«They say things are happening at the border, but nobody knows which border» (Mark Strand)
by Giuseppe Boccuzzi
Abstract: This paper concerns the regulatory responses to the financial crisis, focusing on the construction of Banking Union and the Bank Recovery and Resolution Directive. This paper takes into account that very few banking crises can be resolved without external support, as internal resources are not enough. The analysis shows also that external resources are certainly not government resources, because there is no line in the State budget for this. The Author concludes that the solution of banking crises is a delicate matter. He remarks how crises produce negative effects on a multitude of stakeholders and the the need for appropriate procedures for solving the crisis in as short a time as possible.
Summary: 1. The financial crisis and the institutional and regulatory responses. – 2. The construction of Banking Union: is it solid and resilient? – 3. The Bank Recovery and Resolution Directive: who covers the losses? – 4. Deposit guarantee schemes: which model? – 4.1 Some critical issues. – 4.2 State aid rules: which framework do we need? – 4.3 The European Deposit Insurance System (EDIS): What kind of EDIS do we need? – 5. The need to refine the European framework.
1. The international financial crisis of 2007-2009 and the turbulence in the Eurozone in the summer of 2011 from the vicious circle between sovereign risk and banking risk set in motion institutional and regulation reforms of the banking sector, especially with regard to mechanisms governing crisis management. These are still ongoing.
We all remember what happened in the first phase of the crisis: the run on Northern Rock in the summer of 2007, the Lehman Brothers bankruptcy in September 2008 and the serious effects produced by the turmoil on the financial system with a far reaching banking insolvencies chain. They requires a massive recourse to public bail-outs justified by the “too big to fail” (or too complex or interconnected to fail) principle. Banks could be so big that they could not be allowed to fail for fear of serious disruptive and contagious effects on the financial system and economic activity. This sowed the seeds for a second phase of the crisis: the doom loop between bank risk and sovereign risk which was especially deep in countries with huge fiscal problems.
The Italian banking system emerged substantially unscathed from the first phase. Given their traditional commercial banking model, Italian banks had not been affected by the debacle in sub-prime mortgages and related structured products. However, they succumbed badly to the second phase. Italy was sent into recession.
The crisis has been a long one, unprecedented since the Great Depression. It has been characterized by many interacting factors: (i) a collapse of economic activity and employment levels; (ii) a reduction in loans to businesses and households (credit crunch); iii) an increase in non-performing loans on banks’ balance sheets which hampered efforts to reduce operating costs; (iv) a weakening of own funds, addressed through massive recourse to market recapitalization; and, v) a crisis of banks with troubled or mismanaged governance structures.
Many answers have been given to the many questions posed as to the causes of the crisis. But many aspects still lack adequate explanation. Economists and regulators have not fully succeeded in getting at the root causes of such complex phenomena and less also in knowing how to anticipate them to enable timely intervention and mitigation of damages. Regulation and supervision revealed their limitations and deficiencies; banks’ risk management systems were not able to cope. It was a mix of factors and pernicious effects on the overall economy and on financial stability. A great need was felt for reforms of the institutional architecture and of the rules in place to ensure the orderly performance of banking activity and the very fundamentals of the banking sector.
This is what triggered the European Banking Union project among Eurozone countries, a far-reaching project, meant to provide solutions for the underlying problems at the most acute phase of the financial crisis, to create a more advanced safety net in the Eurozone in defense of financial stability. New rules on supervision and banking crisis management have been put in place; specifically important are the Bank Recovery and Resolution Directive (BRRD) and the Deposit Guarantee Schemes Directive (DGSD). Deposit guarantee schemes have a crucial role, both for banks and depositors.
The new institutional and regulatory framework is innovative and complex: we have now new institutions, new rules and new principles and objectives. We are seeing a new way of thinking, a new way of interpreting phenomena and new conceptual categories. Our language is also changing, with new terms like resolution, burden sharing, bail-in, depositor preference, no creditors worse-off, MREL-TLAC. Legal and economic concepts, often very complex, often lie behind these new expressions.
In operational terms, we are given new ways for managing crises, having uniform procedural schemes, with approaches that can often be quite different from those followed at national level.
Deeper studies are needed to better understand the new framework and its consequences for the financial system. Market operators, professionals and even ordinary citizens are urged to become more acquainted with the issues and, especially, to become aware of their huge impact on the allocation of savings and society.
We all need to carefully analyze the new system in order to verify its overall substance. We need to consider the extreme breadth and variety of the issues and the legal and economic institutes involved, not fully understood until now, given the speed with which it came into being, fueled by the urgency to remedy the shortcomings that emerged during the financial crisis. The impact on national legal systems is significant, with far-reaching consequences, which must be considered from the point of view of the general principles of subsidiarity and proportionality featured in the EU legal framework.
A critical analysis is of the utmost importance, because up to now the different stakeholders have not been significantly involved during the legislative process. Legal and economic scholars need to look closely at the new rules, the new legal institutes that have been created, and their impact on national jurisdictions.
In Europe, there is no field of economic regulation in which differences among the various countries are so pronounced as in the sector of firms insolvency; very different philosophies and approaches as to how to resolve crises are in place and depend on many factors, often linked to legal traditions, basic guidelines for bankruptcy laws and to the stage of development of the economy and finance. Without careful investigation and consideration of the differences among individual legal systems, no appropriate European framework can be designed.
That is why transitional regulations and ex-ante and ex-post impact assessments of reforms are so important: from the very outset, there has been no blanket solution for all possible situations and cases. It is not possible to apply the “one size fits all” approach. Otherwise, we run the risk that initial regulatory weaknesses will lead to excessive regulation or inadequate choices or, above all, to mistaken interpretations that could result in doing even greater damage than the problems we wanted to remedy.
2. European Banking Union is often represented as a building, with three pillars (SSM, SRM and a single DGS) and foundations made up of common rules (the “Single Rule Book”): CRR-CRD IV, BRRD and DGSD.
