National regulators must write-down creditors before any exemptions could be granted, says AXA’s Matt Cairns

Matt Cairns, strategist at AXA Investment Managers, comments on the new EU rules on bank failure.

“Finance Ministers have agreed on the common resolution mechanism and importantly, have defined the role that the European Stability Mechanism (ESM) will play in the order of events of a financial institution’s collapse. There has been debate for several years now as to the size and ultimate firepower of a fund that essentially looks too small to cover a systemic collapse.

“The key details over and above those which were already agreed in principle in May are the provision of greater flexibility for national authorities in terms of the way they apply bail-in. Concerning burden sharing, the Council said certain liabilities will be excluded from bail-in provisions such as covered deposits (i.e. deposits below EUR100k), secured liabilities such as covered bonds, and interbank loans with maturities of less than seven days.

“Deposits from individuals and SMEs would have preference over unsecured creditors (as agreed in May) and over depositors from large corporations. Importantly, the agreement gives national resolution authorities the flexibility to exclude liabilities from bail-in provisions on a discretionary basis – to avoid contagion in light of national idiosyncrasies.

“This is particularly important when you consider that a number of countries within the eurozone, such as Spain, rely heavily on their SMEs for employment, productivity and export growth. Bailing-in their deposits would have broader implications for the wider economy, resulting in failed manufacturers and increases in unemployment, for example.

“National regulators must first write-down creditors, in order of seniority, until 8% of the bank’s distressed liabilities are wiped out, before any exemptions could be granted and national resolution/insurance schemes turned to. Such national funds must equate to at least 1.3% of the national banking system’s deposits, but no more than 5% of these funds can be contributed to any individual bank’s liabilities unless senior unsecured bondholders are first wiped out.

“It is once all of these avenues are used up in any given resolution that the ESM funds could potentially be tapped, suggesting that an important step has been taken in terms of future resolution and clarification over the deep concerns about the magnitude and effectiveness of the ESM. The ESM has become an option of last resort as opposed to the ultimate solution that it was once perceived, but was never big enough to be.”

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