ec bail-in - comparative analysis 221013

8/13/2019 EC BAIL-In - Comparative Analysis 221013

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Bail-in tool: a comparative analysis of

the institutions' approaches18 October 2013


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Cover note

Disclaimer

This is a working paper produced by the services of the Commission. It does not represent a

formal position of the Commission. The analysis relies on publicly available data but contains

a series of assumptions which may or may not hold in practice.

Introduction

In the context of the trilogues on the Bank Recovery and Resolution Directive (BRRD), the

European Parliament and Council have asked Commission services to provide a comparative

analysis of the bail-in tool and its inter-relationship with resolution funds and state support

under the ECON report and the Council General Approach. Requests have also been made to

assess how the approaches would fare in a future crisis. This note provides an overview of how

they would have worked in the past crisis had they been in place, and how they could fare in a

crisis of similar magnitude today.

Bail-in is a key resolution tool in the BRRD. It would allow to write-down debt owed by a bank to

creditors or to convert it to equity. It could be used in the event of a failure of a systemic bank.

By replicating how creditors would incur losses if the bank had gone bankrupt, it reduces the

value and amount of liabilities of the failed bank. It thereby avoids taxpayers from having to

provide funds to cover these liabilities, while allowing for the critical functions of the bank (e.g.

deposit-taking, lending, operation of payment systems) to continue uninterrupted, either in a

new entity such as a bridge bank or in the same, albeit significantly restructured franchise.

Resolution funds are another key feature of the BRRD framework. They would be newly set-up

funds built-up through regular payments by banks based on their size and risk-profile. Their

main function would be to provide medium-term support such as loans or guarantees to help

the resolved bank regain financial viability. In the Council General Approach, they have also

been explicitly given a potential role to contribute funds in lieu of some creditors who would

otherwise have been bailed-in. In the Commissions proposal this role is more implicit and

available only as a last resort, namely when owners and creditors have already been written

down and it would be necessary to help ensure successful resolution in a systemic scenario.

Assessment

Both the ECON and Council approaches protect depositors covered up to 100 000 EUR byDeposit Guarantee Schemes (DGS) from suffering any losses. Both also assume full loss

absorption by capital instruments as per the Capital Requirements Regulation (CRR). They both

reflect the Commissions proposal in this respect.

Beyond this, the analysis confirms the strong inter-relationship between:

(i) Which other liabilities in banks balance sheets can be bailed in if needed, i.e. are notexcluded by way of outright or discretionary exclusions; and

(ii) How much funding would be needed from resolution funds or from the public purse tocompensate for liabilities excluded from bail-in.


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In general, the more liabilities are subject to bail-in without exclusion, the less is needed from

resolution funds or from the state. However, both the ECON and Council approaches introduce

considerable flexibility to depart from comprehensive bail-in. This is intended to allow for

contributions from resolution funds or the state to replace some creditors such as bond-holders

or uncovered depositors from being bailed-in, notably to prevent and, if necessary, to manage a

systemic crisis affecting the banking sector more broadly.

The ECON report proposes to allow for state support immediately after loss absorption by

capital instruments in such cases. It also gives, in all cases, preference to eligible depositors in

the bail-in hierarchy and excludes the DGS from having to contribute at all (which would

otherwise contribute an amount equal to what it would have suffered on behalf of covered

depositors in a liquidation of the bank). The Council General Approach provides for flexibility to

replace loss absorption by some senior creditors and potentially all eligible depositors with a

contribution from resolution funds, provided that 8% of liabilities have already been bailed-in,

and only up to 5% of total liabilities. It also gives preference to eligible deposits from natural

persons and small businesses and, above these, super-preference to the DGS.

The corollary of the ECON and Council approaches is the need for a bigger resolution fund (the

state support provided for in the ECON report is assimilated here to funding from the resolution

fund). Indeed, both approaches provide for bigger resolution funds than in the Commissions

proposal, namely 3% and 1.3% of covered deposits in the ECON and Council approaches

respectively.

By contrast, the Commissions proposal as well as the subsequent choice to opt for preference

for eligible depositors in the hierarchy of claims provided minimal flexibility to depart from the

comprehensive bail-in of liability-holders. Recourse to resolution funds would also be lower. In

the original proposal a comparatively larger share of the losses would have been incurred byeligible depositors and the DGS. With a preferred ranking for eligible depositors, i.e. all who are

not excluded from coverage by DGS irrespective of the amount, losses would fall

commensurately more on other un-preferred and unsecured senior creditors. The latter would

be subordinated to eligible depositors and the DGS, who would only assume the burden of

absorbing losses afterwards.

When assessed against the aid to cover excessive losses and build capital buffer given to EU

banks in the past crisis (473bn EUR from 2008 to 2012), all three approaches would, in the case

of an average bank, have ensured sufficient loss-absorbing capacity through the write-down of

capital instruments, bail-in and contributions from resolution funds. However, this conclusionrests on some notable assumptions. It assumes fully built-up or operational resolution funds,

which will take time. Crucially, it also rests on the mutualisation of national resolution funds

which could be deployed where needed in the EU. Otherwise, the results would only be valid for

the losses that occur evenly across the EU, whereas clearly this has not been the case. This

proposal by the Commission has so far not been endorsed by the Parliament or Council. Equally

importantly, it assumes the availability of bail-in as a resolution tool, while this may not be the

case until 2018. In the case of the ECON approach, it also assumes the ability of public finances

to withstand replacing the resolution fund in a systemic crisis. Finally, differences in banks

liability-structures can be decisive in whether the combination of bail-in and resolution funds


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would suffice or whether exclusions for specific bank-liabilities, for derivatives say, would

render the combination inadequate.

Therefore, in a future crisis of similar magnitude to the past one, it cannot be foreseen with

certainty whether all three approaches would work in all cases. However, what can be said is

that most banks today appear to have enough capital and bail-in-able liabilities to withstand

losses in non-extreme cases without resorting to resolution funds or state support. To cater formore extreme and asymmetric cases a single fund is instrumental in order to help ensure this. It

may also be necessary to circumscribe the flexibility to replace liabilities with contributions from

resolution funds or the state as provided in the Council and ECON approaches, as well as to

strengthen the need to ensure sufficient bail-in-able liabilities as part of big banks Minimum

Requirement for Eligible Liabilities (MREL) at all times. Finally, the calculation basis of MREL

matters and it should be neutral as to types of banks. Excluding specific liabilities such as

covered bonds and derivatives from counting toward MREL, as the ECON and Council

approaches respectively do, could excessively incentivise banks to try to fund themselves via

these instruments. For example, the exclusion of derivatives could excessively favour big trading

banks and complicate efforts to ensure sufficient MREL for them.

Conclusion

Given the above considerations, co-legislators should aim to ensure adequate bail-in-able

capacity at all times, and restrict the flexibility to depart from this to limited cases. It is also

important to incentivise investors to exert discipline and improve certainty for them, and avoid

unintended consequences such as spurring moral hazard by creating an excessively large

resolution fund.