Any building, to be robust and resilient, must have solid foundations and correctly located pillars. This simple rule is also valid for Banking Union. Consequently, we must look at the whole construction and ask whether the whole legal framework is complete and effective and sturdy enough to last; or do we think the foundations are a bit unsteady? Or perhaps, we need different or more pillars?
The overall design of Banking Union is very clear. Decisions on supervision, crisis management and deposit guarantee schemes must be taken at the same level: the European level for larger banks and the national level for smaller ones. Some decisions are exclusive of each authority; others are to be shared. Cooperation, then, between European and national authorities is crucial for the correct functioning of the entire system.
The third pillar – the single deposit guarantee system – has not been realized yet. In the meantime, this project has been replaced by maximum harmonization of regulation – through the Directive on Deposit Guarantee Schemes (2014/49/EU – DGSD) – as an intermediate step towards the Single European Deposit Guarantee Scheme.
We are now at an initial phase of the implementation of DGSD in national jurisdictions. Some countries have not implemented it yet. As a result, we have too little information as yet to evaluate how well it is working from one country to the next. However, we are aware that this is a transitional phase and we should move towards a single DGS in the Eurozone.
However, the single European deposit insurance system (EDIS) is controversial. Some countries are opposed to it because they consider premature, at this stage, the mutualization of national financial resources within the Eurozone, which could lead to the use of the stronger countries’ money for the benefit of the weaker ones. As long as this opposition remains, Banking Union will remain incomplete.
A major question arises here. Is EDIS the only piece missing for the completion of Banking Union? In light of divergent approaches on the modalities and timelines for the European construction, perhaps something more than a European DGS is missing. Perhaps we have to find some force of gravity that will hold all the pieces together.
Apart from the lack of the third pillar, a more in-depth analysis needs to be conducted into the quality of the new rules, into their effectiveness to successfully address banking crises in Europe and into the efficiency of the decision-making processes.
3. The thinking behind the Bank Recovery and Resolution Directive (BRRD) is that the cost of a crisis must be borne by shareholders and creditors of the insolvent bank, as well as by the banking system as a whole, and not by taxpayers, as happened during the financial crisis. This would reduce the impact on a country’s balance sheet and help minimize moral hazard.
The BRRD defines general principles (Article 34.1) and objectives (Article 31.1). It outlines a special regime for dealing with insolvent banks, involving new proceedings and tools different from those generally used with non-financial firms. An administrative regime has existed in Italy since the 1936-38 Banking Code. But the BRRD special regime goes well beyond this traditional administrative approach; it is far more intrusive into bank businesses, even when they are in the course of their ordinary everyday affairs.
In order to make these key principles and objectives effective, BRRD introduces significant methodological changes with a clear strategic vision: an integrated approach to dealing with banking crises, well supported by economic theory and empirical evidence. In this vision, it is important not only to have the right tools that address banking crises once they occur, but also that underpin robust preventative measures.
The crisis of any firm, including a bank, hardly ever comes out of the blue; it is normally the outcome of a process of deterioration that develops over time. Prevention requires adequate preparation by banks and authorities (Recovery and Resolution plans) and the availability of a full toolkit by supervisors for early intervention when the first shows signs of deterioration appear (early intervention measures).
Preparation and prevention are key components of a crisis management system. Businesses face discontinuity at some point during their life and have to be prepared to address it with appropriate corrective measures. In a competitive market, crisis is a natural, inevitable phenomenon. Therefore, preparatory and prevention activities are integral parts of strategic, capital and liquidity plans (ICAAP and ILAAP) and of the policies and objectives of risk management (Risk Appetite Framework).
However, preparatory and supervisory activities – even if well-structured and effectively functioning – can reduce but not eliminate the risk of bank insolvency, given the multitude of internal and external factors that can change a situation from bad to worse. When a crisis occurs, authorities must have appropriate powers and tools available either for an orderly liquidation or resolution of the bank, in order to preserve its essential functions and protect depositors and at the same time reduce to a minimum the burden on taxpayers.
In this special regime, resolution is a new procedure aimed at restructuring the insolvent bank, as an alternative to liquidation, when the public interest is at stake (Article 32.1.c) and when liquidation under ordinary insolvency proceedings would not meet the resolution’s objectives. Resolution may be achieved using various tools: sale of business, creation of a bridge bank, good bank/bad bank separation, and bail-in.
The most important innovation is Bail-in. It addresses the need that coverage of an insolvent bank’s losses should not be borne by the taxpayers, but rather by on those who invested in the bank, such as shareholders and creditors. The burden would be allotted according to a specific hierarchy established by national insolvency laws.
Bail-in is nothing more than the application of insolvency rules outside of a liquidation proceeding. In summary, these rules are applied to situations where the bank is failing or likely to fail; the bank is restructured, not liquidated, to preserve the business continuity (going concern solution) or to facilitate the transfer to another bank or to a bridge-bank (gone concern solution).
But in this “superior” need to keep the insolvent bank alive and to preserve the continuity of the essential functions, to what extent can shareholders’ and creditors’ rights be sacrificed?
The implementation of bail-in has opened up a huge debate in many countries. Concerns have been expressed about the effects of bail-in on shareholders’ and creditors’ rights, also in light of the specific safeguards outlined by the Directive to protect their interests. The main questions are these: are the safeguards envisaged by BRRD sufficient, also in terms of jurisdictional safeguard? Can they strike a proper balance between restructuring the bank and protecting the stakeholders affected by the resolution measures? Many doubts have been expressed by the doctrine on this.
Additional problems may arise when bail-inable financial instruments are held by retail investors, who have little or no ability to judge the riskiness of their financial choices, often as a result of mis-selling of those instruments by banks. The issue here is not the bail-in in itself, but which savers and investors should hold these instruments and under what conditions.
