The EU has now agreed on new regulations regarding the future failure of banks. The overall objective is that, in the future, it shall no longer be tax payers only who pay for the cost of a bank bail-out. Instead, bank creditors/customers will also have to share in the burden. Put differently, a shift away from 'profits are for the private sector but losses are for the tax payers' to more of a 'profits are for the private sector but losses as well'. That overall objective must be unequivocally supported.
Thus, the question is not the 'what' but, instead, the 'how'. The Council of the European Union published a respective Directive on June 28, 2013. It contains 319 pages. By contrast, Chapter 11 of the American Bankruptcy Code contains 32 pages.
This is a classic contrast between the American, more solution-oriented mindset and the more bureaucratic European mindset. Americans state the broader regulatory framework in order not to be straight-jacketed in its application. Europeans prepare an entire to-do list to cover all eventualities which might occur with the result that, in its application, one may find oneself in a straightjacket. The American Constitution consists of a few pages and has served the country very well for over 200 years. The Treaty of Lisbon consists of over 800 pages with the result that it had to be more or less violated ('bent') on several occasions so far.
There is no way that a non-lawyer can understand the 319 pages of the EU Directive. What is lacking is an 'understandable brief'; a brief which summarizes the essential content on a few pages and ignores the voluminous legalese. That is a tremendous oversight on the part of the EU!
I browsed the entire 319 pages with 2 principal questions in mind: (a) When does the liability chain come into force? And (b) Who will be affected by it and how? There is no way that a non-lawyer can answer question (a) and the answer to question (b) can only be guessed.
Who will be affected by the liability chain and how?
The Directive seems to work on the premise that there are 'liabilities eligible for the liability chain' and there are those 'liabilities which are excluded from the liability chain'.
One example of an excluded liability would be a collateralized creditor claim. That is understandable because why should a creditor lose money when he has taken measures to fully collateralize his claim? Employees' claims, commercial and/or trade creditors claims, etc. are also excluded and that, too, is reasonable. But there is a catch to all of this!
What if I pledge all my deposits over 100 TEUR to a family member as collateral for future inheritance claims? The answer to that may be hidden in the 319 pages but I could not find it.
Now here comes one of the real catches! Excluded from eligible liabilities are 'liabilities with an original maturity of less than seven days'. Much of interbank funding is for very short tenors; some of it only overnight. Banks now definitely have an incentive to shorten the tenor of all their interbank lending to within 7 days. The benefit to the lending banks is that they are protected in case of bank failure. The damage is to the borrowing bank because it now has a much shorter overall funding structure. The damage is also to other creditors (including depositors) because if much of the interbank liabilities are exempt from the liability chain, they will have to come up with a higher contribution.
Here is another one of the catches! Subsection II, Article 39, Point 2a reads as follows:
"Where a liability is governed by the law of a jurisdiction outside the Union, resolution authorities may require the institution to demonstrate that any decision of a resolution authority to write down or convert that liability would be effected under the law of that jurisdiction, having regard to the terms of the contract governing the liability, international agreements on the recognition of resolution proceedings and other relevant matters. If the resolution authority is not satisfied that any decision would be effected under the law of that jurisdiction, the liability shall not be counted towards the minimum requi rement for own funds and eligible liabilities".
Thus, the question is not the 'what' but, instead, the 'how'. The Council of the European Union published a respective Directive on June 28, 2013. It contains 319 pages. By contrast, Chapter 11 of the American Bankruptcy Code contains 32 pages.
This is a classic contrast between the American, more solution-oriented mindset and the more bureaucratic European mindset. Americans state the broader regulatory framework in order not to be straight-jacketed in its application. Europeans prepare an entire to-do list to cover all eventualities which might occur with the result that, in its application, one may find oneself in a straightjacket. The American Constitution consists of a few pages and has served the country very well for over 200 years. The Treaty of Lisbon consists of over 800 pages with the result that it had to be more or less violated ('bent') on several occasions so far.
There is no way that a non-lawyer can understand the 319 pages of the EU Directive. What is lacking is an 'understandable brief'; a brief which summarizes the essential content on a few pages and ignores the voluminous legalese. That is a tremendous oversight on the part of the EU!
