Proposal for banks to pay in to ‘resolution fund’

Proposal for banks to pay in to ‘resolution fund’

The European Commission (EC) announced on May 26 2010 a proposal that the European Union establishes an EU network of bank resolution funds to ensure that future bank failures are not at the cost of the taxpayer or destabilise the financial system.Following discussion at the forthcoming European Council, the EC will present these ideas at the G20 Summit in Toronto on June 26 and 27 2010, the EC said in a media statement.Such funds would form part of a broader framework aimed at preventing a future financial crisis and strengthening the financial system, according to the EC."The Commission believes that a way to achieve this is by introducing requirement for member states to establish funds according to common rules into which banks are required to pay a levyl," the EC said.The funds would not be used for bailing out or rescuing banks, but only to ensure that a bank's failure is managed in an orderly way and does not destabilise the financial system.Internal Market and Services Commissioner Michel Barnier, as quoted in the statement, said: "It is not acceptable that taxpayers should continue to bear the heavy cost of rescuing the banking sector. "They should not be in the front line," Barnier said. "I believe in the 'polluter pays' principle," he said. "We need to build a system which ensures that the financial sector will pay the cost of banking crises in the future. That is why I believe that banks should be asked to contribute to a fund designed to manage bank failure, protect financial stability and limit contagion - but which is not a bail-out fund. Europe must take a lead in developing common approaches and providing a model for co-operation which could be applied globally."As a result of the financial crisis, the EC said, national governments have had to use massive amounts of taxpayers' money to support their financial sector, maintain financial stability and protect depositors. "Efforts are now needed to ensure that such situations never happen again." The EC said that it was already putting in place preventive measures which should reduce the probability of bank failure, but work also was needed to ensure that should bank failures arise in the future, robust mechanisms backed by private money are in place to deal with them. In October 2009, the Commission made clear that it supports the establishment of a new crisis management framework at the EU level, the EC said. This new framework will include a harmonised set of powers and rules allowing regulators to prevent bank failures and to take measures to facilitate the orderly resolution of insolvent banks while minimising costs to taxpayers, according to the EC. "The Commission is now suggesting resolution funds as a complement to this new framework. Naturally, their size and scope would depend on the efficiency of improved supervision and regulation." A number of EU Member States have already introduced, or are considering introducing, levies on their banking sector. However, the EC said, the lack of a co-ordinated approach towards how much money should be levied and how it should be used means there is a risk of competitive distortions between national banking markets and of cross-border cooperation during crises being hampered. The EC said that it believes that establishing an EU-wide network of pre-funded schemes with narrowly defined mandates would constitute the best use of bank levies. These funds would be designed to provide financing for the types of measure outlined in the October 2009 Communication on crisis management, which include: providing financing for 'bridge bank' operations; total or partial transfer of assets and/or liabilities; and financing a 'good bank' / 'bad bank' split. The establishment of resolution funds would enhance the resilience of the banking sector and avoid the need to revert to taxpayer funds. The EC said that it also recognises that the existence of large bank-funded schemes raises important 'moral hazard' issues if there is a belief that such funds exist to protect banks against future failure. "This is a major concern which needs to be addressed by making it clear and unambiguous that shareholders and uninsured creditors must be the first to face the consequences of a bank failure and that resolution funds will be no insurance policy, and be used not to bail out failing banks, but rather to facilitate an orderly failure." According to the EC, bank resolution funds would need to be constituted over a period of time and the contributions levied from the banks could be designed in ways which incentivised appropriate behaviour and mitigated the risk of resolution. "However it is not the Commission's intention at this stage to provide precise details about how bank resolution funds would be expected to operate and how large they would need to be," the EC said. "The Commission recognises that it will be essential to develop a clear understanding and careful assessment of the cumulative impacts of the broad set of reforms dealing with levies and bank capital. It will also be necessary to ensure that these costs are calibrated in such a way as to avoid stifling the economic recovery and the cost of credit to the real economy." The EC will present its ideas to EU finance ministers, heads of state and the G20 over the course of June 2010. It will press for broad agreement on general principles and orientations. The EC said that in October 2010 it will put forward more detailed proposals on its broader plans for the development of a new crisis management framework and the planned adoption of legislative proposals. "The Commission will carefully consider the implications of its proposals for resolution funds in accompanying impact assessment work."The EC said that, with a view to maintaining a worldwide level playing field, it intends to lead G20 efforts to find a global approach on resolution funds based on the ideas put forward on May 26. According to the BBC, Angela Knight of the British Bankers Association said that having large resolution funds, as the EU proposes, could help facilitate the next crisis."It would surely increase moral hazard by curtailing the consequences of a bank failure," Knight was quoted as saying.Instead, Knight said that each country should strengthen its regulation and supervision, with a national intervention authority, being the Bank of England in the UK."And each country needs to put in place arrangements so that if intervention is required, then this is paid for by the industry and depositors are protected," she said. 

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