The bail-in regulation states that “from the protection of savers we are going to the protection of depositors and taxpayers”. This has resultant disruptive effects on the financial system in terms of the loss of confidence towards the liabilities (the deposits) issued by banks, those very liabilities the legal framework intends to protect, given that the recourse to last resort guarantee by the public sector is not possible.
Many argue that there could be a negative impact on the composition of liabilities and the cost of funding, and on the structure of the financial system.
Debate on Bail-in is currently underway in many international fora. There is not a unanimous consensus on whether the new tool is appropriate and effective. Some argue that it should only apply to G-SIFIs (global systemically important financial institutions) – as was initially thought – and not to all banks, which seems to be happening in Europe. Others are concerned about applying bail-in to deposits over the 100,000 euro threshold.
The financing of resolution through bail-in could be combined with the use of the Resolution Fund fed in by banks. Hence, the provision of financial resources to resolve banking crises is entrusted to the private sector, such as investors and creditors of the failing bank and the banking system as a whole.
A question remains in the background: To what extent may the private system be charged to solve major crises with systemic relevance? What is the limit to the private intervention?
It is worth noting that BRRD allows recourse to public financial stabilization tools. These can be used as a last resort when ordinary resolution tools are not sufficient to avoid a significant impact on financial stability or to protect the public interest (Article 56).
In Italy, at a time of extraordinary crisis involving significant public interest, a specific government instrument was available under the Ministerial Decree of 27 September 1974. It was utilized until early 2000 and not replaced with another tool having the same function. The Legislative Decree implementing BRRD (No. 180 of 16 November 2015) has no provision in this regard. Accordingly, there is currently no ex-ante instrument of public intervention for cases of crises of systemic importance. This is a gap in the Italian system.
4. Deposit guarantee schemes: which model?
4.1 Deposit insurance is an essential component of a safety net. Its function is to protect depositors and contribute to financial stability. Hence, it is a fundamental element of confidence, which is the connective tissue of any financial system. The experience of the two Italian DGSs is evidence of this. Depositors have never incurred losses in bank insolvencies. Banks’ businesses and essential functions have always been preserved through support interventions, as an alternative to liquidation.
Interventions by the FITD since its formation in 1987 reflect this strategic approach. The FITD has intervened 11 times, only twice to pay depositors in the case of very small banks. The other 9 interventions were in the form of the transfer of assets and liabilities to another bank within the liquidation process, and support for banks under special administration.
Institutional mandates, i.e. the measures and types of intervention that deposit insurers are allowed to carry out, differ across the globe. They depend on the institutional setting of financial systems and the specific safety nets in place.
According to the classification by FSB-IADI, a deposit guarantee scheme may have a mere payout function (pay box) or may perform wider mandates: pay-box plus, loss minimizer and risk minimizer. In many legal frameworks, this classification corresponds to the real evolution of the deposit insurance system over time.
The new European legal framework fully confirms this approach. The overall design aims at conferring on DGS the broadest institutional mandate, consistently with the evolution of DGS functions: from the simplest pay box function to loss minimizer. The DGSD, in line with FSB-IADI standards, outlines and recommends a broad mandate for DGS. Recitals 3 and 16 expressly state that Member States should enable the DGS to go beyond a pure reimbursement function to reduce the likelihood of future claims against it, using the available financial means to prevent the failure of a member bank. In any case, such interventions must comply with State aid rules. Such interventions can be utilized in the different phases of the crisis and in various forms.
In the new framework, interventions can be divided into two categories:
i) mandatory interventions, to reimburse depositors (Article 11.1) and finance resolution (Article 11.2, which makes reference to Article 109 of BRRD);
ii) voluntary interventions, consisting of “alternative measures” aimed at preventing the bank’s failure in compliance with conditions established in Article 11.3, and help with the transfer of assets and liabilities of liquidated banks, as an alternative to payout (Article 11.6).
In addition to the intervention listed above for DGSD, BRRD (Article 59) states that when the bank is “failing or likely to fail”, the crisis may also be addressed outside resolution through the write-down and conversion of capital instruments, in order to recapitalize the bank (pre-resolution). It is implicit in this provision that the bank may also be recapitalized through the intervention of other investors, in conjunction with write-down and conversion of capital instruments. This is pursuant to Article 32 of BRRD, which provides that “alternative private measures” may prevent the failure of the institution within a reasonable timeframe (if this is not possible, resolution is triggered).
Under Italian law, in order to recapitalize a bank, third parties may intervene including the Deposit Guarantee Scheme (Article 27 of the decree implementing BRRD).
The comprehensive legal framework deriving from the combination of DGSD and BRRD is anchored in a wide vision of banking crisis. It considers that a banking crisis is a complex phenomenon, the result of the interaction of multiple factors, interest and values, which require a wide array of tools to be triggered if needed.
However, this far-reaching capacity through alternative means of intervention seems to be contradicted by some provisions and application guidelines, which introduce constraints and limitations and thereby reducing the scope of operation. Uncertainties remain as to what DGSs can and cannot do.
With regard to depositor payout, the scope and limits of such interventions should be carefully considered. In other words, we should ask to what extent liquidation and reimbursement of depositors is realistic and practicable. Those who manage banking crises are well aware that in many cases, liquidation is not a viable solution.
According to the literature, depositor reimbursement is possible only for small banks, and not for medium to large financial institutions. In any case, it does not work in the case of systemic crises. Hence, when major shocks occur (insolvency of one large bank or of several small banks at the same time), liquidation and depositor reimbursement are not really a viable option, for two main reasons:
i) lack of financial resources to cope with the repayments, especially in a crisis with systemic implications. Furthermore, many DGS come from an ex-post system and are currently in the transitional phase of accumulating resources as provided for by the DGSD. In any case, even in ex-ante systems, financial resources may be insufficient and specific mechanisms should be in place for ensuring the availability of funds, also through alternative funding arrangements.
Such mechanisms are necessary to increase the financial capability and credibility of deposit guarantee systems. They may take, for example, the form of borrowing from the market, central bank financing, or a public backstop.