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Annex. A comparative analysis of the institutions'

approaches to bail-in

Annex. A comparative analysis of the institutions' approaches to bail-in ...................................... 5

1. Scope and sequence of bail-in ................................................................................................. 7

2. Impact on bail-in capacity: assessment of approaches ........................................................... 9

2.1. Methodology used to cluster data for the liability structure of EU Banks ....................... 9

2.2. Overview of bail-in capacity in banks ............................................................................. 11

2.3. Impact of bail-in on a bank type: 25% loss scenario ...................................................... 14

2.4. Impact of bail-in on a bank type: 10% loss scenario ...................................................... 24

3. Back-testing: assessment of approaches .............................................................................. 32

3.1. Summary results from the back-testing exercise ........................................................... 32

3.2. Methodology for the back-testing exercise ................................................................... 33

3.3. The Council General Approach ....................................................................................... 34

3.4. The Commission proposal .............................................................................................. 37

3.5. The European Parliament's approach ............................................................................ 40

3.6. Deviation from the assumption of the symmetric crisis ................................................ 42

4. Minimum Loss Absorption Capacity: definitions and implications ....................................... 43

Appendix 1. Data used in the back-testing analysis .................................................................. 45


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In view of trilogue discussions on the proposed Directive on Bank Recovery and Resolution

(BRR)1, the European Parliament and Council have asked the Commission to provide a

comparative analysis of the bail-in tool under the Commission proposal (COM), under the

general approach adopted by the Council (CN) and under the approach put forward by the

Parliaments ECON committee (EP).

Bail-in is one of the key elements of the BRRD framework. It sets out the key principles and rules

that should ensure that in the future, banks will bear the primary responsibility for their failures.

This shall send a clear signal that while a bank failure may come as a surprise, dealing with its

consequences should however be as clear and predictable as possible.

The comparative analysis of the three approaches to bail-in presents:

1) The assessment of bail-in capacity under different approaches, including the impact per type

of a bank;

2) The results of the back-testing exercise, i.e. how losses incurred so far during the current

crisis would have been absorbed in individual banks by different liabilities' instruments and how

much would have been left to absorb by deposit guarantee schemes and resolution funds or in

their absence by public finances;

3) Impact of the three definitions on the level of minimum Loss Absorbing Capacity.

1COM(2012) 280 final.


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1. Scope and sequence of bail-in

All three approaches define to varying degrees what liabilities are able to bear losses and to

what extent. This is achieved through a combination of mandatory and discretionary exclusions

of certain liabilities from bail-in and through determination of the sequence in which those

liabilities that will remain in scope will be bail-in-able.

1.1. Mandatory exclusions

All three institutions widely agree to exclude covered and secured liabilities and deposits as well

as some specific liabilities (to employees, commercial creditors, social security, etc).

All three institutions exclude short term liabilities but scope differs: COM excludes all liabilities

under 1 month, EP excludes all interbank and money market liabilities with the same 1 month

original term and CN excludes interbank liabilities with original maturity less than 7 days and

payment system liabilities with remaining maturity of 7 days. Only EP excludes the DGS as well

as liabilities to DGS from bail-in.

1.2. Discretionary exclusions

COM and EP exclude liabilities arising from derivatives when justified by the need to ensure

inter alia continuation of critical or core functions or financial stability. CN does not propose any

specific derogation for derivative liabilities.

Both CN and EP allow banks under certain extreme circumstances to exclude fully or partially

any type of eligible liability. CN however requires banks to respect no-creditor-worse-off

principle if losses that would fall on excluded liabilities are to be absorbed by those non-

excluded ones. Should there be still some losses remaining afterwards, banks are allowed to

resort to Resolution Fund for a maximum of 5% of total assets under the condition that banks

absorb losses up to a minimum of 8% of their total assets. EP also in extreme crisis situations

allows for state support to replace eligible liabilities.

1.3. Bail-in sequence

COM amended approach provides for a preference in the bail-in hierarchy to the DGS as well as

to all depositors that are not excluded. Non-excluded deposits of banks or other institutions

remainpari-passuwith senior unsecured debt.

CN also gives preference to DGS which has super-senior status above preferred depositors such

as SMEs and retail. The same preference as SMEs deposits is awarded to liabilities of EIB.

In addition to EP exclusion of DGS (subrogating to covered depositors) in bail-in, it gives all other

depositors, including those of credit institutions, senior status to other senior unsecured

liabilities.


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Figure 1.1.Bail-in sequence under the institutions' approaches


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2. Impact on bail-in capacity: assessment of approaches

2.1. Methodology used to cluster data for the liability structure of EU

Banks

The ideal data for an accurate exercise is not publicly available. In general, bank disclosures on

the liability structure are not sufficiently granular. There are not disclosures distinguishingbetween creditors that will be subject to EU regulation and those who will be subject to third

countries one. This is especially relevant for banks with stand-alone subsidiaries outside the EU.

Moreover, the split between senior unsecured and secured debt data is not disclosed in

consolidated annual reports, nor are disclosed the maturity of unsecured senior debt and the

interbank deposits. Furthermore, the amount of covered deposits and SME and retail non-

insured deposits is not individually disclosed on a regular basis. The amount of Repurchase

agreements in the liability part is not reported either.

To overcome these constraints a mix of public data from 3 different data sources has been used.

Senior unsecured debt is reported in private databases such as Bloomberg and Dealogic.Adjustments to reconcile these sources have been made in order to reconcile with banks

annual reports. The Repurchase agreements data is taken from Standard & Poors.

Three key assumptions have been made on deposits structure, first, interbank deposits under 7

days will be 66% and deposit under 1 month will be 85% of the total interbank deposits2.

Secondly, 50% of customer deposits are assumed to be covered by the DGS (based on an

average of the survey of the European Commission in 2010). Thirdly, deposits of SMEs and

individual persons above 100.000 EUR are assumed to be 25% of deposit from the public. The

overall assumption is that all the banks have the same above mentioned proportions. In any

case the outcome of these assumptions seems to be in line with industry reports.

3

Raw data on banks' balance sheets comes from 45 EU banks for the end of 2012, with an

aggregated total assets of almost 28 EUR trillion (ranking from 24 EUR bn to 2042 EUR bn total

assets) and make up around 70% of total banking assets in the Union4. The different liabilities

types and their specific sources are: Total Equity (Source: Annual Report), Subordinated Debt

(Source: Annual Report), Senior debt Unsecured of which less than 1 Month (Source:

Bloomberg DDIS Screen) of which more than 1 Month (Annual reports minus Bloomberg DDIS

Screen), Total Deposits(Source: Annual Report), Deposits by credit institutions (Source: Annual

Report), Deposits and borrowings from the public (Source: Annual Report), Derivative Liabilities

(Source: Annual Report), Repurchase agreements (Source: S&P) and Senior debt Secured(Source: Bloomberg DDIS Screen).

In order to analyse the impacts of the three bail-in approaches on different types of banks,

balance sheets of the 45 EU banks have been put together into 4 groups based on their key

characteristics. The first group are big banks (25) and the other one are medium to small types

2ECB April 2012 : Changes in bank financing patterns,

http://www.ecb.europa.eu/pub/pdf/other/changesinbankfinancingpatterns201204en.pdf

3Autonomus, July 2013: European Banks Bail-inmodest progress

4Source: ECB, DGS 2010 Survey, European Commission elaborations
http://www.ecb.europa.eu/pub/pdf/other/changesinbankfinancingpatterns201204en.pdfhttp://www.ecb.europa.eu/pub/pdf/other/changesinbankfinancingpatterns201204en.pdfhttp://www.ecb.europa.eu/pub/pdf/other/changesinbankfinancingpatterns201204en.pdf


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of banks (20). Big banks in the group of 25 are those that have more than 300 billion EUR of

total assets on their balance sheet. The rest of them have been allocated to the group of

medium banks. Secondly, we have created two more groups of banks based on whether their

source of funding comes from whole-sale markets or from deposits. On the basis of these

additional criteria we have created two more groups of banks: Big banks-market and Big banks-

retail. Market oriented banks (9 out of 25) in our sample are those that whose ratio of

derivative liabilities over total assets is higher than 15%. Retail oriented banks (13 out of 25) are

then those whose ratio of customer deposits over total assets is higher than 30%. Medium

banks in this sample are biased towards those which disclose all the relevant data to pursue the

analysis, normally this might mean the more solvent ones.

