University Press 2016) and Financial Stability Board, Glass
half-full (n 3). Although there may be agreement that bail-in would work in theory, there is considerable scepticism that
it would be employed in practice, given the persistence of obstacles to resolution, the failure of banks to make themselves
resolvable and the incentives (and therefore the revealed preference) of both authorities and bank(er)s for bail-out over bail-
in. See for example E Avgoulos and C Goodhart, ‘Bank Resolution 10 Years from the Global Financial Crisis: A Systematic
Reappraisal’, School of Political Economy, LUISS 7/2019; M Hellwig, ‘Twelve Years after the Financial Crisis – Too-big-to-
fail is Still with Us’ (2019) Journal of Financial Regulation 1; and PD Culpepper and T Tesche, ‘Death in Veneto? European
Banking Union and the Structural Power of Large Banks’ (2021) 24(2) Journal of Economic Policy Reform 134.
5 D Anginer and A Demirgüç-Kunt, ‘Bank Runs and Moral Hazard: A Review of Deposit Insurance’ (2018) .
6 D Schoenmaker, ‘Building a Stable European Deposit Insurance Scheme’ (VoxEU, 17 April 2018) ; D Bonfim and JAC Santos, ‘The Importance of Deposit
Insurance Credibility’ Banco de Portugal Working Paper 2020/11.4 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
to provide it, if and when called upon to do so. If the guarantor cannot, deposit insurance will
not curtail contagion but instigate it.
3 THE CURRENT EURO-AREA CMDI FRAMEWORK
Although the Banking Recovery and Resolution Directive (BRRD), Single Resolution Mech-
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anism Regulation (SRMR), and Deposit Guarantee Schemes Directive (DGSD) follow the
global FSB template, differences in national legal regimes for dealing with bank failures stand
in the way of a fully integrated market and do not allow a uniform level of protection for the
same category of investors and depositors across participating Member States. As a result, the
intrinsic value of a deposit in one Member State could differ from that in another, even within
the banking union.7
The current euro-area CMDI framework therefore fails to achieve its objectives. It neither
creates a level playing field nor avoids recourse to taxpayer money. Nor does it protect covered
deposits fully. Consequently, it does not ensure financial stability.8
The reason for this state of affairs is simple. The Single Resolution Mechanism (SRM) is
not single at all. It is an amalgam of 19 different national insolvency regimes with a ‘European’
option to use bail-in and/or other resolution tools (bridge institution, asset separation, and sale
of business). But to employ this European option the Single Resolution Board (SRB) has to
conduct a public interest assessment and demonstrate that ‘resolution action . . . is necessary
for the achievement of and is proportionate to one or more of the resolution objectives . . .
and winding up of the institution under normal insolvency proceedings would not meet those
resolution objectives to the same extent’.9
This has been difficult to do during the decade-long transition period that Member States
have given themselves and their banks to implement the BRRD.10 Until recently, banks have
had limited amounts of investor obligations outstanding and therefore little ability to use such
obligations to recapitalize the bank, especially since the authorities have generally exercised
forbearance prior to determining that the bank was ‘failing or likely to fail’.11 This made it
less likely that a failing bank would pass the public interest test required for its use. From the
introduction of the SRM in 2014 until the outbreak of war in Ukraine in 2022, resolution
passed this public interest test just once,12 leading some observers to conclude that resolution
will remain an option that authorities refuse to use on the grounds that it would be too
7 European Central Bank, ‘ECB contribution’ (n 2) 1.
8 For a critical assessment of the BRRD from an overall EU perspective see AM Maddaloni and G Scardozzi, The New Bail-
In Legislation: An Analysis of European Banking Resolution (Palgrave Macmillan 2022); J-H Binder ‘Resolution: Concepts,
Requirements and Tools’ in J-H Binder and D Singh, Bank Resolution: The European Regime (Oxford University Press 2016);
and G Franke, J Krahnen and T von Lüpke ‘Effective Resolution of Banks: Problems and Solutions’ Leibniz Institute for
Financial Research SAFE, SAFE White Paper Series No 19 (2014). For analyses of the situation within the euro area see:
Angeloni (n 2); Restoy, Vrbaski and Walters (n 2); and JN Gordon and W-G Ringe, ‘Bank Resolution in the European
Banking Union: A Transatlantic Perspective on What It Would be Like’ (2015) 115 Columbia Law Review 1297.
9 SRMR article 18(1)(c)(5). On the public interest assessment see Single Resolution Board, ‘Public Interest Assessment: SRB
Approach’ (28 June 2019). ; TH Tröger and A Kotovskaia, ‘National interests and supranational resolution in the European banking
union’ SAFE Working Paper No 340, European Banking Institute Working Paper Series 2022 – no 114.
