On 18 April 2023, the European Commission adopted a legislative proposal to review the EU’s bank crisis management and deposit insurance (CMDI) framework. In the context of potential reform opportunities, this blogpost adds to the debate looking to enhance the small and medium-sized banks’ crisis management system based on an analysis of the status quo pain point as well as the further developments for the EU banking legislation. Additonally, the blogpost considers the impact of UNIDROIT’s “Bank Insolvency Project” on global regulatory convergence and how a potentially more effective approach would address some of the deficiencies of the national insolvency regimes.
The current ‘CMDI’: An Internal Complexity
In 2024, 10 years have passed since the adoption of the Bank Recovery and Resolution Directive (BRRD) andthe Deposit Guarantee Schemes Directive (DGSD), which codified the rules for conducting anti-crisis activities in the EU banking sector. At the same time – in less than two months – four mid-sized US banks (Silicon Valley Bank, Silvergate Bank, Signature Bank, First Republic Bank) and a globally significant Swiss one (Credit Suisse) collapsed. This phenomenon has been the most significant system-wide banking shock in terms of scale and scope since the Great Financial Crisis, raising concerns in Europe as well.
In light of these events, the argument underlying the fundamental weaknesses in the EU framework for non-systemic banks was that many Member States had inadequate rule-of-law approaches to managing banking crises, especially for small and mid-sized banks that did not entail systemic implications. According to the European legal framework, while the BRRD has harmonized the resolution procedure rules at the EU level, the design of bank liquidation laws that apply to ‘failing or likely to fail’ banks with a negative Public Interest Assessment (‘PIA’) is left purely to domestic legislation and differs substantially across the EU.
In this regard, this fragmentation acts as an additional deterrent for private market participants, discouraging them from engaging in cross-border banking activity and preventing an EU stand-alone procedure implementation [Restoy, Vrbaski, Walters (2020), Bank failure management in the European Banking Union: What’s wrong and how to fix it, FSI Occasional Papers, 15]. Specifically, the alternatives under national regimes range from court-centred judicial proceedings at one end of the spectrum (for example, France and Germany) to purely administrative procedures with supervisors in the driving seat at the other (for example,Italy and Austria). Due to this variety, creditors and depositors tend to be treated differently across the EU, fuelling financial breakdown and avoiding strengthening the banking union. In response to these shortcomings, the CMDI reform proposal aims to make it easier to resolve the failing of smaller and medium-sized banks, but – at the same time – it does not entirely regulate how these separate regimes can align and operate in conjunction. Consequently, value is destroyed unnecessarily.
Therefore, the CMDI resolution toolbox, while appreciable, seems to be insufficient as a ‘catch-all solution’ for bank failures of all sizes and complexity because liquidation may yield more efficiency in cases where the risk of systemic contagion is non-existent.
The UNIDROIT Work Program: Guiding Principles for Reform Opportunities
The necessity for harmonisation is also felt in the international context. Recently, UNIDROIT ‘Project on Bank Insolvency’ aims to address the current gap in worldwide legal architecture by developing a principle-based approach as a soft legal tool, covering the key features of small and mid-sized banks’ national insolvency proceedings (NIPs).
Firstly, consensus is surfacing on the need for a more homogenous way of dealing with the ‘orderly market exit’ for small and medium-sized banks. This issue is at the core of the current discussions around the review of the CMDI. As advocated by some, this homogenous approach could be achieved by developing a common specific liquidation regime when the PIA is negative and by increasing the ability of the DGS to adopt alternative interventions to depositor reimbursement [De Aldisio, Aloia, Bentivegna, Gagliano, Giorgiantonio, Lanfranchi, Maltese (2019), Towards a framework for orderly liquidation of banks in the EU, Notes on Financial Stability and Supervision, no 15, August]. Secondly, the mix of liquidation tools available to the relevant authorities needs to be enhanced to adequately deal with the failure of small and medium-sized credit institutions. Resolution may not be suitable for such banks. At the same time, a piecemeal depositors’ pay-out liquidation could well have an adverse impact in terms of destruction of economic value and financial stability, at least at regional level.
Further evidence of an orderly liquidation framework can be found in the Italian experience, where the Bank of Italy was able to deploy a wide range of administrative tools to transfer the business of the failing entities to another bank (i.e. ‘Veneto Banks Case’), supported by state aid. Such tools, which are not available in many other Member States, enabled a more favorable treatment of creditors than a court-based approach. More precisely, this scenario offers attractive features, including a smooth exit from the market, minimal impact on customers (especially retail depositors and small borrowers), and the potential to smoothen asymmetric shocks for a specific region through specific solutions to banking crises. These rescue strategies should be implemented by way of several reforms regarding the deposit guarantee scheme (DGS) framework, such as establishing (?) the potential role of DGSs in supporting transfer strategies as an alternative to the basic pay-out function and the replacement of the ‘super priority’ of the DGS/covered deposits with a single-tier depositor preference. In the author’s view, this is the model to look at.
On these grounds, the current CMDI framework is not perfectly suitable for all non-systemic EU bank insolvencies. But despite its flaws, the principles endorsed by UNIDROIT could provide an excellent baseline for the EU harmonization process, mitigating domestic piecemeal insolvency law, levelling the playing field for creditors, and reducing the risk of Member States ‘gaming’ the system.
Concluding Remarks
The lack of European harmonization between national rules governing the ordinary winding up of credit institutions is forcing the European Commission to ‘take the bull by the horns’, following the recent events that have affected financial investors around the world.
Hence, when considering a UNIDROIT-like solution in the banking union, the most important aspects appear to be: (i) a complete regulatory harmonization, ideally through EU regulations; (ii) the importance of administrative tools for the liquidation of banks of all sizes; and iii) the role of a DGS covering the whole area. To conclude, it should be noted that there is widespread agreement that a full harmonization, though desirable, would hardly be practicable in the current political phase. However, the existing divergences among NIPs require every Member State to adopt special administrative insolvency regimes dedicated to banks, tailored around the peculiar features of these institutions and (possibly) harmonized at the European Union level.
*This research blog was written by Edoardo Piermattei Attorney at Law | PhD Candidate at the University of Bologna.
About BWILC and the PhD Workshop
This research was presented and discussed at the last PhD Workshop on European and International Insolvency law, organised by the Stichting Bob Wessels Insolvency Law Collection (BWILC). Since 2018, BWILC maintains the private insolvency law book collections of Prof. em. Bob Wessels, extended with the collections of the late Prof. Ian Fletcher and the late Gabriel Moss QC, in addition to books that have been kindly donated by scholars and practitioners from around the world. To browse or visit this unique collection, click here.
Since 2019, BWILC organises an annual PhD Workshop for PhD students from Europe and beyond. At this workshop, PhD candidates can present their ideas, but also the challenges and questions they are confronted with in a two-day workshop attended by their peers and senior academics. At the end of the workshop, organised in alternately in Leiden and another city, prizes are awarded for the best presentations.
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