Objectives and need for reform
Why is the Commission proposing this package?
The crisis management and deposit insurance framework (CMDI) is a set of rules developed in the wake of the global financial crisis to manage bank failures in an orderly and economically efficient manner. It protects financial stability, depositors, and taxpayers’ money. Thanks to this framework, and the other elements of the Banking Union – the Single Supervision Mechanism and the Single Resolution Mechanism – the EU’s financial system has fared well throughout recent crises, such as COVID-19 or Russia’s war of aggression against Ukraine. Today, financial institutions in the EU are well capitalised, highly liquid and closely supervised.
However, experience over the past years has shown that when medium-sized and smaller banks fail in the EU, authorities have found solutions outside the EU’s harmonised resolution framework. This has often involved the use of taxpayers’ money instead of the bank’s required internal resources or private, industry-funded safety nets.
While the existing rules already enable authorities to deal with failing banks in an effective manner, today’s proposal draws on the lessons learned from these first years of application of the framework and makes further improvements. Further progress is needed to make the rules even more effective in ensuring that European banks keep supporting Europe’s economy and do not burden public finances when they fail. Recent events in the banking sector at global level have highlighted the importance of a strong and operational crisis management framework.
What is the reform about?
The CMDI reform aims to improve the crisis tools used to manage the failure of medium-sized and smaller banks. It will give resolution authorities even more effective tools to ensure that, when a crisis occurs and when financial stability is at stake, depositors, such as citizens, businesses and public entities, can continue to access their accounts.
The reform will ensure that the rules governing the management of bank crises and depositor insurance in the EU will be applied effectively. This will better preserve financial stability, depositors’ confidence and avoid recourse to taxpayers’ money.
The reform has the following three main objectives:
1, Preserving financial stability and protecting taxpayers’ money
The reform facilitates the use of privately-funded deposit guarantee schemes in crisis situations to shield depositors (natural persons, businesses, public entities, etc.) from bearing losses, where this is necessary to avoid contagion to other banks and negative effects on the economy. While banks’ capital buffers will continue to always absorb losses first, these privately funded safety nets, such as deposit guarantee schemes and resolution funds – which, for example, are expected to reach over €55 billion and €80 billion respectively by 2024 in the Banking Union – are meant to be used when necessary to reinforce the application of the crisis management toolbox. This will limit the risk of exposing taxpayers’ money in case of bank failures.
2. Shielding the real economy from the impact of bank failure
The proposed rules will allow authorities to benefit from the many advantages of resolution as a key component of the crisis management toolbox. Although resolution is not always the best solution for all banks, resolution can be less disruptive for the economy and local communities than liquidation, as banks’ critical functions are preserved. Clients can more easily retain access to their bank accounts in resolution, for example, through a transfer of their account to another bank.
3. Better protection for depositors
The level of coverage of €100,000 per depositor and bank, as set out in the Deposit guarantee scheme directive, remains for all EU eligible depositors. At the same time, today’s proposal further harmonises the standards of depositor protection across the EU. For example, the new framework extends depositor protection to public entities (such as hospitals, schools, municipalities) as well as client money deposited in certain types of client funds (such as investment companies, payment and e-money institutions). The proposal includes additional measures to harmonise the protection of temporary high balances on bank accounts in excess of €100,000 linked to specific life events (such as inheritance or insurance indemnities).
How will the scope of banks entering resolution change under this initiative?
From its inception in 2014, the resolution framework was meant to be potentially applicable for the orderly management of any bank failure, irrespective of its geographical footprint, its size or business model, should the expected outcome be superior to insolvency. Resolution does not apply only to large banks, but potentially to any bank that has critical functions for the economy or whose failure could be systemic based on the assessment of the resolution authority.
The proposal does not change this fundamental principle. Resolution authorities determine on a case-by-case basis if a bank should be resolved or enter national insolvency proceedings, on the basis of a public interest assessment that compares the merits of both alternatives and how best they achieve the objectives of the framework (financial stability, protection of depositors and taxpayers).
