This report commits only the Commission's services involved in its preparation and does not prejudge the final form of any decision to be taken by the Commission.

TABLE OF CONTENTS

1..... Introduction.. - 4 -

2..... Procedural Issues and Consultation of Interested Parties. - 5 -

2.1. Procedural issues. - 5 -

2.2. Consultation of interested parties. - 6 -

3..... Policy context, Problem definition and Subsidiarity.. - 7 -

3.1. Background and context - 7 -

3.1.1. Nature and size of the market concerned. - 7 -

3.1.2. Overview of legislative framework and on-going developments. - 7 -

3.2. Problem definition. - 7 -

3.2.1. General description. - 7 -

3.2.2. The framework of bank recovery and resolution. - 7 -

3.2.3. Problem tree. - 7 -

3.2.4. Baseline scenario. - 7 -

3.3. The EU's right to act and justification. - 7 -

3.4. Objectives. - 7 -

4..... Policy Options, Analysis of Impacts and Comparison.. - 7 -

4.1. Preparation and prevention. - 7 -

4.1.1. Possible policies to develop framework for intra group financial support - 7 -

4.1.2. Possible policies to require contingency planning. - 7 -

4.1.3. Possible policies to ensure resolvability of banks. - 7 -

4.2. Early Intervention. - 7 -

4.2.1. Possible policies to provide all supervisors with effective early intervention triggers - 7 -

4.2.2. Possible policies to provide supervisors with effective early intervention tools - 7 -

4.2.3. Possible policies to shorten time period for capital increase in emergency situation - 7 -

4.3. Bank resolution. - 7 -

4.3.1. Possible policies to provide authorities with clear and reliable resolution triggers - 7 -

4.3.2. Possible policies to enable all resolution authorities with a set of resolution tools and powers to resolve banks. - 7 -

4.3.3. Possible options to amend EU and national legislation to eliminate legal uncertainties around the use of resolution tools. - 7 -

4.4. Cross border crisis management - 7 -

4.4.1. Possible policies to foster efficient cooperation of authorities in cross border resolution - 7 -

4.5. Financing resolution. - 7 -

4.5.1. Possible policies to develop arrangements to finance bank resolution that provide optimal and even level of protection for all Member States. - 7 -

5..... Overall impact of preferred options. - 7 -

5.1. The proposed framework. - 7 -

5.2. Proportionality. - 7 -

5.3. Impacts on fundamental rights. - 7 -

5.4. Safeguards. - 7 -

5.5. Increased responsibility and powers for authorities. - 7 -

5.6. Interaction of supervisors and resolution authorities. - 7 -

5.7. Cross border recovery and resolution. - 7 -

5.8. Benefits of the framework. - 7 -

5.9. Impact on stakeholders and cost of preferred options. - 7 -

5.10. Administrative burden. - 7 -

5.11. Impact on EU budget - 7 -

5.12. Social impact - 7 -

5.13. Environmental impact - 7 -

5.14. Impact on SMEs. - 7 -

5.15. Coherence with other proposals. - 7 -

5.16. Choice of legal instrument - 7 -

5.17. Experience of Member States with bank resolution. - 7 -

6..... Monitoring and evaluation.. - 7 -

Annex I Glossary.. - 7 -

Annex II Different stages of bank recovery and resolution.. - 7 -

Annex III Consultations with stakeholders. - 7 -

Annex IV Regulatory Framework.. - 7 -

Annex V On-going developments. - 7 -

Annex VI Description and analysis of Problem drivers and Problems - 7 -

Annex VII Cases illustrating problems of crisis management in the EU - 7 -

Annex VIII Corporate structure of Lehman Brothers. - 7 -

Annex IX Bank levies and taxes in Member States. - 7 -

Annex X Condition for Intra Group Financial Support Agreement - 7 -

Annex XI Recovery and Resolution plans. - 7 -

Annex XII Resolution tools. - 7 -

Annex XIII Debt write down (Bail-in) and ex-ante funding.. - 7 -

Annex XIV A comprehensive strategy to restore financial stability to underpin sustainable growth in the EU.. - 7 -

Annex XV Details on the necessary derogations from stakeholders' rights under EU company law rules in the resolution phase. - 7 -

Annex XVI Impacts on fundamental rights. - 7 -

Annex XVII Overview of the results of the public consultation on technical details of a possible EU framework for bank resolution and recovery (January - March 2011) - 7 -

Annex XVIII Results of targeted discussions on bail in.. - 7 -

1. Introduction

Over the course of the financial crisis, the ability of authorities to manage crises both domestically and in cross-border situations has been severely tested. Financial markets within the EU have become integrated to such an extent that the effects of problems occurring in one Member State cannot always be contained and isolated. Domestic shocks may be rapidly transmitted to credit institutions, businesses and markets in other Member States.

The lessons learned during this crisis have prompted the Commission services to examine the issue of bank recovery and resolution and to consider how existing arrangements and cross-border cooperation can be strengthened to better reflect the degree of integration in the EU financial services market. The Commission Services believe that resolving these issues will also be key to deepening the Internal Market by providing further confidence in the home-host arrangements underpinning banking supervision, and ensuring its smooth functioning in stressed situations.

A regime to facilitate an orderly resolution of failing banks and thus ensure smooth market exit is one of the most important pillars to maintain overall financial stability in crises. This relies on the ability of authorities to detect, prevent and manage problems which threaten the solvency of banks. The involvement of authorities may be crucial to maintaining the stability of the whole financial system, to protecting the deposits of people and companies and to maintaining the continuity of the payment systems and other basic financial services.

At international level, G20-Leaders have called as a medium-term action for a “review of resolution regimes and bankruptcy laws in light of recent experience to ensure that they permit an orderly wind-down of large complex cross-border institutions.”[1] At the Pittsburgh summit on 25 September 2009, they committed to act together to "...create more powerful tools to hold large global firms to account for the risks they take" and, more specifically, to "develop resolution tools and frameworks for the effective resolution of financial groups to help mitigate the disruption of financial institution failures and reduce moral hazard in the future."

In October 2011, the Financial Stability Board adopted "Key Attributes of Effective Resolution Regimes for Financial Institutions" (Key Attributes)[2] that set out the core elements that the FSB considers to be necessary for an effective resolution regime. Their implementation should allow authorities to resolve financial institutions in an orderly manner without taxpayer exposure to loss from solvency support, while maintaining continuity of their vital economic functions.

The Basel Committee also dealt with this issue and issued recommendation on cross border bank resolution.[3] In the US, the existing resolution arrangements have been further improved with the introduction of the Dodd-Frank Act.[4] In the EU, several Member States (UK, Spain, Germany, Sweden etc.) have reinforced their systems to enable the prompt and effective resolution of failing banks.

The report of the High-Level Group on Financial Supervision in the EU chaired by Jacques de Larosière[5] observed: “The lack of consistent crisis management and resolution tools across the Single Market places Europe at a disadvantage vis-à-vis the US and these issues should be addressed by the adoption at EU level of adequate measures.”

2. Procedural Issues and Consultation of Interested Parties

2.1. Procedural issues

An Inter-service Steering Committee on early intervention and bank resolution was established in October 2008 comprising of the Directorate Generals MARKT, ECFIN, SG, SJ, ENTR, EMPL, COMP, JLS, TAXUD and the European Central Bank (ECB). The steering committee met in November 2008, June and September 2009 and supported works on communications, a staff working document and a related impact assessment[6]. In 2010 and 2011, the Committee continued to work on these issues with a view to a legislative proposal. The Steering Committee had meetings in November, December 2010, and in January, February 2011.

The draft impact assessment was discussed with the Impact Assessment Board (IAB) of the Commission on 18 May 2011. The IAB requested the following modifications to the text:

(1) Strengthen the analysis of the problem drivers and the baseline scenario.

(2) Clarify the legal and institutional context.

(3) Clarify the content, and better assess the proportionality, of the various options.

(4) Strengthen the analysis of impacts.

The IAB examined the above revisions of the resubmitted text on 9 June 2011 and issued additional recommendations. Adjustments reflecting these recommendations including updates following latest developments in international fora a as well as incorporation of results of the discussions on the bail-in tool that took part in April 2012 can be found in the following sections of the document:

1. Introduction: Reference is made to the Key Attributes of Effective Resolution Regimes for Financial Institutions" adopted by the Financial Stability Board in October 2011.

2. Consultation of interested parties: On one of the resolution tools, the so called bail-in or debt write down tool, targeted discussions were organised with experts from Member States, banking industry, academic world and legal firms in April 2012, the results of which are summarised in Annex XVIII. The presentation of all consultations can be found in detail in Annex III.

3. Improved presentation of the legal and institutional context:

Chapter 5.6 presents in a more details the responsibilities of national supervisors and resolution authorities and chapter 4.3.2 lays out in a more detail the relationships between the proposal for bail-in and the planned CRD requirements.