With a view to European integration, the mutualization of national resources should be speeded up, in order to effectively deal with far-reaching insolvency phenomena. The proposed European Deposit Insurance Scheme (EDIS) seems to move in this direction.
In any case, resorting to a public backstop seems to be inevitable. It solidifies the implicit public guarantee on which the market relies for the capacity of a DGS to repay depositors up to the protected amount;
ii) various forms of contagion that may trigger the liquidation of one or more banks, even if a deposit guarantee system is in place.
To prevent contagion, authorities often resort to solutions other than liquidation, in the form of financial support for the bank’s restructuring and recovery.
For insolvent banks of large size or having systemic implications, the alternative to liquidation is resolution. For small and medium-sized banks, resolution could not be applicable, given the difficulty of proving the existence of a public interest, so as to avoid liquidation and restructure the bank through a recapitalization or a sale of business to third parties. Consequently, this scenario paves the way for only one solution: the liquidation of small and medium banks, with serious prejudice to the continuity of credit relations and to depositors. Unless alternative measures are allowed, both before/outside liquidation and within liquidation, through the sale of assets and liabilities to another bank.
This is the knotty part of European Directives and their implementation. And it is aggravated by the joint incidence of State aid rules and the “least cost” principle (applied together with the depositor preference principle), which tends to reduce the space for maneuvre for such alternative interventions. In fact, alternative measures could turn out to be ineffective. So, Are the “alternative measures” contemplated by the DGSD actually “impossible alternatives”?
Circumstances seem to contradict the very principles and guidelines envisaged in the Directive (Whereas 3 and 16; Art. 11, par. 3; art. 11, par. 5; art. 19, par. 3). Specific regulatory interventions and a revision of applicable criteria can represent a remedy to the situation.
4.2. Many issues have been raised by the EU Commission Communication in force from 1 August 2013 on State Aid in the banking sector. It provides that interventions other than depositor reimbursement – i.e. alternative measures – may consist of State Aid when certain conditions are met. Therefore, the application of State aid rules is a possibility and alternative measures by DGSs are not automatically State aid.
The Communication clarifies that in principle, interventions by deposit guarantee systems to reimburse depositors of failed banks do not constitute State aid. However, the use of such funds to assist in the restructuring of credit institutions may constitute State aid “to the extent that they come within the control of the State and the decision as to the funds’ application is imputable to the State”. The Commission assesses the compatibility of State aid in the form of such interventions (point 63). Point 64 makes a similar provision for interventions by resolution funds.
In issuing these guidelines, the EU Commission has given quite an extensive interpretation of State aid rules and applies them to DGS. This is the case even when the DGS is a legally a private entity, financed by private banks and managed by private bodies and when interventions alternative to depositor payout are discretionary.
This peculiar application of Article 107 of the TFEU raises many doubts about the compliance of the Communication itself and the rationale of the TFEU, which is to avoid undue distortion in market competition through improper State intervention, not external support by DGS in case of a banking crisis. They represent “assisted solutions” of banking crises, with private resources.
We are well aware that very few banking crises can be resolved without external support, as internal resources are almost never sufficient. But external resources are different from State funds. It is as if some genetic mutation or magic touch turned private money into public: but they are certainly not government resources. The reality is that there is no line in the State budget for this.
Clear evidence of this (mis)interpretation of State aid rules is the case of Banca Tercas. After an in-depth investigation last February, on 23 December 2015 the EU Commission concluded that the Fondo Interbancario di Tutela dei Depositi (FITD), acting on behalf of the Italian State, had provided incompatible State aid to cover the bank’s losses and facilitate the sale to Banca Popolare di Bari (SA 39451) .
In the subsequent press release, the EU Commission welcomes the plans of private funds to step in, mentioning that the FITD “has consulted its members as to whether they would voluntarily agree to support Banca Tercas. If private actors decide according to their own objective and from their own funds, without mandate from the State, to support banks in difficulties, no state aid issues would arise.”
In the same vein, we have the well-known case of the four Italian banks under special administration, in which the FITD – according to its by-laws and Article 11.3 of DGSD – decided to intervene for the recapitalization of the banks in a pre-resolution context, in conjunction with the write-down and conversion of capital instruments (Articles 59 and following of BRRD).
In this case, the EU Commission ruled that the FITD intervention qualified as State aid and Italy had to place the banks in resolution. It argued that FITD resources are public, since they refer to a compulsory scheme; State aid require the application of the resolution procedure provided for by the BRRD; outside of the resolution, support measures should come from the private sector, identified in accordance with the rules on State aid.
The banks – declared failing or likely to fail – have subsequently been put in resolution, with the transfer of all business to four bridge banks and use of the national resolution fund for loss coverage and recapitalization. The results have been higher costs for the Italian banking system and for retail investors (and their families) than those foreseen with the FITD intervention. Furthermore, the resolution process and the tools used are even more akin to State aid than the FITD intervention that the Commission wanted to avoid.
With reference to these cases, the EU Commission has elaborated on the concept and consequences of State aid, again in the direction of supporting voluntary schemes for alternative interventions. It concludes that “(I)f an assessment leads to the conclusion that the use of the deposit guarantee scheme is State aid, resolution of the bank will be triggered under the Bank Recovery and Resolution Directive, which defines ‘extraordinary public financial support’ as being ‘State aid…in order to preserve or restore the viability, liquidity or solvency of an institution’. Therefore, the conditionality under the Bank Recovery and Resolution Directive would apply. If on the other hand the use of the deposit guarantee scheme would not be assessed as State aid, and instead would be assessed as a purely private intervention, it would not trigger resolution under the Bank Recovery and Resolution Directive” (EU Commission, letter to Italian Minister of Economy and Finance of 19 November 2015).
