Bail in Mechanisms in the Bank Recovery and Resolution Directive

Abstract

With the adoption of the Bank Recovery and Resolution Directive, Europe has completed one of the three important pillars of the Banking Union. This directive introduces the resolution tool of ‘bail in’ that aims at putting the burden of bank rescue operations with the private sector. Bail outs financed with public money must be avoided, as a result of this new mechanism. The original ideas for contingent capital instruments had been developed by the Bazel Comite on Banking Supervision in 2010, albeit that the concepts of the Bazel Comite aimed at forcing the bank’s shareholders and creditors to contribute to loss absorption exclusively in situations where a bank was beyond a point of viability. The manner in which that concept was described at the time of issue of the report in 2010, suggested that the contingent capital mechanism was particularly to be applied in circumstances where a bank’s operation were still going concern. The European transposition of the ideas of the Bazel Comite has taken place at the level of two different frameworks. On the one hand certain bank regulatory capital providers will be obligated to accept a contingent capital mechanism resulting into write down of debt or conversion of debt to equity if certain regulatory triggers apply. Such regulatory triggers are not necessarily clear evidence that a bank is beyond a point of viability. To the contrary, the trigger as defined in European law suggests that a bank may be financially healthy, albeit that certain constraints in the regulatory capital base became imminent. The other framework where a contingent capital mechanism have been introduced, concerns the bail in mechanism of the BRRD. The distinction between the objectives of the two frameworks is not easy to make. One cannot distinct the contingent capital mechanism in the framework of common regulatory capital rules by stating that it applies only if a bank’s operation is going concern, whereas BRRD only applies when the bank’s operation is gone concern. Both frameworks aim at safeguarding the continued operations of banks. In this working paper we explore further differences and question whether or not the European lawmakers have sufficiently aligned the applicable rules of both frameworks with each other. In the meantime practice develops where it seems that banks aim at issuing debt capital instruments aligned to avoid the application of the BRRD bail in mechanism, by introducing relative high triggers resulting into recapitalization of the bank at a very early stage and prior to recovery or resolution mechanisms become applicable to the bank.