4. Better explained the content of some options:

Chapter 5.4 presents safeguards envisaged to avoid unnecessarily intrusive actions by regulators. Chapter 4.3.2, option 4: the debt write-down tool presents extended description of this tool including its main aspects: the scope, interaction between ex-ante funds and bail-in and the amount of bail-in-able liabilities. This chapter also presents the impact on the cost of funding, the impact of the tool depending on its phasing- in as well as the bail-in tool in light of current international considerations. The preferred option of the bail-in tool incorporates view of the key stakeholders following the discussions organised by the Commission in the course of April 2012. Finally, Annex XIII provides for a more detailed overview of all the features of the debt write-down tool. Chapter 5.15 sets out the aspects of coherence with other proposals, namely related to the latest amendments to the Directive 94/19/EC on Deposit Guarantee Scheme, the proposal for a Financial Transaction Tax as well as with the Capital Requirements Directive.

5. Further strengthening impacts analysis: Chapter 5.6 presents the interaction between supervisors and resolution authorities. Furthermore, the impact of the proposed measures on existing national resolution regimes and other significant impacts are presented in chapter 4.3.2, in chapter 5.8 and 5.9 related to costs and benefit and the impact of the preferred option on stakeholders. Full analysis is available in Annex XIII dedicated to the debt write-down tool and in chapter 5.1. In addition, chapter 5.17 outlines current experience of Member States with bank resolution.

6. Other changes:

- Chapter 4.5 Financing Resolution: the related Annex XV has been merged with Annex XIII

- Chapter 5.11 Impact on EU budget: since EBA will have to develop an expertise in a completely new area, it is now estimated that compared to the previous conclusions that did not estimate any impact on EU budget, EBA will as a result need 5 permanent and 11 temporary staff for 2013 and 2014.

- Chapter 6 Monitoring and Evaluation: indicators for monitoring were added

2.2. Consultation of interested parties

In the period between 2008 and 2011, the Commission services organised a number of consultations with experts and key stakeholders concerning bank recovery and resolution. As the last public consultation before the adoption of the proposal, a Commission Staff Working Paper describing in detail the potential policy options under consideration by the Commission services was published for consultation in January 2011. The consultation ended on the 3rd of March 2011. The summary of this consultation can be found in Annex XVII.[7] On one of the resolution tools, the so called bail-in or debt write down tool, targeted discussions were organised with experts from Member States, banking industry, academic world and legal firms in April 2012, the results of which are summarised in Annex XVIII. The presentation of all consultations can be found in detail in Annex III.

3. Policy context, Problem definition and Subsidiarity

3.1. Background and context

3.1.1. Nature and size of the market concerned

The proposal addresses bank recovery and resolution in relation to all credit institutions and certain investment firms. The scope of the proposal is identical to that of the Capital Requirements Directive (CRD)[8], which harmonised banking legislation and introduced the Basel II framework in the EU[9]. Investment firms need to be part of the framework, as the recent crisis showed that their failure (i.e. Lehman Brothers) could have serious systemic consequences. The above mentioned public consultations supported this policy as respondents agreed that the framework should apply to all credit institutions and investment firms as defined in the CRD with the application of the proportionality principle (obligations proportionate to the systemic relevance of the institution concerned) and adequate adjustment to deal with the specificities of investment firms. They also supported that financial holding companies should be part of the framework.

According to the ECB[10], in 2009, 8,358 credit institutions[11] operated in the EU with total assets of €42,143 billion.[12] There are 39 large cross border banking groups in the EU and around 100 further banks that have subsidiaries or systemic branches in another Member State. According to the Committee of European Banking Supervisors, 3800 investment firms operated in the EU in 2009.

In the European Union banks traditionally play a more prominent role in financial intermediation than in the United States. The Institute of International Finance (IIF) calculated that as of end-2009, US banks accounted for only 24 per cent of credit intermediation in the country, versus 53 per cent in Japan and as much as 74 per cent in the Euro area[13]. EU financial markets are strongly integrated, in particular at the wholesale level. The banking and insurance markets are dominated by pan-European groups, whose risk management functions are usually centralised. The 39 large cross-border groups' total assets represent around 68 % of the total EU banking market. Especially in the EU-12, banking markets are dominated by foreign (mostly Western European) financial groups. In these countries, on average 65% of banking assets are in foreign-owned banks. In countries like Estonia, the Czech Republic and Slovakia over 92% of banking assets are in foreign-owned banks.

Chart 1. Market share of foreign-owned EU subsidiaries and branches in Member States (% of total assets, 2009)

3.1.2. Overview of legislative framework and on-going developments

To guard against the risk of financial instability, banks are regulated and subject to supervision by authorities. The summary of the relevant EU and national legislation can be found in Annex IV. The description of on-going developments including the creation of the new European Supervisory Authorities and developments at the international level can be found in Annex V.

3.2. Problem definition

Key concepts used in this impact assessment: Preparation and Prevention: improved supervision by banking supervisors which aim at collecting better information on the risks in the financial sector; contingency planning for de-risking and resolutions measures; and powers to prevent too complex and interlinked operation hence ensure resolvability. Early intervention: early remedial actions of banking supervisors aimed at correcting problems at an early stage and hence helping banks to return to normal business, avoiding the need for resolution actions. Bank resolution: administrative, non-judicial procedures and tools for the restructuring or managed dissolution of failing banks while preserving insured deposits and other services essential for maintaining financial stability such as payment services. Bank resolution may use specific tools (e.g. bridge banks, assisted acquisition, partial sale of assets, asset separation, debt write down, debt conversion to equity) to reach the above objectives. The resolution process is managed by an administrative resolution authority (national bank, financial supervisor, deposit guarantee scheme, ministry of finance, special authority), defined by Member States.

3.2.1. General description[14]

During the recent financial crisis, it became clear that there was no simple way for a bank to continue to provide essential banking functions whilst in insolvency, and in the case of a failure of a large bank, those functions could not be simply shut down or substituted without significant systemic damage.

The banking sector plays a special role in the economy and have critical functions which are essential for economic activity to take place. Banks collect funds (deposits and other forms of debt) from private persons and businesses (financial and non-financial). They carry out maturity transformation and provide loans for households and businesses allowing savings to be allocated most importantly to investments. They also manage payment transactions that are crucial for all sectors of the economy and society. The banking business is based on trust of stakeholders. Banks' most important capital is the reputation i.e. the confidence of others in it. If confidence is lost depositors and other debtors immediately try to withdraw their funds. This would make the bank unavoidably bankrupt since no bank holds sufficient liquid assets to cover all short term liabilities[15]. Bank failures are capable of undermining financial stability, especially if they lead to a loss of depositor confidence in other banks. During this crisis, these issues led Governments to, for the most part, recapitalise and save failing banks. The most important factors behind these decisions were the following:

· Fear of contagion and domino effects. The financial crisis has illustrated that the failure of some financial institutions would cause other financial institutions to fail and ultimately, cause wider damage to the financial system. The turmoil created after the failure of the Lehman Brothers, which the US Government decided not to save, demonstrated the materialisation of this risk. If a financial institution fails other banks that provide funds to it would not get access to those funds. This would cause liquidity problems for them that would make these banks vulnerable too. If their debtors and depositors consider that it is better to withdraw funds from these vulnerable banks then a domino effect could take place. This could cause liquidity and ultimately solvency problems to a significant part of the financial sector. Capital markets may also experience shocks and the payment systems be disrupted.

· Larger or more interconnected banks also are at increased risk of needing public support. Their failure would most likely result in the systemic instability described above. Size is not the only reason for an institution to be systemically important. The financial connections with other financial institutions are equally important. The more inter-connected a bank is, the more likely it is that problems affect other institutions (contagion). Moreover, if a bank is the dominant service provider in one market, then the consequences of its failure would be more significant (as there will be fewer institutions that can step into its place: substitutability). In addition, some institutions may be more complex than others due to their organisational set-up, risk management or funding structures. Finally, a bank active across the world in jurisdictions that have completely different rules, system of supervision, currencies etc may be more complex to resolve and hence more likely to fail were it to experience trouble, which would increase its potential systemic impact ex ante.

· Lack of special powers and tools to manage the failure of banks in an orderly way. Authorities could choose between placing banks into formal insolvency procedures and risking systemic problems or rescuing the banks using public funds. No special tools and powers geared towards maintaining crucial financial services of a bank as an ongoing business (special resolution) were available in most Member States. (for example, the forced sale of Fortis was not available for Belgian authorities. The UK adopted the new banking act during the crisis to enable bank resolution instead of insolvency and it was subsequently applied in two cases) One of the reasons that in many cases authorities did not oblige creditors to pay in the crisis, or eliminate the holdings of shareholders, was because they did not have a legal mechanism to do so in an orderly manner without causing further financial disruption (i.e. outside an insolvency procedure).

· The magnitude of problems. In the crisis so many banks were affected that the crisis became systemic. (e.g. In the UK an number of mid and large banks suffered losses and needed help; All major banks in Belgium (KBC, Fortis, Dexia) had problems, In Ireland government support for banks amounted to more than 30% of GDP etc.).

Rescuing banks with public funds (bail-out) helped to avert what could have been economic depression on a scale not seen for 80 years, but it has also created a number of medium to long term problems that are becoming increasingly apparent:

· The distortion of competition: Institutions that are perceived by the market as being systemic are often perceived to benefit from an implicit state guarantee. As a result, those institutions are able to raise funds in the market at a cost that is lower than their non-systemic competitors. Research highlights that irrespective of methodological differences, the advantage can be significant.