Table 2.1. Liability structure per type of bank (EUR m, 2012YE)Average

Banks Big Banks

Medium

Banks

Big Banks-

Market

Big Banks-

Retail

Total Assets 619,250 979,564 1 68 ,8 57 1,36 7,90 0 77 8,6 51

Total Equity 27,705 46,887 8,457 52,848 45,836

Subordinated Debt 9,490 16,046 2,460 17,528 16,347

Senior Unsecured debt >1 Month 42,652 62,706 27,943 64,849 55,301

Senior Unsecured debt < 1 Month (discret. exempt. COM) 12,606 22,509 369 25,724 21,929

Deposits of credit institutions 60,790 94,632 33,727 145,725 71,298

Deposits of credit institutions >7days-CN * 20,669 32,175 11,467 49,546 24,241

Deposits of cr edit insti tutions > 1Month-EP, COM* 9,118 14,195 5,059 21,859 10,695

Deposits and borrowings from the public 196,689 342,876 45,456 338,269 354,508

Deposits from publ ic non ins ured and not SME/retai l**,*** 49,172 85,719 11,364 84,567 88,627

DGS** 98,345 171,438 22,728 169,134 177,254

SME/retai l deposits*** 49,172 85,719 11,364 84,567 88,627

Derivative Liabilities (discret. exempt.) 97,340 171,579 9,757 362,424 64,176

REPOs-Exempted 35,146 62,077 5,489 111,507 34,690

Senior debt Secured-Exempted 39,598 57,161 26,279 70,311 44,099

Other non fin liabilities-Exempted 97,233 103,091 8,920 178,716 70,467

Total 619,250 979,564 168,857 1,367,900 778,651

Source: see section 2.1

Table 2.2. Liability structure per type of bank (% of Total Assets, 2012YE)

Average

Banks Big Banks

Medium

Banks

Big Banks-

Market

Big Banks-

Retail

Total Assets ( m) 619,250 979,564 1 68 ,8 57 1,36 7,90 0 77 8,6 51

Total Equity 4.5% 4.8% 5.0% 3.9% 5.9%

Subordinated Debt 1.5% 1.6% 1.5% 1.3% 2.1%

Senior Unsecured debt >1 Month 6.9% 6.4% 16.5% 4.7% 7.1%

Senior Unsecured debt < 1 Month (discret. exempt. COM) 2.0% 2.3% 0.2% 1.9% 2.8%

Deposits of credit institutions 9.8% 9.7% 20.0% 10.7% 9.2%

Deposits of credit institutions >7days-CN * 3.3% 3.3% 6.8% 3.6% 3.1%

Deposits of cr edit insti tutions > 1Month-EP, COM* 1.5% 1.4% 3.0% 1.6% 1.4%

Deposits and borrowings from the public 31.8% 35.0% 26.9% 24.7% 45.5%

Deposits from publ ic non ins ured and not SME/retai l**,*** 7.9% 8.8% 6.7% 6.2% 11.4%

DGS** 15.9% 17.5% 13.5% 12.4% 22.8%

SME/retai l deposits*** 7.9% 8.8% 6.7% 6.2% 11.4%

Derivative Liabilities (discret. exempt.) 15.7% 17.5% 5.8% 26.5% 8.2%

REPOs-Exempted 5.7% 6.3% 3.3% 8.2% 4.5%

Senior debt Secured-Exempted 6.4% 5.8% 15.6% 5.1% 5.7%

Other non fin liabilities-Exempted 15.7% 10.5% 5.3% 13.1% 9.0%

Total 100.0% 100.0% 100.0% 100.0% 100.0%

Source: see section 2.1


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2.2. Overview of bail-in capacity in banks

Table 2.3 together with Figure 2.1 depict the maximum bail-in capacity the four groups of banks

would have on average when applying the three approaches as regards the resulting bail-in

capacity and sequence of bail-in.

If there would be no use of resolution fund to absorb losses for some excluded liabilities, then

both COM5and CN approach (without recourse to any flexibility) would leave banks with nearly

about 50% of their liabilities eligible for bail-in (including the DGS substituting for covered

deposits) whereas under the EP approach (under non-systemic scenario) the capacity would be

only about 30% on average for the sample of 45 banks, primarily due to the exclusion of

covered deposits from bail-in.

COM and EP approach appear to have comparable levels of the bail-in buffer across the four

bank types in a range of 11%-26% (COM) and 12%-23% (EP) before one would need to bail-in

preferred deposits. CN approach at this stage appears to generate on average 10 percentage

points more bail-in-able liabilities than COM and EP across the four bank types in a range of

22%-37%. This is largely explained by a substantial share of non-preferred customer deposits

and by the shorter thresholds as regards maturities of deposits of credit institutions and other

senior unsecured debt. Moreover, it should be kept in mind that the loss-absorption capacity of

the CN approach would increase further thanks to the possible contribution of resolution fund

of up to 5% (of the total assets) and possibly even more before the losses would have to be

absorbed by preferred deposits.

Overall, based on average losses experienced during the financial crisis, it appears that in a vast

majority of cases banks in the sample would have enough capacity on their balance sheets to

absorb the amount of losses and recapitalize, except for the EP crisis scenario, which would limit

the bail-in buffer only to capital and its instruments.

5COM amended approach that provides for depositor preference


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Table 2.3. Overview of bail-in capacity

Total Equity (EP systemic) 4.5% 4.8% 5.0% 3.9% 5.9%

Subordinated Debt 1.5% 1.6% 1.5% 1.3% 2.1%

Capital buffer EP, COM, CN 6.0% 6.4% 6.5% 5.1% 8.0%

COM, EP, CN senior unsecured > 1M 7% 6% 17% 5% 7%

CN, EP senior unsecured < 1M 2% 2% 0% 2% 3%

COM deposits non-preferred 1% 1% 3% 2% 1%

CN deposits non-preferred 11% 12% 14% 10% 15%

EP deposits non-preferred 0% 0% 0% 0% 0%

COM capital, unsecured and deposits 14% 14% 26% 11% 16%

CN capital, unsecured and deposits 26% 27% 37% 22% 32%

EP capital, unsecured qnd deposits 15% 15% 23% 12% 18%

COM preferred deposits 32% 35% 27% 25% 46%

CN preferred deposits (SMEs, retail) 8% 9% 7% 6% 11%

CN preferred DGS 16% 18% 13% 12% 23%

EP preferred deposits 17% 19% 16% 14% 24%COM Total capacity incl Preferred 46% 49% 53% 36% 62%

CN Total capacity incl Preferred 50% 53% 57% 40% 67%

EP1 Total capacity incl Preferred 32% 34% 40% 26% 42%

COM exclusions 54% 51% 47% 64% 38%

CN exclusions 50% 47% 43% 60% 33%

EP exclusions 68% 66% 60% 74% 58%

EP(systemic) exclusions 96% 95% 95% 96% 94%

Big Bank -

retail

(13)

Number of banks in a sample

European

Banks

(45)

Big Banks

(25)

Medium

Banks

(20)

Big Bank -

market

(9)

Buffer before preferred

deposits

Senior unsecured + non-

preferred deposits

Equity + Sub Debt

Total liabilities excluded

Prefered deposits

Total bail-in-able liabilities

including preferred

deposits

Source: Based on average liability structure of banks presented in Tables 2.1 and 2.2


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CONFIDENTIAL

CONFIDENTIAL 13

Figure 2.1.Bail-in sequence


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2.3. Impact of bail-in on a bank type: 25% loss scenario

This section provides an assessment of how each approach is able to deal with huge losses on

individual bank per type of the bank on the basis of the currently observed average liabilities

structure. For the simulation exercise a threshold of 25% of losses, including recapitalisation needs,

has been chosen. 4 out of 32 banks (12.5%) in the back-testing analysis (see Annex 1) had higherlosses, whereas 28 banks (87.5%) had lower losses.

