Naturally, since the exercise aims primarily to strengthen confidence in the European banking sector, it is vital that the European authorities should determine as soon as possible the formula to be used to cover the potential capital needs arising from the exercise, for those banks that cannot do so through their own means. Single resolution mechanism Yet if, as I said at the outset, we want to put an end to the current market fragmentation and to bank liabilities being valued differently depending on their location, the unified supervision of banks is not enough. These liabilities also need to be treated similarly – irrespective of the jurisdiction under which they fall – if banks experience acute solvency problems. Thus, the banking union requires, as indicated by various authors in the issue of Papeles de Economía Española presented today, the adoption of a single resolution mechanism for non-viable institutions. In the past, supervisory authorities responded to banks’ solvency problems following the principle of constructive ambiguity. Hence, except for guaranteed deposits, there was no specific legal framework for the treatment of banks’ liabilities, should a bank experience solvency problems, aside from commercial law provisions on insolvency. However, to prevent the undesired systemic effects of a disorderly bankruptcy of a bank, public authorities have traditionally used discretionary power to protect holders of bank liabilities (mainly deposits and debt) through capital injections so as to avoid the winding-up of these institutions. One of the lessons of recent crises is that the principle of constructive ambiguity has become considerably weaker.

Public authorities – at least in Europe – have tended to come to the aid of weak institutions, thus confirming the existence of an implicit guarantee for banks’ liabilities. This guarantee distorts the incentive system for the managers of banks and for their creditors, generating considerable costs for the public finances of the countries concerned. A key factor in encouraging the suitable risk perception of each liability instrument, and thus in minimising the cost for taxpayers, is bail-ins. These establish a clear order for the incurring of losses by shareholders and creditors, and provision is made for this arrangement to be activated prior to any injection of public funds. In Europe, given the political agreement reached on the Recovery and Resolution Directive, a set of common rules will be adopted in the near future establishing a clear and homogeneous order of seniority of liabilities in the event of bank resolution, and it will ensure the administrative power to impose losses on the holders of each instrument. That will notably minimise the cost to taxpayers of bank bail-outs. But common rules are not enough. The only way to ensure the possible homogeneous application of these rules is through the creation of a common resolution authority for all countries. BIS central bankers’ speeches  3  Similarly, it is important to have a common resolution fund in place which ensures, under similar conditions, that there is the necessary financial support for those institutions which might need it, irrespective of the budgetary situation of the State concerned.