Europe Told to Boost Firepower to Deal With Future Bank Failures

(Bloomberg) -- Europe still has to build up its war chest to keep failing banks from cratering the economy.

Weeks after agreeing on steps to shore up the currency union, politicians received a reminder that the arsenal to handle banks in trouble remains incomplete without the power to provide hundreds of billions of euros in emergency cash.

Elke Koenig, head of the euro area’s bank-failure agency, said that even a new arrangement that doubles the firepower of her institution’s crisis fund may not be enough to return a failed bank to the market. Her call faces skepticism on multiple fronts, including in Germany, where officials have prioritized other reforms.

“You need a funding facility, and a public funding facility to some extent, to bridge the time between resolution and the market carrying on with funding,” Koenig, head of the Brussels-based Single Resolution Board, said in an interview. “We will push hard to keep it on the agenda and not let it end up in the long grass.”

After months of divisive talks on how to develop the euro area, heads of government agreed last month to provide a public guarantee to the Single Resolution Fund, which can be used to restore a bank’s health after it failed. The pot is still being filled by banks themselves and is meant to reach 1 percent of protected deposits by 2024. Based on current balance sheets, that corresponds to about 60 billion euros ($70 billion), which the public backstop may double.

Public Backstop

When a large bank fails, funding needs can quickly outstrip those numbers, Koenig said. “When you look at the last crisis, on the liquidity side, to talk about 100 or 200 billion euros is not out of reach,” she said. The assumption that the market would quickly provide the necessary funding after losses have been imposed on investors isn’t realistic either, she said.

After a resolution, which ideally happens on a weekend, a bank “doesn’t have any decent collateral and the market will still be scratching its head to see how this really plays out,” Koenig said. She reiterated that central banks may be best placed to quickly provide the cash injections.

The European Central Bank has started to develop a new tool that would allow it to provide funding to banks that are rescued from insolvency. The measure is controversial, as the ECB is banned by law from financing action that should be taken by public authorities, such as bank resolution. The plan also foresees a far-reaching public guarantee to guard against central bank losses.

Banco Popular

Yet new commitments from euro-area finance ministers won’t be easy to obtain either. Asked about new liquidity tools, German Finance Minister Olaf Scholz said on July 13 that those weren’t an immediate priority for him and his counterparts.

“I understand why this proposal is being made, but it has many complications that you need to think through,” Scholz told reporters. “But what concerns me more is the question of how many balls we can keep in the air, as jugglers, if we want to achieve substantial results by Dec. 31. If it’s too many, we may end up with nothing.”

The need for a new liquidity source was also highlighted when the SRB handled its first big case last year by forcing the sale of Spain’s Banco Popular Espanol SA to Banco Santander SA. Koenig has said that Santander provided more liquidity than the SRB could have, underscoring the need to find a solution when a buyer can’t immediately be found and there is limited or no access to normal sources of liquidity.

Even without a complete framework, the SRB would still be able to handle the failure of a large bank, according to Koenig. “We will get there,” she said. “But I would prefer that I know exactly what are our thoughts, how do we put it in place and not that on that weekend, we come up with an idea how to get it done.”

©2018 Bloomberg L.P.