10 The SRMR was adopted in 2014 along with the BRRD. To implement the BRRD the EBA had to develop scores of
Regulatory Technical Standards and Guidelines and the SRB had to create detailed procedures. As they did so, it became
apparent that further amendments to the BRRD and SRMR would be required in order to harmonize the creditor hierarchy
that the SRB would use for resolution and to establish MREL subordination requirements. The BRRD and SRMR were
amended accordingly in 2019 and banks were given until 1 January 2024 to meet these requirements (as well as to complete
the funding of the SRF).
11 In some jurisdictions normal insolvency procedures require the bank to be balance sheet insolvent before the authorities can
intervene. This fosters forbearance and increases the likelihood that eligible liabilities will be insufficient to absorb losses
incurred by the failing bank (Restoy, Vrbaski and Walters (n 2)).
12 This was the case of Banco Popular in Spain in 2017. For a complete list of resolution cases see Single Resolution Board,
‘Cases’ .Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework • 5
disruptive to deploy.13 National standards have therefore remained the norm. Although the
Single Supervisory Mechanism may have made banks European in life, they largely remain
national in death.
National insolvency regimes differ considerably, even with respect to the creditor hierarchy
and the role that deposit insurance is expected to play. For depositors and other creditors of the
failed bank, liquidation under national insolvency regimes can result in anything from bail-out
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to wipe-out.14 Consequently, the risk of a claim on a bank, be it debt, derivative, or deposit,
varies across Member States and the playing field remains uneven. This diversity diminishes
competition, undermines the Single Market, and threatens financial stability.15
The use of national insolvency regimes does not limit recourse to taxpayer money. Indeed, it
does the opposite. Various national insolvency regimes permit the use of taxpayer money when
handling a failing bank, in some cases under conditions that amount to bail-out on terms less
stringent than would be required if the failing bank were subject to resolution under the aegis of
the SRB.16
Although the euro area has accumulated significant resources to defray losses that may be
incurred in resolution, these funds will not necessarily protect deposits – even covered deposits.
These resources are not pooled together and there are restrictions on their use.
The Single Resolution Fund (SRF) has already collected over e50 billion in contributions
from banks and is on track to achieve its fully funded target level of resources (1 per cent of
covered deposits) by the deadline of 1 January 2024. Currently, however, the SRF may only be
employed in cases where it is in the public interest for the SRB to employ resolution tools. The
SRF is not explicitly charged with the protection of deposits. The SRB can use the SRF solely for
specific purposes, subject to preconditions, and in limited amounts.17 Last but not least, until
recently the SRF had no backstop.
National deposit guarantee schemes are also building their funding levels in line with the
requirement that such schemes employ an ex ante funding model with a target funding level
equivalent to 0.8 per cent of covered deposits.18 Currently, the national DGS in the euro
area have over e35 billion available for use.19 However, a national DGS may only be used in
connection with a member of that scheme.20 Although a failed bank’s national DGS may be
13 Avgoulos and Goodhart (n 4). TH Tröger, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool under the
European Bank Recovery and Resolution Regime’ (2018) 4(1) Journal of Financial Regulation 35.
14 M Schillig, ‘EU Bank Insolvency Law Harmonisation: What Next?’ (2021) International Insolvency Review 1.
15 FISMA (n 1) 3–4.
16 FISMA (n 1) 3–4.
17 The SRF may (i) guarantee the assets or the liabilities of the institution under resolution; (ii) make loans to or purchase
assets of the institution under resolution; and (iii) make contributions to a bridge institution and/or an asset management
vehicle. In exceptional circumstances, where an eligible liability or class of liabilities is excluded or partially excluded from
the write-down or conversion powers, a contribution from the SRF may be made to the institution under resolution if
losses totalling not less than 8% of the total liabilities (including own funds of the institution under resolution) have already
been absorbed by shareholders, the holders of relevant capital instruments, and other eligible liabilities through write-
down, conversion, or other methods. The amount of resources that the SRF may employ in the case of any one bank is
limited to 5 per cent of the assets in the fund. For further details see Single Resolution Board, ‘The Single Resolution
Fund’ (2021) https://www.srb.europa.eu/system/files/media/document/2021-01-01%20The%20Single%20Resolutio
n%20Fund.pdf.
18 Although the target level of funding for a national DGS is 0.8% of covered deposits, four Member States have higher targets
(Estonia [1.66%], Luxemburg [1.60%], Greece [1.30%] and Malta [1.30%]) and one has a lower target (France [0.5%]).
European Banking Authority, ‘Deposit Guarantee Schemes data’ . On national DGS in general see European Banking Authority,
‘Opinion of the European Banking Authority on deposit guarantee scheme funding and uses of deposit guarantee scheme
funds’ (23 January 2020) .
