From bail-out to bail-in

The switch is made

November 2016

The state of execution of the European Single Resolution Mechanism (“SRM”) in Germany.

No name is as closely connected to the bank rescues in Germany after the financial crisis 2007/2008 as the “SoFFin” (Financial Market Stabilisation Fund). Founded in 2008, the year of the Lehman collapse, and administered by the “FMSA” (Financial Market Stabilisation Agency), it stabilised troubled banks like WestLB, Hypo Real Estate, Commerzbank et al.

Now, in 2016 profound and comprehensive organisational changes of the German bank rescue mechanism have been adopted. At the same time, this marks the transformation from the much criticised bail-out regime to a more bail-in oriented rescue concept.

In the past the bank rescues or stabilisations largely happened with tax-payers money. This “bail-out” approach, as it was designated in technical jargon, was deemed necessary back in 2007/2008 and afterwards implemented in order to avoid the uncontrolled collapses of banks with disastrous consequences for the national and the international financial system. From a hindsight perspective, the bail-out oriented actions are viewed by a majority as having been without an alternative, given the prevailing circumstances at that time, which lacked the necessary legal and technical preconditions for a different approach.

At the beginning of this year the Financial Market Stabilisation Fund “SoFFin” was finally closed down, i.e. since then no new funds or other rescue measures can be obtained from it. Furthermore, details of the reorganisation of national resolution competences were set down in a draft statute in July 2016. The FMSA will be the German national resolution authority but will be integrated into the BaFin (Federal Financial Supervisory Authority), the German Banking Authority, in order to facilitate the close collaboration of banking supervisory and banking resolution. FMSA’s previous responsibility for administering the Financial Market Stabilisation Fund, however, will be transferred to the „Bundesrepublik Deutschland – Finanzagentur GmbH“ (Finanzagentur). Those reorganisations are scheduled to be completed by the beginning of 2018.

Simultaneously the newly set up European “Single Resolution Board” picked up the baton. This board is headed by Elke König, former head of the BaFin, and adjudges the resolution of banks that are directly supervised by the ECB and those with subsidiary companies in foreign countries, which also take part in the “Single Resolution Mechanism” (SRM). Its core task is to restructure or to wind up systemically important banks that are not capable to survive on their own.

The Single Resolution Mechanism (SRM) is, in addition to the Single Supervisory Mechanism (SSM), the second pillar of the European Banking Union, which was adopted in June 2012 by the European Council.

The SRM is directly applicable particularly to all “systemically important” German banks. For other German banks the Bank Recovery and Resolution Act (“Sanierungs- und Abwicklungsgesetz” (SAG)) was adopted. The SAG is a special insolvency law for banks that is designed to take into account the interdependencies in the banking sector and the aspect of overall financial stability. As opposed to the normal insolvency law the competent authority is granted comprehensive powers by the SAG, which can be used by it autonomously and which also comprise the right of intervention into the constitution of the bank. Against the background of the implications that an uncontrolled collapse of a bank could have even for other banks, those strong powers appear to be justified in principle.

The SAG offers relevant instruments to tackle acute and severe crises of banks without endangering the financial stability on the one hand or tax payers’ money on the other. The aim of the SAG is to avoid a winding up of the respective bank, if at all possible. Hence, the primary goal is the early recognition and elimination of financial problems without endangering the going concern of the bank. Banks are required under the SAG to be able to react to situations of crisis in a prudent and structured manner, i.e. they immediately must have well prepared plans at hand. For this purpose SAG provides rules regarding “recovery and resolution plans” that the banks are obliged to prepare. Those plans must contain concrete steps to be taken in certain possible situations of crisis. On the other hand, the state authorities (in particular the FMSA) need strong means of immediate intervention to be able to effectively get a grip on such a situation in the public interest of financial stability.

The SAG basically consists of three parts: recovery planning, resolution planning and resolution. Recovery and resolution plans are the concepts that must be at hand in case of emergency. They must be very concrete in stipulating measures in order to resolve the crisis and preserve the existence of the bank, including its most critical and important functions. Pursuant to the principles of the SAG, a resolution should be avoided as far as possible.

A recovery and resolution planning had already been part of the German Act of Ringfencing of Credit Institutions (“Abschirmungsgesetz”) of 2013, while a participation of the shareholders and creditors in the losses and resolution costs are new in the SAG. Only after shareholders and creditors the state might step in with tax payers’ money.

The formal switch from bail-out to bail-in is made. A (partial) state bail-out is only provided for as the very last resort in future cases. It can hardly be predicted how efficiently the new approach can be executed in acute cases. It remains a mammoth task to separate highly complex entities in distinctive parts and apply predefined solutions to each of them. The so called “resolution weekend” puts it in a nutshell: within a few days the recovery measures must be activated. Despite all rules and all precaution measures in place, regarding the recovery and resolution planning, it is hardly foreseeable in which cases and how smooth this will work. Furthermore, a political risk will remain. It might become questionable, when confronted with “real” cases, how strict the participating nations are prepared to follow the principles of the SRM; how strong might instead be the incentive to interpret the rules extensively or consider exceptions to avoid hardship?

Your Contacts

Philipp von Websky
Tel: +49 211 8772 3867

Niko Jakovou
Tel: +49 211 8772 3891