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These views do not necessarily represent those of Bank of Spain or the Eurosystem

The Insufficiency of Traditional Safety Nets: What Bank Resolution Fund for Europe? Maria J. Nieto Gillian Garcia. Finlawmetrics 2012 Bocconi University 21-22 June. These views do not necessarily represent those of Bank of Spain or the Eurosystem. Outline.

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These views do not necessarily represent those of Bank of Spain or the Eurosystem

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  1. The Insufficiency of Traditional Safety Nets: What Bank Resolution Fund for Europe? Maria J. Nieto Gillian Garcia Finlawmetrics 2012 Bocconi University 21-22 June These views do not necessarily represent those of Bank of Spain or the Eurosystem

  2. Outline • Failed bank resolution in the EU • Our proposal • Background • BRRF: • Contributors • Functions • Intervention capacity and funding • Governance • Conclusions and questions for debate Nieto

  3. Failed bank resolution in the EU Source: Impact assessment Directive proposal (2012) Nieto

  4. Failed bank resolution in the EU • EU Directive proposal establishing a framework for the recovery and resolution of credit institutions  No single book • Offers a harmonized EU regime for pre insolvency - Preparation and prevention PS tools - Early intervention as to avoid insolvency • Harmonizes resolution tools: Defines clear means to reorganize or wind down the bank in an orderly fashion, limiting to the maximum extent any exposure of taxpayers to losses in insolvency - Bank should enter into resolution at a point very close to insolvency, i.e. when it is on the verge of failure (point of non viability) … It does not establish a single closure rule (authorities´ judgment) • Does not harmonize the authority responsible but advises separation • Member States shall establish financing arrangements (Resolution Funds) for the purpose of ensuring the effective application by the resolution authority of the resolution tools Nieto

  5. Outline • Failed bank resolution in the EU • Our proposal • Background • BRRF: • Contributors • Functions • Intervention capacity and funding • Governance • Conclusions and questions for debate Nieto

  6. Our proposal • Priors: • “Bottom up” banking crisis and not with “top down” caused by sovereign debt crisis … • Resolution laws establish SEIR cum PCA (Nieto, Wall 2006)  Aimed at limiting forbearance • Take as granted decentralized safety net in EU w/o questioning its adequacy Nieto

  7. Our proposal • National BRRFs funded by FIs contributions • FI “contribution” based systemic importance • BRRF part of effective bank resolution framework   • Ex ante defined BRRFs shift the government’s trade off between bailing out and restructuring in favor of restructuring • Importance in the case of the Euro area   Nieto

  8. Our proposal • Alternative to … • Flat tax rates • No cross subsidies • Systemic capital surcharges: • FIs “contribution” BRRF vs capital add-on systemic banks • Applicable to all leveraged FIs (not only banks) • (+)Transparent: Funds outside the FIs Nieto

  9. Our proposal • IMF (2010) “A Fair and Substantial Contribution by the Financial Sector” Final Report to the G20, June 2010 • FSB (2011) “Effective Resolution of Systemically Important Financial Institutions: Recommendations and Timelines “Consultative Document, July 19 • DG Internal Market and Services WD (2010) “Technical Details of a Possible EU Framework for Bank Recovery and Resolution” Pag 83 envisages the requirement National BRRFs Nieto

  10. Our proposal • German Council of Economic Experts (May, 2010) • EU perspective: Operational and governance arrangements demand harmonization • Perotti and Suarez(2009); Acharya and Richardson (2010) • BRRF vs Part of the general tax revenues • Resolution tool vs purely macroprudential tool Nieto

  11. Outline • Failed bank resolution in the EU • Our proposal • Background • BRRF: • Contributors • Functions • Intervention capacity and funding • Governance • Conclusions and questions for debate Nieto

  12. Background Source: EU Commission Public Support toFinancial Sector 13% EU GDP Jan 2012 Nieto

  13. Background Capital injections and debt guarantees (Dec 2011) in €bill Source: Author’s analysis of EU Commission data Nieto

  14. Outline • Failed bank resolution in the EU • Our proposal • Background • BRRF: • Contributors • Functions • Intervention capacity and funding • Governance • Conclusions and questions for debate Nieto 14

  15. BRRF: Scope • Contributors • Banks • Non bank credit intermediation that has the potential to pose systemic risk • Leverage • Maturity transformation • Liquidity transformation • Rationale Nieto

  16. BRRF: Functions • Guarantees for the issuance of banks´ senior debt, when normal access to the capital market is not possible in an early phase of a formal resolution process • Funding for the take-over of banks´ impaired assets • Provide finance for temporary capitalization / bridge bank StateAid Rules Changes in the national laws that give different powers to decide and to execute reorganization/winding up to different authorities: EU Directive ? 9/1/2014 Nieto 16

  17. BRRF: Intervention capacity • Max. [4% GDP; Avg. adjust. eligible liabilities] • Capitalization, the strongest form of gov´t intervention   • 2- 4 % of each countries´ GDP (IMF, April 2010) Sweden 2.5 % GDP Germany 4% GDP Luxembourg 5% GDP (P) • Avg. adjust. eligible liabilities of Member State • Total liabilities (excluding intra group debt transactions) minus own funds (T1 and T2) and customer current, savings and term deposits (derivatives ?) • BRRFs will be different among countries and overtime within a country • If additional funding needed: Market issuance with gov´t guarantees, repaid by the FIs Nieto

  18. BRRF: Intervention capacity Source: BankScope unconsolidated data Nieto

  19. BRRF: Intervention capacity Financial support to program countries over the program period (% 2009 GDP) as of September, 2011 Source: Nieto and Garcia (forthcoming) ESM could play the role of national BRRFs “Act on the basis of a precautionary program and finance recapitalization of FIs through loans to govt´s including non program countries” Council of European Union 21 / 7 / 2011 Nieto

  20. BRRF: Funding • Contribution of financial institution i Nieto

  21. BRRF: Funding (a) Limits to moral hazard • Necessary condition: SEIR cum PCA • BRRF not an insurance fund • Levies should be paid “ex ante” by all FIs legally incorporated in each country (subs) • FIs take first losses of the BRRF (b) Limits to pro-cyclicality • Levies should be paid “ex ante” • Levies take into consideration the banks´ structural systemic importance and should be periodically reassessed • Funding of BRRF over a sufficiently long period of time Nieto

  22. BRRF: Governance • BRRFs housed in the resolution authority • Banks´ Recovery and Resolution Plans should include info on the role of BRRFs on conserving / restoring own funds and having adequate access to liquidity (Huertas, 2011) • Triggers of intervention: Resolution authority • Importance of mkt based indicators + stress test • Mechanism to limit supervisors´ forbearance (Hart & Zingales, 2010) • In the EU, a number of DIs have resolution powers  House BRRF but funds keep separated Nieto

  23. BRRF: Governance Nieto

  24. Conclusion • Our proposal aims at redirecting existing regulatory proposals • Towards further strengthening resolution authority • Extra costs of regulation, more effectively limit the public costs of financial distress Nieto

  25. Conclusion Rational of financial regulation: Limit the probability and costs of negative externalities caused by financial distress when the public costs of those externalities exceed both the private costs of failure and the extra costs of regulation The Fundamental Principles of Financial Regulation (Geneva Reports on the World Economy 11) Nieto

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