Concrete proposals to strengthen Europe's crisis prevention framework are currently being discussed at the European Council and at the European parliament, with improved regulation and the creation of the “European Systemic Risk Board” and the “European Supervisory Authorities”, including a “European Banking Authority”, as key outcomes (see de Larosière 2009a and 2009b). However, even the best crisis prevention structure is not a guarantee against the occurrence of a crisis, which suggests that Europe also needs to strengthen its resolution framework. Dominique Strauss-Kahn (2010) has recently called for the creation of a European resolution authority. The situation in which each European country has a different resolution framework, indeed, reached its limits in the recent crisis.
When faced with an ailing, systemically important institution, a resolution authority works like a team of doctors in an emergency room.
- The emergency physician first stabilises the patient.
- Then, the surgeon may operate to restore the patient's “long-term” viability.
- If the disease is incurable, palliative measures may be applied to help the patient depart in peace.
These different stages are familiar to resolution authorities.
In an emergency situation, they first attempt to rescue the ailing bank. This often necessitates tapping public funds if no private sector solution can be found. In the second stage, the restructuring phase, authorities may undertake an open bank resolution, which involves the restructuring of a bank's assets and liabilities and a review of its business strategy. Alternatively, if viability cannot be restored, authorities will move to a closed-bank solution, aimed at orderly liquidation.
The current European framework for banking crisis resolution contains an additional feature. Namely, state aid to institutions must be authorised by the European Commission. In this context the Commission has played an important role in the recent crisis – despite its essentially micro-perspective and the systemic nature of the crisis – and has aided in coordinating member states’ actions, minimising distortions of the level playing field and mitigating moral hazard.
The Commission’s powers resemble somewhat those of a resolution authority, especially in the restructuring phase associated with state aid. Namely, the Competition Directorate General assesses aided institutions' viability and evaluates their restructuring plans. If the Commission judges that viability cannot be restored, it may not authorise the state aid and may require a liquidation plan.
Although, in the current European framework for crisis resolution, the Commission is not called upon to intervene directly in the rescue phase of the resolution process, it has undoubtedly influenced national resolution authorities' behaviour. The Commission has published several communications describing its assessment criteria for different interventions (impaired assets, funding guarantees and recapitalisations), discussing for example required remuneration and behavioural conditions imposed on banks. The Commission's past decisions have also created precedents that allow national authorities to infer how the Competition Directorate General would likely assess their case.
Yet, despite its influence on the rescue and restructuring processes, the Commission is not a resolution authority, as it does not decide upon the resolution path nor does it pay the final bill. At most, it acts as a referee, both between different member states and between the aided institution and its competitors.
Assigning the Commission the role of a resolution authority would require eliminating hurdles that may be difficult to overcome in the short term. In particular, the Commission's powers in the rescue phase would need to be redefined. For example, a resolution authority must be able to initiate and coordinate a private-sector solution that would not require state aid. In addition, a resolution authority must have access to public funds. Different options might be considered, including creating a European resolution fund financed by the private sector, as recently suggested by Commissioner Barnier (2010). A second issue relates to the need to explicitly clarify how the Commission should arbitrate the trade-off between competition and financial stability. Finally, the accountability issue would need to be addressed.
An alternative possibility to improve the current framework, if creating a European resolution authority is not possible or desirable in the short term, would be to assign the Commission a more prominent role in coordinating national resolution authorities. Dispersed initiatives, some of which are still in the reflection phase, have been launched. These form a patchwork which, once integrated, should reinforce the resolution framework and facilitate this coordination role. The initiatives relate to issues as diverse and challenging as the development of a common resolution toolkit for national authorities, recognition of the group dimension in insolvency laws, burden sharing between states and with the private sector, etc.
An additional avenue worth exploring to reinforce the coordination role of the European Commission would be to evaluate whether the Commission could integrate, in its state aid assessment criteria, national resolution authorities' behaviour to determine if non-cooperative solutions were privileged by some countries at the expense of other countries. This assessment would likely have a positive influence on group dynamics in the early phases of the rescue process, as it would limit the incentives for authorities to act non-cooperatively and would favour a coordinated, orderly restructuring, creating positive externalities for the whole financial industry.
European institutions have played an important role in the resolution of the crisis, which has constituted strength for Europe. Yet, the resolution framework still exhibits intrinsic weaknesses. It is therefore crucial, for the various authorities involved in crisis resolution, including European policymakers, national authorities in charge of prudential control and national ministries of finance, to collectively determine how the necessary reforms could take advantage of these strengths.
Peter Praet and Gregory Nguyen are respectively executive director and senior economist at the National Bank of Belgium. The views reflected are the personal views of the authors.
Barnier, Michel (2010), "Laying the foundations for crisis prevention and management in Europe", European Commission conference on Cross-Border Crisis Management, Brussels, 19 March.
Basel Committee on Banking Supervision (2010), “Report and Recommendations of the Cross-border Bank Resolution Group”, March.
de Larosière, Jacques (Chair) (2009a), “Proposal for a regulation of the European Parliament and of the Council on Community macro prudential oversight of the financial system and establishing a European Systemic Risk Board”, Commission of the European Communities, Brussels, 2009/0140, September.
de Larosière, Jacques (Chair) (2009b), “Proposal for a regulation of the European Parliament and of the Council establishing a European Banking Authority”, Commission of the European Communities, Brussels, 2009/0142, September.
European Commission (2009), “Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee , the European Court of Justice and the European Central Bank on An EU Framework for Cross-Border Crisis Management in the Banking Sector", Brussels, 561/4.
Strauss-Kahn, Dominique (2010), “Crisis Management Arrangements for a European Banking System: Building a Crisis Management Framework for the Single Market”, Keynote speech, European Commission conference on Cross-Border Crisis Management, Brussels, 19 March.
 See, for instance, European Commission (2009) which raises issues such as early intervention, resolution toolkits and insolvency laws or, at the international level, Basel Committee on Banking Supervision (2010) with recommendations on issues such as convergence of national resolution measures, planning in advance for orderly resolution (living wills), transfer of contractual relationships, etc.