Early Introduction of European Union Bail-In Regime Is Credit Negative for Banks’
Unsecured Bondholders
Last Thursday, the European Commission announced an agreement between the Commission, the
European Parliament and the European Union Council of Ministers on key elements of the Bank Recovery
and Resolution Directive (BRRD). Among other things, the parties agreed that the bail-in framework at the
heart of the BRRD will be introduced in 2016, two years earlier than originally planned. While that
agreement still needs to be ratified by the Council and the Parliament, it sends a clear, credit-negative signal
to unsecured bondholders in EU banks that the development of a credible bail-in regime, allowing creditors
to bear losses, remains an urgent policy objective.
Details of the agreement are sparse and a revised text is not yet available. However, the main features of the
draft directive have not changed from earlier drafts. Creditor bail-in remains the first resort for bank
recapitalisations; national policymakers’ discretion to bail out banks using public funding remains
constrained. The list of creditors “exempted” from bail-in remains short, and the Commission retains its
central role in approving any broadening of exemptions or the commitment of any public funds. All these
elements are negative for unsecured bondholders in EU banks whose ratings incorporate some measure of
systemic support uplift.
The main challenge policymakers face in introducing an effective bail-in regime is minimising the
contagion risks associated with bailing in creditors. Policymakers believe that if investors are clear about
where losses will and will not fall in a resolution, the financial markets are less likely to be seriously
disrupted when losses materialise. By prescribing how losses on creditors will be imposed and providing
the powers to allow that to happen, while allowing national authorities little discretion to bail-out rather
than bail-in, the wording of the BRRD is intended to condition investors’ expectations and mitigate
contagion risks.
The headline change agreed to on Thursday – the 2016 introduction of bail-in – seems intended to send a
clear signal to creditors that the policymakers’ debate between (credit negative) “prescription” and (credit
positive) “discretion” is increasingly balanced in favour of prescription. Other signals include the fact that,
while the Council’s desire to be able to use public funds for precautionary capitalisations of solvent and
viable firms following regulatory stress tests has been realized, such recapitalisations would be subject both
to state aid rules (which require write down of junior debt prior to any public support) and to guidelines
that the European Banking Authority will draw up. And the Parliament’s demand for stabilisation tools
(e.g., public capital) to pre-emptively quell contagion fears has been met, but only once 8% of total
liabilities including a bank’s own funds have been written down and the Commission (which we expect
would be averse to any use of public funds) has approved their use.
Areas of uncertainty remain. National authorities appear to have wider discretion (subject to the
Commission’s approval) to exempt uninsured deposits held by natural persons and small and mid-sized
enterprises from bail-in where contagion is feared. And it remains unclear how far deposit guarantee
schemes will be liable to bail-in once they step in to repay insured depositors (who will be exempt from
bail-in).
More broadly, the decision-making framework – the Single Resolution Mechanism – and the need for a
single resolution fund remain under discussion. The more resolution decisions and resources are centralised,
the less likely it is that national concerns will be allowed to lead to bail-outs rather than bail-ins. It seems
increasingly likely that the European Commission will play a key role in resolution decisions, which would
be significant and negative for senior unsecured bondholders.
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