Handling bank failures: JRC research feeds into Commission proposal for revised crisis management and deposit insurance framework

The European Commission today puts forward a legislative proposal for a reformed bank crisis management and deposit insurance (CMDI) framework. The proposal improves the rules for handling bank failures, while preserving financial stability, protecting depositors, and further limiting the use of public financial resources.

The JRC has contributed to the proposed revision of the CMDI with a broad assessment of policy options for managing bank crises in an orderly and economically efficient manner by protecting financial stability and depositors, while reducing recourse to taxpayers’ money. The assessment is published in the report Quantitative analysis on selected deposits insurance issues for purposes of impact assessment.

The CMDI framework

The CMDI framework consists of three EU legislative texts and provides a set of instruments that can be applied in the different stages of the lifecycle of banks in distress: the Bank Recovery and Resolution Directive (BRRD - Directive 2014/59/EU), the Single Resolution Mechanism Regulation (SRMR - Regulation (EU) 806/2014) and the Deposit Guarantee Schemes Directive (DGSD - Directive 2014/49/EU).

Despite the progress achieved in promoting a stable and integrated financial system, the EU resolution framework has not been sufficiently applied in practice. Therefore, some of its original objectives, such as shielding public money from the effect of bank failures, risked being achieved only partially.

In fact, the evaluation of current rules to handle a bank crisis has identified challenges that could hinder consistent protection of depositors and limit the application of predictable and consistent solutions for all types of banks across Member States.

To address these issues and enable the framework to fully achieve its objective, the JRC assessment of policy options highlights remedies to some of the challenges. The assessment:

• finds that EU-wide harmonisation and higher level of protection of the temporary high deposit balances (THDBs) – resulting from important life events, such as real-estate transactions – would safeguard the wealth of households while limiting the burdens on guarantee schemes.
• applies JRC models to provide estimates of the potential loss-absorption capacity of banks under different funding options and creditor hierarchies in resolution and insolvency. The models identify policy solutions that can facilitate the use of deposit guarantee schemes in crisis situations, outside of payout events.
• highlights how a European deposit insurance scheme (EDIS) could reinforce the protection of depositors and estimates the effects of using different methods for the calculation of risk-based contributions to EDIS.

The coverage of high deposit balances

Temporary high deposit balances (THBs) arise when large deposits remain in bank account for a limited period following certain life events involving large payments, such as deposits resulting from real estate transaction, insurance benefits or other compensations.

The current legislation, the Deposit Guarantee Schemes Directive (DGSD), allows some flexibility in the protection of temporary high deposit balances and therefore the coverage varies between countries. Specifically, according to Article 6(2) of the DGSD, Member States are required to ensure that temporary high deposit balances are protected above EUR 100 000 for at least three months and no longer than 12 months after the amount has been credited or from the moment when such deposits become legally transferable.

The JRC report presents an analysis to assess the financial impact of harmonising the coverage of the temporary high deposit balances. The analysis shows that — given the substantial share of household wealth represented by some of these transactions — an increase of the level of protection up to EUR 500 000 for 6 months might improve the protection of the wealth of households involved in real estate transactions, with respect to the current situation in case of failure of the bank where the deposit is held. This policy option appears to pursue the policy objective of enhancing depositor confidence while limiting the burden on guarantee funds.

Funding in resolution and insolvency

The JRC developed SYstemic Model of Banking Originating Losses (SYMBOL) has been used extensively to analyse the loss-absorbing capacity of banks and the performance of crisis management frameworks under different crisis scenarios and alternative policy options. In particular, the JRC team contributed with technical expertise and modelling support to the work of the European Banking Authority (EBA) on the review of the CMDI.

This analysis shows that a revised CMDI framework would allow more banks to access resolution financing in case of a crisis, especially medium and small banks, and would ensure a more efficient use of resources as well as the ability of national deposit guarantee scheme to effectively intervene in resolution.

SYMBOL is the workhorse model of the European Commission for the estimation of impacts of alternative regulatory and institutional designs on the outcomes of banking crises. The tool has been used to evaluate banking-related policy questions and to analyse the impact of changes in a wide range of regulatory frameworks. The model was originally developed to provide scientific evidence in support of decisions on harmonising the level of protection of EU citizens’ deposits.

Once the Commission started working on its ambitious banking regulatory reform agenda, JRC applied the model to estimate the potential effects of selected measures for the banking sector (e.g., capital requirements, use of bail-in, resolution tools, alternative designs of deposit guarantee schemes) and is also using the model to estimate the potential impact of banking losses on public finances.

A step toward a common European deposit insurance scheme

In 2015 the European Commission proposed to create a common European deposit insurance scheme (EDIS), with the aim to provide a more resilient tool to protect depositors below EUR 100 000 against bank failures.

The JRC report, which builds on the work originally developed for the EDIS Effects Analysis paper, assesses how national deposit guarantee schemes (DGS) pay-out capacity would change if they would be replaced or complemented by a common European fund. Specifically, the assessment estimates that a system with joint financial means and joint liability, such as EDIS or a hybrid model (where a central EDIS coexists with national DGSs), would be more effective and efficient in providing liquidity support than a scheme based solely on national DGSs, and it would effectively protect a larger share of depositors.

A common fund would therefore be considerably less likely to fall short on pay-outs than a national DGS. Pooling of resources is estimated to increase the probability of a full protection of deposits in case of a crisis, and delivers a higher efficiency for various EDIS designs, potentially creating room for lowering the target level and consequently the contributions from the banking sector.

Risk-based contributions and additional indicators

The European Banking Authority (EBA) has published detailed guidelines on methods to calculate risk-based contributions to DGSs.

Scenarios simulating the implementation of those guidelines have been developed by the JRC, in order to show the differences in banks’ contributions under the actual national schemes on the one hand and a potential common scheme (EDIS) on the other. The JRC report provides a comprehensive assessment of potential contributions under alternative methodologies including several risk factors, such as capital ratios, liquidity and funding ratios, asset quality and non-performing loans, or concentration for sovereign exposures.

Reference:

Bellia, M., Calès, L., Di Girolamo, F., Joossens, E. and Petracco Giudici, M., Quantitative analysis on selected deposits insurance issues for purposes of impact assessment, EUR 31391 EN, Publications Office of the European Union, Luxembourg, 2023, ISBN 978-92-76-61824-9, doi:10.2760/60440, JRC132364.