· The realisation of moral hazard: as the state guarantee risks encouraging excessive risk-taking within systemic institutions. The management, senior executives and shareholders of systemic institutions could on the basis of past evidence reasonably expect that while they stand to gain from the upside risk (profits) of their actions, society would have to cover the downside risk (losses). Research shows that such a skewed incentive structure within financial institutions is not only a theoretical proposition, but over time has a material impact.

· Growth regardless of synergy gains: as non-systemic institutions have an incentive to reach systemic importance, thus leading banks to expand beyond their ideal economic size. This will over time contribute to an overly concentrated market place with potential negative effects on competition and welfare.

· Increased burden on public finances: Between October 2008 and October 2010, the European Commission has approved €3.6 trillion (equivalent to 31% of EU's GDP) of State aid measures to financial institutions, of which €1.2 trillion has been effectively used (of which €409 billion was used for capital injections and asset relief programs). Budgetary commitments and expenditures in this range are not sustainable from a fiscal point of view, and impose heavy burden on the present and future generations. Moreover, the crisis which started in the financial sector plunged the EU economy in a severe recession, with the EU GDP contracting by 4.2% or €0.7 trillion in 2009.[16]

Major problems addressed by the proposal

Before the crisis, neither banks nor supervisors and other authorities were sufficiently prepared for the financial crisis. Contingency planning for de risking banking operations and resolving failing banks were not in place. Supervisors discovered problems within banks at too late a stage. Highly complex operations and business structures, interlinkages and large institutions impeded resolution or liquidation of banks. There was no legislation at EU level governing the entire process of bank resolution. Beyond introducing a minimum set of early intervention powers for supervisory authorities aimed at restoring a situation in a bank[17], and establishing arrangements for the winding-up and reorganisation of credit institutions with branches in other Member States[18], no EU framework existed which set out how and under which conditions authorities should act in the event of a crisis arising in a bank.

During the financial crisis, authorities in many Member States did not have adequate tools and powers to handle the failure of banks. The lack of bank-specific resolution tools left authorities with no choice other than to intervene with public funds. This cost significant amount of taxpayers' money and in some cases even put the whole country at the risk of default. Although a few European authorities have tools available to intervene in banking crisis[19], the tools are different, or in many cases do not exist at all. The diverging approaches, tools, and powers are likely to lead to inefficient resolution and deliver sub optimal results at EU level. Differences and gaps, including legislative differences between Member States and/or a lack of a legislative/institutional basis in some countries, have the potential to complicate and even hinder the efficient cross-border handling of a banking crisis. This could weaken the functioning of the Internal Market.

In the absence of bank specific resolution tools, the reorganisation of banks under insolvency procedures would most likely be unsuccessful, as debtors would immediately withdraw funds from the banks. Depriving depositors' access to their accounts may not be compatible with objective of maintaining financial stability, and will usually lead to the loss of any residual franchise value in the bank, thereby reducing the likelihood of a recovery. Insolvency procedures may take years, and the objective of authorities is to maximise the value of assets of the failed firm in the interest of creditors. In contrast, the primary objective of a resolution is to maintain financial stability and minimise losses for the society, in particular taxpayers. For this reason, certain critical stakeholders and functions (such as depositors, payment systems) need to be protected and maintained as operational, while other parts, which are not considered key to financial stability, may be allowed to fail in the normal way. In order to avoid moral hazard and the use of taxpayers' money to support failing banks, shareholders and debt holders need to face the actual risks of banks and bear an appropriate share of the failure. Bank resolution also ensures that decisions are taken rapidly in order to avoid contagion.

Moreover, the existing EU supervisory framework has proved inadequate to deal with cross-border banking failure. While the operation of cross border banks has become highly integrated, (with the result that business lines and internal services have become interconnected and cannot be easily separated along geographical borders of Member States), crisis management as well as related legislative framework of banks has remained national[20]. As a consequence, in the event of a cross border bank failure, financial supervisors and other (resolution) authorities concentrate only on the operations within their respective territories. A key shortcoming to effective cooperation is the misalignment between the national accountability and mandate of supervisors (protecting interest of depositors and creditors at national level) and the cross-border nature of the banking industry, which complicates voluntary co-operation between supervisors of different Member States and lead to inefficient and possibly competing resolution approaches and suboptimal results at EU level. The introduction of the EU Memorandum of Understanding on Cross-border Stability came too late to be applied during the recent bank failures, and moreover it is questionable whether this arrangement would have been sufficient to ensure optimal results at EU level.

The lack of private financing arrangements for bank resolution purposes[21] also led to the significant use of taxpayers' money to support banks. There were no or limited private funds available in Member States for financing resolution measures. Even though in some countries the funds of deposit guarantee schemes (DGS) could have been used for the purposes of resolution, they were not adequate in size and availability.

These problems led to more expensive outcomes for EU citizens and tax-payers, as the bail-out of systemically important cross border banks can be very expensive compared to the cost of a timely and effective resolution[22]. The extent of the cost savings that might result from effective bank recovery and resolution arrangements at EU level can be expected to be significant, given the overall costs associated with banking crises.

The financial crisis has provided clear examples (Fortis, Lehman Brothers, Anglo Irish, Icelandic banks among others) of how damaging the absence of adequate arrangements (both at national and EU level) in the field of bank resolution can be. The description of these cases and their relevance to the problems described in this chapter can be found in Annex VII.

3.2.2. The framework of bank recovery and resolution

There are three key stages which need to be considered in the context of a bank recovery and resolution framework: (i) preparation and prevention, (ii) early intervention and (iii) resolution. The chart below presents the different stages and the proposed policies under them.

The actual application of crisis management tools might follow the order presented in the chart, but it is also possible that authorities use the resolution tool directly without any intermediate solution. Since problems and failures can differ to a large extent it is important that the framework remains flexible and adaptable to all situations. More detailed explanation of the different stages can be found in Annex II.

Chart 2. Stages of the bank recovery and resolution process

The diagram below presents the problems and their relations. The most important drivers for this proposal are the followings: i) Divergence and lack of effective resolution tools & powers and ii) Misalignment between national accountability and mandate of authorities and cross-border nature of the industry. While the proposal introduces policies that can solve the first problem, changing the political, institutional and legal setup that result in the second problem is beyond the objectives of this proposal. Annex VI extensively describes and discusses the drivers and problems contained in the problem tree.

3.2.3. Problem tree

3.2.4. Baseline scenario

The baseline scenario is one in which the EU continues to rely on the existing narrow (or non existing) EU legislation and widespread national legislations and arrangement in crisis situation of banks.

In the case of preparation and prevention, supervisors would continue to rely on current practices for detecting risks at credit institutions. In the absence of contingency plans, supervisors would lack key information about the possible de-risking strategies of credit institutions or about their recovery, financing or resolution possibilities. When it comes to failure, resolution authorities would not have an adequate overview about the structure and operation of complex banks thus it would be difficult to determine whether such banks could undergo special bank resolution. Supervisors would not have any power to ask overly complex, large or interrelated institutions to reorganise or simplify their operations which could be a major hurdle in an eventual resolution. This would entrench moral hazard among banks that are too big, complex or interconnected to fail. Lack of legal clarity around intra group financial support would discourage group entities to make arrangement help each other even if it were in the interest of the whole group.

In the case of early intervention by supervisors, this would mean that supervisors in different Member States would continue to have different powers and intervention tools for different members of the same cross border banking groups. They would be required to intervene at different times, under different conditions and implement different measures. This would probably not ensure that problems of cross border banks could be effectively dealt with before they became more serious and affected other financial institutions and members of the group located in different Member States. This would risk suboptimal outcomes for stakeholders in the EU and would maintain the uneven playing fields.

If no special bank resolution tools and powers are granted to authorities, resolution of systemic banks will remain impossible to execute, and bail-out remains the only alternative. Currently only a few Member States (UK, Germany, Sweden, Denmark) operate special bank resolution systems. If authorities can intervene in certain countries only when banks are formally insolvent, those countries will bear much higher social cost if banks fail. The lack of an EU framework will represent a source of distortions in the internal market.

When cross border banks approach insolvency, different national authorities would continue to focus their resolution activities only on the respective legal entity located in their territory. Conflicting interests would be likely to impede a more optimal reorganisation solution for the group as a whole, taking into consideration the interest of all Member States. Resolution of a cross border banking group would remain fragmented by national borders where authorities would follow diverging goals and apply diverging measures. National solutions would probably be more costly for the citizens and taxpayers of the EU than if the group was reorganised at EU level.

If no changes to current financing arrangements were implemented, there would be no private resources raised today to finance the resolution of tomorrow's failures in addition to existing safeguards. This accordingly means continuing to rely on capital buffers at the level of individual institutions and Deposit Guarantee Schemes (DGS) to the extent that these are able to finance resolution measures.[23] If losses are not be covered by private means, recourse to public funds may continue to be the only option for governments.

