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European bank resolution – depositors to have preference

by William Arnold | Jul 03, 2013

The Council of the European Union has made an amendment to the proposed EU Recovery and Resolution Directive published last year. While this is not necessarily the final version, it needs to be adopted by the end of this year and further major changes would be unlikely. As a reminder, the main resolution measures include powers for the authorities to sell businesses, to establish publicly controlled bridge banks to which assets may be transferred and to separate assets and transfer them to an asset management vehicle (i.e. a bad bank).

Compared with the proposals last year the main change is the introduction of depositor preference, in direct contrast with the European Commission's initial view that deposits should rank pari passu with other senior creditors.

This is a credit negative outcome for senior unsecured creditors in EU banks. The introduction of depositor preference means that the likelihood of burden sharing is higher and the potential recovery rates in a bail-in or insolvency will be much lower than the market has so far been assuming, which will place more pressure on spreads and ratings. We have previously highlighted this as a possibility and discussed the possible impact of spreads and ratings (please refer here).

Otherwise, the new draft looks similar to the old one, although it will allow a significantly higher level of national flexibility in several areas. The deadlines appear to be unchanged (despite speculation about an earlier implementation of the bail-in framework) and the Directive is still scheduled to be effective from 1 January 2015, and full bail-in to be introduced on 1 January 2018.


The main focus for investors is on bail-in (i.e. the ability to impose losses on shareholders and unsecured creditors). The main principle continues to be that under bail-in the creditor hierarchy will be respected and that no creditor will be worse off than under normal insolvency proceedings.

The main exclusions from bail-in continue to be insured deposits and secured liabilities including covered bonds. Interbank liabilities with an original maturity of less than seven days and liabilities relating to payments systems with a remaining maturity of less than seven days are also excluded. This is a change from the previous draft, which excluded liabilities with a maturity of less than one month.

Depositor preference

Direct bail-in of insured deposits up to €100,000 has never been contemplated and that is still the case. However, the position of the deposit guarantee schemes (DGS) that stands behind these deposits has changed substantially since last year's draft.

In the first version, there was a prohibition on giving insured deposits any preference over other senior creditors in national insolvency regimes. This reflected the existing lack of depositor preference in all the major EU member states' national insolvency regimes. So losses would effectively have been shared evenly across the total value of deposits and senior debt – which would give governments a reason to bail-out/protect senior bondholders as any loss to them would also be taken by depositors – which can lead to significant instability.

The latest version reverses that prohibition and states that insured/covered deposits must rank above all other deposits and unsecured, non-preferred creditors in national insolvency regimes. Most importantly for senior bond holders and other unsecured counterparties, it means there is a higher likelihood of burden sharing (given depositors under €100,000 are excluded) and that the bail-in loss burden will now be shared among a smaller group of creditors, reducing recovery rates, compared with those implied by the original draft of the Resolution Directive.

Overall, the agreed upon bail-in framework is a clear statement of intent by EU economic and finance ministers that creditors should bear losses ahead of taxpayers in resolutions. The inclusion of depositor preference is significant in enabling the loss to be shared across the capital structure and therefore further negative pressure is likely on spreads and ratings for senior unsecured creditors, particularly for securities maturing after the bail-in implementation date of 1 January 2018.