The EU Commission’s arguments are not shareable, as we cannot understand why the DGS “voluntary arm”, as suggested by the Commission, is different from the “mandatory arm”. Clearly, both voluntary and mandatory schemes – under the same umbrella of the FITD – have the same characteristics: financial resources come from private banks and are allocated by private bodies, and interventions are discretionary. Furthermore, Article 11.3 of the Directive, which provides for alternative measures, refers to mandatory DGS and not to voluntary schemes. Finally, consistently with this provision, the Article 11.5 requires banks, when resources have been used for alternative measures, to refund the DGS to ensure that the target level of 0.8% of covered deposits is reached by 2024. As a consequence, alternative measures have no impact on the scheme’s financial resources.
The EU Commission guidelines also contradict the very principles affirmed in BRRD and DGSD, based on the sole use of private resources to resolve banking crises without recourse to public funds. Indeed, a DGS’s financial resources are private if provided by private banks.
From here the question: Can a mere Commission’s Communication be contrary to the letter of a Directive? More in general, can a Communication be the legal instrument to regulate such complex and delicate aspects, involving rights and obligations of various subjects?
If such an interpretative approach should persist, we should conclude that the crisis management system created by the new directives needs to be reconsidered. Indeed, while, on the one hand, an articulated public system of powers and tools to solve banking crises has been designed, we, on the other hand, are obliged to resort to forms of voluntary interventions – as suggested by the Commission – outside of the compulsory deposit guarantee schemes, with resulting difficulties in their application. It would seem, then, that a system has been created that does not work, at least from the Italian perspective.
Italian DGSs, in order to follow the consolidated experience of banking crisis management, driven by the prevention of insolvency, have created voluntary schemes in order to intervene with restructuring operations, also for small and medium sized banks, before liquidation and resolution. Does this really make sense?
In evaluating the consistency of alternative interventions with market discipline, it is important to highlight that competition rules are in any case applied. The banks resulting from alternative measures are very different from the ones at the beginning of the crises, given the restructuring plans that are normally put in place to ensure their long-term viability. We should ask whether the antitrust rules alone would be sufficient to evaluate if a DGS intervention is compatible with the market principles, without the need for State aid rules.
4.3 The recent Five Presidents Report on “Completing Europe’s Economic and Monetary Union” deals with this topic within a wider strategic plan to be completed by 2025. In order to implement such a plan, the EU Commission released a draft of the Regulation to establish the EDIS and the Deposit Insurance Fund.
The draft Regulation on EDIS presented by the EU Commission envisages a gradual process of mutualization of financial resources and centralization of decisions. The project is divided into three phases: the first, with a system of deposit re-insurance (from 2017); the second, with a co-insurance system (from 2020) and the third, with the establishment of Single Insurance Fund, based on the full mutualization of financial resources at the European level (from 2024). Starting from the third stage, the DIF will have the same functioning of the SRF and will be managed by the Single Resolution Board.
The basic question during this delicate preparatory phase is not whether a European deposit guarantee scheme is necessary, but ‘What kind of EDIS do we need?’.
We wonder how, through what institutional architecture, we could shift to a single deposit insurance system, departing from a framework strongly rooted in national schemes with their own legal identities and operational structures, and specific institutional mandates. This is not an easy task.
Each model should necessarily start from the consideration of national experiences. There is no one silver bullet or ideal scheme. Any model must be consistent with the way a crisis is managed, using the tools and measures available in the various countries. The model developed by the EU Commission is geared toward mandatory interventions only, via depositor payout and contribution to resolution procedures. It is a very narrow model.
Therefore, we should ask whether such a configuration is sufficient and what is the rationale for excluding the alternative means of intervention, widely used in many national systems, where DGS are an essential component of banking crisis management. In the absence of such provisions, who is allowed to intervene? When? How?
A European deposit guarantee scheme is a key completing element of Banking Union, but it must be properly designed. The challenge facing European regulators is how to combine the payout function of EDIS with the BRRD-DGSD rationale and with national experiences and frameworks. Also, to what extent should the mutualization process apply: Is it reasonable to give EDIS the same solutions as those identified for the Single Resolution Fund? Finally, we need to consider proportionality: how will small and mid-sized banks be treated? Who decides?
Indeed, the introduction of EDIS regulation is an opportunity to settle many open questions.
i) The overriding need is to eliminate the State aid regulation applicable to DGS, since lacking valid arguments to consider DGSs intervention as State aid. In this sense, it should be considered that in non-European jurisdictions (including USA and Canada) there is no specific regulation for State aid in the banking sector applicable to deposit insurance systems, without prejudice of the general antitrust rules. As a second-best solution, the principles and application criteria should be re-thought, emphasizing the capability of the individual alternative intervention to determine potential distortions to the European internal market, in relation to the size and other characteristics of the bank;
ii) an effective principle of proportionality must be applied, preserving the role of national DGSs in EDIS framework. In general, in the performance of the traditional function of depositors repayment, national DGS would be in the best position to make payouts and have smoother relationships with depositors than a centralized body. Moreover, they may have an exclusive role in carrying out alternative interventions in favor of small and medium-sized banks, in cases where the public interest test is not met for the application of the resolution proceeding;
iii) in the context of alternative interventions, the transfer of assets and liabilities within the liquidation proceedings should be enhanced, instead of the atomistic realization of assets and the repayment of depositors; this is the consolidated Italian experience, which could become a useful reference model also for other European regulations.
In Italy, the banking license of the bank under compulsory administrative liquidation is revoked. The legal entity, at the end of the liquidating process is extinguished.
In this context, the transfer of assets and liabilities to another bank configures as a way of realization en bloc of assets and of payment of liabilities, in alternative to atomistic liquidation (piecemeal liquidation). It speeds up the liquidation process of the insolvent firm, which otherwise could last many years and at higher costs. In substance, the operation is aimed at safeguarding the continuity of the bank’s essential functions and maximizing the proceeds.