At the same time, as a result of recent measures, the new European Authorities will improve the macro warning systems and will create an improved supervisory environment. The European System of Financial Supervisors (ESFS), and the new European Supervisory Authorities[24] (ESAs), will help cooperation between supervisors and the better functioning of Supervisory Colleges. The ESAs should fulfil an active coordination role between national supervisory authorities, in particular in case of adverse developments which potentially jeopardise the orderly functioning and integrity of the financial system in the EU. However, in some emergency situations, coordination may not be sufficient. The ESAs will therefore, in such exceptional circumstances, have the power[25] to require national supervisors to take the necessary action. They will however have no formal role in the resolution phase of crisis management. The safeguard clause of the regulations on ESAs makes it clear that decisions by the ESAs should in no way impinge on the fiscal responsibilities of the Member States.

The current EU financial stability framework is focused on ensuring that banks are adequately capitalised. The Capital Requirements Directive (CRD)[26] contains provisions aimed at stabilising capital within banks, but it is not prescriptive in case the banks fail to meet the 8%[27] minimum capital threshold. The handling of situations when a bank does not meet the requirements of banking laws (8% CAR) but is still not insolvent is left to national legislation. At EU level, currently the article 136 of the CRD deals with the early intervention powers and tools of banking supervisors in a crisis situation. This article enables the supervisors to oblige banks to implement measures that correct irregularities and restore capital requirements, e.g. by requiring them to hold additional capital, improve governance, systems and internal control arrangements, increase reserves, limit business operations and risk exposures, etc. However, these early intervention powers proved to be insufficient in the financial crisis. The CRD also established rules about alerting other authorities[28] (i.e. Central Banks and Ministries of Finance) in emergency situations, requiring coordination of supervisory activities and exchange of information in emergency situations[29] among Member States. However, if no change in banking legislation is proposed, the CRD will not be enough (as it was not enough during the crisis) to address situations when banks actually fail.

In the future, banks will also need to abide stricter prudential requirements. The Basel III accord which is expected to be introduced in the EU acquis by modifying the Capital Requirements Directive (CRD4) will require banks to hold more and better quality capital. Banks will also need to fulfil new liquidity requirements, stricter rules in counterparty credit risk and at later stage limit leverage. The new rules are expected to largely increase the safety of the banking sector, but will not completely eliminate the risk of bank failure. Thus there remains a strong need to have a new bank recovery and resolution framework in the EU.

In addition, higher capital requirements for systemically important financial institutions (SIFIs) are being considered in the Financial Stability Board (FSB). There are three pillars of the too-big-to-fail (TBTF) or SIFI discussions: (i) higher loss absorbency, (ii) ensuring resolvability and (iii) more effective and intense supervision. This IA deals with the latter two. The requirements related to higher loss absorbency relate predominantly to so-called 'going concern' loss absorbency, i.e. a requirement for SIFIs to hold higher loss absorbing capital (capital surcharge) in good times to ensure that they can absorb losses without failing. The Commission is considering amending the CRD once the international negotiations on the attributes of such a loss absorbency regime (magnitude, imposition approach, instruments) have been finalised. This impact assessment deals with so-called 'gone concern' loss absorbency provisions, i.e. additional resources that could be mobilised once a SIFI is failing and hence placed in resolution context. These are the bail-in debt provisions, which will contribute to higher ability to absorb losses in a resolution context (by writing down the value of debt and, possibly, convert to equity (which could absorb further losses).

Nevertheless, the objectives of a resolution framework and capital surcharge are different: The former aims to reduce the impact of failure through improving resolvability while higher capital requirements are primarily a tool for reducing the probability of failure; they affect the impact of failure to a much lesser and more indirect extent. Estimates of the magnitude of potential further SIFI capital charges in the international debate are rather low compared to the levels required by many academic models. Moreover, capital buffers – while useful – have proven during this crisis to be of limited value. Many of the failed institutions had ample capital at the time of failure.[30] Accordingly, it is important to find more effective ways of increasing loss absorbency for banks than capital requirements. Debt write-down (bail-in) attempts to fill that gap, by (depending on scope/limitations etc) providing a potentially much larger (multiples of going concern higher loss absorbency) additional buffer in a resolution context.

The proposal of the Commission (in 2010) on changing the Directive on Deposit Guarantee Schemes also aims at improving the financial safety net. The risk of bank failures due to depositor runs should be reduced as a result of shorter payout delays and more robust funding arrangements. The coverage level has also been raised to € 100 000 by Directive 2009/14/EC. DGS are permitted to finance resolution. This role has clear relevance for financing bank resolution, as it is explained later in the Policy Options section of this document.

In the UK, the Independent Banking Commission assessed a variety of proposals to improve competition and increase resolvability of institutions.[31] These options range (in broad terms) from structural separation to higher capital requirements. Capital and competition issues are being considered through other legislative and non-legislative fora. The objective of this proposal is to ensure resolvability and in this context we have concluded that it is highly likely that there is no 'one size fits all' approach to resolution, for example non-deposit taking banks (e.g. investment banks) can contribute to systemic risk in the event they fail and may require public assistance in the absence of an effective resolution regime.[32]

Despite the above-mentioned improvements in banking regulation at EU level, failure of financial institutions cannot be excluded in the future. Increased and better quality capital, new liquidity rules provide stronger safety-net for bank losses. Strengthened DGS arrangements reinforce depositors' confidence in banks. However, if no legal framework is developed to manage the failure of financial institutions, governments could again find themselves in a situation when their only choices are to either rescue banks from public funds or risk financial systemic instability.

3.3. The EU's right to act and justification

Due to the advanced cross border integration of the financial sector, only EU action can ensure that credit institutions are subject to adequate interventions in crisis situation. EU level action is necessary since current tools to deal with bank crises are nationally based and insufficient to deal with cross-border institutions in difficulty. Moreover, objectives pursued by each national authority may differ. As a consequence, Member State authorities cannot be sure that critical problems arising in a cross-border banking group can be solved fairly, effectively and expediently. Unless these flaws in the framework are adequately addressed, national authorities will be left in practice with only two alternatives: they can either take the politically unpopular option of using public money to bail out banks or they can decide to ring fence assets in a cross-border bank and apply national resolution tools (where they exist) at each entity level – which may drive up the overall cost of the resolution. The first option can have substantial impacts on the budget of Member States, while the other would substantially fragment the internal market and could lead to overall more costly solutions (e.g. Fortis). Limited options available to authorities would increase the risk of moral hazard and generate an expectation that large; interconnected and complex banks would need public assistance in the event of problems.

As a response to the financial crisis, some Member States have already enacted legislative changes in order to introduce mechanisms to resolve failed credit institutions; others have indicated their intention to introduce such mechanisms. Differences in rules concerning the pre-conditions, tools and powers for resolving credit institutions would likely constitute barriers to the smooth operation of the internal market, as national authorities would not have the same level of control and the same ability to resolve credit institutions as each other. European financial markets are highly integrated and interconnected with many credit institutions operating extensively beyond national borders. The failure of a cross-border credit institution is likely to affect the stability of financial markets in the different Member States in which it operates. The inability of Member States to take control of a failed credit institution and resolve it effectively can undermine Member States' mutual trust and the credibility of the internal market in the field of financial services. These differences would hinder the cooperation between national authorities when dealing with failing banking groups operating across borders.

The framework should apply to all credit institutions (domestic and cross-border) since banking groups may be composed of several entities, only some of which operate cross-border, but it is necessary that authorities be able to intervene in all the entities and to resolve the group as a whole. Using different tools and powers for entities affiliated to the same group would be inefficient and would raise issues of inequality of treatment.

The proposal does not intend to introduce EU solution at the following two fields:

1. In order to achieve the objectives, it is necessary to confer resolution powers to a public administrative authority[33] to ensure the required speed of action. It is however not indispensable to determine which authority should be appointed in each Member States. A harmonisation would facilitate coordination but the effectiveness of resolution would not depend on the chosen institution. It would also interfere with the constitutional and administrative orders of Member States. A sufficient degree of coordination can be achieved also with the less intrusive requirement that all the national authorities involved in the resolution of a cross-border group be represented in resolution colleges, where coordination will take place. A detailed harmonisation of resolution processes would imply a deeper and more complex harmonisation of substantial and procedural insolvency rules applicable to banks.

This degree of flexibility for Member States was fully supported in the latest public consultation. Resolution authorities could be for example national banks, financial supervisors, deposit guarantee schemes, ministries of finance, or specially appointed authorities. They need to have adequate expertise and resources to manage possible bank resolutions at national and cross border level. If a member state decides to set up the resolution authority within the same institution that is responsible for supervision, functional separation of the two activities is recommended to avoid supervisory forbearance.[34] Most respondents to the public consultation acknowledged the risk of forbearance and favoured to combine resolution and supervision in the same institution with the establishment of functional separation. Even if resolution authorities would not be determined by EU legislation, their powers and tools would be harmonised to a certain extent by this proposal (minimum harmonisation, see in section 4.3.2).

2. Similarly there is no need for action at EU level as regards the way an administrative, non-judicial[35] resolution process is managed. There can be different models in different Member States, like receivership, administration or direct executive powers,[36] which can be equally effective during a bank resolution. This view was fully supported in the public consultation. Respondents believed that Member States should be free to choose what resolution mechanism they use, whether receivership, administration or executive decree mechanism or a combination. As long as it is clear what resolution mechanism(s) Member States use, different resolution solution should not stand in the way of an efficiently coordinated cross-border resolution.