19 By 1 January 2024 the funds available to national DGS are likely to rise by a further e20 billion or more as banks reduce
shortfalls to current target levels and as the amount of covered assets grows.
20 In some Member States a DGS may lend funds to another DGS within the EU, but practically no DGS has elected to do so.
See A Arda and MC Dobler, ‘The Role for Deposit Insurance Funds in Dealing with Failing Banks in the European Union’6 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
used in connection with a resolution led by the SRB,21 the primary purpose of a national DGS
is to support the pay-out of covered deposits under national insolvency regimes.22 To this end
the DGSD requires national DGS to improve their operational capabilities so that pay-out can
occur no later than seven days after the bank has failed. However, schemes across the euro area
vary with respect to their readiness to conduct pay-out and the resources at their disposal to
do so, as well as in the eligibility for coverage, the amount of coverage, and their ability to
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support the protection of covered deposits via alternative resolution methods23 or via open bank
assistance.24
But above all, national DGS differ with respect to the strength of the backstop provided by
national governments. For a euro in covered deposits to remain a euro, the backstop to the DGS
must come from an entity that can fulfil such a commitment without propelling itself into or
close to default. A fiscally weak Member State government is not such an entity; indeed, its
default or private sector involvement in the restructuring of the government’s debt may have
caused the bank to fail. Nor is a fiscally stronger Member State necessarily able to do so; indeed,
if it decides to bail-out its banks, assuming responsibility for additional debt may compromise
its ability to service any of its debt.25 In other words, a national DGS cannot guarantee that a
euro in covered deposits will remain a euro. Pretending that it can threatens financial stability.
4 THE NEW EURO-AREA CMDI SHOULD BE MORE UNIFORM AND
MORE ‘EUROPEAN’
The euro-area CMDI framework therefore requires a reset, and the 1 January 2024 deadline for
completion of the transition phase for the current framework would be an opportune time for
such a reset to come into effect. By that date banks in the euro area will have fulfilled Minimum
Requirement for own funds and Eligible Liabilities (MREL) subordination criteria (see below)
and improved their resolvability,26 so that a failing bank would not only have enough investor
IMF Working Papers 2022/2, 12 .
21 DGSD article 11.2 limits the contribution of the DGS under a SRB-led resolution to the amount of loss attributable to
covered deposits (Arda and Dobler (n 20) 10).
22 DGSD article 11(1). However, national schemes are not funded to, or operationally capable of, paying out covered deposits
at the largest banks in the scheme.
23 Under DGSD article 11.6 Member States may authorize the use of national deposit guarantee schemes to finance (in
accordance with the least cost principle) the transfer of assets and liabilities. Ten Member States (Austria, Finland, Greece,
Ireland, Italy, Lithuania, Luxembourg, Malta, Portugal, and Slovenia) have done so: European Forum of Deposit Insurers,
EFDI State of Play and Non- Binding Guidance Paper, ‘Deposit Guarantee Schemes’ Alternative Measures To Pay-Out
For Effective Banking Crisis Solution’ (7 November 2019) 16 .
24 Under DGSD article 11.3 Member States may authorize the use of national deposit guarantee schemes in connection with
alternative measures to prevent bank failure. Seven Member States in the euro area (Austria, France, Germany, Ireland, Italy,
Malta, and Spain) have chosen to do so (EFDI (n 23) 16).
25 P Tucker, ‘Resolution – A Progress Report’ (3 May 2012) . For example,
Ireland’s blanket guarantee of bank liabilities significantly weakened its credit rating and led to its submission to an EU
restructuring programme. For details see P Baudino, D Murphy and J-P Svoronos, ‘The Banking Crisis in Ireland’ FSI Crisis
Management Series No 2 (October 2020) .
26 As part of the resolution planning process the SRB evaluates the progress that banks are making toward becoming resolvable
via bail-in and other resolution tools. See Single Resolution Board, ‘Expectations for Banks’ . In particular, banks are expected to develop bail-in
playbooks (Single Resolution Board, ‘Operational Guidance on Bail-In Playbooks’ )
that summarize the processes that the bank would undertake to implement bail-in. The SRB has developed a heat map
to identify areas in which banks may be lagging. See S Laviola, The SRB Blog, ‘SRB’s new heat-map approach enhances
resolvability assessment’ (22 July 2021) . If necessary, the SRB has the
power to order a bank to remove impediments to resolvability.Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework • 7
obligations to recapitalize the bank, but authorities would also have the ability to use bail-in to
do so. This prospect is already increasing market discipline.27
In addition, the euro area will have amassed resolution funds amounting to more than 1.5 per
cent of covered deposits, an amount comparable to the Deposit Insurance Fund available to the
Federal Deposit Insurance Corporation (FDIC) in the United States.28 Importantly, the SRF
will also have access to a credible backstop from the European Stability Mechanism (ESM),
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an arrangement comparable to the line of credit that the FDIC has from the US Treasury.29
Last but not least, the pandemic appears to have driven policymakers to conclude that systemic
shocks deserve systemic responses. Governments have found it economically more efficient and
politically more appealing to assist borrowers rather than bail-out banks.