The transfer of assets and liabilities within the liquidation process would be equivalent to the sale of business applicable within the resolution (Article 38 BRRD). In such a way, a full equating of tools utilizable would be realized in the two procedures, even though in a different legal context;
iv) to this end, an appropriate solution should be found to the problem regarding the availability of financial resources for national DGS in the context of the funding mechanism of EDIS. We could think of the maintenance at the national DGSs of a significant part of financial means, within the target-level established by DGSD (0,8% of protected deposits). Therefore, reinsurance and coinsurance, envisaged for the first two phases of EDIS, could represent the steady-state solution, consequently abandoning the idea of the full mutualization of resources.
This set-up would be consistent with the overall picture of Banking Union, according to which the responsibility for supervision and crisis management of less significant banks is in the hands of national supervisors and resolution authorities. EDIS involvement would be limited to cases of large bank insolvency, when national DGS resources are insufficient.
This could be the proper balance between centralized and national competence, in keeping with the proportionality principle.
5. At present, it is difficult to assess whether the reforms have created the best institutional and regulatory framework. Accordingly, at this stage it is premature to draw conclusions on the adequacy of the individual components of the design, since there are no background information, over an appropriate period, about the effects of the new institutions and instruments introduced. Therefore, time is fundamental to perform a significant evaluation.
However, criticalities and uncertainties have been already identified, in Italy and in other European countries, as usual during a transitional period. The many doubts raised require a deep reflection.
The solution of banking crises is a delicate matter. Crises produce negative effects on a multitude of stakeholders (shareholders, creditors, corporate borrowers and families, depositors, other banks, the banking system as a whole). Therefore, there is the need to have clear rules, an effective design of decision-making processes and appropriate procedures for solving the crisis in as short a time as possible. When a banking crisis occurs, time is of the essence. It is key to finding the causes, assessing the damage and defining the suitable solutions.
In the new European set-up, meeting all these requirements is no simple task. Inconsistencies pointed up in this work require appropriate refining of the new legal framework. One thing is certain: Given the complexity of the reform, we still have a lot of work to do.
Many aspects should be given high priority
i) the complexity of the institutional architecture. A multi-level decision-making system (European and national) is in itself problematic, so if a consistent design is not established – and examples are numerous – there could be overlaps and redundancies. We have national and European supervisory authorities; national and European central banks; national and European resolution authorities. Who is responsible for doing what, is not always clear.
Just a few examples. Think about the involvement of the supervisory authority and the resolution authority in the preparatory phase of crisis management (recovery and resolution plans), where the resolution authority has powers and tools that are typical of the supervisory authority with regards to the design and implementation of resolution plans; or, the hybrid role of the European Banking Authority (EBA), acting as a regulator, a standard setter, a relevant actor in micro and macro supervision, and mediator, often not having clear boundaries with the regulatory and supervisory powers of ECB; or, the combination of regulatory and resolution powers of the EU Commission and the European Council, given their involvement in the bank resolution decision-making process in various forms and situations.
Then, there is the crucial role of EU Commission in the assessment of crisis management solutions in the implementation of State aid rules, also with regard to restructuring plans of the banks, with overlaps with supervisory and resolution functions. In the end, who decides the solution of banking crises? If we assume that hardly ever can we have a solution without external support (including DGS support), we should conclude that the EU Commission really has the final say. Is this consistent with the framework introduced by the Directives?
ii) the interaction between different types of rules from different authorities. Beyond regulations and directives, and the related recitals, we have implementing and regulatory technical standards, guidelines, recommendations, with the consequent proliferation of rules.
The rules have been written in a very short time frame, under the pressure of urgency, and not always consistently. Rules, we know, are often difficult to interpret. Who will interpret them? Who ensures the necessary equality of treatment? What are the coordination mechanisms to prevent the deadlock that might occur when an authority has to wait for decisions to be taken by other authorities?
iii) the lack of a transitional period for several rules. Given the enormous changes, the transition from the old to the new regime is extremely delicate, especially when the starting basis can be so different as in the field of banking crisis management. It is of utmost importance to provide graduality, flexibility and proportionality, and to give due consideration – even if only for a transitional period – to principles, experiences and practices rooted at the national level;
iv) the fact that BRRD is a discipline of minimum harmonization is not fully considered. The Directive allows the utilization of other instruments available at the national level, when these make it possible to achieve the same objectives.
Experience during this first phase of the reform demands that we reflect on the new system we are creating. After a financial and economic crisis of such proportions, it is important to avoid rigidity in favor of a proportional, gradual and flexible approach, aimed at appreciating virtuous experiences in the different countries in keeping with the new principles. This applies to the many ways DGS can be used to finance solutions alternative to liquidation, which need to be preserved. Qualifying these as State aid limits the ability of the system as a whole to resolve banking crises. Formal considerations seem to prevail over substance; especially when the DGS is a private fund managed by private bodies, used for transactions that are not mandatory but decided on a discretionary basis.
Proportionality, a key principle of the European framework, must be ensured: the same rules and procedures cannot apply to operators of different sizes and complexity. The “one size fits all” approach may cause serious distortions.
To conclude, we cannot deal with complexity with rigidity.
 G. BOCCUZZI, Towards a new framework for banking crisis management. The international debate and the Italian model, Bank of Italy Legal Research Papers, October 2011.
 G. BOCCUZZI, The European Banking Union. Supervision and Resolution, Palgrave McMillan, 2015.
 According to Art. 31 BRRD, resolution objectives are: i) to ensure the continuity of critical functions; ii) to avoid a significant adverse effect on the financial system, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline; iii) to protect public funds by minimising reliance on extraordinary public financial support; iv) to protect depositors covered by Directive 2014/49/EU and investors covered by Directive 97/9/EC; v) to protect client funds and client assets.
When pursuing the above objectives, the resolution authority shall seek to minimise the cost of resolution and avoid destruction of value unless necessary to achieve the resolution objectives.