3.4. Objectives

The general objectives are to

· Maintain financial stability and confidence in banks, ensure the continuity of essential financial services, avoid contagion of problems;

· Minimise losses for society as a whole and in particular for taxpayers, protect depositors, and reduce moral hazard;

· Strengthen the internal market for banking services while maintaining a level playing field (i.e. same conditions for all players to compete in the financial markets of the EU).

In the public consultation, all respondents supported the objectives of the bank recovery and resolution proposal. Public authorities had mixed views on the order of importance as half of them considered financial stability as the most important, while the other half regarded all objectives as equally essential.

The specific and operational objectives are the following:

Preparation and prevention

Problems || Problem drivers || Operational objectives || Specific objectives

Suboptimal level of preparedness of supervisors and banks for potential crisis situations || Lack of EU rules for intra group financial support || Develop framework for intra group financial support for effective crisis prevention while providing legal certainty || Increase preparedness of supervisors and banks for crisis situations

Lack of contingency planning for potential crisis situations || Require contingency planning from credit institutions and authorities

Irresolvable banking operations and structures || Too complex operation and structure of banks to fail || Make it possible to reduce the complexity of certain banks || Enable resolvability of all banks

Too large and interconnected banks to fail || Make it possible to reduce the size and interdependence of certain banks

Early intervention

Problems || Problem drivers || Operational objectives || Specific objectives

Sub-optimal early intervention arrangements for supervisors || Divergence and lack of effective early intervention triggers for supervisors || Provide all supervisors with effective early intervention triggers || Improve early intervention arrangements for supervisors

Divergence and lack of effective early intervention tools for supervisors || Enabling all supervisors with effective tools to intervene at an early stage

Too long time required to increase capital in emergency situation || Shorten time period to increase capital at banks in emergency situation

Bank resolution

Problems || Problem drivers || Operational objectives || Specific objectives

Inefficient bank resolution process and suboptimal outcomes || Divergence and lack of resolution triggers || Provide authorities with clear and reliable resolution triggers || Ensure resolution of banks in a timely and robust manner

Divergence and lack of effective resolution tools & powers || Enabling all resolution authorities with a set of resolution tools and powers to resolve banks

Lack of legal certainty in bank resolution || Legal obstacles to effective and efficient bank resolution || Amending EU and national legislation to eliminate legal uncertainties around the use of resolution tools by drawing the right balance between effective resolution and the protection of shareholders' rights || Ensure legal certainty for bank resolution

Cross border crisis management

Problems || Problem drivers || Operational objectives || Specific objectives

Suboptimal level of cooperation between authorities responsible for bank resolution || Misalignment between national responsibility of authorities and cross-border nature of the industry || Ensure that national interest of resolution authorities does not jeopardise resolution of cross border banks || Foster efficient cooperation of authorities in cross border resolution

Financing

Problems || Problem drivers || Operational objectives || Specific objectives

Use of public funds in crisis situation National systems not calibrated to ensure an optimal and even level of protection of financial stability across MS (with other prudential measures) || Lack of arrangements for financing resolution from private sources in most MS || Develop private financing arrangements for bank resolution || Develop arrangements for financing bank resolution from private sources Develop arrangements to finance bank resolution that provide optimal and even level protection for all Member States (in line with other prudential measures)

Diverging national policies concerning financing of crisis situations (where available) || Develop and calibrate optimal arrangements for financing bank resolution across EU

Conflicting interests of Member States concerning financing of crisis situations || Align national interest with group wide (EU) interest in financial arrangements

4. Policy Options, Analysis of Impacts and Comparison

This section sets out the policy options under consideration, their impacts on stakeholders and their comparison along the lines of effectiveness and efficiency. Description of certain policy options and their impact analysis can be found more extensively in the Annexes. The presented policy options are not necessarily mutually exclusive, hence the combination of two or more options are also analysed. We use the following score system when presenting impacts on stakeholders, efficiency and effectiveness: Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; +/– both positive and negative ≈ marginal/neutral; ? uncertain; n.a. not applicable

4.1. Preparation and prevention

4.1.1. Possible policies to develop framework for intra group financial support

Policy option || Description

1. No policy change || The baseline scenario applies

2. Introduction of group interest || The notion of 'group interest' could be introduced for credit institutions in the company law legislation of the EU. This approach would depart from the traditional focus on separate legal entities and would accept that a group of enterprises constitute a single economic entity.

3. Voluntary group financial support agreement || An EU parent credit institution or an EU parent financial holding company and subsidiaries that are credit institutions or investment firms could voluntarily enter into an agreement to provide financial support (in the form of a loan, the provision of guarantees, or the provision of assets for use as collateral in transaction) to any other party within the group that experiences financial difficulties. Any group financial support agreement could be approved ex-ante by the shareholders' meeting of every group entity that proposes to enter into the agreement. The shareholders' meeting could authorise the respective management body to take a decision that the entity will provide financial support if needed. State aid rules should be met. Further information can be found in Annex X.

4. Review of proposed agreement by supervisors || Supervisors could grant the authorisation for a group financial support agreement if the conditions for financial support are satisfied. As a safeguard for the financial stability, the supervisor of the transferor could have the power to prohibit or restrict a transfer of assets pursuant to the agreement when this transfer threatens the liquidity or solvency of the transferor or financial stability. If the supervisor were not to prohibit the transfer within a set period of time, the transferor should be able to proceed with the transfer.

5. Transfer by supervisors || In the case a voluntary intra group financial support agreement is already in place, supervisors may also apply the agreement for compulsory financial assistance. If a credit institution that is party to a group financial support agreement is in breach or is likely to be in breach of the requirements of the CRD, the supervisor could require the management body of the credit institution to request financial support pursuant to the agreement, after consulting the other supervisors responsible for supervising the entities subject to the agreement.

As a first option, the notion of 'group interest' would be very effective in reaching the goal of legal certainty around intra group asset transfer. With the group interest the legal concerns around the management's liability, retroactive void transfers in consecutive insolvency would be eliminated[37]. This would however undermine the traditional approach of company laws and insolvency laws that focus on the legal entity as a separate economic entity. In addition, not only these laws but also contract laws would need to be changed. The fundamental change of these laws would be disproportionate with the benefits of a clear asset transferability framework for crisis situations[38].

Signing a voluntary agreement on intra group financial support and eventually providing intra group financial assistance would greatly increase the effectiveness of crisis prevention. Financial help from an entity in one Member State to an entity in the other would also balance and minimise the effects of adverse financial developments across the EU. As an early financial support mechanism, it could stop the aggravation of financial problems at bank entities working as part of a group. Legal certainty would increase as it would be clear when and how such financial support can be provided. In this way, shareholders could jointly agree on the importance of mutual financial help in cases where the group interest could prevail over the interest of group entities (with adequate safeguards). Shareholders' approval to the agreement would reinforce the mandate of bank managers to take into consideration the interest of the group as one economic entity and not only the interest of the entity they are directing. This would alleviate concerns regarding directors' liability laid down in company laws and the risk of rendering a transfer retroactively void in a consequent insolvency proceeding. In this way, managers of group entities would be more willing to help other group entities in the interest of all. Shareholders and creditors of group entities would be aware of the possibility of such pre-emptive transactions, which would further increase clarity. Transferring assets from a healthy entity would decrease its liquidity and capital and hence the position of debt holders and depositors could weaken. Safeguards are needed to ensure that they cannot suffer losses as a result. Therefore the transfers should be executable only in case it does not jeopardise the liquidity or solvency of the support provider.

The agreements should be on a voluntary basis, because it is best to leave to banking groups assess whether such arrangements would be in the group interest within the wider objective of the financial stability of the entire group (a group might more or less integrated and pursue more or less strongly a common strategy) and to identify the companies that should be part to the agreement or not (it may be appropriate to exclude certain companies that pursue the riskier activities). In addition, the interest in entering into such agreements will depend on the existence and the nature of the obstacles to asset transferability posed by national laws under which banks operate. Supervisors' approval is appropriate for prudential purposes in order to verify that the agreement complies with the specific conditions and the prudential requirements in general. The agreement should not work against resolvability because it is not an unconditional intra-group guarantee, rather a commitment to help only when this does not jeopardize the solvency of the supporting entity. In insolvency therefore the agreement would not apply. The supervisor's control of each transaction would be a further guarantee for financial stability; it is however limited in scope to verifying that the conditions for the support are met and it should be facilitated by the existence of the already approved underlying agreement.

Supervisory approval to the intra group agreement and actual asset transfers would largely increase the stability of the framework, as one of the main barriers/uncertainties (blocking of transfers by supervisors) could be eliminated. In addition, different national supervisors would need to come to an agreement about the interest of a cross border banking group, taking into account not only their own but the interest of other member states, too. This would also further strengthen the internal market, as host and home supervisors’ opposing interest around an intra-group transfer could be tackled[39]. In case of disagreement, the European Banking Authority could play a mediating role.

Financial support from one group entity to the other may be ordered by the supervisors as part of an early intervention measure if a voluntary ex-ante agreement is in place. This measure would be very effective in providing quick fix to a temporary (liquidity) problem. Transfers required by supervisors could ensure optimal pre-emption solutions at EU level. At the same time, such a measure would limit the freedom of management over the banks' assets. This would probably discourage banks from voluntarily signing such agreements. Creditors (of both transferring and receiving entity) would be in a similar situation as under the third option.