2.3.1. Bail-in: average big bank vs medium size bank

Medium/small banks have on average slightly more capital and subordinated debt than an average

big bank. The biggest difference between their liabilities structures arises from the unsecured senior

debt, which medium banks have more than double compared to big banks. This difference impacts

the sequence in which individual classes of liabilities would absorb losses for each approach given

25% loss scenario.

Under the CN approaches, 5% of flexibility would be sufficient not to reach deposits in medium/smallbanks, whereas for big banks this would require a resolution fund to contribute with a total of 5.9%

of total assets of the bank under resolution (see Figure 2.4 and 2.6). CN 0% flexibility in both an

average big and medium bank would avoid the recourse to RFs and DGSs.

Under EP systemic crisis scenario, the contribution from RFs to both big and small/medium banks is

substantial respectively, 20.2% and 20% of total assets. In EP's non-systemic crisis, uncovered

depositors would have to contribute on average 9.1% of total assets to the resolution of big banks,

but only 1.5% in small/medium size bank.

The big differences in average total assets for these two types of banks (big bank: 1 EUR trillion vsmedium: 170 EUR billion) translates into big differences in the absolute amounts of loss absorption.

In CN general approach, the resolution fund would need to contribute to a big bank on average up to

60 EUR billion, depending on the flexibility pursued. For medium banks this would be on average 8

EUR billion.

In the same vein, uncovered deposits would have to contribute only 0.7% (7 EUR billion) under CN

approach with higher flexibility than 5% whereas with limited 5% flexibility depositors would be

haircut by about 1.6% or 16 EUR billion in a big bank. Under the EP non-systemic bail-in, uncovered

depositors would need to contribute on average 9.1% (90 EUR billion) in a big bank failure and only

1.5% (2.5 EUR billion) in a medium/small bank failure. The EP non-systemic crisis scenario is verysimilar to CN 0% flexibility scenario. Both would likely avoid the use of RFs and DGSs.

Under the EP systemic crisis scenario, depositors would not be haircut. However the resolution fund

would need to contribute on average nearly 200 EUR billion for a big bank, in comparison to 34 EUR

billion for a medium bank.


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Table 2.4. 25% loss absorption in an average big bank (% of total assets)

Commission proposal Council General Approach6European

Parliament (ECON)report

NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 4.8% 4.8% 4.8% 4.8% 4.8% 4.8% 4.8%

Subordinated debt 1.6% 1.6% 1.6% 1.6% 1.6% 0.0% 1.6%

Senior debt7 3.4% 7.9% 0.9% 0.9% 10.7% 0.0% 9.5%

RFs 0.0% 0.0% 5.0% 5.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 11.1% 11.1% 0.0% 0.0% 0.0%

Uncovered customer

deposits8 7.6% 5.4% 0.7% 1.6% 7.9% 0.0% 9.1%

Covered deposits / DGS 7.6% 5.4% 0.0% 0.0% 0.0% 0.0% 0.0%

RFs 0.0% 0.0% 0.9% 0.0% 0.0% 20.2% 0.0%

Total 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Table 2.5. 25% loss absorption in an average big bank (EUR, bn)

Commission proposal Council General ApproachEuropean


NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 47,019 47,019 47,019 47,019 47,019 47,019 47,019

Subordinated debt 15,673 15,673 15,673 15,673 15,673 0 15,673

Senior debt 33,378 76,896 9,058 9,058 105,294 0 92,642

RFs 0 0 48,978 48,978 0 0 0

Senior debt 0 0 108,294 108,294 0 0 0

Uncovered customer

deposits 74,410 52,652 6,615 15,869 76,905 0 89,556

Covered deposits / DGS 74,410 52,652 0 0 0 0 0RFs 0 0 9,253 0 0 197,872 0

Total 244,891 244,891 244,891 244,891 244,891 244,891 244,891

6Under CN 5% and >5% flexibility it has been assumed that intervention from RF excluded non-preferred

eligible customer deposits from bail-in.

7Including also bail-inable deposits of credit institutions

8The ratio between uncovered and covered customer deposits has been assumed to be 1


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Table 2.6. 25% loss absorption in an average medium size bank (% of total assets)


Parliament (ECON)

reportNOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%


Senior debt 7.8% 18.5% 1.2% 1.2% 14.4% 0.0% 17.0%

RFs 0.0% 0.0% 5.0% 5.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 12.0% 12.0% 0.0% 0.0% 0.0%

Uncovered customer

deposits 5.4% 0.0% 0.3% 0.3% 4.1% 0.0% 1.5%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 20.0% 0.0%

Total 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Table 2.7. 25% loss absorption in an average medium size bank (EUR, bn)



NOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 8,443 8,443 8,443 8,443 8,443 8,443 8,443


Senior debt 13,123 31,239 1,969 1,969 24,282 0 28,753

RFs 0 0 8,443 8,443 0 0 0

Senior debt 0 0 20,263 20,263 0 0 0

Uncovered customer

deposits 9,058 0 564 564 6,957 0 2,485

Covered deposits / DGS 9,058 0 0 0 0 0 0

RFs 0 0 0 0 0 33,771 0

Total 42,214 42,214 42,214 42,214 42,214 42,214 42,214


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2.3.2 Bail-in: big retail vs big wholesale banks

Big retail banks have on average more capital, more subordinated debt as well as more senior

unsecured debt (around 50% more) than big wholesale banks. In addition, there are considerable

differences as to the share of derivatives and deposits they have on the balance sheet which then

considerably impact the sequence in which individual classes of liabilities would absorb losses foreach approach given 25% loss scenario.

Under all three CN approaches big retail banks have already 8% of loss absorption covered by capital

and subordinated debt, whereas big wholesale banks would need in addition to bail-in part of the

senior unsecured debt before the resolution fund can be used. For big retail banks 5% of flexibility

would be sufficient not to reach deposits. On the contrary, for big wholesale banks the contribution

of 8.5% of total assets from resolution fund would be required (see Figure 2.8 and 2.10).

Under EP systemic crisis scenario, the difference as regards the use of the resolution fund is material

2% of total assets more in big wholesale banks. Moreover, in EPs non-systemic crisis scenario, thecontribution to bail-in by uncovered depositors at big retail banks would on average be a half of the

contribution in big wholesale banks (6.7% vs 11.7%).

