(CN) – The European Commission proposed new rules meant to ensure that bank owners and creditors, not taxpayers, are liable for the costs of restructuring or closing should their businesses fail.
Commission President Jose Manuel Barroso called the proposal “an essential step” toward banking union in the EU that will make the banking sector more responsible.
The proposed rules would create new national resolution funds to pay for recapitalization or bank closures. To “bail-in” banks teetering on the verge of collapse under the new system, shareholders must lose equity and creditors have to take a haircut.
The European Commission divided the new framework into three parts: prevention, early intervention and resolution.
Banks operating in the European Union would have to create recovery plans addressing a variety of financial scenarios that would kick in to prevent deterioration of their financial stability. They would also have to draw up resolution plans, or living wills, to wind down operations if successive interventions do not resolve the problem.
The proposal allows banks to form support agreements with other institutions to provide liquidity through loans, loan guarantees or the sharing of assets for use as collateral.
If these measures fail, and a bank cannot meet its capital requirements, regulators could order early intervention measures. One measure includes mandatory meetings where bank shareholders discuss debt restructuring and other possible resolutions. The bank could also appoint of a special manager to take actions the board and regular management are unwilling or unable to implement.
If prevention and early intervention measures are unsuccessful, regulators can force implementation of the institution’s resolution plans.
In resolution, special managers could order the sale of all or parts of the failing bank to another bank either outright or by segregating good debts from bad debts that would be liquidated.
Regulators could also order the “bail-in” procedures.
Since private investors might have little interest in an institution where their equity is uncertain, banks would have to structure some of their debt, funding the bail-in until the institution could be wound down or sold off.
Bail-ins and bank closings would be paid for in part by new national resolution funds that banks must contribute to in an amount that equals 1 percent of their insured deposits within 10 years. The commission stressed that the funds will never be used to pay off creditors or otherwise bail out a bank’s shareholders.
The proposed rules must be passed by the European Parliament and adopted by member states before going into effect.