The proposal improves the framing of this discretion to ensure improved harmonisation at EU level. This reform does not intend to set ex ante thresholds to determine whether banks should be subject to resolution, as the diversity of the EU banking sector could not be reflected in a system with fixed quantitative limits.
The proposal clarifies that the criticality of a bank’s functions on financial stability must be assessed at regional level (and not only at national level). It introduces a clear distinction between the use of taxpayers’ money and private, industry money to support the execution of the strategy when assessing the benefits of resolution. The proposal also requires the resolution authorities to minimise losses for deposit guarantee schemes, and makes clear that all resolution objectives must be assessed with the same degree of attention.
These amendments serve two objectives: ensure the resolution framework is applied properly to banks of any size when this best achieves the objectives of an orderly crisis management, and reduce the likelihood that the choice made by the resolution authority during the planning stage changes at the time of failure.
It is therefore not possible to anticipate exactly the number of banks that would enter the scope of resolution with today’s reform. This will remain a decision of the resolution authorities. We want to facilitate the use of all tools that are available to authorities to deal with failing banks in the most effective way.
Does this mean that more medium-sized and smaller banks in the Banking Union will come under the remit of the Single Resolution Board?
No. The reform does not change the division of tasks between the Single Resolution Board (SRB) and the national resolution authorities in the Banking Union. All significant institutions and less-significant cross border institutions remain under the direct responsibility of the SRB, irrespective of whether the strategy is resolution or liquidation, while all other less-significant institutions remain within the remit of the national resolution authorities.
What are the expected overall benefits of the reform, in particular for citizens, companies, public entities and banks?
By better applying the CMDI toolbox, as proposed in today’s package, financial stability risks will be reduced, thereby benefitting taxpayers and depositors. In particular, the proposed reform facilitates the implementation of resolution strategies that envisage the transfer of the failing bank’s business, including deposits, to a buyer, ensuring an orderly market exit. This means that the bank’s critical functions for society (e.g. deposit taking/saving for retirement, lending, payments), and the franchise asset value of failing banks, are better maintained.
In this context, depositors, including households and small and medium enterprises, would be more likely to retain uninterrupted access to their accounts. Taxpayers would also be better off under this reform since banks’ failures could be more easily financed by banks’ own internal loss absorption capacity and industry-funded safety nets created for this purpose, rather than through recourse to public budgets.
Overall, the reform is expected to bring significant benefits to taxpayers, depositors and the economy at large.
What are the different legislative elements of this package?
The core part of this reform is made up of three legislative proposals amending the Bank recovery and resolution directive (Directive 2014/59/EU), the Single resolution mechanism regulation (Regulation 806/2014) and the Deposit guarantee schemes directive (Directive 2014/49/EU).
Separately, the package also includes a fourth, unrelated legislative proposal to amend the Bank recovery and resolution directive and the Single resolution mechanism regulation (the ‘daisy chain’ proposal). This follows up on a review clause introduced by the European Parliament and Council in the daisy chain Regulation of October 2022 (Regulation 2022/2036). The choice to separate these provisions in a specific proposal aims to facilitate its swift negotiation in parallel, in view of the entry into force of the requirements for banks in January 2024.
In addition, the package also contains a report from the Commission on the review of the Single Supervisory Mechanism.
Finally, the Commission has also published a Communication which explains how today’s review helps to enhance the resolution framework and recalls the need to continue progress towards the completion of the Banking Union.
Banking Union – the broader picture
The importance of a strong supervisory architecture
The creation of the Banking Union in 2014, building on the foundations of the EU single rulebook, was a powerful response to the global financial crisis and the ensuing euro area sovereign debt crisis. The progress made on the two pillars of the Banking Union – the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) which are now fully operational – is a success.
The EU has implemented strong prudential requirements and the banking sector is supervised closely and effectively. The capital ratios of significant banks operating in the Banking Union have grown steadily over the last few years. As of Q4 2022, the aggregate Common Equity Tier 1 ratio in the Banking Union was 15.3 % of their total risk exposure amount, the aggregate Tier 1 ratio 16.6 % and the aggregate total capital ratio 19.3 %. Asset quality has also steadily improved for significant banks since 2015, overall driven by further reductions in the stock of non-performing loans. In addition, the build-up of liquidity buffers increased since 2019, with aggregate liquidity coverage ratio standing at 161 % in Q4 2022.
