Exploring Governance Issues between the SRB and the ESM in the Use of the Common Backstop

Abstract

To date, the resolution of the Banco Popular Espanol, being the first and only resolution case in the euro area, has had the “benefit” of bringing to light several shortfalls of this crisis management system. Back then, thanks to the sale of business, the need of the use of the Single Resolution Fund (SRF) has been avoided, prompting criticism on whether the fund had sufficient means to overcome a major widespread crisis. During the period elapsed from the last financial crisis, the euro area banking sector has built capital and liquidity buffers, which were aimed at protecting them for future shocks. Although it is now widely accepted that crises are of a cyclical nature, new risks and the high interconnectivity of today’s economic activities brought an unexpected crisis due to the current pandemic. The consequences of this unprecedented event in modern history had severe effects to the worldwide economy, mostly for the boundless block of labour activities, which caused severe losses for households, enterprises and governments that consequently affected the financial intermediation function of the banks. Concerning the European Stability Mechanism (ESM), the current pandemic has had the effect to put temporary on hold the discussion on the revision of the ESM Treaty, including its role as a Backstop to the SRF, so that the Mechanism could experience a new role through the ESM Pandemic Crisis Support. In such a framework, this paper aims to bring back the attention to the unfinished path in the establishment of the Common Backstop by addressing an important element of risk, namely its decision-making process. The main aim is to explore possible governance issues, which could hamper a timely and effective use of the Common Backstop, in the case that the SRF would be depleted and no alternative funding sources would be available.