On 17 September 2007, the British credit institution Northern Rock was the victim of a bank run. The videos of the queues formed at that time are still available on YouTube. A similar situation occurred in March 2013 when it emerged that many banks in Cyprus were in a desperate situation and that Europe was not going to bail them out without an internal contribution from the banks' creditors. Better protection for depositors to avoid bank runs while winding-up a defaulting institution – this is one the mechanisms that Europe would like to introduce with the BRRD.
Introduction
To avoid bank runs, the European authorities are trying to identify the causes of the recent financial crisis and prevent it from happening again. Besides the issues of governance, own funds and the separation of trading activities, they are designing mechanisms to reduce or eliminate the implicit State guarantee which, in practice, benefits the biggest credit institutions. The rationale of this guarantee is that the State would lose more if it let a credit institution – too big, too interconnected or too complex – go bust. Such a bankruptcy could block the whole economic system by disrupting the flow facilitated by the payment and credit system controlled by such institutions.
One of the ideas is to increase the protection of numerous deposits of individuals and small and medium-sized enterprises within the assets of the credit institutions. The idea of "priority" being granted to such depositors was adopted in the context of the proposal for a Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (hereinafter, the "BRRD"). The Council, the Commission and the European Parliament agreed upon this proposal in late 2013, and its final adoption is scheduled for mid-April 2014 (document 2012/0150 (COD)). This idea had already been envisaged in the final report of the National Bank of Belgium dated July 2013 relating to the "structural banking reform in Belgium" (see Eubelius Spotlights September 2013).
Framework of the BRRD
In the first place, any credit institution or investment firm (hereinafter, an "institution") will need to have a "recovery plan" in place at all times (Articles 5 to 8a), outlining the means to be implemented for the recovery of the institution in the event of a significant deterioration of its financial position.
The resolution authorities will be required to draw up "resolution plans", specifying actions to resolve the potential default of an institution. The resolution plans must identify any impediments to "resolvability" (Article 9), and it will be possible to require an institution to address or remove such impediments (Articles 14 and 15). An institution will be deemed to be difficult to "resolve" if its liquidation may have a material adverse effect on the financial system (Article 13 and 13a ).
The BRRD proposal requires a harmonised set of instruments to resolve the default of an institution. The objectives of these instruments are:
- "to ensure the continuity of critical functions" of the institutions;
- "to avoid significant adverse effects on financial stability, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline";
- "to protect public funds by minimising reliance on extraordinary public financial support"; and
- "to protect depositors covered by Directive 94/19/EC and investors covered by Directive 97/9/EC and to protect client funds and client assets" (Article 26(2) of the BRRD proposal).
The bail-in tool
The most important resolution mechanism is the "bail-in" tool (Article 37), which is a solution whereby the burden of the default of an institution is absorbed by the shareholders and some of the creditors of the institution and which thus allows the continuity of the institution.
Article 38(1) requires the Member States to adopt measures allowing resolution authorities to write down the equity and liabilities of an institution to ensure its bail-in. However, Article 38(2) excludes from the writing down the "covered deposits" (covered by the EUR 100,000 guarantee system introduced by Directive 94/19/EC), secured liabilities, liabilities related to the critical functions of the institutions, short-term interbank liabilities, and liabilities related to participation in a payment system.
Articles 42 and 43 organise the contribution order of the shareholders, subordinated creditors and other creditors in the context of a bail-in of the institution.
The new priority for deposits
It is in this context that an Article 98a has been included in the BRRD. This provision requires the Member States to set up the following system:
- "eligible deposits from natural persons and micro, small and medium-sized enterprises […] shall have a higher priority ranking than the claims of ordinary unsecured, non-preferred creditors";
- "covered deposits shall have a higher priority ranking than that part of eligible deposits from natural persons and micro, small and medium-sized enterprises which exceed the coverage level";
- "the ranking of the deposit guarantee scheme subrogating to the rights and obligations of covered depositors in insolvency shall correspond to the ranking of covered deposits provided for in point 2".
The micro, small and medium-sized enterprises are defined by reference to Recommendation 2003/361/EC as "enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding EUR 50 million, and/or an annual balance sheet". The "eligible deposits" are defined by reference to the first article of Directive 94/19/EC.
Impact of this new priority and precedents under Belgian law
This new lien, combined with the resolution mechanisms, will reduce or eliminate the implicit States guarantee in favour of big banks.
This new lien will also result in a (mechanic) subordination of the unsecured liabilities, due to the importance of eligible deposits in the bank's balance sheets.
As a result of these two effects, the cost of credit for such banking institutions might increase.
This priority can be compared with the lien existing under Belgian law for the benefit of insured persons and insurance beneficiaries (articles 18 and 48/16 of the Act on the supervision of insurance undertakings) but that lien is primarily on the assets representing the technical provisions of the insurer. The priority can also be compared to the old lien of depositors which had been introduced in the regulation related to private savings funds ("private spaarkassen"/"caisses d'épargne privées") – Royal Decree no 42 dated 15 December 1934 relating to the supervision of savings banks coordinated by the Royal Decree of 23 June 1967 and repealed by the Banking Act of 22 March 1993 – but this lien was on certain specified assets constituted by the reinvestment by the savings banks.
Entry into force
The BRRD will enter into force 20 days after its publication in the Official Journal and must be implemented and applicable in national law no later than twelve months thereafter.
The banking reform announced by the Belgian Government contains a provision which implements bail-in mechanisms (as described above) in Belgian law and creates a new lien whose entry into force will occur in accordance with the BRRD.