Recent events in the banking sectors of the United States and Switzerland are a reminder that bank failures can still occur. These events underline the importance of strong, demanding, and effective bank supervision, particularly at the current juncture. They also support the EU’s conscious choice to apply the Basel standards to all its banks, not just the largest ones – and hence implement high prudential standards across the entire EU banking system.
Today the Commission is publishing its second Single Supervision Mechanism (SSM) report, in line with the Commission’s mandate in Article 32 of the SSM Regulation. The report concludes that, overall, the SSM is functioning well and has become a mature established supervisory authority delivering on the objectives set out when it was created. It is actively contributing to ensure that banks are well prepared and capitalised for possible economic and financial crises, and it is providing good quality and proactive banking supervision, and rapidly adapting to supervisory challenges. The review finds that the SSM has been generally praised, including by industry stakeholders, for its swift and agile approach to addressing the challenges posed by the COVID-19 pandemic and Russia’s war of aggression against Ukraine. The EU banking sector is overall in good shape and supervised closely and effectively by national and European authorities. Authorities regularly conduct stress tests to ensure the overall resilience of the EU banking sector.
The report also highlights areas that may require continued focus, going forward. One of them relates to the scarcity of technical skills that are required to conduct supervision in highly specialised areas, such as ICT/cyber risks and internal model assessments and validation. Another relates to the continued importance of external communication and cooperation, both with banks and other supervisors. In recent years, the SSM has put a lot of effort in its cooperation with other supervisory authorities, including from third countries.
How does the CMDI reform relate to the efforts to complete the Banking Union?
The crisis preparedness of the EU banking system has been significantly enhanced through recovery and resolution planning, the build-up of bail-inable buffers (minimum requirement for own funds and eligible liabilities, or MREL) by banks and of industry-funded resolution safety nets and continued improvement in banks’ resolvability. This enabled a shift towards a new paradigm for handling bank failures and instilled a culture of crisis prevention across the EU.
Statistics by the Single Resolution Board (SRB) for the Banking Union demonstrate that banks have kept up the pace with MREL build-up, despite the deteriorating market funding conditions in 2022. The average MREL shortfall in Q3 2022 with respect to the final 2024 targets, considering the combined buffer requirement, declined to €30.5 billion (€3.2 billion reduction year-on-year). According to the 2021 SRB assessment, banks have made significant progress and are on track to achieve full resolvability by 2023.
Likewise, the Single Resolution Fund is on track to be fully funded though industry contributions and should reach €80 billion by early 2024. In December 2020, Member States agreed on a common backstop to the Single Resolution Fund through a revolving credit line provided by the European Stability Mechanism (ESM), capped at €68 bn. The backstop will become available as soon as the amending agreement on the Treaty establishing the ESM has been ratified by all ESM Members. The build-up of deposit guarantee schemes is equally satisfactory and should reach by 2024 an EU-wide aggregate amount of €63 bn, and €55 bn in the Banking Union.
However, the work on the Banking Union is not finished since its third pillar, the European Deposit Insurance Scheme, as proposed by the Commission in 2015, is still pending. The legislative process has been put on hold for more than seven years by the European Parliament and Council.
The discussions in the Eurogroup did not deliver a workplan towards completing the Banking Union. The Eurogroup agreed however, in its statement of 16 June 2022, that, as an immediate step, work on the Banking Union should focus on strengthening the common framework for bank for crisis management and deposit insurance. Today’s reform of the CMDI framework constitutes an important step forward in strengthening the second pillar of the Banking Union and it paves the way towards further progress on completing the Banking Union.
Europe is confronted with major challenges which require better use of public finance: the transition to ‘net zero’, the accelerated reduction of our dependency on fossil fuels and the rapid digitalisation of our societies, as well as new challenges brought about by Russia’s illegal and unjustified aggression of Ukraine, are causing significant geopolitical and economic shifts, globally and in Europe.
