In the late afternoon of November 28, Luigino D’Angelo typed a suicide note on his computer. Twenty minutes later he hanged himself from the banister of his home in the Italian city of Civitavecchia.
The 68-year-old pensioner, a former employee of energy group Enel, had lost his life savings in a government-backed reorganisation of Banca Etruria, a troubled lender active mainly in Tuscany and central Italy, where D’Angelo had been a customer for 50 years. His mistake had been to place €110,000 of savings not in a conventional deposit but in an investment product, in practice a risky form of the bank’s own debt.
As soon as the reason for his suicide was clear, D’Angelo became a symbol of the human damage wrought by Italy’s reorganisation effort, which covered four banks and saw thousands of people lose money on these kinds of investments. Popular protest forced the Italian government to promise “hardship” compensation for those most affected.
The tragedy was a bitter taste of the challenges ahead for the banks, governments and people of Europe. This week, even tougher EU rules took effect, requiring the imposition of greater losses on the creditors of failed banks. It marks a decisive moment in the architecture of financial regulation, more than seven years after the peak of the financial crisis.
In the wake of Lehman Brothers’ collapse in 2008, dozens of banks failed worldwide, triggering government bailouts. The US alone spent an initial $430bn on its troubled asset relief programme (Tarp), rescuing Citigroup among others, while the UK laid out £133bn to save the likes of Royal Bank of Scotland and Lloyds. The cost to taxpayers — and the political backlash it produced — hardened the resolve of governments to ensure there could be no repeat of that disastrous period.
“Taxpayers will be protected from having to bail out banks if they go bust,” said Jonathan Hill, the EU’s financial stability chief, welcoming the changes last week. “No longer will the mistakes of banks have to be borne on the shoulders of the many.”
Europe’s new system, which puts bank bondholders rather than taxpayers on the hook for losses, has been cemented with the creation of the Single Resolution Board. Within the eurozone, much of the responsibility for preventing any backsliding in the application of the new standards will fall to Elke König, the 61-year-old former head of Germany’s financial regulator BaFin, and the first chief of the SRB.
It is a crucial element in Europe’s three-pillar “banking union” construct, which also spans eurozone regulatory supervision and deposit guarantees. The implications are vast but the big question is: will it work?
Ms König says that while the new system for handling failing banks was forged by national governments, each will be desperate to avoid their banks being the first to feel its firepower. “My sense is that each and every country tried to address issues ahead of time,’’ she says in her Brussels office. “Because nobody wants to be the first one.”
The SRB will decide when a bank has failed and when it should be put into “resolution” — a special system of rules to prevent a failure from spreading panic across the financial system. It has the power to decide which steps should be taken to ensure a safe wind-down.
The essence of the change is that the EU is going to abandon the status quo under which, in a crisis, governments have been able to pump taxpayer money into banks, and where only shareholders and low-ranking creditors have been expected to feel the pain.
With the new system, regulators will have stronger powers to force senior creditors and even large depositors to take losses before public money is used.
While regulators often shied away from hitting senior bondholders, among the best protected investors, during the crisis — a consequence of concerns that this could freeze bank funding, harming the economy — they are now in the line of fire, on paper at least.
A golden rule is that 8 per cent of a stricken bank’s liabilities must be wiped out before any public money can be injected.
According to Jean-Pierre Mustier, former investment banking chief at UniCredit: “For the big banks this change should be like the atomic bomb: they will know it’s there but it will never be used.” In practice, he says, the rules will lead bank supervisors such as the European Central Bank to push big institutions to bolster their financial position, so reducing the risk that they could fail.
Using the tools
If any big bank did get into trouble, however, some sceptics doubt that regulators and politicians would have the courage to impose significant losses, either because of the probable political fallout or worries over contagion.
“They will be concerned about creditors going on strike,” says one veteran financier.
In an early sign of EU reluctance to embrace what it has created, officials raced to recapitalise Greece’s banks last year to avoid the measures. Officials argued that the new standards were not designed for a case such as Greece where its banks had been brought low, in part, by a wider economic crisis. Specifically, they feared the effect of the 8 per cent rule, which would have wiped out the country’s corporate deposits
That reluctance has raised questions about how regulators will handle the new system. While the standards include emergency loopholes, in practice it will be difficult to get around the 8 per cent requirement.
