The Commission's proposal is based on the so-called 'polluter pays' principle. It is designed to establish "a system which ensures that the financial sector will pay the cost of banking crises in the future," according to the EU commissioner responsible for financial services, Michel Barnier.
"It is not acceptable that taxpayers should continue to bear the heavy cost of rescuing the banking sector," reads a statement from the commissioner delivered today. To address this possibility, banks will be forced to put extra money aside as a sort of levy to finance resolution funds.
The proposals must still be approved by member states, possibly at the next summit of EU leaders, set to take place in Brussels in mid-June.
Should the leaders give the proposals their green light, the European Union will be in a position to present the plan at the next G20 summit in Toronto at the end of June, paving the way for global bank resolution funds.
How large will the funds be?
Brussels underlines that it is still too early to define the actual amount of money needed to set up a bank resolution fund or, as is more likely, many such national funds.
However, the draft Commission proposal makes clear that funds "will need to be sufficiently resourced to cope with different resolution costs, and the approach taken will need to be tailored to entities of different sizes and nature".
In the beginning, banks are likely to be the only financial actors affected by the new funds. "At this stage, it does not seem appropriate to extend resolution funds to other financial institutions, such as investment funds or insurance institutions," reads the EU document.
Preventive action
Funding a preventive tool rather than making ex-post payments is preferable for the Commission, because it is a more effective means of avoiding wider economic turmoil in the event of bank failure, argues the EU document.
"The Commission takes the view that resolution funds should be built up on the basis of contributions from banks ex ante. Fully ex post-funded schemes may imply upfront taxpayer funding and therefore increase the risk that banking failures would be accompanied by broader negative economic impacts," explains the paper.
However, Brussels acknowledges the risk of moral hazard, which is governed by the implicit idea that if there is a resolution fund, then risk will be lower. To prevent resolution funds from encouraging risk-taking rather than preventing risks, the Commission makes clear that "resolution funds must not be used as an insurance against failure or to bail out failing banks, but rather to facilitate an orderly failure".
How can banks' risk be calculated?
The Commission is keeping its options open regarding the criteria for assessing the risk of bank failure, but it already tends to favour the use of liabilities rather than assets to establish the fair price to be paid by a bank versus its possible failure.
"Banks' assets are good indicators of their risk" but they "are already subject to risk-weighted prudential capital requirements in the form of capital charges," the Commission paper reads. "Imposing a levy based on assets could therefore amount to an additional capital requirement and would have to be considered carefully."
Banks' liabilities appear to be "the most appropriate indicators of the amounts that might be needed when facing the need to resolve a bank," although they could prove less effective at calculating the degree of risk, the document argues.
As an alternative or complementary solution, "levies could be related to profits and bonuses as an indicator of a bank's size and more reflective of the 'polluter pays' principle," the paper suggests. However, they "may not be closely correlated to the amount of resolution financing a bank might require or the probability of its failure," it adds.
Public finance temptations
Since the size of a bank resolution fund is likely to be significant in most economies, Brussels recognises that "some member states could find it attractive to use these contributions to reduce their public deficit".
In other words, the Commission assumes that the money put aside by banks could be used to temporary tackle public imbalances. However, in the longer term, this "may further reinforce the moral hazard problem associated with 'too big to fail' institutions," the paper stresses.
"The Commission therefore takes the view that bank resolution funds should remain separate from the national budget and dedicated only to resolution costs," concludes the document.
