The approach to bank recapitalization
The communiqué of the euro area summit of 29 June 2012 envisaged the possibility for the ESM (European Stability Mechanism) to recapitalize euro area banks directly, once the single supervisory mechanism was established with the involvement of the ECB . As this Commission is certainly well aware, in recent weeks the implementation of the decisions of the Eurosummit in June has been bogged down in an unconstructive discussion on the treatment of CDs. “legacy assets” of Spanish banks: why Germany and other countries do not want the ESM to cover the past losses of Spanish banks (and then, soon after, those of Irish banks); but if nothing is done, the vicious circle between the banking crisis and the sovereign debt crisis risks overwhelming Spain and rekindling instability.
The fundamental principle to be followed in crisis management and resolution is that financial resources intended to save shareholders and creditors should never be injected into a bank: only in this way, in fact, would moral hazard and the discipline of market could work effectively. The implication of this principle is that any transfer of money to failing banks under a European financial assistance program should not be used to cover their losses, but should be constructed as temporary financial support, to allow time for the necessary restructuring processes, therefore with strong conditionality. From this point of view, the modalities of intervention of the ESM in the capital of the banks must be designed.
In this regard, a useful example is the Troubled Assets Relief Program (TARP), adopted by the US government in October 2008 to recapitalize banks and other systemic financial institutions (eg AIG) and curb the crisis of confidence. According to that model, the recapitalization interventions took place with the purchase of privileged shares, at a very convenient cost, but with stringent management conditions and constraints (for example, the remuneration and dividend distribution policies, and the appointment of directors of administration). At the end of the pre-established period, the banks that were not in a position to buy back the shares would become the property of the ESM, which would take control of them; the residual losses would be covered by the cancellation of the ordinary shares and the restructuring of the bank's debts other than bank deposits.
This model has the advantage of offering private shareholders the possibility of reorganizing the bank, avoiding immediate nationalisation; but if the restructuring fails, shareholders and private creditors will retain full responsibility for the bank's losses. Note, however, that the intervention program could offer positive returns for the ESM, as happened with the US TARP.
Deposit insurance and bank crisis resolution
The European banking union requires the three pillars of supervision, deposit insurance and bank resolution. The Commission's proposal, despite the critical issues discussed, represents significant progress on the supervisory front; the work is still incomplete for the other two components.
As far as deposit guarantees are concerned, the European Commission's proposal of July 2010 provides for the harmonization of national deposit guarantee schemes, introducing an ex-ante financing obligation by banks, with contributions based on the risk profile , and also providing for the possibility of loans between the national schemes of different countries.
However, we are not yet in the process of building an integrated European deposit guarantee scheme, including both a European and a national level. The first key requirement is that the guarantee only covers depositors and cannot be used to cover bank losses and protect managers, shareholders or creditors other than depositors. Furthermore, a European insurance fund is needed, which guarantees an adequate pooling of the risks of bankruptcy, or at least of significant losses, of the large cross-border banks. Importantly, in this respect, the accumulation and pooling of the European insurance fund would start with the new system and would not concern the resources already accumulated by the national deposit guarantee schemes. The establishment of a European fund establishes delicate connection relationships with national funds, which should probably continue to exist, but would be impoverished due to the transfer of the protection of larger banks to the European level.
As for the guarantee of deposits, the Commission's proposal for the creation of a European legal framework for the resolution of bank crises provides for a harmonization of national systems, with common prevention tools (for example, elaboration of recovery and resolution plans), early intervention (for example, the procedures for the implementation of recovery plans, the urgent convening of the shareholders' meeting, the appointment of a special administrator, and the like) and resolution (bridge banks, asset sales, bail-in). But the management of the resolution processes is left to the national authorities; the establishment of national resolution funds is also envisaged, which should serve to support corporate reorganisations.
Therefore, as for deposit guarantee schemes, for now we are thinking in terms of harmonizing national systems, rather than creating a single European system. But without a European crisis management system, the problem of moral hazard cannot be solved, due to the tendency of national authorities to protect their major banks.
The key to the solution lies in giving the European Supervisory Authorities all powers of crisis management – not just those of early intervention, as the Commission has done with its proposal; then, what remains of the bank after all the resolution interventions can effectively be entrusted to the national authorities, without fear of "supervisory forbearance".
Such a system presupposes, above all, the adoption of the American supervisory model of Prompt Corrective Action (PCA), developed by the Federal Deposit Insurance Corporation (FDIC). According to this model, when the capital of a bank falls below certain levels, the supervisors are forced to act (mandated action system), with interventions of a progressively more invasive nature as the capital solidity deteriorates.