The EU’s capacity to navigate those transitions will depend on its capacity to mobilise the necessary investments and ensure a more efficient allocation of capital. The EU’s banking sector has an important role to play in financing EU companies and households in and help the real economy and its competitiveness. Completing the Banking Union would allow EU banks to navigate from a position of strength, further enhancing the sector’s resilience and enabling it to harness the economies of scale of the Single Market.
The Commission remains convinced that it is important to continue seeking a European solution to further enhance depositor protection and make the Banking Union future-proof. The Commission stands ready to actively contribute to, and facilitate, the discussions in the European Parliament and the Council on the best design for a European Deposit Insurance Scheme.
Depositor protection
How will the reform improve depositor protection under the Deposit Guarantee Scheme Directive? Will the €100,000 coverage be affected by today’s reform?
The €100,000 coverage per depositor and bank, as set in the Deposit guarantee scheme directive, remains for all EU eligible depositors. Its current calibration was deemed appropriate by the European Banking Authority in its public opinion on the eligibility of deposits and coverage level. Combined with the solid prudential requirements and loss absorbing capacity of EU banks, the €100,000 coverage level provides strong protection for EU depositors.
In terms of guarantees for deposits, the new framework extends depositor protection to public entities (schools, hospitals, municipalities, etc.) as they play a key role for local communities. Likewise, money deposited in client funds accounts (e.g. e-money institutions, investment firms, etc.) would now fall under the scope of deposit protection, thereby keeping up with the recent evolutions in the financial system. Moreover, the review will also guarantee temporarily high balances on bank accounts resulting from important life events, such as insurance premium, inheritance or real-estate transactions.
The reform will also enhance the quality of information provided to citizens regarding the protection of their deposits through the establishment of a pan-European harmonised information sheet.
Lastly, the reform will improve the day-to-day functioning of deposit guarantee schemes. This will improve their efficiency in ‘payout’ events, i.e. in the case of a reimbursement of all covered depositors.
Funding the smooth market exit of failing banks
What are the sources of funding in resolution and how will they be affected by the reform? Will the conditions to access the resolution funds change?
Under current rules, resolution authorities set – on a bank-by-bank basis – the minimum requirement for own funds and eligible liabilities (MREL). MREL is the minimum amount of equity and easily ‘bail-inable’ instruments that a bank must hold at all times to absorb losses and provide capital in resolution. MREL is and will remain the first line of defence to ensure that the bank will have sufficient own internal resources to pay for the cost of its failure.
Resolution authorities may use complementary external funding to finance resolution, if needed, from private, industry-funded safety nets, such as the resolution funds or the Single Resolution Fund in the Banking Union. National deposit guarantee schemes may also be used, under certain conditions, in addition to resolution funds, to shield depositors from bearing losses.
One of the main conditions to access resolution funds is that the shareholders and creditors must first pay for the losses (‘bail-in’) with an amount equal to at least 8% of the failed bank’s total liabilities and own funds. MREL buffers held by the bank and, once they are depleted, liabilities of other creditors can be used to absorb losses up to the threshold of 8%. The condition of the minimum bail-in of 8% remains in place.
However, experience has shown that for certain banks with a high prevalence of deposits, meeting the 8% condition may result in losses on depositors, which in turn may negatively affect the community, depositor confidence and financial stability.
Today’s proposal facilitates the use of the funds from national deposit guarantee schemes in resolution, including, under certain conditions, as a ‘bridge’ to meet the 8% condition, in order to shield depositors from bearing losses. This added flexibility is put forward with strong safeguards.
Will the reform create shortfall risks in national deposit guarantee schemes?
The most sustainable way to reduce the risk of shortfalls in national deposit guarantee schemes remains the mutualisation of such schemes at a pan-European level as it would increase the resilience of funds against significant depletion events. The current rules provide for the possibility for national deposit guarantee schemes to voluntarily lend to each other, but in the absence of a political agreement to establish a European Deposit Insurance Scheme, today’s reform cannot fully avoid the risk of shortfalls in national deposit guarantee schemes.
