O Tell Me The Truth About Bail-In: Theory and Practice

Bank resolutions and specifically bail-ins are among the most complicated and contentious issues of banking law, in the EU and elsewhere.. Bearing the potential to directly affect thousands of investors, and limiting the flexibility of Member States to rescue banks, they have stirred controversies well beyond the regulatory, scholarly and business circles, and have attracted the interest – and sometimes fueled the anger – of the public. Cases such as the one of the Banco Popular Español or the Italian so-called ‘Banche Venete’ have also been used and sometimes manipulated as political arguments. The first applications of the Bank Recovery and Resolution Directive (‘BRRD’) have demonstrated the reluctance of policy makers and regulators to use the bail-in tool, due to the effects it can have on investors.. In light of the experience gained with the BRRD  in the last few years, the time is ripe for a full discussion of the legal framework, an empirical analysis of the most important cases, an assessment of the law-in-action, and some proposals for reform.

While we subscribe to the overall desirability of the new resolution regime, or at least recognise the validity of its underlying principles, we also believe that regulators and many scholars have shown too much enthusiasm with the new resolution regime (and, especially, the bail-in procedure), due to its elegant but highly theoretical framework, underestimating its practical implications and forgetting some intuitive fairness considerations – such as the retroactive application of the new rule toward investors – that have sometimes dramatically demonstrated their importance. 

In our Paper, we analyse the functioning of the European regulatory approach to the crisis of credit institutions in the EU banking supervision framework, in light of its early applications, with a special focus on bail-in. More specifically, after a brief introduction, in Part II we set out a summary of the common regime applicable to credit institutions within the EU, based on harmonised requirements for capital and liquidity. In Part III, we illustrate the pre-crisis and crisis tools, as spelled out in the BRRD, in coordination with bordering regulatory areas, such as the regimes applicable to the liquidation of insolvent banks, and State aids in the context of banking rescues.

After a brief comparison with the US system (Part IV), in Part V we investigate how the new resolution mechanisms have inter-played with legal and institutional contexts still characterised by a certain political willingness to use public funds to rescue banks and by non-harmonised national insolvency rules. The focus of our analysis — which fills a gap in the existing literature, mostly concerned with the theoretical aspects of the resolution regime — is on the practice of bank restructuring, because it is in the practical details that the theory shows its limitations. We draw a comparison between some of the most important resolutions implemented before the BRRD entered into force, and the first post-BRRD experiments. We discuss in greater detail two cases (the resolution of Banco Popular Español and the liquidation of the Italian ‘Banche Venete’) which, in our view, aptly illustrate the features of the new regime and its strengths and weaknesses.

We find that, during the first three years of BRRD application, several ‘endogenous’ and ‘exogenous’ factors have eroded the foundations of the abstract legal framework, and altered the functioning of the bail-in. By ‘endogenous’ factors, we mean intrinsic flaws or shortcomings of the resolution rules, which end up weakening (if not contradicting) its policy ends. By ‘exogenous’ factors, we mean other sets of rules (such as the EU State aid rules, or the national rules on the liquidation of insolvent banks) or factual and economic circumstances (such as the health of the banking industry) that have critically interplayed with the introduction of the BRRD.

Among the endogenous shortcomings of the resolution framework, we include: (a) The hardly acceptable levels of uncertainty and resolution authorities’ ample discretion in the assessment of the triggers of a resolution procedure; (b) The unpredictability in the selection of liabilities to be possibly written off in the context of resolution; (c) The shaking and somewhat contradictory grounds on which the ‘no creditor worse off’ principle (‘NCWO’) rests.

Among the exogenous factors, we count: (i) The inconsistency between the requirements for entering into resolution and those for the granting of State aids in the context of banking restructurings, a key distorting element in the decision-making processes of the EU and national authorities; (ii) The lack of harmonisation in the national rules governing the ordinary liquidation of failed banks, which may severely affect the NCWO; (iii) The untimely introduction of the bail-in tool before a sufficient cushion of eligible liabilities was available to the banking sector; (iv) The insufficient coordination between the resolution rules and the issue of the mis-selling of banks’ capital instruments, a phenomenon observed in several European countries.

In suggesting some corrections to the EU resolution framework, the core of our proposal revolves around four ideas: (1) A clarification and harmonization of the concept of ‘public interest’ relevant for both the adoption of resolution tools and the granting of State aids; (2) Harmonization of those aspects of national insolvency and liquidation rules that might facilitate the adoption of the resolution decisions and a leveled playing field; (3) A more flexible write-down requirement than the current 8%; (4) Greater transparency and better timing for resolution decisions.

Marco Ventoruzzo is Professor of Law at Bocconi University

Giulio Sandrelli is an Academic fellow at Bocconi University