The BRRD (Bank Recovery and Resolution Directive), which introduced harmonised rules to prevent and manage bank crises in all European countries, came into force more than four years ago. The bail-in, the mechanism for sharing the cost of a crisis with a bank's creditors, has been in operation for more than three years. During this period, in Europe, there have been a few bank failures and rescue operations: in Italy alone, a dozen have been counted. Resolution authorities showed a willingness to avoid the application of bail-in, preferring, before public intervention, to involve subordinated creditors (burden sharing), as well as, obviously, shareholders.
The regulatory framework on crises is the same, but in practice each failure seems to have been managed in a different way. The constraints imposed by the BRRD and the Commission's state aid guidelines have severely restricted the scope for public action, yet a way to ensure state aid intervention has always been found within the scope of what is envisaged in the directive.
What are the possible tools to rescue a failing bank?
The rules introduced by the BRRD require that a bank in crisis must be resolved or (if the conditions for resolution are not met) liquidated. The difference between liquidation and resolution measures is that the latter aims at re-structuring the bank in order to safeguard the public interest (continuation of the bank's core functions, financial stability and minimum costs for taxpayers).
In order to access the resolution procedures, the bank will have to be declared failing or likely to fail. This occurs, for instance, if there are valid reasons to believe that the institution will – in the near future – infringe the requirements to continue to operate by the competent authority; its assets are or will be below its liabilities (based on objective evidence); it is, or will be, unable to pay its debts; or it requires extraordinary public intervention (se figure 1).
When one or more of these four conditions are met, the resolution authority (after consulting the supervisory authority) declares the bank "failing or likely to fail". The initiation of a resolution programme also requires that no supervisory or private-sector measures are available and able to restore the bank's viability within a reasonable time frame and that resolution is necessary in the public interest. The resolution authority will then identify the tool (or combination of tools) to be applied between selling the business, setting up a bridge institution, separating the assets, and bail-in (resolution authorities can apply the activity separation tool only by combining it with another resolution tool).
The presence of a public interest is a discriminating point for the choice between a resolution or a liquidation procedure.
If a resolution tool is activated, the use of public funds is possible after the application of the bail-in, which involves the reduction of the nominal value of shares, subordinated and potentially ordinary bonds and unsecured deposits.
In case of liquidation, state aid can be provided after burden sharing of shareholders and subordinated creditors to ensure that the exit process takes place in an orderly manner. For example, this principle has been applied for the acquisition by Intesa SP of certain assets and liabilities of Banca Popolare di Vicenza and Veneto Banca.
The Commission, in agreement with the Italian government, has recently introduced another tool for managing the crises of small banks: the so-called "liquidation scheme for small banks". In order to guarantee the orderly exit from the market of banks with assets of less than €3bn, the Italian government has been authorized (until April 12, 2019, but the period may be extended) to grant, subject to burden sharing, state aid through the Interbank Deposit Protection Fund (FITD) and the Cooperative Credit Depositors Guarantee Fund (FGDCC). This scheme, already applied in Croatia, Denmark, Ireland and Poland, will allow the transfer of the healthy part of a bank to another institution. Small banks will therefore be able to benefit from a solution similar to that used for the two Venetian banks. The most recent case of application of this scheme is the acquisition of Banca del Fucino by Igea Banca.
What are the rescue options if a bank is not in default, but in temporary difficulty?
In this case, public support will be granted if necessary to remedy a serious disturbance in the economy and preserve financial stability. This support may take the form of a government guarantee on newly issued bonds or on liquidity provided by central banks or of a capital increase, provided that capital shortfalls are established under stress tests. The latter is the so-called precautionary recapitalization, which can only be implemented if the intervention is precautionary and temporary. It cannot be used instead to cover current or future losses and it is always subject to authorization by the EU Commission (which requires a restructuring plan and burden sharing).
Figure 1: Art.32 BRRD: resolution and precautionary recapitalization
In Italy, public support mechanisms for liquidity and capital have been applied for the first time to manage the crises of Monte dei Paschi and those of Venetian banks (Law Decree no. 237/2016). In the first case, the bank benefited from the public guarantee on three bond issues and subsequently from a capital injection (preceded by the conversion of subordinated loans). Banca Popolare di Vicenza and Veneto Banca also received liquidity support, but after a few months they were declared bankrupt or at risk of bankruptcy and, subsequently, put into liquidation. More recently, Decree Law no. 1/2019 made precautionary support instruments (guarantees and capital injection) potentially applicable also to Banca Carige.
In summary, the application of the new European crisis management framework to specific cases has highlighted two important points. First, while restricting the possibilities for state intervention, a form of public contribution has always been provided in difficult situations. The initial state of solvency of the financial institution is an important element, which discriminates against the nature of the aid and the way in which shareholders and creditors share the burden. Second, the bail-in has only been used rarely because its application risks "undermining confidence in banks and generating instability". Recently the Bank of Italy itself has expressed the need to correct some critical aspects of the crisis regulation regime. In particular, Bank of Italy would favour a revision of the way the bail-in is applied (limiting it only to larger banks) and its implementation mechanisms (such as the intervention of deposit guarantee funds), to ensure the orderly exit from the market of medium-sized banks in difficulty, thus limiting the effects on the economy and investors.