Fine-tuning the use of bail-in to promote a stronger EU financial system

Thursday, 21 April 2016
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This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law.

Stefano Micossi is Director General of Assonime, Chairman of the LUISS School of European Political Economy (SEP – LUISS) and a member of the CEPS Board of Directors. Ginevra Bruzzone is Deputy Director General of Assonime, where she heads the competition and regulation division, and visiting professor at the SEP – LUISS. Miriam Cassella is senior legal officer in Assonime’s competition and regulation division.