 According to Art. 2, paragraph 1, no. 57) of BRRD, “bail-in tool” is a mechanism for effecting the exercise by a resolution authority of the write-down and conversion powers in relation to liabilities of an institution under resolution. The bail-in aims at restoring the capital of the bank under resolution to the extent necessary to comply with prudential requirements or, in the case of a transfer, to reduce the nominal value of the transferred liabilities, including debt securities, or to convert these liabilities into capital.
 In particular, doubts concern the effectiveness of the safeguards designed to protect creditors’ rights, with regard to many aspects of the discipline, including the “no creditors worse-off” principle (Article 34.1.g). This states that no creditors should incur greater losses than they would have if the bank had been liquidated under normal insolvency proceedings. On these issues, see J.H. BINDER, The position of creditors under the BRRD, Eberhard-Karls-University – Faculty of Law, December 2015; L. DI BRINA, Sulla dubbia costituzionalità degli Interventi comunitari e nazionali in materia di “risoluzione delle banche”, FIRSTon line, 11.12.2015. R. LENER, Bail-in: una questione di regole di condotta? See Conference “Salvataggio bancario e tutela del risparmio”, Rivista di Diritto Bancario, n. 2, 2016; F. CAPRIGLIONE, Luci e ombre nel salvataggio di quattro banche in crisi. See Confernce “Salvataggio bancario e tutela del risparmio”, Rivista di Diritto Bancario, n. 2, 2016.
 F. PANETTA, Finanza, rischi e crescita economica, speech at the Conference: “Benchmarking the UK Market: A way to create an efficient and effective capital market in Italy”, at Equita Sim, Milano, 27 January 2016.
 The Resolution Fund can be used to support any resolution operation, in different ways and technical forms, such as: (i) to guarantee the assets and liabilities of the insolvent bank, its subsidiaries, a bridge bank or an asset management vehicle; (ii) to provide loans to the same entities; (iii) to purchase assets from the bank under resolution; (iv) to provide contributions to a bridge bank or asset management vehicle; (v) to pay compensation to shareholders and creditors within the safeguards provided for by Article 75; (vi) to make a contribution to the insolvent bank in place of the amount it would have obtained from the write-down or conversion of the liabilities of specific creditors, if the authority has decided to exclude some liabilities from the bail-in; (vii) to provide loans to other resolution-financing arrangements on a voluntary basis.
In any case, the resolution fund cannot be used to cover losses directly or to recapitalize a bank or another entity referred to above. Moreover, if the resolution fund incurs indirect losses, the principles regulating the use of the resolution fund within the bail-in framework will apply, including the use of bail-in covering at least 8% of total liabilities and the rule that use of the fund may not exceed 5% of total liabilities.
 The Ministerial Decree of 27.9.1974 provided that the Bank of Italy could grant special financing to banks subrogating to the rights of depositors of a bank in liquidation.
 According to the report accompanying the Decree, the BRRD provisions on government stabilization tools have not been incorporated because such measures are not provided for in the SRM Regulation and their implementation would require the approval of a specific law including such measures.
 FSB Compendium of Key International Standards of Financial Stability. The IADI Core Principles for effective deposit insurance systems, as revised in 2014, are included in the Compendium.
 E. KANE, A. DEMIRGUC-KUNT, Deposit insurance around the globe: where does it work?, NBER Working Paper n. 8493, 2001; ED. J. FRYDL, M. QUINTIN, The benefit and costs of intervening in banking crises, IMF, 2000; S. SCHICH, K. M. BYOUNG-HWAN, Systemic financial crises: how to fund resolution, OECD, 2008.
 This principle provides for that reorganization (alternative) measures are allowed only when they are less costly than depositor reimbursement in case of liquidation. With the introduction of the “depositor preference” rule (Article 108 BRRD), it is highly likely that paying out depositors could be (ex-ante) less expensive than the alternative measures. Indeed, as a consequence of the depositor preference, deposit guarantee schemes, subrogating to the rights and obligations of covered depositors, have a priority ranking which is higher than the ranking provided for the claims of ordinary unsecured, non-preferred creditors in normal insolvency proceedings. The application of the “least cost” principle is a complex issue, as there are no standard assessment methodologies; calculating the cost of reimbursing depositors can not only be the result of the initial payment net of recoveries, but should also take into account spillover and other indirect effects (public confidence) on the whole banking system and the economy, that may result from the liquidation of the bank.
 EUROPEAN COMMISSION, Communication from the Commission on the application, from 1 August 2013, of State aid rules to support measures in favor of banks in the context of the financial crisis (“Banking Communication”), 2013/C 216/01, 30.7.2013.
 The case is very complex. It involves two issues: i) the qualification of the DGS intervention as State aid, and ii) the compatibility of State aid with the single market. Regarding the first issue, the Commission stated that: the amounts paid by member banks are mandatory and can, therefore, be considered as public resources; the decisions to intervene are attributable to the State, in view of the role of the Bank of Italy in the decision-making process, that approved the intervention. On the second topic, the Commission stated that Italy did not present a restructuring plan, the burden-sharing principle was not applied (subordinated debts were not written down), and no measures were implemented to limit the distortion of competition created by the aid. On both aspects the EU Commission ignored the many strong arguments presented by the Italian Government, the Bank of Italy and FITD. Among others, the main argument was that Tercas, although still a going concern, was entirely controlled by Banca Popolare di Bari (BPB) after a recapitalization process and had been restructured with a view to its absorption by BPB. Moreover, at the time of the intervention, Italy had no burden-sharing rules in force (write-down or conversion of subordinated debts), so there were no legal conditions to apply burden-sharing.
 The qualification of DGS alternative intervention as State aid, de facto prevents DGSs from performing any activity different from the payout, triggering resolution for the bank in crisis: indeed, public interventions may be carried out only in a resolution procedure (as per BRRD Art. 56 on government financial stabilization tools), when conditions are met. The key point of the Commission’s construction resides in the equalization of DGSs interventions to extraordinary public financial support, which is State Aid pursuant to Art. 2, paragraph 1, no. 28) of BRRD (incorporated in Art. 1, paragraph 1, letter mmm) of the Legislative Decree n. 180/2015). Under this provision, extraordinary public financial support means State Aid within the meaning of Article 107(1) TFEU, or any other public financial support at supra-national level, which, if provided for at national level, would constitute State aid, that is provided in order to preserve or restore the viability, liquidity or solvency of a bank.