According to the ECB, every Member State has at least one medium-sized or smaller bank for which a reimbursement of covered deposits would fully deplete the national deposit guarantee scheme. Therefore, pay-outs in case of liquidation presents the biggest danger of shortfalls for deposit guarantee schemes.
The current rules already recognise the important role that deposit guarantee schemes should play beyond the reimbursement of covered depositors: in resolution, for preventive measures or for alternative measures in insolvency.
The current rules already provide the tools for the replenishment of national deposit guarantee schemes through ad hoc contributions from the banking industry or activation of alternative funding arrangements. This ensures the financial robustness of the national deposit guarantee schemes, even after successive interventions.
Today’s reform will facilitate all these different uses of funds from deposit guarantee schemes, so that they can be used more effectively instead of public funds. At the same time, these uses will be subject to a harmonised ‘least cost test’. This test ensures that any use of these funds cannot exceed the hypothetical cost of reimbursing covered depositors in the event of liquidation.
Compared to the reimbursement of covered depositors, using funds from deposit guarantee schemes in resolution is usually the most cost-effective option, under the least cost test principle. Similarly, under strict conditions, re-establishing a bank’s long-term viability through preventive measures is less costly as long as it happens sufficiently early when the financial situation of the bank has not deteriorated significantly.
Could the use of the deposit guarantee scheme “bridge” increase the risk of moral hazard or reduce market discipline (by incentivising the avoidance of bailing in some creditors)?
A bank’s internal loss absorption capacity must remain the primary tool to fund the handling of that bank’s failure. But when the use of deposit guarantee schemes in a resolution situation is necessary and warranted, it will be subject to safeguards. Such use is not automatic as resolution authorities will only be able to use them for banks earmarked for resolution and under certain conditions: 1) in case they conclude that bailing in depositors (to reach the 8%) would lead to financial instability; 2) when the resolution strategy leads the failing bank to exit the market; and 3) their amount will be capped to protect the funds of the deposit guarantee scheme.
The possibility to use the deposit guarantee scheme to bridge the access to the resolution funds will not increase the risk of moral hazard or reduce market discipline, as this would not affect the requirements for banks to hold enough MREL. The existing safeguards to ensure that resolution authorities require an appropriate amount of MREL will remain unchanged. A failure to comply may be addressed through several measures (e.g. restrictions to distribute dividends, supervisory measures, penalties, procedure to remove impediments to resolvability, etc.). The fact that MREL levels are disclosed to the markets may also have a disciplinary effect.
Experience shows that moral hazard is, on the contrary, rather encouraged outside resolution via the implicit subsidy provided by the availability of public funds in insolvency. By allowing a more credible use of resolution via this bridge mechanism for specific banks, the reform aims to disincentivise the recourse to taxpayer money, which may affect market expectations ex ante, leading to more market discipline and lowering moral hazard.
Hierarchy of claims and depositor preference
Why do you need to change depositor preference in the hierarchy of claims?
Existing rules set out a three-tier depositor ranking, according to which claims are assessed in a resolution case: covered deposits/claims of deposit guarantee schemes rank above non-covered deposits of households and small and medium enterprises, which rank above other non-covered deposits. In a majority of Member States, non-covered deposits have the same ranking as other ordinary unsecured claims (e.g. senior bond holders), while in some Member States, non-covered deposits rank above other ordinary unsecured claims.
The new depositor preference entails two changes: the removal of the ‘super-preference’ of deposit guarantee schemes and the creation of a single-tier ranking for all deposits (covered deposits and deposit guarantee schemes’ claims, non-covered deposits of households and small and medium enterprises, other non-covered deposits). In addition, all deposits relative to ordinary unsecured claims would be preferred.
The change of depositor preference in the hierarchy of claims aims to enhance and harmonise the protection of depositors by clearly distinguishing deposits from other sorts of liabilities that can bear losses in case of failure with a less material impact on financial stability.