This fundamentally alters the situation that the euro-area CMDI framework must address. If
the authorities take prompt corrective action and declare a bank that reaches the point of non-
viability to be ‘failing or likely to fail’, there should be enough investor obligations at the failed
bank to recapitalize it without bail-in having to touch operating liabilities such as deposits and
derivatives. This creates the prospect that authorities can resolve failing banks without loss to
deposits, much less to covered deposits and to the DGS that insures such deposits. That in turn
opens the door to the creation of a Single Deposit Guarantee Scheme and to the completion of
Banking Union.
To realize this prospect, the reset proposed here would continue the Eurogroup risk reduction
programme. To date this programme has focused on steps the banks could take to lower risk,
such as reducing non-performing exposures or increasing issuance of MREL-eligible subordi-
nated liabilities.30 In contrast, the reset focuses on the steps authorities should take to limit
loss given failure. The first is to limit forbearance. To do so the reset shifts responsibility for
emergency liquidity assistance (ELA) from national central banks to the European Central Bank
(ECB). This creates a single lender of last resort and will help ensure that bail-in starts from the
right place: namely, as soon as a bank becomes failing or likely to fail and in any event before
its net worth is exhausted. The second step is to restrict the additional losses that the resolution
process itself can create. To do so, the reset creates a single presumptive path for resolution:
exit via bail-in followed by solvent wind-down. This ends ‘too big to fail’ and improves market
discipline. The third step is to make more efficient use of resolution resources. For resolutions
conducted under the SRB, the reset employs national DGS as an investor of last resort. This
ensures that all banks have enough investor obligations outstanding to allow bail-in to stop
short of operating liabilities. It also removes the need for a national DGS to lend to, reinsure,
or otherwise support a DGS in another Member State. Together, these steps pave the way both
economically and politically for risk mutualization: namely, the creation of the Single Deposit
Guarantee Scheme with a backstop from the ESM.
27 See Financial Stability Board, Evaluation of the Effects of Too-Big-To-Fail Reforms. Final Report. 1 April 2021. https://
www.fsb.org/wp-content/uploads/P010421-1.pdf and M Bellia, S Maccaferri and S Schich, ‘Limiting too-big-to-fail:
market reactions to policy announcements and actions’ (2021) Journal of Banking Regulation .
28 On 30 September 2021 the FDIC Deposit Insurance Fund amounted to $121.9 billion or 1.27% of covered deposits. See
Federal Deposit Insurance Corporation, ‘Remarks by FDIC Chairman Jelena McWilliams and Director of the Division of
Insurance and Research Diane Ellis on Third Quarter 2021 Quarterly Banking Profile’ (30 November 2021) .
29 According to 12 USC 1824(a) the FDIC may borrow up $100 bn from the US Treasury without prior approval.
30 Eurigroup, ‘Statement of the Eurogroup in inclusive format on the ESM reform and the early introduction of the backstop
to the Single Resolution Fund’ (30 November 2020) .8 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
5 THE SINGLE LENDER OF LAST RESORT
Stopping forbearance is one of the most effective measures that authorities can take to protect
deposits and limit recourse to taxpayer money. Forbearance can last only as long as the troubled
bank has access to liquidity.31 Whether such a bank gets that liquidity is largely up to the central
bank of the euro-area Member State in which the troubled bank is headquartered.32
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This decision effectively determines whether the bank is ‘failing or likely to fail’. If the central
bank denies the troubled bank’s request for ELA the bank will fail; the authorities must then
put it into resolution. If the central bank provides ELA, it will have done so on the basis that the
bank is solvent and that the bank will prospectively recover. In such circumstances, it is extremely
doubtful that a supervisor or resolution authority would attempt to contradict the central bank
and trigger resolution by declaring the troubled bank ‘failing or likely to fail’.