But this equation does not seem well founded, since the discipline called by Art. 56 concerns the direct intervention of the State in a resolution procedure (in the forms of capital support or taking temporary ownership) as a last resort remedy, decided by the Government in cooperation with the resolution authority. This case is, in all evidence, quite different from the interventions of a DGS carried out with private resources and determined by private entities.
 Published on Ministry of Economy and Finance website.
 On the issue, see the Sicilcassa case: Commission Decision of 10 November 1999 conditionally approving the aid granted by Italy to the public banks Banco di Sicilia and Sicilcassa (C81999) 38651). In that decision, the Commission stated that the contribution by FITD towards the liquidation of Sicilcassa to cover part of the losses resulting from the transfer to Banco di Sicilia of the assets and liabilities of Sicilcassa did not constitute State aid. State aid was excluded because the Commission verified the significant contribution of non-public-sector banks to the adoption of the decision of FITD. In fact, private banks accounted for the majority of votes in the Board of FITD, at the date of the decision.
 Case C 526/14, Kotnik and Others, Request for a preliminary ruling from the Ustavno sodišče (Constitutional Court, Slovenia), Opinion of Advocate General (AG), delivered on 18 February 2016. In this case, the AG, referring to the provisions of the Treaty on State aid, provided an interesting opinion on the role of the 2013 Banking Communication of the European Commission in the qualifying of interventions in support of banks in difficulty as State aid. Pursuant to Article 108 TFEU, the assessment of the compatibility of specific aid measures with the internal market in principle concerns the exclusive competence of the Commission, subject to review by the EU Courts.
In this field, the Commission has no general legislative power, as only the Council is empowered, pursuant to Article 109 TFEU, to adopt any appropriate regulations for the application of Articles 107 and 108 TFEU, on a proposal from the Commission and after consulting the European Parliament.
This means that the Commission is not empowered to set general and abstract binding rules governing the situations in which aid may be considered compatible; for reasons of transparency, and in order to ensure equal treatment and legal certainty, the Commission may publish acts of ‘soft law’ (such as guidelines, notices or communications).
The Court (See, to that effect, judgment in Grimaldi, C 322/88, EU:C:1989:646, paragraphs 18 and 19; and Opinion of Advocate General Kokott in Expedia, C 226/11, EU:C:2012:544, point 38) has held that the provisions of such acts of ‘soft law’ are, respecting the duty of sincere cooperation pursuant to Article 4, TEU, to be taken into account by the Member States’ authorities, but that duty cannot be considered as making those rules binding – neither de facto – on pain of breaking the legislative procedure set out in the TFEU.
The only effect those rules may directly produce is vis-à-vis the Commission, merely as a limit on the exercise of its discretional power.
As a result, the Banking Communication cannot be considered to be, de jure or de facto, binding upon the Member States: any effect of those rules upon Member States can at most be indirect; after the publication of such a communication, Member States could notify the Commission of State aid which they consider compatible, although without respecting the conditions set in that Communication.
Upon such a notification, the Commission would be diligently examine the compatibility of such aid measures taking into account the Treaty provisions.
Accordingly, the mere fact that one or more rules in the Banking Communication are not complied do not represent a valid reason for the Commission to declare the aid incompatible.
What is key is that, from a legal point of view, a Member State might be able to demonstrate that, despite the lack of any other criteria stated by the Banking Communication, aid to a bank in difficulty still satisfy the requirements of Article 107, TFEU.
In the light of the foregoing considerations, in the present case, the Commission cannot consider burden-sharing a condicio sine qua non for declaring planned aid to a bank in distress compatible under Article 107, TFEU: burden-sharing is required only ‘normally’, ‘in principle’, and cannot be required where it may infringe fundamental rights or endanger financial stability or lead to disproportionate results.
 A. Argentati, Sistemi di garanzia dei depositi e crisi bancarie: c’è aiuto di stato? Mercato Concorrenza Regole, no. 2/2015.
 EUROPEAN COMMISSION, Completing Europe’s Economic and Monetary Union, July 2015.
 EUROPEAN COMMISSION, Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme, 2015, accompanied with a Communication “Towards the completion of the Banking Union”, COM (2015) 585.
 The transfer of assets and liabilities is regulated by Art. 90 of the Italian Banking Law, which provides for the liquidation of assets in a compulsory administrative liquidation. According to this provision the liquidators, with the favourable opinion of the oversight committee and subject to authorization by the Bank of Italy, may assign assets and liabilities, the business or parts of the business, as well as assets and legal relationships identifiable en bloc. Assignments may be effected at any stage of the procedure, including prior to the filing of the statement of liabilities; the assignee shall be responsible only for liabilities appearing in the statement of liabilities.
 On this topic, for a different approach, see, D. GROS, Completing the Banking Union: Deposit Insurance, CEPS Policy Brief, No. 335, December 2015.
 See Regulation (EU) no. 806/2014, Art. 18 on the resolution procedure.
 The Directive contemplates a minimum set of tools for the orderly restructuring of the insolvent bank, while allowing Member States to add other tools available at national level which are consistent with the goals pursued by the Directive (recital no. 44).
Giuseppe Boccuzzi is Director General, Fondo Interbancario di Tutela dei Depositi – FITD (Interbank Deposit Protection Fund).
This paper develops, through further analysis and insights, the speech of the Conference “Preventing and Resolving Bank Crises in the European Banking Union and depositor Protection”, held in Turin on 12 February 2016, organized by the European Regional Committee (ERC) of the International Association of Deposit Insurers (IADI).