S&P: Without resolvability, Europe’s banks are In a halfway house

18-Jul-2019

2019 marks a milestone in EU bank resolution planning, S&P Global Ratings noted in a report published today. We see it as the halfway point between the May 2014 creation of the Bank Recovery and Resolution Directive (BRRD), the cornerstone piece of legislation that created a harmonised vision of how EU resolution frameworks would operate, and the January 2024 deadline for many EU banks to have built their bail-in buffers or, better, be substantially resolvable. It is maybe not surprising, therefore, that many systemically important European banks find themselves in a halfway house. Behind them, widespread taxpayer bailouts so visible in the financial crisis, and ahead resolvability, albeit not yet in sight. Among their global peers, this continues to place European banks and their regulators in a particularly awkward position.

Bank resolvability is naturally a long-term project. The creation of fully functioning resolution frameworks and resolvable banks--the transition from bailout to bail-in--requires a quantum leap from a legal, structural, and practical perspective. Banks and their regulators also have many other competing preoccupations and investment needs--they cannot achieve everything at once.

Positively, we see progress across the board, but there is also significant divergence--from jurisdictions like Switzerland and the U.K. leading the way with the U.S., to others that follow behind, often taking their lead from the continent's most influential resolution authority--the Single Resolution Board.

Without adequate resources with which to restore a failed bank to solvency, resolution could fail. A rapid ramp-up of banks' bail-in buffers seems critical because BRRD and European state aid rules now heavily constrain authorities' ability to support failing banks. Positively, we have seen substantial progress in the past two years, but it remains centered on the most important players in the strongest markets.

The substantial completion of regulatory rulemaking in the past year has provided investors with enhanced insight into how resolution frameworks should operate in Europe. We see a significant risk, though, that one critical element of successful resolution--predictability--could prove elusive. This arises anyway from the fact that resolution frameworks are novel and relatively untested--there is no strong track record to guide how decisions would be made in future. However, even within the EU, marked differences in national implementation and national insolvency frameworks lead to a fragmented picture and undue uncertainty. Bank disclosure is slowly improving, but investors often face significant guesswork when trying to understand a bank's resolution strategy, the size and composition of its buffer requirements, the prospects for its subsidiaries, and whether the institution is substantially resolvable or not.

With the focus now squarely on implementation, we expect substantial progress across a number of these fronts in the coming 18 months. Among them, agreeing and implementing a liquidity backstop in the banking union would be a critical step forward. The ramp-up of bail-in buffers will continue to support upgrades of our issuer credit and resolution counterparty ratings on systemically important European banks, but only where they are credible and the resolution strategy is likely to avoid default on all senior preferred liabilities.