In fact, national central banks have frequently granted ELA to banks at or near the point of
non-viability, and in some cases, ELA has turned into extended liquidity assistance, remaining
outstanding for many months or even years. Such extended liquidity assistance allows banks
reaching the point of non-viability to avoid being characterized as ‘failing or likely to fail’ and
therefore enables such banks to postpone or avoid resolution. This in turn allows unsecured
creditors (including uninsured depositors) to run or secure their claims, shrinking the under-
pinning that would have supported covered deposits had the authorities initiated resolution
promptly. Losses continue to mount, possibly pushing the bank below its minimum capital
requirement or even to the point where the bank has negative net worth. If the bank does
enter resolution at some future point, losses to any liabilities that remain unsecured (including
deposits) will have very likely increased.33
To limit forbearance, the reset CMDI framework would shift responsibility for ELA to the
ECB, making it the single lender of last resort. In addition, the Single Supervisory Board (SSB)
would revise its procedures to ensure that any less significant institution requesting ELA would
immediately come under direct ECB supervision and that a request from any bank for an
extension of ELA would trigger an examination by the SSB of whether the bank was ‘failing
or likely to fail’ as well as the imposition of covenants on the ELA recipient to ensure that it
continued to meet threshold conditions while ELA remained outstanding.
6 THE SINGLE PRESUMPTIVE PATH FOR RESOLUTION
The resolution process itself can be a source of additional losses. Avoiding forbearance makes it
feasible to avoid such losses as well, and that is the purpose of the single presumptive path for
resolution in the reset of the euro-area CMDI framework. If a bank is determined to be ‘failing
or likely to fail’, the SRB will use resolution via bail-in to facilitate an orderly liquidation of the
31 On the role of liquidity in resolution see WP de Groen ‘Financing bank resolution: An alternative solution for arranging
the liquidity required’ (November 2018) .
32 Under the current Agreement on emergency liquidityassistance (European Central Bank, 9 November 2020) it is the national central bank that decides whether to extend or deny ELA to the
troubled bank. For further discussion see CV Gortsos, ‘Last Resort Lending to Solvent Credit Institutions in the euro
area before and after the Establishment of the Single Supervisory Mechanism (SSM)’ ECB Legal Conference 2015: From
Monetary Union to Banking Union, on the Way to Capital Markets Union (Frankfurt: European Central Bank) 53–76;
RM Lastra, ‘Reflections on Banking Union, the Lender of Last Resort and Supervisory Discretion’ ECB Legal Conference
2015, 154–73.
33 E. König ‘Banking Resolution – Keynote Speech by Dr Elke König, Chair of the Single Resolution Board’ (2018) . European Systemic Risk Board Advisory Scientific Committee, ‘Forbearance,
resolution and deposit insurance’ ( July 2012) .Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework • 9
failed bank under a solvent wind-down strategy. Hence, the entry into resolution signals the exit
of the bank from the market, not a prelude to its resurrection.
The basis for this single presumptive path is the MREL subordination requirement. This
requires significant institutions in the euro area to have outstanding and available for bail-in
liabilities subordinated to any class containing instruments that are exempt from bail-in.34
This effectively subordinates investor obligations to operating liabilities such as derivatives and
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deposits. The aggregate amount of such subordinated liabilities should be at least 8 per cent of
the bank’s total own funds and liabilities. This is an amount sufficient to recapitalize the bank,
if it were to fail, as well as an amount sufficient to enable the SRB to access the SRF if a claim
were made under the ‘no creditor worse off’ provision.35 At the end of the third quarter 2021
the largest banks in the euro area – which issue the bulk of covered deposits – already met these
requirements in full and the others were well on their way to doing so.36
Under the reset CMDI framework, it is the job of the banks to issue enough subordinated
MREL-eligible liabilities to recapitalize the bank, and it is the job of the authorities to initiate
and execute the resolution of a failing bank in a manner that does not exhaust that loss-bearing
capacity. The task facing the authorities begins with ensuring that the bank enters resolution
while it still has positive net worth. That responsibility falls primarily to the supervisor. The
supervisor has to monitor the bank’s performance against the regulations that limit the risk the
bank can take, much as the bank itself monitors the covenants that it imposes on borrowers.37
The supervisor also has to take appropriate measures in a timely fashion if the bank violates
those regulations, in much the same way that a bank would declare a borrower to be in default
and seek to enforce the remedies available to it as creditor. Thus, it falls to the supervisor to call
time on any bank that no longer meets minimum threshold conditions, and to declare the bank
to be ‘failing or likely to fail’ and turn the bank over to the SRB for resolution.
Valuation plays a key role in that decision.38 Although management may have an incentive
to overvalue assets and/or undervalue liabilities,39 the ECB is well placed to conduct such
prudential valuations, given that it already regularly values the assets that banks may use as
collateral in connection with normal lending facilities.40 Together with the shift of responsibility
34 To meet the subordination requirement banks may use AT1 and T2 capital as well as senior non-preferred debt. In certain
circumstances senior preferred debt may be used. See Single Resolution Board, ‘Minimum Requirement for Own Funds
and Eligible Liabilities (MREL) – SRB Policy under the Banking Package’ (2020) .