The difference in total assets for these two types of big banks (retail bank: 780 EUR billion vs

wholesale bank: 1.37 EUR trillion) translates into rather big absolute amounts of loss-absorption.

In CN general approach, the resolution fund would need to contribute to a resolution of a big

wholesale bank up to 117 EUR billion (8.5% of total assets), depending on the flexibility pursued. For

big retail banks this would amount to 39 EUR billion. In the same vein, uncovered depositors in a big

retail bank would under both CN approaches that allow for flexibility to use RF (5% or above 5% of

banks total assets) not suffer any losses but uncovered deposits in big wholesale bank would be

haircut between 14 EU billion and 63 EUR billion depending on the flexibility pursued. 0% flexibility

scenario would double the contribution by uncovered deposits further to 131 EUR billion, but would

avoid the use of resolution funds for loss absorption in big wholesale banks.

Under the EP systemic crisis scenario, depositors would not be impacted. However, resolution funds

would need to contribute on average 289 EUR billion in a wholesale bank, in comparison to 149 EUR

billion in a big retail bank. The EP non-systemic crisis scenario is very similar to CN 0% flexibility

scenario. Both would likely avoid the use of RFs and DGSs and contributions of senior unsecured debt

and uncovered deposits would not differ substantially between these two types of banks up to 2%.

Under the EP approach uncovered depositors would need to contribute to loss absorption on

average 160 EUR billion in a big wholesale bank and 52 EUR billion in a big retail bank.


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Table 2.8. 25% loss absorption in an average big wholesale bank (% of total assets)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 3.9% 3.9% 3.9% 3.9% 3.9% 3.9% 3.9%


Senior debt 4.0% 6.3% 1.7% 1.7% 10.2% 0.0% 8.1%

RFs 0.0% 0.0% 5.0% 5.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 8.5% 8.5% 0.0% 0.0% 0.0%

Uncovered customer

deposits 7.9% 6.8% 1.1% 4.6% 9.6% 0.0% 11.7%


RFs 0.0% 0.0% 3.5% 0.0% 0.0% 21.1% 0.0%

Total 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Table 2.9. 25% loss absorption in an average big wholesale bank (EUR bn)



NOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 53,348 53,348 53,348 53,348 53,348 53,348 53,348


Senior debt 55,007 86,178 23,868 23,868 139,526 0 110,976

RFs 0 0 68,395 68,395 0 0 0

Senior debt 0 0 115,931 115,931 0 0 0

Uncovered customer

deposits 107,919 92,333 14,433 62,650 131,318 0 159,868

Covered deposits / DGS 107,919 92,333 0 0 0 0 0

RFs 0 0 48,217 0 0 288,627 0Total 341,975 341,975 341,975 341,975 341,975 341,975 341,975


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Table 2.10. 25% loss absorption in an average big retail bank (% of total assets)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 5.9% 5.9% 5.9% 5.9% 5.9% 5.9% 5.9%


Senior debt 2.7% 8.5% 0.0% 0.0% 9.1% 0.0% 10.3%

RFs 0.0% 0.0% 5.0% 5.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 12.0% 12.0% 0.0% 0.0% 0.0%

Uncovered customer

deposits 7.2% 4.3% 0.0% 0.0% 7.9% 0.0% 6.7%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 19.1% 0.0%

Total 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Table 2.11. 25% loss absorption in an average big retail bank (EUR bn)



NOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 45,940 45,940 45,940 45,940 45,940 45,940 45,940


Senior debt 20,766 65,952 0 0 70,609 0 80,225

RFs 0 0 38,933 38,933 0 0 0

Senior debt 0 0 93,438 93,438 0 0 0

Uncovered customer

deposits 55,802 33,209 0 0 61,762 0 52,145

Covered deposits / DGS 55,802 33,209 0 0 0 0 0

RFs 0 0 0 0 0 148,722 0Total 194,663 194,663 194,663 194,663 194,663 194,663 194,663


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Figure 2.2.25% loss absorption under the Commission's approach (no depositor preference).

Figure 2.3.25% loss absorption under the Commission's approach (WITH depositor preference).


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Figure 2.4.25% loss absorption under the Council approach (MORE THAN 5% flexibility).

Figure 2.5.25% loss absorption under the Council approach (5% flexibility).


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Figure 2.7.25% loss absorption under the European Parliament's approach (systemic crisis scenario).


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Figure 2.8. 25% loss absorption under the European Parliament's approach (NON-systemic crisis

scenario).


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2.4. Impact of bail-in on a bank type: 10% loss scenario

Table 2.12. 10% loss absorption in an average big bank (% of total assets)

Commission proposal Council General Approach9European

Parliament (ECON)

reportNO

depositorpreference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 4.8% 4.8% 4.8% 4.8% 4.8% 4.8% 4.8%


Senior debt10 0.7% 3.6% 0.9% 0.9% 2.1% 0.0% 3.6%

RFs 0.0% 0.0% 2.0% 2.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Uncovered customerdeposits11 1.5% 0.0% 0.7% 0.7% 1.5% 0.0% 0.0%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 5.2% 0.0%

Total 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Table 2.13. 10% loss absorption in an average big bank (EUR, bn)



NO

depositor

preference

WITH

depositor

preference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemic

crisis

Capital 47,019 47,019 47,019 47,019 47,019 47,019 47,019


Senior debt 6,460 35,264 9,058 9,058 20,379 0 35,264

RFs 0 0 19,591 19,591 0 0 0

Senior debt 0 0 0 0 0 0 0

Uncovered customer

deposits 14,402 0 6,615 6,615 14,885 0 0


RFs 0 0 0 0 0 50,937 0

Total 97,956 97,956 97,956 97,956 97,956 97,956 97,956

9Under CN 5% and >5% flexibility it has been assumed that intervention from RF excluded non-preferred

eligible customer deposits from bail-in.


11The ratio between uncovered and covered customer deposits has been assumed to be 1


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Table 2.14. 10% loss absorption in an average medium size bank (% of total assets)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%


Senior debt 1.5% 3.5% 1.2% 1.2% 2.7% 0.0% 3.5%

RFs 0.0% 0.0% 2.0% 2.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Uncovered customer

deposits 1.0% 0.0% 0.3% 0.3% 0.8% 0.0% 0.0%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 5.0% 0.0%

Total 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Table 2.15. 10% loss absorption in an average medium size bank (EUR, bn)



NOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 8,443 8,443 8,443 8,443 8,443 8,443 8,443


Senior debt 2,483 5,910 1,969 1,969 4,594 0 5,910

RFs 0 0 3,377 3,377 0 0 0


Uncovered customer

deposits 1,714 0 564 564 1,316 0 0


RFs 0 0 0 0 0 8,443 0Total 16,886 16,886 16,886 16,886 16,886 16,886 16,886


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Table 2.16. 10% loss absorption in an average big wholesale bank (% of total assets)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 3.9% 3.9% 3.9% 3.9% 3.9% 3.9% 3.9%


Senior debt 1.0% 4.8% 1.7% 1.7% 3.0% 0.0% 4.8%

RFs 0.0% 0.0% 2.0% 2.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Uncovered customer

deposits 1.9% 0.0% 1.1% 1.1% 1.8% 0.0% 0.0%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 6.1% 0.0%

Total 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Table 2.17. 10% loss absorption in an average big wholesale bank (EUR bn)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 53,348 53,348 53,348 53,348 53,348 53,348 53,348