Results of the public consultation are mixed on intra group financial support. Some Member States are in favour as they believe that a framework for asset transferability would be useful to improve the ability of groups to prevent financial difficulties and to increase the legal certainty and transparency of cross-border intra-group asset transfers. Other Member States are against such a framework because they fear that it would blur the boundaries of the limited liability of individual companies (and the distinction between branches and subsidiaries) and might become a source of contagion within a group. The main concerns from host Member States is the provision of up-stream financial support (i.e. from subsidiary to parent company).

The banking industry is mainly in favour of the framework with the exception of few respondents, who think that banks are already able to transfer assets within groups under the current rules and are concerned that the framework might reduce flexibility. The support of the industry shows that banks would be interested in having the possibility to benefit from a framework facilitating intra-group asset transfers, although a number of respondents expressed reservations on the need to obtain a preliminary shareholders' agreement.

The majority of respondents consider that a mediation role of EBA is necessary. However, the views are split regarding whether this role should imply a binding decision or not. The majority of supervisory authorities agree to give the supervisor the power to require an institution to request financial support; banks and federations, on the contrary, take the opposite view.

The preferred option is to implement the voluntary agreement together with the approval of supervisors without the possibility for supervisors to order a transfer.

Table 1. Intra group financial support - comparison of options

Operational objective || Policy options || Comparison criteria

Effectiveness || Efficiency || Coherence

Develop framework for intra group asset transferability || 1. No policy change || 0 || 0 || 0

2. Introduction of group interest || ++ || - || -

3. Voluntary group financial support agreement || ++ || + || +

4. Review of proposed agreement by supervisors || + || + || +

5. Transfer by supervisors || + || - || -

6. Voluntary agreement with approval of supervisors || ++ || ++ || ++

Table 2. Intra group financial support - impact on main stakeholders

|| Transferring banks' creditors and depositors || Transferring banks' shareholders/ management || Receiving banks' creditors and depositors || Receiving banks' shareholders/ management || Supervisors

1. No policy change || 0 || 0 || 0 || 0 || 0

2. Introduction of group interest || +/- || +/- || +/- || +/- || +/-

3. Voluntary group financial support agreement || +/- || + || + || + || ++

4. Review of proposed agreement by supervisors || + || + || + || + || ++

5. Transfer by supervisors || - || - || + || + || ++

6. Voluntary agreement with approval of supervisors || +/- || +/- || + || + || ++

4.1.2. Possible policies to require contingency planning[40]

Policy option || Description

1. No policy change || The baseline scenario applies

2. Introduction of recovery plans || Recovery plans prepared by the banks may set out the arrangements that banks have in place or the measures that it would adopt to enable it to take early action to restore its long term viability in the event of a material deterioration of its financial situation in foreseeable and conceivable situations of financial stress. Supervisors would assess and would need to approve recovery plans. For groups, recovery plans at both group and individual level would be necessary. For more description, including the content of such plans see Annex XI.

3. Introduction of resolution plans || A resolution plan, prepared by the resolution authorities in cooperation with supervisors in normal times of business may set out options for resolving the credit institution in a range of conceivable scenarios, including circumstances of systemic instability. Such plans could include details on the application of resolution tools, ways to ensure the continuity of critical functions, among others. Group resolution plans would also have to be drawn up. For more description, including the content of such plans see Annex XI.

Recovery plans could largely help supervisors in identifying the appropriate actions that can restore the viability of banks at an early stage. Early reaction could stop aggravation of problems and thus avoid the implementation of more serious (resolution) measures. As recovery plans would be prepared by banks, this process would also help them reviewing their operations, risks, and necessary actions in a problematic situation. Recovery plans thus would increase the preparedness and awareness of both banks and their supervisors for and about problematic financial situations. Planning in itself may not however be sufficient. It is also very critical that credit institutions take any necessary measures to ensure that there are no impediments to the implementation of the plan in situations of financial stress.

Resolution plans enable rapid, more efficient and effective execution of potential measures that can substantially decrease the (social) cost of bank failure. If resolution authorities are fully aware of the options they have to resolve or liquidate a failing bank or group, the likelihood of a successful resolution is substantially higher.

The case of Bradford & Bingley

UK authorities took Bradford & Bingley into temporary public ownership on 29 September 2008 following a determination by the FSA that the bank no longer met threshold conditions. Thanks to extensive prior contingency planning by the authorities, the UK was able over the weekend to conduct an auction of Bradford & Bingley’s retail deposits, branches and associated systems and to sell these to Santander/Abbey. The Bradford & Bingley branches opened for business as usual on Monday morning with no interruption in service.

Resolution plans reduce moral hazard, as they indicate to the market that authorities will take steps to avoid to be “forced” to rescue large firms, and that no firm is necessarily to be considered as too big or too complex or too interconnected to fail. This can already have a salutary effect on market discipline. Moody’s alerted investors to the fact that resolution plans “would remove the necessity to support banks as banks would no longer be too interconnected or complex to fail. This could potentially result in ratings downgrades where ratings currently incorporate a high degree of government support” (cited in Croft and Jenkins 2009).[41]

In public consultation, the majority of supervisory authorities and banks supported the introduction of recovery and resolution plans. They considered the required content of recovery plans[42] to be sufficient with some suggestions to expand it. All respondents agreed that resolution plans would adequately prepare possible resolution of institutions. The majority of authorities believed that resolution plans should be required for all the institutions that would be covered by the framework. Most of them also considered that the content of the obligation should be proportionate to the size and systemic nature of the entity. The industry had mixed views whether all institutions should be required to prepare resolution plans. In some of their opinion small and not interconnected firms should be excluded as this would be too burdensome for them. Respondents would welcome the involvement of EBA in contingency planning, although views are mixed about the binding or non-binding nature of the involvement.

Devising, analysing and maintaining contingency plans would entail cost for both authorities and banks. Staff tasked with this activity need to be trained and prepared for carrying out this relatively new activity. Respondents to the public consultation however were unable to estimate these costs at this point in time.

The preferred option is the introduction of both plans, which, in a complementary way, would help supervisors, resolution authorities and banks in different phases of an evolving crisis situation. In case of disagreement between authorities in different Member States, the EBA could play a mediating role. In an early stage, recovery plans would make supervisory action more prompt and effective, hopefully avoiding the escalation of problems. Resolution plans, on the other hand, would enable a timely resolution of a failing bank. The development and continuous maintenance of such plans would increase cost at both supervisors and banks. However the benefits of quicker and more effective supervisory actions and the decrease in moral hazard would substantially surpass the expenses. In the US, the Dodd-Frank Act has also implemented similar requirements for contingency planning. Implementation in the EU would also contribute to a global level playing field.

Table 3. Contingency planning - comparison of options

Operational objective || Policy options || Comparison criteria

Effectiveness || Efficiency || Coherence

Require contingency planning from credit institutions and authorities || 1. No policy change || 0 || 0 || 0

2. Introduction of recovery plans || + || + || +

3. Introduction of resolution plans || + || + || +

4. Introduction of both plans || ++ || ++ || +

Table 4. Contingency planning - impact on main stakeholders

|| Bank shareholders || Bank creditors || Banks' clients (depositors, borrowers) || Supervisors and Resolution authorities || Taxpayers / governments

1. No policy change || 0 || 0 || 0 || 0 || 0

2. Introduction of recovery plans || +/- || + || + || ++ || ++

3. Introduction of resolution plans || +/- || - || + || ++ || ++

4. Introduction of both plans || +/- || +/- || + || ++ || ++

4.1.3. Possible policies to ensure resolvability of banks

Policy option || Description

1. No policy change || The baseline scenario applies

2. Ensure resolvability by general requirement of laws || Laws could require the changing of banking structures, limiting build up of certain business lines, unwind certain business models, imposing quotas (e.g. size caps), prohibiting certain activities altogether (e.g. Volcker rule) or downsize, break up banks.

3. Empower authorities to require the change of business structure and operation of credit institutions || If, as a result of preparing the resolution plan, an authority identifies significant impediments to the application of the resolution tools or the exercise of the resolution powers, a resolution authority could draw up a list of measures that the authorities reasonably believe to be necessary to address or remove those impediments. Measures to address or remove impediments might include requiring changes to legal or operational structures of the entity for which the resolution authority is responsible so as to reduce complexity in order to ensure that critical functions could be legally and economically separated from other functions through the application of the resolution tools.

4. Empower authorities to limit or modify exposures and activities of credit institutions || If an authority identifies in a resolution plan significant impediments to the application of the resolution tools or the exercise of the resolution powers, a resolution authority could also implement the following measures or ask the banks to address or remove impediments: (a) to draw up service level agreements (whether intra-group or with third parties) to cover the provision of critical economic functions or services; (b) to limit its maximum individual and aggregate exposures; (c) to impose specific or regular information requirements for resolution purposes; (d) to limit or cease certain existing or proposed activities; (e) to restrict or prevent the development or sale of new business lines or products; (f) to issue additional convertible capital instruments in excess of the minimum.