35 The minimum of 8% of total own funds and liabilities is necessary in order to be able to access the SRF. In terms of total
risk exposure, the subordination requirement is at least 13% of the bank’s risk-weighted assets.
36 Single Resolution Board, ‘Minimum Requirement for Own Funds and Eligible Liabilities (MREL) – SRB Policy under the
Banking Package (1 February 2022) .
37 M Dewatripont and J Tirole, The Prudential Regulation of Banks. (MIT Press 1994).
38 On the role of valuation in resolution see European Banking Authority, ‘Regulatory Technical Standards on
valuation for the purposes of resolution and on valuation to determine difference in treatment following resolution
under Directive 2014/59/EU on recovery and resolution of credit institutions and investment firms’ (23 May
2017) ; W de Groen, ‘Valuation Reports in the
Context of Banking Resolution: What Are the Challenges?’, European Parliament Economic Governance
Support Unit ( June 2018) ; Hellwig, Martin F. (2018) :
Valuation reports in the context of banking resolution: What are the challenges?, Discussion Papers of the Max Planck
Institute for Research on Collective Goods, No. 2018/6, Max Planck Institute for Research on Collective Goods, Bonn.
Available at: http://hdl.handle.net/10419/194175. Single Resolution Board, ‘Framework for Valuation’ (February 2019).
39 EJ Kane ‘Masters of Illusion: Bank and Regulatory Accounting for Losses in Distressed Banks’ Institute for New Economic
Thinking Working Paper 136 (27 August 2020) available at https://www.srb.europa.eu/system/files/media/docume
nt/2019-02-01%20Framework%20for%20Valuation.pdf.
40 In addition, the SSM (Room for Improvement of valuation risk management. SSM Supervision Newsletter 19
May 2021.10 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
for ELA to the ECB, this should enable the supervisor to avoid forbearance and resolution to
begin at a point where the bank still has positive net worth.
Valuation also plays a key role in the SRB’s determination of where bail-in should stop. This is
where the write-down or conversion of the liabilities (in reverse order of seniority) is sufficient
to absorb all the losses at the failed bank and to recapitalize it so that it again meets threshold
conditions. If it determines that bail-in can stop at the senior non-preferred class,41 the SRB
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will immediately do two things upon taking control of the bank: bail-in investor obligations and
have the SRF guarantee the bank’s operating liabilities.42 To implement bail-in the SRB will
immediately convert AT1 and T2 capital instruments into CET1 capital in accordance with the
write-down or conversion provisions of such instruments.43 In addition, the SRB will place a
stay on the other investor obligations (senior non-preferred debt and senior preferred debt) of
the failed bank. This will suspend interest and amortization payments to investors in such debt.
Instead, they will receive certificates entitling them – in strict order of seniority – to the proceeds
realized from the orderly liquidation of the failed bank.44
By guaranteeing the bank’s operating liabilities the SRB assures that the bank-in-resolution
will have access to adequate liquidity during the solvent wind-down process.45 This in turn
enables the bank-in-resolution to minimize the costs that the resolution process could itself cre-
ate. In particular, the guarantee will ensure that the bank-in-resolution repurchases the securities
that it had sold under repo agreements. This enables the bank-in-resolution to avoid the loss that
might have resulted if the repo counterparty had exercised its rights to sell the collateral pledged
by the bank. Similarly, the guarantee from the SRF enables the bank-in-resolution to meet its
obligations to central counterparties and other financial market infrastructures. This will avoid
the need for such entities to start their default procedures, thereby limiting contagion from
the bank-in-resolution to financial markets and the economy at large. The guarantee will also
prevent counterparties from closing out derivatives and thereby enable the bank-in-resolution
n.html>) is strengthening its controls over the quality and timeliness of the data submitted by significant institutions in the
euro area as well as the criteria by which banks determine the amount of any asset or liability carried at fair value.
41 If the SRB determines that bail-in is likely to stop only in the class containing senior preferred debt, the SRB must decide
how to treat operating liabilities, such as derivatives, subject to bail-in but eligible for exclusion from bail-in, if the resolution
authority decides that the cost of bailing in the liability exceeds the benefit. Under the single presumptive path, the SRB
is assumed to restrict bail-in within the senior preferred class to senior preferred debt. This choice makes all investor
obligations subordinate to operating liabilities.
