EU wants bond holders to share pain of bank failure


The European Union's executive outlined a proposal yesterday (6 January) that could force those who lend to banks to bear big losses should they fail, opening a new line of attack on bondholders who escaped the crisis unscathed.

The first outline of plans that could become law by 2013 would end the privileged position of creditors, who were untouched for fear of triggering panic as the banks they lent to crumbled.

Instead, shareholders and governments bore the brunt of the costs. A new regime, now the subject of consultation with industry ahead of a final proposal in months, could allow authorities to impose losses on creditors in order to keep stricken banks afloat.

It could put further pressure on banks, driving up their costs of borrowing, as they face a series of other reforms such as requirements to set aside more capital for an emergency and curbs on cash bonuses to star performers.

Worried about the mounting bill for rescuing the financial sector as well as Europe's debt-laden countries, political leaders are also turning their attention to bank creditors and bond owners – mainly institutional investors such as insurers and pension funds.

Bank creditors to bear brunt of losses

In draft rules, the European Commission proposes new powers for authorities to force top-ranking creditors, such as bond owners or a bank that has lent money to another, to take losses if the institution they lend to comes to the brink of collapse.

Currently, a bond holder only loses his money if a bank goes bust, which authorities are unlikely to permit following the chaos triggered by the collapse of Lehman Brothers in 2008. New rules could allow the authorities to step in ahead of a collapse, imposing losses on creditors to keep the bank alive.

"We must put in place a system which ensures Europe is well prepared to deal with bank failures – without taxpayers being called on again to pay the costs," said Michel Barnier, the top European official in charge of financial reform.

AFME, the lobby group representing the world's biggest banks, welcomed the move.

"AFME has argued for some time that resolution tools such as converting debt into equity could be a highly effective way of staving off a potential bank failure without recourse to taxpayers," said a spokesman.

Others indicated that it could hamper efforts by banks to repair their balance sheets by selling loan portfolios secured by withered assets such as property.

Money market traders remained nervous about the proposals as news that Portugal planned to borrow more sent its cost of borrowing rising and amid continuing jitters over Spain.

Avoid to repeat 'big mistakes'

EU officials, seeking to calm investors, promised "no surprises" in the new rules, which could be phased in up to 2015 or beyond. If agreed with European countries and the European Parliament, however, they could apply to existing bank loans should those deals be renewed in the coming years.

"There have been big mistakes made in protecting bond holders in the banking crisis," said Karel Lannoo, chief executive of the Centre for European Policy Studies think-tank.

"They were seen as untouchable or equivalent to deposit holders rather than shareholders. If you look at the UK, most received back their investment at par."

Such a scheme could have dramatically altered the banking crisis that engulfed Ireland and forced it to turn to European neighbours and the International Monetary Fund for a bailout.

Bondholders in Ireland's biggest banks, such as Anglo Irish Bank, suffered only marginal losses, while shareholders were almost entirely wiped out, and the government was forced to step in to nationalise the nation's top lenders.

"Debt holders are about six times as big as equity holders in EU banks," said Sony Kapoor of think-tank Re-define.

"There could be hiccups – the cost of funding will go up for banks, but that would be no bad thing because they have enjoyed subsidised funding backed by the government."

The idea comes as Germany pursues controversial plans to force private holders of government debt securities to share the pain of a sovereign default from 2013. This has rattled investors worried about the security of their investments.

The European Commission, which writes the first draft of laws for the EU's 27 countries, will start negotiations with the bloc's member countries and its parliament within months to thrash out the final law.

(EURACTIV with Reuters.)


At last October's European Council, some EU leaders expressed a desire for investors to share the losses in the event of debt restructuring.

Opponents fear this will cause further economic strife accross the euro zone as investors shun Irish, Portuguese and Spanish bonds, pushing their yields to record highs. 

France and Germany have proposed setting up a permanent system to handle crises in the euro zone, admitting it would mean changing the EU treaty.

Ministers are currently discussing whether bondholder haircuts should form part of a permanent loan facility.

Many analysts believe Portugal will follow Ireland in seeking financial assistance from the European rescue fund, and there are fears that Spain might be forced to follow suit.

Separately, European Central Bank Governing Council member Axel Weber said he believed eurozone states could come up with more money if the existing 750-billion-euro EU-IMF safety net ever were to prove insufficient.

  • By summer 2011: Legislative proposal to be announced after consultation ends on 31 March 2011.

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