Option two would have the possible advantage that banks may be regulated in such a way that they would no longer pose any significant threat to an effective resolution and in theory avoid the need for banks to be bailed out using public money in future. Such a regulation would however have uncertain impacts since practically it would be very difficult to design general rules, methods, benchmarks that would suit to all situations and institutions and ensure resolvability of all banks. It would also be not efficient as a blanket rule would force many well functioning and ultimately resolvable banks to reorganise themselves. This could unjustifiably burden business without any certain, significant gains. General rules that prohibit certain businesses would also risk urging market players to shift activities to less regulated parts of the financial system. Finally, it may contribute to make banks more resolvable to some extent but it probably would not effectively reduce systemic risk and interconnectedness.

Separation of retail, wholesale and investment banking activities do not seem to deliver the desired financial stability either. Firstly, many interconnected financial institutions which may pose systemic risks are not deposit taking institutions (the problems at Bear Stearns, Lehman Brothers, and AIG would have been identical to what we experienced). Second, even the most basic deposit taking institutions can become systemic as seen in the savings and loans crisis of the late 1980s.[43]

Providing power for resolution authorities to change the operation and business structure of banks (option three) would place the right of judgement with authorities. Based on resolution plans, in normal times of business, they could effectively and efficiently examine those banks where such intervention might become necessary. Authorities could satisfy themselves that critical functions of banks could be legally and economically separated from other functions so as to ensure continuity in a resolution.

Decisions on actual measures would be placed with the resolution authority but the proper involvement of supervisory authorities would need to be ensured. They would be consulted before any decision is taken in order to avoid any conflict between the resolution and the supervisory authorities. A forum where the decisions are discussed could ensure that prudential and supervisory concerns are taken into account while ensuring resolvability of banks.[44] In addition, the mediation of EBA could help to resolve conflicting interests at cross border level.

These actions would effectively remove the implicit state support (likely bail out) from those banks that are too complex or too important to fail. This would decrease moral hazard and ensure banks operate more prudently. Ensuring the resolvability of banks would mean that reliance on support using taxpayers funds would be reduced. At the same time, the removal of implicit state guarantee would likely increase funding cost for banks, some of which may be passed on to consumers..

The possible changes in operations and business structure would entail cost for banks. It is very difficult to estimate such costs in advance of the assessments of resolvability undertaken by national authorities. However based on experiences of certain restructurings (see the case of ING in Annex VII), global groups may spend tens of millions of euros on preparing, taking inventory and designing the restructuring of their business operation. The actual cost of execution of restructuring might go up to hundreds of millions of euros for the largest players, which might be the most concerned by such decision. These costs however have to be seen against the benefits, namely that as a result of the measures, banks could be resolved in a managed way, which would maintain financial stability and avoid the need to resort to public funds.

The powers to change business operation of banks may also have an impact on the internal market especially on the freedom of establishment if branches are requested to locally incorporate. Safeguards need to ensure that such measures should not be implemented or only in cases of public interest.

Limiting exposures, activities services by resolution authorities could also make certain banks more resolvable. This way the proposed resolution tools could be applied with more likelihood of success, and the objectives of resolution could be more easily reached. On the other hand, size limitations or downsizing would decrease economies of scale and certain business advantages, or synergies. Limiting exposures would also affect clients of banks which might not receive loans necessary for the development of their business. However clients could request financing from other banks, where restrictions are not needed for systemic considerations.

Some of the powers listed under option two and three are already available for supervisory authorities but not for resolution authorities. Their objectives are different: supervisors need to ensure that banks comply with banking legislation (CRD), limiting the probability of failure, while resolution authorities’ aim is to make sure that banks are resolvable when a failure takes place.

The above measures would limit the rights of shareholders and management[45] to operate in the form and way that is the most optimal for their objectives and business strategies. This may decrease competitiveness. Hence, any measures proposed to address or remove impediments to resolution should be proportionate to the systemic importance of the credit institution and the likely impact of its failure on financial stability in Member States. Measures should also serve public interest. In addition the framework would propose a number of safeguards. These fall into two categories. The first restrict the way in which authorities may exercise such powers. In particular:

- the power may only be used to remove identified obstacles to resolvability;

- it cannot be used to address impediments that arise from operational or financial weaknesses in the home Member States or its resolution authority;

- it is expressly specified that the power should not be used in a way that restricts firms from exercising the freedom of establishment (for example, the right to establish branches rather than subsidiaries);

- national authorities may not propose measures that would have an adverse impact on financial stability in another Member States;

- any use of the power is subject to the usual principles, derived from ECH jurisprudence, that restrictive measures must be non-discriminatory, justified by an overriding public interest, and suitable and proportionate to achieving their objective.

The second category of safeguards is procedural. Decisions on the exercise of preventative powers in relation to groups would be subject to joint decision within the resolution college, with reference to the EBA where there is disagreement. The EBA would also have a role in ensuring that any decisions by individual authorities are consistent with Community law. Finally, the proposal will specify an iterative procedure between the authorities and the firm in question that allows the firm to challenge any measures proposed and suggest alternatives that would achieve the same objective, and, ultimately, to challenge the exercise of the power through judicial review.

The preventative powers would affect not only banks that are in the phase of development through organic growth or acquisitions, but also banks that are already too big, too interconnected or complex to undergo a resolution in a short space of time such as a weekend. Once the above powers are granted to authorities, these banks might expect that resolution authorities would require them to restructure in order to ensure resolvability.

With some exceptions, many respondents to the public consultation considered that the suggested powers are too intrusive. Authorities that opposed these powers consider that they would conflict with the powers they already have under Pillar II[46] of the CRD. For some of the respondents these powers could be accepted but only if they were to be used at the early intervention stage. These powers would, however, be granted to resolution authorities, and be used for different purposes than supervisors do. The main objective here is to ensure resolvability of banks before any problem materialises. Major overhaul of banks is time consuming so in an early intervention process, such measure would be too late to implement and expect results.

Respondents who supported the preventative powers argued that improving the resolvability of groups will help to ensure the correct functioning of the single market by removing implicit state aid. Respondents had mixed views whether the proposed safeguards are adequate to protect the rights of stakeholders: some were content while some suggested adding extra safeguards beyond the right of appeal and judicial review.

In cross border cases, most respondents considered that the EBA could play a mediation role. Respondents generally agreed that changes to legal or operational structures should not be decided by a single authority, even if it is the group level resolution authority. Respondents from the industry suggested that it would be fairer and more effective to confer such a power to the resolution college as a whole with a decisive mediation role played by EBA.

The preferred option is that authorities should be empowered to change the operation, business structure as well as the exposures and activities of banks to ensure resolvability. Despite the views of stakeholders, such a power is necessary to make the resolution framework effective and credible. If banks are not resolvable, authorities, even equipped with all resolution tools and powers, would not be able to complete a resolution within a short period of time.

No two banks are the same or operate (legally and in terms of business) in the same way. The objective pursued by the framework is that the authorities should fully understand the banks that they may have to deal with. This will be done through resolution planning. On the basis of these plans they will be able to assess the resolvability of each institution (either alone or in the context of a more systemic crisis) in accordance with the toolkit they have at their disposal and act if they consider that resolvability is not ensured.

The cooperation of different national resolution authorities[47] through colleges would ensure that cross border banks are made resolvable without losing the benefits of the single market. The involvement of the EBA could ensure that the single market is respected and a balance is maintained among Member States.

To avoid that banks shift activities to non-regulated parts of the system, resolvability should be assessed comprehensively and not only with respect to the regulated part of the bank. Measures should encompass both the supervised entities and the non-supervised ones and their internal relationships. To provide safeguards for stakeholders and ensure that measures are proportionate and triggered only if absolutely necessary, authorities need to apply the principles listed above.

Table 5. Resolvability of banks - comparison of options

Operational objective || Policy options || Comparison criteria

Effectiveness || Efficiency || Coherence

Enable resolvability of all banks || 1. No policy change || 0 || 0 || 0

2. Ensure resolvability by general requirement of laws || - || - || -

3. Empower authorities to require the change of business structure and operation of credit institutions || ++ || ++ || ++

4. Empower authorities to limit or modify exposures and activities of credit institutions || ++ || ++ || ++

5. Provide authorities with both powers || ++ || ++ || ++

Table 6. Resolvability of banks - impact on main stakeholders

|| Bank shareholders || Bank management || Bank creditors || Bank clients (depositors, borrowers) || Resolution authorities || Taxpayers / governments

1. No policy change || 0 || 0 || 0 || 0 || 0 || 0

2. Ensure resolvability by general requirement of laws || - || - || - || - || +/- || +/-

3. Empower authorities to require the change of business structure and operation of credit institutions || - || - || - || + || ++ || ++

4. Empower authorities to limit or modify exposures and activities of credit institutions || - || - || - || +/- || ++ || ++

5. Provide authorities with both powers || - || -- || - || + || ++ || ++

4.2. Early Intervention

4.2.1. Possible policies to provide all supervisors with effective early intervention triggers

Policy option || Description

1. No policy change || The baseline scenario applies

2. Assessment of authorities (soft triggers) || In order to ensure that supervisors can intervene at a sufficiently early stage to address effectively a developing problem, the circumstances in which supervisors can impose measures under Article 136 of the CRD could be expanded. Powers of early intervention could be granted to the supervisors in not only those cases where any credit institution does not meet the requirements of the CRD but also in those where it is likely to fail to meet the requirements of the CRD.