42 Such a SRF guarantee should not constitute state aid, inasmuch as the borrower is in the process of exiting the market
and will therefore not derive long-term benefit from the guarantee. Moreover, any losses from providing the guarantee
will first be for the account of the failed bank’s CET1 capital, then to the receivers’ certificates representing the claims
of the failed bank’s senior non-preferred and senior preferred debt. If these amounts were insufficient the loss would be
absorbed by the SRF and, if need be, by the ESM. However, any loss to the SRF or to the ESM would be temporary, as
they are entitled to recoup such losses via levies on the banks. See European Commission, ‘Report from the Commission
to the European Parliament and the council on the application and review of Directive 2014/59/EU (Bank Recovery and
Resolution Directive) and Regulation 806/2014 (Single Resolution Mechanism Regulation)’ (30 April 2019) 7 .
43 It is not necessary for the SRB to review conversion ratios. This can be done on the terms in the instrument itself. For
resolution purposes, what matters is the amount of CET1 capital created.
44 Note that interest would continue to accrue on the debt at the contractual rate and that the debtholder would be
entitled to receive cash from the proceeds of the liquidation rather than equity in the bank-in-resolution. This simplifies
administration and helps preserve strict seniority. Receivers’ certificates correspond to the claims that a debtholder would
receive in a corporate bankruptcy proceeding and thus broaden the market for the debt instruments qualifying as MREL
subordinated liabilities to those institutional investors who may not invest in instruments convertible into equity at the
option of the administrator. This market-broadening effect is important in light of the regulatory restrictions on banks’
and insurance companies’ holding such subordinated debt instruments. For further details see W-G Ringe and J Patel,
‘The Dark Side of Bank Resolution: Counterparty Risk through Bail-in’ European Banking Institute Working Paper Series
2019 – no. 31, Oxford Legal Studies Research Paper (2019); S Laviola, The SRB Blog, ‘The public interest assessment and
bank-insurance contagion’ (26 January 2022) .
45 Obligations with such a guarantee would be eligible for use as collateral by other banks to secure their borrowings from
the ECB under normal central banking facilities. On the importance of liquidity in resolution see Bindseil, Ulrich, Central
Bank Collateral, Asset Fire Sales, Regulation and Liquidity (November 6, 2013). ECB Working Paper No. 1610, Available
at SSRN: https://ssrn.com/abstract=2350657orhttp://dx.doi.org/10.2139/ssrn.2350657.Reset Required: The Euro-area Crisis Management and Deposit Insurance Framework • 11
to avoid the losses that would have resulted from the counterparties being able to do this at their
replacement cost. In addition, the guarantee enables the bank-in-resolution to avoid fire sales.
This enables the bank-in-resolution to realize full value over time.46 Last, but by no means least,
the guarantee is likely to induce authorities in third countries to cooperate with the SRB and
refrain from invoking ringfencing measures.47
Together, the bail-in of investor obligations and the guarantee of operating liabilities will
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enable the SRB to reopen the bank-in-resolution at the start of the next business day. The bank
will then start to wind itself down under the oversight of the SRB. This will enable critical
economic functions to continue. The bank-in-resolution will make payments as due on its
operating liabilities, including derivatives and deposits. Holders of covered deposits will retain
access to their accounts. In the trading book the SRB will direct the bank-in-resolution to reduce
risk via trades that balance its positions and/or via commutation of its exposures to major
counterparties.48
The SRB will also seek to realize any franchise value that the failed bank may still have. To do
so, the SRB may employ additional resolution tools to transfer deposits to another bank and/or
sell businesses, subsidiaries, or even the entire bank to third parties. As any franchise value is
likely to erode rapidly, the SRB should take such steps as quickly as possible. This will accelerate
the wind-down and insulate the bank-in-resolution from changes in the economic environment
that may subsequently occur.
To make this path the single presumptive path, the new CMDI framework will reverse the
public interest assessment required under the SRMR. National competent authorities will have
to demonstrate that it would be in the interest of the euro area as a whole to liquidate the
failing bank under national insolvency law rather than have the SRB use bail-in and/or other
resolution tools. This will effectively make resolution under the SRB the standard for handling
failing banks. This in turn will harmonize the creditor hierarchy across euro-area Member States,
level the playing field, and improve market discipline. It will also protect deposits, particularly
covered deposits. This will create the basis for establishing a Single Deposit Guarantee Scheme
(see below).
7 NATIONAL DEPOSIT GUARANTEE SCHEMES AS INVESTORS OF
LAST RESORT
That leaves the question of how the euro area might employ the resolution funds built up via
bank contributions during the transition period. The problem is (see above) that these resources
are not pooled together and they do not operate in tandem. The reset remedies this by giving
national DGS and the SRF separate and complementary functions: national DGS will function
as an investor of last resort in the bank’s MREL-eligible subordinated liabilities. This will ensure
that the single presumptive path can apply to all institutions in the euro area. The SRF will
function as the Single Deposit Guarantee Scheme with a backstop from the ESM. This will
46 Derivatives and repos are qualified financial contracts and generally exempt from the mandatory stay imposed on secured
financing in bankruptcy. To make resolution feasible such contracts should be subject to a statutory or contractual stay. For
further discussion see MJ Roe, ‘Derivatives and Repos in Bankruptcy’ in BE Adler (ed), Research Handbook on Corporate
Bankruptcy Law (Edward Elgar 2020) 102–23.