Senior debt 13,335 65,659 23,868 23,868 40,917 0 65,659

RFs 0 0 27,358 27,358 0 0 0


Uncovered customer

deposits 26,162 0 14,433 14,433 24,742 0 0

Covered deposits / DGS 26,162 0 0 0 0 0 0RFs 0 0 0 0 0 83,442 0

Total 136,790 136,790 136,790 136,790 136,790 136,790 136,790


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Table 2.18. 10% loss absorption in an average big retail bank (% of total assets)



NO

depositorpreference

WITH

depositorpreference

>5%

Flexibility

5%

Flexibility

0%

flexibility

Systemic

crisis

NO

systemiccrisis

Capital 5.9% 5.9% 5.9% 5.9% 5.9% 5.9% 5.9%


Senior debt 0.3% 2.0% 0.0% 0.0% 1.1% 0.0% 2.0%

RFs 0.0% 0.0% 2.0% 2.0% 0.0% 0.0% 0.0%

Senior debt 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Uncovered customer

deposits 0.8% 0.0% 0.0% 0.0% 0.9% 0.0% 0.0%


RFs 0.0% 0.0% 0.0% 0.0% 0.0% 4.1% 0.0%

Total 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Table 2.19. 10% loss absorption in an average big retail bank (EUR bn)



NOdepositor

preference

WITHdepositor

preference

>5%Flexibility

5%Flexibility

0%flexibility

Systemiccrisis

NOsystemic

crisis

Capital 45,940 45,940 45,940 45,940 45,940 45,940 45,940


Senior debt 2,443 15,573 0 0 8,307 0 15,573

RFs 0 0 15,573 15,573 0 0 0


Uncovered customer

deposits 6,565 0 0 0 7,266 0 0


RFs 0 0 0 0 0 31,925 0Total 77,865 77,865 77,865 77,865 77,865 77,865 77,865


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Figure 2.9.10% loss absorption under the Commission's approach (no depositor preference).

Figure 2.10.10% loss absorption under the Commission's approach (WITH depositor preference).


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Figure 2.11.10% loss absorption under the Council approach (MORE THAN 5% flexibility).



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Figure 2.14. 10% loss absorption under the European Parliament's approach (systemic crisis

scenario).


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Figure 2.15. 10% loss absorption under the European Parliament's approach (NON-systemic crisis

scenario).


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3. Back-testing: assessment of approaches

3.1. Summary results from the back-testing exercise

Table 3.1.Summary results from the back-testing exercise

Commission proposalEuropean


Council General Approach

NO

depositorpreference

WITH

depositorpreference

Systemic

crisis

NO

systemiccrisis

>5%

Flexibility

5%

Flexibility

0%

Flexibility

Capital; EUR bn (% oftotal losses)

316(67%)

316(67%)

316(67%)

316(67%)

316(67%)

316(67%)

316(67%)

Subordinated debt; EURbn (% of total losses)

56(12%)

56(12%)

056

(12%)56

(12%)56

(12%)56

(12%)

Senior unsecured debt12;EUR bn (% of total losses)

21(4%)

60(13%)

065

(14%)33

(7%)33

(7%)52

(11%)

Uncovered eligibledeposits1314; EUR bn (%

of total losses)

40(8%)

20(4%)

034

(7%)10

(2%)36

(7%)47

(10%)

Covered deposits / DGSs;EUR bn (% of total losses)

40(8%)

20(4%)

0 0 02

(0.4%)2

(0.4%)

RFs; EUR bn (% of totallosses)

0.06(0.01%)

0.06(0.01%)

157(33%)

2(0.4%)

57(12%)

29(6%)

0

TOTAL state aid(recapitalisation and

asset relief measures)473 473 473 473 473 473 473

Minimum DGSswith fullbail-in (% covered

deposits)

40(0.6%)

20(0.3%)

0 0 0 2(0.02%)

2(0.02%)

Minimum RFswith fullbail-in (% covered

deposits)

0.06(0.001%)

0.06(0.001%)

157(2.3%)

2(0.02%)

57(0.82%)

29(0.42%)

0

Minimum RFs + DGSswith fullbail-in(%covered deposits)

40(0.6%)

20(0.3%)

157(2.3%)

2(0.02%)

57(0.82%)

31(0.45%)

2(0.02%)

Minimum RFs + DGSswith partialbail-in(%

covered deposits)

101(1.45%)

101(1.45%)

157(2.3%)

101(1.45%)

101(1.45%)

101(1.45%)

101(1.45%)

Minimum DGSs + RFsforeseen in the approach

1% 1% 3% 3% 1.3% 1.3% 1.3%

12Including also bail-in able deposits of credit institutions

13including EIB loans to banks (in CN approach), being parri passu with non-preferred customer deposits; on

the basis the available data, EIB loans to banks were assumed to be equal to 0.43% of total assets in each bank

included in the analysis14

Non-preferred eligible deposits under the CN approach are pari passu with the deposits of credit institutions

and other senior unsecured debt.


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3.2. Methodology for the back-testing exercise

The analysis is built upon the losses, including recapitalisation needs, that 32 European banks from

11 Member States (see Appendix 1) incurred individually since the outset of the crisis and shows how

these losses would have been absorbed by bail-in-able liabilities and the other financing

arrangements under the approaches of the Council, of the Commission and of the European

Parliament. Back-testing these approaches on the banks' loss absorption aims to provide an insight

on the effectiveness of each approach in tackling a future crisis of a similar magnitude and with a

similar loss distribution pattern in the banking sector.

As far as the data for the losses is concerned, due to the presence of bail-outs by Governments, the

financial statements of the banks could not be used to estimate the full amount of losses. Therefore,

the amounts of State aid in terms of recapitalisation and asset relief interventions used for these

banks have been taken as a proxy of the losses, including recapitalisation needs. The state aid

provided in the form of liquidity support or guarantees are not subject to the back-testing analysis.

The data used in the analysis refers to the state aid used by 26 banks within the period 2008-2011

and covers 85% of all asset relief and recapitalisation measures granted to the sector over those 4

years. It should however be noted that, due to the absence of comparable data, the analysis does not

include yet state aid provided to European banks in 2012 and 2013. However, given the large scale

restructuring of banks taking place currently in Spain, and in order to obtain more informative

conclusions of the analysis it has been decided to also include 6 Spanish banks for which the amounts

of approved state aid by 2012 were only available (see Appendix 1 for a list of individual banks).

Figure 3.1.State aid in terms of recapitalisation or asset relief measures received by 32 European

banks in the current financial crisis (% of total assets)


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Table 3.2. The size of average liabilities items found currently in European banks and relevant for theback-testing exercise

Over totalassets 2012YE

Total Equity 4.5%Subordinated Debt 1.5%

Senior Unsecured debt >1 Month 6.9%

Senior Unsecured debt 7 days (relevant for the Council approach)Of which EIB loans

3.34%0.43%

Deposits of credit institutions >1 Month (relevant for the EP andCommission approaches)

1.47%

Eligible customer deposits:

Uncovered non-preferred deposits 7.94%

Uncovered deposits from SME/retail 7.94%Deposits covered by DGS 15.88%

Source: see Table 2.2 in section 2.1

It has been assumed that, given one of the approaches had been in place at the time the resolution

decisions on these banks had to be taken, banks would have had the liabilities structure similar to the

one currently observed in existing banks, which already, at least partially, takes into account the

future application of the bail-in tools. Table 3.2 indicates the estimated size of liabilities' items

relevant for the assessment of the different approaches.