I browsed the entire 319 pages with 2 principal questions in mind: (a) When does the liability chain come into force? And (b) Who will be affected by it and how? There is no way that a non-lawyer can answer question (a) and the answer to question (b) can only be guessed.
Who will be affected by the liability chain and how?
The Directive seems to work on the premise that there are 'liabilities eligible for the liability chain' and there are those 'liabilities which are excluded from the liability chain'.
One example of an excluded liability would be a collateralized creditor claim. That is understandable because why should a creditor lose money when he has taken measures to fully collateralize his claim? Employees' claims, commercial and/or trade creditors claims, etc. are also excluded and that, too, is reasonable. But there is a catch to all of this!
What if I pledge all my deposits over 100 TEUR to a family member as collateral for future inheritance claims? The answer to that may be hidden in the 319 pages but I could not find it.
Now here comes one of the real catches! Excluded from eligible liabilities are 'liabilities with an original maturity of less than seven days'. Much of interbank funding is for very short tenors; some of it only overnight. Banks now definitely have an incentive to shorten the tenor of all their interbank lending to within 7 days. The benefit to the lending banks is that they are protected in case of bank failure. The damage is to the borrowing bank because it now has a much shorter overall funding structure. The damage is also to other creditors (including depositors) because if much of the interbank liabilities are exempt from the liability chain, they will have to come up with a higher contribution.
Here is another one of the catches! Subsection II, Article 39, Point 2a reads as follows:
"Where a liability is governed by the law of a jurisdiction outside the Union, resolution authorities may require the institution to demonstrate that any decision of a resolution authority to write down or convert that liability would be effected under the law of that jurisdiction, having regard to the terms of the contract governing the liability, international agreements on the recognition of resolution proceedings and other relevant matters. If the resolution authority is not satisfied that any decision would be effected under the law of that jurisdiction, the liability shall not be counted towards the minimum requi rement for own funds and eligible liabilities".
Suppose the
decision of a resolution
authority to write down or convert a liability into equity would not be permissable under US law, then all liabilities of the, say, US subsidiary of Deutsche Bank would be exempt from the liability chain. Deutsche would be incentivated to shift much of its funding and deposit base to such a foreign subsidiary which, under local laws, would not be permitted to bail-in creditors. Banks will not discover and/or take advantage of such a loophole? Well, think again!
As mentioned above, the principal premise of the Directive is that tax payers should no longer be the only ones paying for damage incurred by banks and their irresposible managements. In a way, I question this premise. I think the real premise should be that tax payers, when they are obligated to put money into failed banks, should have a fair chance of making a good profit on it. The American TARP made a profit on its bail-out's of financial institutions! When investors buy distressed companies, they don't do that with the intent of losing as little of their investment as possible. Instead, they do it with an intent to make money off it!
I am surprised that the 'good bank', 'bad bank' approach is being more or less ignored in the Directive (unless I overlooked it). When a TBTF-bank fails, all assets of impaired value should be put into a bad bank and put on rapid liquidation. The original shareholders remain shareholders of the bad bank.
The remaining good bank should then indeed be a very good bank into which tax payers can be expected to invest. Hopefully, tax payers will make a profit when the good bank is eventually sold back to private investors.
When the bad bank is fully liquidated, substantial losses will have been recognized. These losses are NOT for the tax payers. Instead, they are for shareholders and all the other members of the liability chain. Since those losses will not be known until a few years down the road, creditors subject to the liability chain should be given new debt instrumens for their claims (i. e. negotiable CD's). When the day of final reckoning comes, those creditors will find out what their contribution to the damage will be. If they don't want to wait that long, they can sell their CD's in the market at a loss.
In summary, the overall objective of the new regulations must be considered as correct. Whether the Directive remains the best instrument to implement them remains to be seen. Oftentimes, things appear very plausible before an event takes place but when the event does take place, some of those things may turn out to be inoperable. The no-bail-out clause in the Lisbon Treaty seemed to be a very plausible clause at the time. When the time came to have it implemented, EU-politicians found out that they had trapped themselves in a straight-jacket.
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