EU may crack down on bank bailouts after governments exploit loopholes

European Union officials are weighing a new crackdown on bank bailouts after national governments exploited loopholes in rules passed in the wake of the financial crisis.

One focus of the discussions is the so-called "precautionary recapitalisation" rule that Italy used to inject €5.4 billion into Banca Monte dei Paschi di Siena in 2017, according to an internal document written by European Commission staff. Officials are considering tighter limits on taxpayer funds for institutions close to collapse.

After almost €2 trillion of public funds were channelled to European banks in the financial crisis, the EU moved to make investors bear the costs of a failing lender. Since then, though, politicians have deployed tens of billions of euros to stave off collapses, prompting a backlash from lawmakers and public-interest groups.

Most recently, Germany agreed to a €3.6 billion rescue of Norddeutsche Landesbank-Girozentrale, a lender in the country's north that had been weighed down by toxic shipping loans. Italian politicians have also said they were ready to help Banca Carige when the bank faced capital pressure last year.

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The principle of making investors pick up the bill in case of a crisis proved difficult for governments to implement as bonds and shares issued by banks were often owned by retail investors. A main result of Monte dei Paschi’s rescue was that senior bondholders were spared.

The commission document focuses on the exemption in EU law used by Italy, which allows funds to be given to banks that are still solvent. The law lists a range of conditions that need to be met so that this option isn’t abused – for example, the funds can only be used to cover unexpected future losses of a bank, not past ones.

Experience with the rule “provided some insight on elements that may need to be further clarified or adjusted,” according to the commission. Specifically, it’s seeking feedback on whether there should be a clearer definition of what is a “solvent” bank, so that aid isn’t given to a firm that’s already breaching capital requirements or likely to do so in near future.

A spokesperson for the commission in Brussels declined to comment.

Balance sheets

It also says that the balance-sheet checks conducted in the context of recapitalisations may have to be revamped to better divide a bank’s past losses from future ones. This could be a safeguard against public funds being used to cover losses that an lender has already incurred, for example through bad loans.

The bank-failure rules, which fully took effect in 2016, also require banks to issue special kinds of liabilities that can be used for recapitalisation if they run into trouble. The regulations went hand in hand with tougher capital requirements agreed to after the crisis to make banks more resilient in a future upheaval.

The EU executive is "starting the internal reflection" on the bloc's methodology for dealing with failing banks, Sean Berrigan, a senior official at the commission, said at an event in Brussels on Tuesday. "Hopefully we'll come forward with something on that, but not in the very near term."

Any changes are likely to face intense debate with European governments and may take months or even years to agree. They could also feature as part of talks over German finance minister Olaf Scholz’s plan to fix the fragmentation of European banking markets. – Bloomberg