In addition, it enables a more effective use of funds from deposit guarantee schemes to finance cost-efficient measures other than the reimbursement of covered deposits in liquidation. A single-tier depositor preference, where the ranking of the deposit guarantee scheme is no longer preferred relative to all other deposits, is the key pre-requisite to unlocking deposit guarantee scheme funding in resolution under the least cost test. This change is necessary to make sure that deposit guarantee schemes can intervene in practice. By boosting the availability of funding in resolution, this change would facilitate the application of the resolution toolbox to medium-sized and smaller banks that are too big to liquidate without negative consequences on financial stability, depositor protection and taxpayer money.
What will the change in creditor hierarchy mean for citizens, companies and banks?
Covered deposits below the €100,000 threshold continue to be protected by law, irrespective of their rank in the hierarchy of claims. They are excluded from bearing losses in resolution and are protected by the obligation for deposit guarantee schemes to repay covered deposits within seven days from the moment their accounts are declared unavailable in insolvency.
Non-covered deposits from citizens, companies and public entities will benefit from the change in creditor hierarchy – both in resolution and in insolvency. In resolution, it will make it easier to transfer all deposits to a competitor with the support of deposit guarantee schemes, thereby preserving depositors’ access to their bank accounts. In case of insolvency, depositors will recover larger parts of the uncovered amounts under a single tier preference.
This change should not materially affect the financial resilience of deposit guarantee schemes in case of insolvency. The amounts to be recovered depend on the case-specific quality of the assets of the failing bank and the effectiveness of the national insolvency law, apart from the ranking of the deposit guarantee scheme in the hierarchy of claims. Lower recoveries for deposit guarantee schemes could mean that the banking sector may have to replenish the safety nets for a higher amount. Nevertheless, the prospect of improving the situation of depositors, and therefore for financial stability and depositor confidence, the diminished risk for taxpayers and the facilitation of cost-efficient transfer solutions with fewer payout events outweigh these potential costs, which would be borne by the industry.
Additional tools to deal with resolution
What are the other tools to deal with ailing banks and how will they interact with the resolution toolbox?
Current EU rules do not impose a specific way to manage the failure of a bank but provide for a number of crisis tools, made up of resolution tools, harmonised at EU level, and optional national tools such as preventive and precautionary measures, as well as measures under national insolvency proceedings, which vary among Member States. These different tools are maintained to give discretion to authorities to take the best decision for the case at hand.
In order to improve the effectiveness and consistency in the management of bank failures, today’s proposal allows for a broader use of resolution tools, where they better protect financial stability, taxpayers’ money and depositors. When it is not the case, resolution authorities may still decide to deal with a failing bank through other tools harmonised at EU level or under national regimes.
The reform will also harmonise the methodology for the least cost test. The rules in place today are very heterogeneous across the EU, which can have undesirable effects on the financial resilience of deposit guarantee schemes, as well as the level playing field across the Single Market.
Lastly, the reform improves the consistency of the early intervention framework to deal with the early distress of banks.
Institutional protection schemes
What are the envisaged changes related to the functioning of Institutional Protection Schemes (IPSs)?
Current rules provide for the possibility for Institutional Protection Schemes to be recognised as deposit guarantee schemes. IPSs recognised as deposit guarantee schemes are subject to requirements laid down under the Deposit guarantee scheme directive (art 11(3)). At the same time, the treatment of these IPSs should take due account of their dual mandate to protect depositors and their member institutions.
Therefore, under the new reform, Member States which have recognised an IPS as a deposit guarantee scheme would have the possibility to apply a specific transition period for IPSs to comply with Article 11(3) DGSD (on preventive measures).
IPSs recognised as deposit guarantee schemes will have a longer timeframe to integrate the new safeguards applicable to preventive measures into their existing risk management framework, also in view of their specific missions under Capital requirement regulation. The possibility for Member States to require lower contributions from IPS members is maintained.
Interaction with State aid rules
Will the Banking Communication from 2013 also be reviewed in line with the CMDI reform?
The Commission is carrying out an evaluation of its State aid framework for banks, which is expected to be completed in the first quarter of 2024. The outcome of this evaluation will inform a subsequent potential review of the State aid framework for banks.
Given the links between the CMDI framework and the State aid framework for banks, such a potential review would aim to ensure consistency between the two frameworks, taking into account the regulatory scenarios that will be set out in the renewed CMDI framework.
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