In EU financial market regulation, a more unhurried approach is currently in order, as there are no major legislative hurdles like Basel or MiFID on the horizon. Nonetheless, the atmosphere remains tense. EU lawmakers are working on a dossier with the potential for explosive controversies: the legislative package on bank Crisis Management and Deposit Insurance (CMDI).

In April 2023, the European Commission presented the CMDI proposal, with the stated goal of strengthening crisis management for severely distressed small banks. The European Parliament reached a position in April this year, followed by the Council in June. However, the positions of the two bodies are miles apart.

„The European Parliament's position is closer to the European Commission's proposal than to the general orientation in the Council. Therefore, difficult negotiations in the trilogue are expected“, says Jan Tibor Böttcher, Head of Policy at the National Association of German Cooperative Banks (BVR). He is closely monitoring the legislative process, as it involves issues that are crucial for credit unions, savings banks, and smaller private banks.

„The European Commission's proposal essentially aims to make resolution the standard procedure when a bank – even a small one – encounters serious problems“, explains Böttcher. This represents a departure from the approach described by the former head of the EU Single Resolution Board, Elke König, with the phrase: „Resolution is for the few, not for the many.“ It also deviates from the common practice of using insolvency as the typical exit strategy for smaller and medium-sized banks in trouble, according to the BVR expert.

The intention to include smaller banks in resolution procedures means there will be a higher financial requirements. Representatives of the SRB, and EU Commission officials, have highlighted this. In this context, the funds managed by deposit insurance schemes come into play.

„In the trilogue, the co-legislators will primarily need to address two key issues that remain contentious“, notes Böttcher. First is the question of under what conditions national deposit insurance systems can finance measures beyond merely compensating depositors. Second is the extent to which funds from national deposit insurance systems could be used to cover the gap if the bail-in-able capital of a troubled bank is insufficient to meet the requirements for accessing the EU Single Resolution Fund (SRF).

Access to the SRF can only occur after shareholders and holders of so-called eligible liabilities have contributed to loss absorption and recapitalisation of the distressed institution. This contribution, such as through write-downs or conversions, must amount to at least 8% of the bank's total liabilities.

Next Steps:

The trilogue is expected to start in October or November. Hungary has announced its intention to advance the dossier.
The European Commission is somewhat dissatisfied with how far the Council has diverged from its proposal. Although it theoretically has the power to stop the legislative process, it is unlikely to do so.
Final negotiations on the European Deposit Insurance Scheme (EDIS) are likely to start only after the completion of CMDI.

BVR expert Böttcher points out that „small and medium-sized institutions often do not issue enough eligible liabilities and instruments to meet this requirement in a crisis.“ Under the resolution mechanism, they would therefore need to issue more eligible liabilities, which would involve a large effort and high costs. Without access to capital markets, this is often difficult: „In such cases, the deposit insurance system would need to step in if the 8% threshold is not met – a problem that arises when the resolution mechanism is extended to institutions for which it was not originally designed.," he explains.

Closely related is the so-called super-priority. In the EU, all deposits from savers and businesses up to 100,000 euros have been protected for ten years. To make this protection promise credible – as it effectively counters the risk of bank runs – deposit insurance systems, which ultimately fulfill this promise, have been granted super-priority in the creditor hierarchy in insolvency proceedings, reflecting the principle of „protect the protector.“ Indeed, deposit insurance has incurred almost no losses in crisis situations to date.

CMDI proposes the removal of this super-priority, thereby equating all deposits. This would result in higher compensation costs for deposit insurance and, consequently, for banks. As a result, the „Least-cost test“ – whether insolvency or resolution is more cost-effective – would likely favor resolution more often. This is another reason why BVR, along with other associations in the German banking sector, opposes the removal of super-priority. „We welcome the Council's rejection of the removal of super-priority“, emphasizes the BVR expert.

At the same time, CMDI will significantly influence the future use of national preventive measures. „The European Commission's proposal effectively makes it nearly impossible to use deposit insurance funds for national preventive measures“, says Böttcher. Such use is conditioned on troubled banks presenting a detailed business plan to receive assistance – which is „unrealistic“ in a time-critical crisis situation.

Finally, there is the issue of institutional protection. Currently, networks that maintain institutional protection can also have it recognised as a deposit insurance system. This means they must hold the EU-mandated 0.8% of covered deposits to use them for depositor compensation if needed. However, these funds can also be used for other measures, such as transferring deposits. „The European Commission now wants institutional protection systems to accumulate additional financial resources for their measures“, reports the BVR representative. The Council has opposed the European Commission's approach, and wants to maintain institutional protection in its current form. This is one of the reasons many in the German banking sector hope the Council will prevail in the trilogue.