Since, under all three approaches, derivatives would be bailed in on a net basis when subject to a

netting agreement, and due to the ability to only observe gross positions in banks balance sheets,

for the moment we assume that derivatives are excluded from bail-in. This assumption represents a

lower bound on the loss absorption capacity of derivatives, which however would be normally small

when considering net exposure as compared to gross exposures.

Given that the analysis covers EU-27 banks, the assessment and comparison of approaches (in

sections 3.3 3.5) focuses on the amount to be absorbed by all national financial arrangements

jointly. Looking at financing arrangements in each Member State would have led to different results

(see section 3.6 below).

3.3. The Council General Approach

The Council General Approach provides incentives for banks to obtain the buffer of at least 8% of

total assets (total liabilities, including own funds). Only after the "contribution to loss absorption and

recapitalisation equal to an amount not less than 8% of the total liabilities" the resolution financing

arrangement is allowed to intervene in the loss absorption.

Table 3.3 below shows how the past losses compare with the thresholds set by the Council General

Approach. Figures 3.2 3.4 below show that if bail-in rules had been present during the crisis, the

losses would have been absorbed and recapitalisation needs would have been satisfied exclusively by


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35

banks themselves in 2/3 of banks under the Council 5% or more flexibility scenarios in all except 1

bank under the Council 0% scenario, where DGS would have been required to intervene.

Table 3.3 indicated that the contribution from the resolution financing arrangements (RF) increases

with the flexibility provided. 0% flexibility scenario would have not required the use of resolution

funds. 5% RF contribution would have been used to further absorb 29 EUR billion (6% of total losses)in the EU. The allocation of remaining losses in 6 banks would have depended on resolution

authorities' decisions to exclude or not customer deposits from bail-in, which would have had

repercussions also on the use of deposit guarantee schemes (DGSs) (table 3.3 and figures 3.23.4).

Table 3.3.Back-testing: loss absorption under the Council General Approach

ScenarioLoss absorption by instruments in

EUR bn (% of state aid)

> 5% flexibility;EUR bn (% of total

losses)

5% flexibility;EUR bn (% of total

losses)

0% flexibility;EUR bn (% of total

losses)

Capital and subordinated debt372

(79%)372

(79%)372

(79%)

Senior unsecured debt15before5% contribution

15(3%)

15(3%)

52(11%)

Non-preferred eligible depositsbefore 5% contribution

10(2%)

10(2%)

0

RF 5% contribution29

(6%)29

(6%)0

Senior unsecured debt after 5%contribution

18(4%)

18(4%)

0

Non-preferred eligible deposits16 015

(3%)37

(8%)

Preferred deposits of SMEs andnatural persons 0 11(2%) 10(2%)

Covered deposits / DGSs 02

(0.4%)2

(0.4%)

RFsfor remaining losses27

(6%)0 0

TOTAL state aid (recapitalisationand asset relief measures)

473(100%)

473(100%)

473(100%)

Minimum DGSs(% covereddeposits)

02

(0.02%)2

(0.02%)

Minimum RFs(% covered

deposits)

57

(0.82%)

29

(0.42%)

0

Minimum RFs + DGSs (% covereddeposits)

57(0.82%)

31(0.45%)

2(0.02%)

Minimum DGSs + RFs foreseen inthe approach (% cov. Dep.)

1.3% 1.3% 1.3%


16Non-preferred eligible deposits under the CN approach are pari passu with the deposits of credit institutions

and other senior unsecured debt.


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Figure 3.4.Back-testing: loss absorption implied by the Council General Approach with 0% of

flexibility (no use of RF until all bail-inable liabilities including uncovered depositors have been bail-ed

in)

3.4. The Commission proposal

With respect to the Commission proposal, the back-testing exercise focuses on two scenarios. The

first scenario deals with the initial Commission proposal, which does not foresee depositor

preference rules, while the second scenario introduces depositor preference to the Commission

proposal (table 3.4).

While loss absorption by capital and subordinated debt instruments would have been the same in

both scenarios 372 EUR billion (79% of total losses), the loss allocation between the deposits and

senior unsecured debt instruments would have been different. Only deposits being pari passuwith

senior unsecured instruments would have limited the loss to senior debt holders to 21 EUR billion,

whereas depositor preference would have tripled their loss to 60 EUR billion. On the contrary, under

pari passutreatment of customer deposits, uncovered depositors and DGSs would have absorbed 80

EUR billion, while depositor preference would have halved this amount to 40 EUR billion.

Finally, RFs can intervene in the absorption of the remaining losses if there are no more bail-inable

liabilities left.


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Table 3.4.Back-testing: loss absorption under the Commission approach

Scenario

Loss absorption by instrumentsin EUR bn (% of state aid)

Initial Commission proposal (nodepositor preference);

EUR bn (% of total losses)

Commission proposal assumingdepositor preference;

EUR bn (% of total losses)

Capital and subordinated debt 372(79%)

372(79%)

Senior unsecured debt17 21(4%)

60(13%)

Uncovered eligible deposits 40(8%)

20(4%)

Covered deposits / DGSs 40(8%)

20(4%)

RFs 0.06(0.01%)

0.06(0.01%)

TOTAL state aid(recapitalisation and asset

relief measures)473

(100%)473

(100%)

The useof DGSs and RFs in theback-testing exercise

40(0.6%)

20(0.3%)

The minimum amount offinancial arrangements (DGSs +RFs) foreseen in the approach

1% 1%

Figures 3.5 and 3.6 below present the graphical illustration of loss absorption under two scenarios of

the Commission proposal.



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Figure 3.5.Back-testing: loss absorption under the Commission proposal: NO depositor preference

Figure 3.6.Back-testing: loss absorption under the Commission proposal: WITH depositor preference


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3.5. The European Parliament's approach

Back-testing of the European Parliament's (ECON) approach focuses on two scenarios (table 3.5). The

first scenario assumes a systemic crisis, whereby government stabilisation tools will be used and only

capital related instruments could be bailed-in. Another alternative scenario deals with a non-

systemic crisis which assumes depositor preference and excludes covered deposits from bail-in.

The systemic crisis scenario allowed under the European Parliament's approach would have limited

the use of banks' liabilities in loss absorption to capital instruments only, thereby limiting loss

absorption by banks to 67% of total losses (316 EUR billion). The remaining loss of 157 EUR billion

would have had to be incurred by RFs and would have amounted to 2.3% of covered deposits held in

the EU banking system. On the contrary, in the non-systemic risk scenario with depositor preference,

hardly any resources would have been required from RFs and DGSs (2 EUR billion or 0.02% of

covered deposits).

Table 3.5.Back-testing: loss absorption the European Parliament's (ECON) approach

Scenario ///Loss absorption by instruments

in EUR bn (% of state aid)Systemic crisis Non-systemic crisis

Capital and capital relatedinstruments

316(67%)

316(67%)

Subordinated debt0

56(12%)

Senior unsecured debt180

65(14%)

Uncovered eligible deposits0

34(7%)

Covered deposits / DGSs 0 0

RFs 157(33%)

2(0.4%)

TOTAL state aid(recapitalisation and asset

relief measures)

473(100%)

473(100%)

Minimum DGSs(% covereddeposits)

0 0

Minimum RFs(% covereddeposits)

157(2.3%)

2(0.02%)

Minimum RFs + DGSs (%covered deposits)

157(2.3%)

2(0.02%)

The minimum amount offinancial arrangements (DGSs +RFs) foreseen in the approach

(% covered deposits)

3% 3%

Figures 3.7 and 3.8 below present the graphical illustration of loss absorption under two scenarios of

the European Parliament's approach.



