Following the 2008 financial crisis, international authorities began a process of reviewing the regulatory framework for credit institutions in order to protect financial stability. This renewal process, which on one hand has tightened some existing rules (capital standards) and on the other has created new ones (the resolution framework, among others), has come at the cost of providing banking regulation with an extreme level of technical complexity and substantially increasing the regulatory costs for banks.
The resolution framework for credit institutions is a set of rules aimed at helping authorities manage banking crises while minimizing their cost to the economy. In other words, it is a framework that defines the steps to be followed when seeking to revive a bank that is on the brink of collapse. This highly complex regulation has had a very significant impact on bank balance sheets, to the point of significantly conditioning an element as strategic for entities as their funding structure (through the MREL requirement, also known as ‘crisis capital’). Furthermore, the rule has led to a very significant increase in the regulatory costs that banks must face in terms of information reporting or financial costs associated with the issuance of financial instruments to achieve compliance with the aforementioned MREL.
European authorities are set to begin, for the second time in a seven-year period, a review process of this young regulation. This week marked the deadline set by the European Commission to respond to the public consultation proposing the revision of the Bank Recovery and Resolution Directive (BRRD).
The objective of this reform is to improve certain deficiencies that have become apparent since its approval in 2014. Since its entry into force, there have been several cases of banking crises in Europe, and the resolution framework has been executed on only one occasion. That is to say, member states have sought alternative solutions for managing banking crises, which contrasts with the burdensome requirements and high costs associated with the resolution rule. It should be a priority for authorities to carry out the necessary reforms to ensure the consistent, harmonized, and more widespread application of the framework across the European Union.
On the other hand, the current framework presents some obstacles to its execution in cases of crises involving medium-sized entities—those that are too large for their crises to be managed through traditional insolvency proceedings but are considered too small to meet the demanding MREL requirements. To solve this problem, the creation of an alternative figure to insolvency and resolution (referred to by authorities as the ‘orderly liquidation tool’) is proposed. In the view of the authorities, this would facilitate the management of crises for these entities, but on the other hand, it complicates the general crisis management framework once again and could lead to an uneven playing field between medium-sized entities and larger entities competing in the same markets. The Commission’s proposal should be ambitious and seek solutions that, although they may be more controversial from a political negotiation standpoint due to the number of conflicting interests in Europe—such as the harmonization of insolvency laws—can reduce the excessive complexity of the framework and ensure a level playing field in the European banking sector.
Finally, the revision proposal would attempt to resolve other more technical shortcomings, such as the reform of the early intervention measures framework, which to date has not been widely used by authorities.
This revision of the Resolution Directive is an opportunity to reduce the degree of technical complexity of the framework, to ensure that all European entities and therefore all creditors of European credit institutions compete on equal terms, and finally, to reduce regulatory costs as much as possible in an economic environment where low interest rates and uncertainties caused by the pandemic could hinder the performance of the European banking sector.
Pedro Cadarso Palomeque, Advisor to the Spanish Banking Association (AEB)