47 The most severe ringfencing option is that available to third countries (such as the United States) that follow the territorial
approach to bankruptcy. The third country may elect to resolve the failed bank’s branch in that country separately from
the rest of the bank. If it were to do so, the third country would first use the assets of the branch to satisfy the liabilities of
the branch. If this proves to be insufficient, the estate of the branch would have a claim on the estate of the failed bank in
its home country. For details see PL Lee, ‘Cross-Border Resolution of Banking Groups: International Initiatives and U.S.
Perspectives, Part III’ (2014) Pratt’s Journal of Bankruptcy Law 291.
48 For a discussion of solvent wind-down see Financial Stability Board, ‘Solvent Wind-down of Derivatives and Trading
Portfolios’ (3 June 2019) ; Single Resolution Board, Sol-
vent Wind-down of Trading Books, Guidance for banks 2022’ (1 December 2021) .12 • Journal of Financial Regulation, 2022, Vol. 00, No. 00
complete Banking Union and bring a concrete, readily understandable, and credible benefit to
the citizens of the euro area: the assurance that a euro in covered deposits will remain a euro.
This allocation of responsibility addresses both the political objections to a European Deposit
Insurance Scheme (EDIS) and economic objections to resolution via bail-in. To date, reinsur-
ance and mutualization of national DGS have been the foundation on which the EDIS would be
built.49 This has been anathema to groups such as the German savings banks that have built up
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considerable deposit guarantee funds. They are concerned that the EDIS would require them to
make their funds available as a backstop to schemes in other euro-area Member States without
the prospect of timely (or even any) repayment, leaving their own scheme unable to fulfil its own
functions should the need arise.50
To date, there has also been little support for using resolution via bail-in to handle the failure
of less significant credit institutions, partly on the grounds that such institutions do not have
access to capital markets and cannot issue gone-concern capital instruments to investors. The
current CMDI framework therefore presumes that ‘resolution is for the few, not the many’51
and that less significant institutions need less gone-concern capital, as they would be liquidated
under national insolvency regimes. However, this approach means that an uninsured deposit at
a less significant institution is inherently riskier than such a deposit at a significant institution,
even within the same Member State – another instance of the unlevel playing field that exists
under the current CMDI framework in the euro area.
Under the reset proposed here, a national DGS would not be required to lend to other
schemes or be responsible for the insurance or reinsurance of covered deposits in any bank that
was not a member of the DGS concerned. Instead, the responsibility of a national DGS in any
SRB-led resolution would be limited to the amount by which the failed bank’s subordinated
liabilities failed to meet the target of 8 per cent of total liabilities and own funds.
This should be no problem for schemes such as that of the German Savings Bank Association,
for the scheme is first and foremost an institutional protection scheme (IPS). As such, it ensures
– via a contractual or statutory liability arrangement – that its member institutions have the
liquidity and solvency needed to avoid bankruptcy where necessary. Indeed, it was the scheme’s
history of success in dealing with troubled savings banks without loss to depositors that led to
its designation as a DGS in accordance with DGSD article (4)(2). In the euro area as a whole
over 1700 banks are members of institutional protection schemes in Austria, Germany, Italy,
and Spain. They account for the majority of less significant institutions, not only in the Member
States concerned, but in the euro area as a whole.
Even if a national DGS is not itself an IPS, it should have little trouble fulfilling the ‘investor
of last resort’ role. This relies on the same dynamic that makes pay-out possible; namely, the
fact that large institutions are required to pay premiums but not expected to generate claims, as
their resolution plans do not envisage pay-out. Similarly, there would be no need for a national
DGS to plug the gap for the members who are able to issue subordinated liabilities either to
investors or to affiliates. Such entities include G-SIBs, subsidiaries and branches of G-SIBs, other
rated significant institutions, subsidiaries of rated non-financial corporations, and members of
cooperative and mutual associations that are not formally an IPS. Such entities generally account
for the bulk of deposits covered by a national DGS.
49 See High-Level Working Group on EDIS, ‘Letter by the High-Level Working Group on a European Deposit Insurance
Scheme (EDIS) Chair to the President of the Eurogroup, Further strengthening the Banking Union, including EDIS: A
roadmap for political negotiations’ (3 December 2019) .
50 Tümmler (n 2).
51 König (2018) E König, ‘Banking Resolution – Keynote Speech by Dr Elke König, Chair of the Single Resolution
Board’ (2018) .You can also read