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Figure 3.7. Back-testing: loss absorption under European Parliament's approach: systemic crisisscenario

Figure 3.8.Back-testing: loss absorption under European Parliament's approach: no systemic crisisscenario


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3.6. Deviation from the assumption of the symmetric crisis

The analysis above focused on real loss examples from the whole Union. Consequently, the

estimation of the needs for financial arrangements has been estimated taking into account the whole

Union area. Given that the Directive will be implemented by each Member State and individual

financial arrangements are isolated from each other (i.e. there exist no mutualisation of lossesbetween the financial arrangements), the results discussed in the previous sections are only valid in a

fully symmetric crisis19, where the losses are distributed evenly between individual Member States in

proportion to the size of their banking sector. This is an important assumption since the deviations

from this assumption would require much higher amounts in the national financial arrangements

than the ones discussed above.

As seen in the current crisis, a failure of one big bank can hardly be tackled by bail-in tools and

national resolution financial arrangements. Only pan-European financial arrangements would have

prevented the recourse to the public money. Due to the geographical asymmetry of the crisis, even if

the national resolution financial arrangements and deposit guarantee schemes had been fullyprefunded, in none of the approaches Ireland would have avoided the public support. The financing

arrangements would have had to be set at the levels going far beyond the level estimated under

these approaches in order to avoid the recourse to the public finances. The Anglo Irish Bank and INBS

required 38.2 EUR billion of state aid20, primarily in terms of capital injections; even after 8% loss

absorption by capital and other instruments, the remaining aid would have accounted to 21% of

covered deposits21.

19Where bank losses are distributed evenly between Member States in proportion to the size of their

respective banking sectors.

20State aid, in terms of recapitalisation and asset relief measures, used between 2008 and 2011. Source:

Commission services.

21Source: European Commission, ECB, DGS Survey 2010, European Commission elaborations


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4. Minimum Loss Absorption Capacity: definitions and implications

Overview of the approaches

Under all three approaches banks are required to maintain certain minimum of LAC, which is

composed of banks own funds and a portion of other liabilities selected from the eligible liabilities

pool. Minimum LAC should serve as the very first buffer that has real and immediate loss absorbing

capacity. One should be able to trust the presence of LAC if an institution fails. The following three

features determine the actual composition, size and of the LAC.(i) Required quality of liabilities in the LAC:

COM requires certain loss absorbing features that would guarantee immediate bail-in only to certain

subordinated liabilities that dont fall under the definition of Additional Tier 1 or Tier 2 instruments.

Other eligible liabilities can thus be added to the LAC without any specific criteria as to their

maturity, ownership, etc. CN approach on the other hand extends the loss-absorbing features to be

fulfilled also by other eligible liabilities, however at the same time it excludes deposits, derivativeliabilities from the scope of the LAC.

(ii) Level and basis of assessment of the minimum LAC:

The basis for determining the appropriate minimum level of LAC differs under the three approaches

in the following way:

COM: LAC = own funds + eligible liabilities / (total liabilities)

CN: LAC = own funds + eligible liabilities / (total liabilities + own funds - derivative liabilities)

EP: LAC = own funds + eligible liabilities / (total liabilities - covered bonds).

Assessment of the approaches

CN approach appears to ensure the easiest implementation and mobilization of the liabilities that are

part of the LAC as they all need to have certain quality features to ensure bail-in success. Should the

LAC be only composed of own funds and subordinated liabilities, then the COM approach would be

on par with CN especially since both approaches require the liabilities to have remaining maturity of

at least 1 year. However, if banks under the COM approach include other types of eligible liabilities to

LAC (e.g. senior unsecured, derivatives or deposits), it may later prove impossible for whatever

reason (time, complexity) to bail them in.

In addition, what matter in an equal way is the way how the LAC should be determined. The three

approaches differ as to the basis/denominator against which the authorities should determine the

sufficient amount of LAC.

In particular CN and EP exclude specific type of liabilities from the denominator. This endangers the

level playing field across the varying banking models and could promote more risk taking and moral

hazard.

- In this vain, the CN approach appears to be more in favour of bigger trading banks who could

disregard their derivative liabilities when assessing the minimum amount of LAC.


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- EP approach creates similar result however for different types of banks. Excluding covered bonds

from the basis that should be used to determine loss absorbing capacity of a bank creates incentives

for unlimited asset encumbrance.

Total assets is the most appropriate basis on which to determine the LAC for a bank. Losses arise and

impact the whole of the asset side of a bank, regardless of what is being assumed is one or the otherbanks perceived riskiness. CN approach would be preferred if derivatives were not excluded from

the baseline or COM approach should the basis include own funds.

Table 2.6 shows the level of min LAC levels different types of banks would have under the three

approaches to calculate the minimum level thereof. If the 8% of eligible liabilities over total assets is

taken as a benchmark, it is evident that depending on the varying levels of denominator due to

exclusions some banks would need to hold much less LAC in absolute value than others.

Table 4.1.Comparison of the MREL (minimum LAC) under the three approaches

2012YE

EuropeanBanks

(45)

Big Banks(25)

Mediumbanks

(20)

Big Banks -market

(9)

Big Banks -retail

(13)

8% 8% 8% 8% 8%

COM: LAC = own funds + eligibleliabil ities / (total

ass ets - own funds)7.64% 7.62% 7.60% 7.69% 7.56%

CN: LAC = own funds + el igible l iabi l i ties / (total

ass ets - derivative liabil ities)6.72% 6.58% 7.51% 5.84% 7.41%

EP: LAC = own funds + el igible l iabi l ities / (tota l

ass ets - own funds - covered bonds).7.24% 7.28% 6.27% 7.38% 7.10%


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Appendix 1. Data used in the back-testing analysis22

Bank

Referenceyear forbalancesheet

Totalassets;EURbillion Country

Kommunalkredit 2008 37.4 AT

VAG 2008 55.8 AT

BAWAG 2009 41.2 AT

Ethias 2008 28.6 BE

KBC Group 2008 355 BE

Fortis 2008 974 BE

WestLB 2008 288 DE

Hypo Real Estate 2008 420 DE

HSH 2008 208 DE

BayernLB 2008 422 DELBBW 2008 448 DE

Commerzbank 2008 625 DE

NordLB 2011 227.6 DE

ATEBank 2010 30.431 EL

CAM 2011 70.8 ES

Banco Valencia 2011 22.5 ES

UNIMM 2011 29.3 ES

Catalunya Banc 2011 77.00 ES

NCG Banco 2011 72.2 ES

BFA 2011 312.3 ES

Dexia 2008 651 FR/BE

INBS 2009 13.3 IE

Anglo Irish Bank 2008 101.32 IE

Bank of Ireland 2009 197 IE

Parex 2008 3.369 LV

ABN Amro/Fortis Netherlands 2008 367.7 NL

AEGON 2008 287 NL

ING 2008 1332 NL

SNS Reaal 2008 125 NL

RBS 2008 2219 UK

Lloyds 2008 436 UK

Northern Rock 2008 104.3 UK

ec bail-in - comparative analysis 221013

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