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When Brussels last month trumpeted the launch of its new rule book on failing banks, it could hardly have imagined the political backlash would come so swiftly, or that the regime could be blamed for so much market turmoil.
At the time they were agreed in 2014, these so-called “bail-in” reforms secured unanimous backing from EU governments, which wanted to shift the burden of bank rescues away from taxpayers and on to investors.
But the nascent regime is now under sustained attack from Italy for being ill-thought through, rushed and destabilising. Some analysts also cited it as one of several factors driving this week’s volatility in European bank stocks. A messy round of forced bondholder writedowns at Portugal’s Novo Banco last month heightened creditor jumpiness.
With European bank shares facing another tempestuous day on Thursday, these issues will be on the agenda of eurozone finance ministers at their regular Brussels gathering.
What are the rules?
Known in EU jargon as the Bank Recovery and Resolution Directive, the legislation is the centrepiece of efforts to avoid a repeat of the €1.6tn of taxpayer support to banks during the 2008 financial crisis.
It empowers regulators to intervene quickly when a bank is weak, avoiding the panic that could arise from a messy and prolonged insolvency procedure. The law took effect in 2015, but markets were given an extra year to adjust to the most controversial measure: tougher rules imposing losses on a failing bank’s creditors, which kicked in on January 1.
This stipulates that 8 per cent of a bank’s liabilities must be wiped out before any taxpayer support can be provided, placing unsecured senior bondholders and also large corporate depositors on the hook for forced losses, also known as bail-ins.
Why are the Italians so unhappy?
Matteo Renzi, Italy's premier, has complained about the new regime; Pier Carlo Padoan, his finance minister, described it as “an increase in instability, rather than stability”. Yet in practice it has never actually been used. What caused a stir were events in the run-up to its inauguration.
The Italian government was rocked in December when the rescue of four small regional banks saw thousands of pensioners lose their savings. Rather than being anything to do with the new EU rules, the writedowns were the result of earlier, less tough, European competition standards requiring only low-ranking creditors to take a hit.
This turned toxic in Italy because of a history of banks encouraging high-street customers to take out investment products — actually risky debt issued by the bank itself — instead of traditional deposits, raising questions about whether people actually understood the risks of what they were buying.
Italy also faces broader challenges. Rome last month agreed with the EU commission’s powerful competition enforcers to launch a scheme of state guarantees to help its banks offload their heavy stockpiles of non-performing loans. While the plan was welcomed by investors, its design involved fractious negotiations between Rome and Brussels to find a blueprint that would not count as state aid that triggers the bail-in rules.
Is bail-in a culture shock for markets?
In the immediate aftermath of the 2008 crash, regulators shied away from imposing losses on senior creditors. Controversially, the European Central Bank in 2010 pressured Ireland not to write down seniors, hastening the country’s path towards an international bailout.
The push for more senior bail-ins grew with the eruption of the euro-area debt crisis. When Cyprus was bailed out by governments in 2013, it became a test-case as large deposits were forcibly converted into Bank of Cyprus shares.
At the end of last year, Portugal’s central bank wrote down around €2bn of senior bonds at Novo Banco, the new lender that emerged from the 2014 failure of Banco Espírito Santo. The move has provoked threats of lawsuits from investors who claimed that the central bank discriminated against them by imposing losses on certain bondholders and not others.
What changes with the new law is that senior bail-in becomes standard practice in the event of a big banking collapse, with common, formalised EU rules on how it should be conducted.
Lord Hill, the EU commissioner for financial services, told the FT that it would be “a bit of a stretch to put any change in global sentiment towards the banks in recent days down to the BRRD, given that it has been known about now for over 18 months”.
Nicolas Véron of the Peterson Institute for International Economics, a US think-tank, said some unease stemmed from markets “only now waking up” to senior bail-in, and yet having no precedent to price that risk under the new regime.
What is the chance of the rules being changed?
Almost none. Mr Renzi is upset. But other EU governments have pinned their fiscal credibility on rigorous bail-in. Wolfgang Schäuble, Germany’s powerful finance minister, was the main architect of the 8 per cent rule. And the ECB supports the rules; it has conspicuously failed to echo any Italian concerns.
The measures are also essential to the euro-area’s ambitious “banking union” project to centralise supervision and crisis-management of its banks — a project credited with helping to take the sting out of the bloc’s debt crisis. Mr Schäuble has in recent months called for further tightening of EU bank rules in general as a prerequisite to any further development of the banking union.