EU Commission unveils proposals on bondholder 'bail-ins' for banks

Wed, Jun 6, 2012, 01:00

THE EUROPEAN Commission unveils draft legislation today that will give member states the power to impose bank bailout costs on senior bondholders, a step blocked to the Government in the rescue of Ireland’s banks.

The proposal is part of a new scheme in which banks will be compelled to “bail-in” their creditors whenever they fail, the basic aim being to prevent taxpayer-funded bailouts in the future.

The public authorities would also be given powers to replace the management teams in banks even before the lender fails.

Each institution would also be obliged to set aside at least 1 per cent of the deposits covered by their national guarantees for a special fund to finance the resolution of banking crisis.

Although this scheme would eventually become part of the nascent euro zone “banking union”, the measures, to be published today by internal markets commissioner Michel Barnier, will to do little to address the immediate banking crisis in Spain.

If Mr Barnier’s draft law is enacted by European governments and MEPs, senior bank bondholders would no longer be sacrosanct after 2018. This will be too late to ease the cost of propping up the Irish banks and some critics believe the new measure may yet curtail or complicate their ability to tap private bank debt markets whenever they break free of extraordinary support from the European Central Bank.

The Fine Gael-Labour Coalition and its Fianna Fáil-Green predecessor made several attempts in the course of the Irish EU-IMF bailout to reduce the €64 billion cost of rescuing the banks by tackling senior bondholders in the former Anglo Irish Bank.

The ECB ruled out any such move at every turn, arguing that any savings Ireland made would be outweighed by the risk of destabilising senior bonds in all weakened euro zone banks.

However, a senior EU official said yesterday that the commission had consulted the ECB in detail when preparing the legislation. The ECB was “very supportive” of the proposal, the official added.

By waiting until 2018 to impose any losses on senior creditors, Mr Barnier aims to give banks time to prepare for this eventuality. The proposal states that the bail-in tool should apply to all outstanding and newly issued debt on January 1st, 2018.

“This provides the relevant institutions and resolution authorities with a period of time (additional to the entry into force of the rest of the framework) during which to ensure required levels of eligible liabilities,” said a draft explanatory note from the commission.

European banks are estimated to have incurred losses approaching €1 trillion between the outbreak of the financial crisis in 2007 and 2010.

The commission approved some €4.5 billion in state aid for banks between October 2008 and October 2011, a sum which includes the value of taxpayer-funded recapitalisations and public guarantees on banking debts.

Under Mr Barnier’s proposal, banks and new resolution authorities would be required to draw up far-reaching recovery or resolution plans to be deployed in times of financial stress. Banks that fail to comply would run the risk of being compelled to change their corporate or legal structure.

National authorities would be given powers to intervene in banks when they breach or are about to breach their capital requirements.

Any bank that is failing or about to fail will be obliged to sell or merge viable businesses or transfer assets to a publicly owned temporary bridge bank which might be sold eventually.

The scheme also includes powers to create a “bad bank” to manage impaired assets. The bail-in mechanism would give the authorities the power to write down the claims of unsecured creditors and covert debt claims into equity or shares in the lender.