In another example of countries acting before the rules took effect, Portugal last month agreed to a €2.2bn state rescue for Banco International do Funchal, its seventh largest lender. The move will see the bank broken up and its good assets sold to Spain’s Santander. And Investors last month threatened legal action after the Lisbon government announced plans to impose heavy losses on almost €2bn of senior bonds at Novo Banco, the so-called “bad bank” created as part of last year’s €4.9bn rescue of Banco Espírito Santo.
Similarly, Italy’s intervention last month was meant to resolve problems while the country still had flexibility over how to do it. The pre-emptive manoeuvre turned sour, however, when so many retail investors — like D’Angelo — lost their money.
The main lesson of the episode was that even wiping out junior creditors — a step that took place in a number of EU countries in the wake of the 2008 crisis and was generally regarded as much less fraught than imposing losses on senior creditors — can be controversial.
Ms König says that, while the D’Angelo case is tragic and any mis-selling should be tackled vigorously, the affair should not be seen as undermining the case for creditor bail-ins — the practice of regulators writing down a bank’s debts or converting debt claims into equity in order to shore up its financial position.
“We all knew that, especially in Italy but also in some other markets, you have a lot of retail investors [in bank bonds],’’ she says. “I feel sorry for each and every one who loses money. But at the same time an investor also has his own responsibility and we have clearly learnt over the last 10 to 15 years . . . to make sure that mis-selling and market conduct is addressed.
“That a bank used cheap retail money to fund itself is not a reason to say that something went wrong and . . . that you get bailed out,” adds Ms König.
High stakes for EU
The Italian debacle is, nevertheless, symptomatic of a wider challenge facing the SRB — one of sequencing.
Ideally, were a bank to get into distress and face the full force of the bail-in rules, it would do so with its balance sheet structured in a way that makes it easy to impose losses.
There are different, overlapping ways that this can be pursued: requirements for minimum issuance of junior debt; changes to insolvency rules to make it easier to write down senior debt and, on a more prosaic level, tougher enforcement of rules against mis-selling to ensure debt does not end up in the hands of vulnerable retail investors.
Much work has been done by supervisors such as the ECB and Bank of England to make the banking system more robust. But key rules to make institutions easier to wind down are still not in place and many EU lawmakers are calling for further steps to end the problem of banks being too big to fail.
Ms König says it is clear that this sequencing poses challenges but that a longer timetable for introducing the bail-in system would have run counter to the wish of national governments to “get the message across’’ to banks that the days of taxpayer bailouts are over.
The stakes for the EU could not be higher. At their most fundamental level the rules are about protecting taxpayers from having to bail out banks, but the implications go waybeyond this, touching on the durability of the euro.
Policymakers such as ECB president Mario Draghi have hailed the eurozone system for handling failing banks as a key step to breaking the “bank-sovereign nexus” where the financial woes of governments and banks are mutually reinforcing.
The change in how bank failures are handled is a central part of a policy programme credited with drawing the sting of the euro-area debt crisis that began in Greece.
That agenda, known as the “banking union,” focused on taking key policy decisions and their financial consequences out of national hands. Decision-making on banks both in their life and death have been moved to the European level.
So far, the other main plank of the banking union has been the transfer of supervision powers for banks in the euro area to the ECB. Leaders have called the banking union the biggest policy step for the EU since the creation of the euro.
The overall effect — from the additional cost of selling bail-in bonds to the broader regulatory burden — is likely to be a jolt to the banking sector, further undermining lenders’ ability to focus on their core business and pull Europe’s economy out of its torpor.
Stephen Jones, until October the finance director of Santander UK, says British banks and their regulator have been preparing for the new rules for some time “but this new EU approach will come as a bit of a shock to many European banks”.
Ultimately for Ms König, the test of the SRB’s success will not be how many creditors at failed banks get bailed in, but whether the advance planning and crisis management is good enough to avoid it ever being necessary.
“We would be an extremely successful resolution authority,” she says, “if we could [manage] it [so] that we don’t have to resolve any bank.”
Additional reporting by Rachel Sanderson in Milan
Get alerts on Financial & markets regulation when a new story is published