A Proposal for a Temporarily Amended Version of Precautionary Recapitalisation Under the Single Resolution Mechanism Regulation involving the European Stability Mechanism

Abstract

European credit institutions are expected to pile up a relevant amount of non-performing loans (NPLs) as a consequence of the crisis provoked by the Covid-19 pandemic. Against this backdrop, one of the most critical issues at stake is whether credit institutions currently hold an amount of capital which is sufficient to absorb the losses that they will likely experience in the forthcoming future. If this will not be the case, then they will have to undergo recapitalisations. In a context of global, generalised and prolonged economic crisis, nevertheless, it could turn out to be extremely challenging to find private investors able and willing to significantly invest in their equity. Therefore, a new solution capable to balance conflicting, yet legitimate, needs, such as credit institutions’ recapitalisation without recurring (again) to excessive and generalised public bail-outs, might have to be quickly found.

Accordingly, because of the high bar set in the recent past by the Single Resolution Board (SRB) for the submission of failing or likely to fail (FOLF) credit institutions to resolution (unless a different interpretation of the public interest criterion in light of the current crisis is put forward), and with a view to avoiding credit institutions’ liquidation financed through public resources, what we propose hereby is a temporary, revised and standardised form of privately and publicly funded precautionary recapitalisation, designed beforehand and operating on an quasi-automatic basis. Thus, this paper advocates a temporary amendment of the so-called precautionary recapitalisation under the Single Resolution Mechanism Regulation (SRMR) with the major involvement of the European Stability Mechanism (ESM). Such proposal should, of course, build on the regime currently in place also in light of the European Commission’s (Commission) decision to temporarily suspend the application of the state aid prohibitions laid down in the Treaty on the Functioning of the European Union (TFEU).

Along with the European Central Bank (ECB), a major role in the process should also be played by the SRB and the ESM, with a view to keeping as much as possible the same level playing field within the Banking Union (BU). The final goal would be to strike a fair balance between the primary need to avoid the collapse of the whole banking system as a consequence of the Covid-19 crisis and the interest to discourage excessive moral hazard and unsound public policies.

Accordingly, for a limited period of time, we propose that some of the conditions currently required by the SRMR for the precautionary recapitalisation of credit institutions established in the BU should be amended in line with the recent measures adopted by the Commission to facilitate public intervention to support the economy. This should be combined with an ESM facility allowing it to buy hybrid instruments issued by the credit institutions that would need to be recapitalised. In this regard, the ESM could raise the resources needed by issuing senior bonds on the market to be then used to buy contingent convertibles (CoCos) with characteristics enabling them to be included in the credit institutions’ Common Equity Tier 1 (CET1) capital, as was the case in Greece in 2015, with a view to divesting as soon as the market conditions will allow it. Such an action, in turn, could be placed within a broader framework permitting the ESM to monitor the credit institutions’ activity against some targets designed to allow them, over time, to pay back the issued instruments.

Keywords: public policy, credit institutions, NPL, capital requirements, COVID-19, SRB, SRMR, ESM, ECB, Banking Union, CET1

JEL Classification: H12, G28, K29, K39, G32