3. Automatic, hard triggers || It is also possible to activate authorities to intervene if certain thresholds of indicators are hit (hard triggers). Mostly quantitative indicators can be applied for implementing such hard triggers based on solvency (such as a capital adequacy or leverage) or liquidity indicators. As a sub-option, it is also possible to tie concrete supervisory actions to thresholds i.e. obliging supervisors to implement predefined measures without any discretion regarding the concrete situation and specificity of the banking group.

4. Combination of soft and hard triggers || It is possible to combine the supervisory assessment with some pre-defined trigger mechanism tied to quantifiable benchmarks. If selected indicators are hit, supervisors will have the right to intervene. Action is however not compulsory, only a possibility.

If supervisors can intervene in the operation of banks when they are likely to breach the requirements of CRD (e.g. capital and future liquidity ratios), it would give further room for supervisors to assess the financial situation of the bank. The timely intervention of supervisors can be a very effective tool to stop the escalation of financial problems, which would substantially increase the chances of a successful intervention. Banks on the other hand would be exposed to a more intrusive environment, where supervisors might intervene at the early stages of deterioration. The general early intervention powers would be an extension of the existing supervisory powers in the Capital Requirements Directive. A soft trigger is necessary to allow supervisors to respond flexibly to the diverse situations of breach (that may or may not involve financial distress) that an institution may encounter. For cross-border institutions, supervisory intervention is coordinated within supervisory colleges (Article 129 CRD).

Harmonised hard triggers applied in all Member States would greatly decrease the uncertainties around intervention of supervisors as conditions and possible actions of supervisors would be clear ex-ante. On the other hand, advance knowledge of the basis for supervisory intervention could provide opportunities for regulatory arbitrage on the part of banks. Knowledge that the supervisor focuses on certain indicators, might lead to perverse incentives within the bank to focus on particular metrics. Moreover, hard indicators / benchmark ratios could reduce supervisors’ incentives to maintain comprehensive oversight of financial institutions, thereby allowing potential problems elsewhere to escape detection. Moreover, it is very difficult to identify single indicators that would be adequate to detect every possible technical problem and/or incorporate all the possible relevant data and information for a proper supervisory assessment. As each case is different, indicators that efficiently detect problems in a specific case can be also different[48]. A single set of hard triggers could thus prove to be a blunt instrument for use in complex and developing situations. If not only the need for actions is tied to quantitative levels, but also the measures/tools to be applied by supervisors are pre-defined, the certainty of intervention is even higher. This would protect supervisors from possible litigation by stakeholders who are negatively affected by the interventions (where that is possible under national law) and also bring certainty for ailing banks that can be fully aware of the consequences of their incorrect operation. On the other hand, supervisors would lose flexibility, increasing the risk that problems are inappropriately handled and potentially resulting in suboptimal outcomes.

It is possible to combine the supervisory assessment with a pre-determined trigger mechanism tied to quantifiable benchmarks. Authorities would be protected from litigation, if they act after the pre-defined triggers are hit. In addition, supervisory assessment would ensure the flexibility and adaptability of the system. Situations could be evaluated on a case by case basis and specificities could be taken into account. Ratios, indexes or other quantitative triggers could bring more transparency but at the same time they may not be adequate for all situations. Other arguments against such hard triggers (mentioned above) would also remain valid even in a mixed system.

In the public consultation, all Member States that replied to the consultation agreed with the inclusion of likely breach of the CRD as a trigger for early intervention. Few Member States were concerned that the wording gives too much discretion to supervisors. The industry respondents were generally against the preferred trigger as they considered it to be too vague and subjective, which could be interpreted in different ways across jurisdictions. The proposal will ask EBA to develop guidelines about early intervention triggers, which would ensure harmonised application across the EU and higher certainty for stakeholders.

The preferred option is to allow supervisors to assess the situation freely (as it is currently in the CRD) but with a larger room for manoeuvre than presently granted. They should be able to implement early intervention measures in cases of likely breach of the requirements of the CRD (not only at actual breach as presently established). Potential problems regarding the transparency and predictability of 'soft' triggers can be addressed to a significant extent through the publication of guidance. It is proposed that the EBA should define common criteria to guide supervisors' assessment regarding the triggers. This will promote convergence and limit the extent to which supervisors take divergent approaches.

Table 7. Early intervention triggers - comparison of options

Operational objective || Policy options || Comparison criteria

Effectiveness || Efficiency || Coherence

Provide all supervisors with effective early intervention triggers || 1. No policy change || 0 || 0 || 0

2. Assessment of authorities (soft triggers) || ++ || ++ || +

3. Automatic, hard triggers || +/- || +/- || +/-

4. Combination of soft and hard triggers || +/- || +/- || +/-

Table 8. Early intervention triggers - impact on main stakeholders

|| Bank shareholders || Bank management || Bank creditors || Bank clients (depositors, borrowers) || Supervi-sors || Taxpayers / governments

1. No policy change || 0 || 0 || 0 || 0 || 0 || 0

2. Assessment of authorities (soft triggers) || +/- || +/- || + || + || ++ || ++

3. Automatic, hard triggers || +/- || +/- || + || +/- || +/- || +/-

4. Combination of soft and hard triggers || +/- || +/- || + || +/- || +/- || +/-

4.2.2. Possible policies to provide supervisors with effective early intervention tools

Policy option || Description

1. No policy change || The baseline scenario applies

2. Expanded minimum set of early intervention tools (minimum harmonisation) || Supervisory powers of early intervention under Article 136(1) of the CRD may be expanded to include the following powers: requiring the credit institution to take steps to raise own funds; to use net profits to strengthen the capital base, to request intra-group financial support, to replace one or more board members or managing directors or require their dismissal, to draw up and implement a specific recovery plan, to draw up a plan for negotiation on restructuring of debt with some or all of its creditors, to carry out a full fledged review of its activities. And also requiring the divestment of activities and imposing additional or more frequent reporting requirements.

3. Single set of harmonised early intervention tools (maximum harmonisation) || Fully harmonised, closed list of supervisory tools and powers that need to be made available for all European banking supervisors.

4. Introduction of special management || In addition to expanded supervisory powers under Article 136(1) of the CRD, supervisors could be given the power to appoint a special manager for a limited period of up to one year to take over the management, or assist the existing management, of an institution that is failing or likely to fail to meet the requirements of the CRD and either has not submitted a credible plan or fails to implement that plan effectively. The primary duty of a special manager would be to restore the financial situation of the credit institution by implementing the recovery plan or prepare for winding-down. A special manager would have all the powers of the management of the credit institution under the statutes of the credit institution and under applicable national law, including the power to exercise the administrative functions and powers of the management of the credit institution.

An expanded harmonised set of early intervention tools could pre-empt or deal with problems at supervisory level and therefore greatly increase financial stability. Measures like divestment of activities could substantially decrease accumulated excessive risks of institutions thus their failure could be avoided. A more aligned set of tools available to each supervisor could improve cooperation of different supervisors and enable important actions/measures that are presently not available in all Member States where a cross border banking group may operate.

The new early intervention measures that would be available under the current Article 136 of the CRD vary in their intrusiveness. First of all they would limit the freedom of management (e.g. limiting business, replacing managers) and shareholders (e.g. suspending dividend payment). Such measures could therefore be introduced only together with safeguards that ensure that these powers will not be misused and will serve public interest, and banks will not be forced to bear unnecessary limitations and costs. Hence, supervisors should only take actions or steps that are proportionate to the nature of the breach in question and appropriate to address that breach and restore compliance with the requirements of the CRD.

Compared to the baseline scenario, a single set of supervisory early intervention tools would deliver all the benefits which are outlined under the previous option. Having exactly the same tools and powers in all Member States would reinforce further chances of developing cooperative early remedial actions for the same banking group. This could also enable effective solutions to prevent escalation of problems and hence assure stability for all stakeholders. Legal implementation of such a solution might however pose problems for certain Member States. Due to differences in legal systems (e.g. constitutional limitations) and arrangements for banking supervision (single supervisor or shared competences among supervisor, national bank and DGS), setting exactly the same tools and powers (and not tools that achieve the same results) in all Member States could be difficult to reach. Certain Member States could be deprived of powers and tools that are available for them now and might be effective to settling problems at national level.

Although it could be part of the tool-set under option two, special management is considered separately given the intrusiveness of this measure. The nomination of a special manager to a bank is a very powerful and effective way to correct a problematic situation. Shareholders' right to nominate management would be limited and the nomination of a special manager would in most cases mean that existing managers would be removed. However, the special manager would need to respect company law legislation, and act in accordance with the decisions of the general meeting of shareholders. The main benefit would be that authorities could immediately stop mismanagement of banks and implement corrective measures to avoid the deterioration of the situation.

To avoid any uncertainty and legal challenge to the measures, supervisors should not be held liable against shareholders or creditors of a credit institution to which they have appointed a special manager for any actions, decisions taken by, or any failure to take an action or decision by the special manager. The actions of the special manager could be challenged at courts, and compensation could be obtained. It must also be made clear that the appointment of a special manager would not imply any state guarantee of the bank to which it is appointed.

The appointment of a special manager if made public could have implications to market participants and counterparties of a bank. This could be regarded as a sign that there are