The European Commission’s proposed revisions to the Crisis Management and Deposit Insurance Framework

Relevant to:

Board members; risk, compliance and finance leads; heads of resolution planning, heads of regulatory affairs and other interested executives of banks operating in the European Union.

At a glance

• The European Commission proposed revisions to the Crisis Management and Deposit Insurance (CMDI) Framework on 18 April 2023. The reforms aim to increase the protection of depositors in case of a bank failure, to harmonise resolution practices across the EU and to bring a broader range of small and medium-sized banks under the resolution framework.
• The Commission’s intention with its CMDI proposals is not to overhaul the framework, which it judges to be functioning well, but to amend it so that resolution strategies are more frequently and consistently used across EU jurisdictions and to promote a more level-playing-field between banks.
• The proposal comes in the aftermath of the recent banking market stresses which highlighted the need for more predictable and harmonised resolution practices. The Commission's proposal, however, does not address the last pillar of the EU’s Banking Union architecture, i.e., the European Deposit Insurance Scheme (EDIS), where legislative progress has been stalled since 2015, nor does it include further measures to harmonise national insolvency regimes in the EU.
• The CMDI framework will expand the application of resolution tools to banks with regional business models and increase the burden of proof for resolution authorities to show that resolution is not in the public interest. This will translate into higher short-term compliance costs for the medium- and smaller-sized banks that will be newly captured by the scope of the resolution strategies as well as putting pressure on them to focus on their resolvability.
• New amendments aimed at enhancing the credibility of resolution strategies and the availability of funding in resolution would allow Deposit Guarantee Schemes (DGS) to support resolution activities based on transfer transactions.
• The CMDI proposal also includes changes to the depositor creditor hierarchy, with the introduction of a single tier of depositor preference. The Commission’s aim is to facilitate the use of DGS funds to support resolution and to avoid the imposition of losses on depositors in cases of failure.

Background and context on the EU Crisis Management Framework

On 18 April, 2023, the European Commission proposed a package of changes to the CMDI framework: the Bank Recovery and Resolution Directive (BRRD), the Deposit Guarantee Scheme Directive (DGSD), and the Single Resolution Mechanism Regulation (SRMR). In addition, the Commission also proposed amending the “Daisy Chains” aspects of the minimum requirement for own funds and eligible liabilities (MREL).

These changes have been expected since the Eurogroup published its position on the CMDI in June 2022, which urged a review of the recovery and resolution framework to ensure consistent and effective rules across the EU as a key part of completing the Banking Union.

Recent stresses in global banking markets have brought renewed attention to the publication of these proposed changes and the extent to which the Commission is eager to harmonise the framework across the EU, by facilitating resolution practices and increasing predictability for banks in distress.

What changes have been proposed...

Following the blueprint published by the Single Resolution Board (SRB) in 2021 and the Eurogroup statement in 2022, the CMDI revised framework aims to expand the scope of resolution by making changes to the Public Interest Assessment (PIA) articles in BRRD. The Commission specifies that banks’ critical functions should be evaluated at “national or regional level”, expanding the application of resolution tools to banks that have regionally focused business models. The proposal amends the resolution objectives articles of the BRRD to specify that insolvency should only be pursued if it meets the national resolution authority’s (NRA) objectives better than a resolution strategy – significantly increasing the burden of proof for resolution authorities to show that resolution is not in the public interest. The Commission’s stated goal with these changes is to broaden the application of resolution strategies. It does not, however, provide an estimate of the number of banks that would now be in scope as there would still be some element of discretion by NRAs. While improved consistency in the application of resolution strategies and tools will likely be welcomed, there are potential challenges for small and medium-sized banks that could face higher MREL requirements, resolvability, and resolution planning demands as the scope of the framework is widened.

Another major objective of the Commission with this proposal is to strengthen the availability of funding in resolution without imposing losses on depositors – something it points out is particularly difficult for small and medium-sized banks given their funding structure. This is also made more challenging by the existing requirement in EU law that resolution authorities must bail in at least 8% of a bank’s total liabilities and own funds (TLOF) in order to access resolution funding. To address this and to increase the credibility of resolution strategies that are based on the use of bridge banks, the Commission has proposed amendments to the BRRD and DGSD that would allow DGSs, under certain conditions, to provide support for resolution actions that are based on transfer transactions and that include covered deposits. The Commission adds to this by including an amendment that would allow the 8% TLOF bail-in requirement to be satisfied in part by the DGS contributions for banks which have MREL requirements that include both loss-absorbing and recapitalisation amounts. In seeking to reinforce market discipline and limit any moral hazard risk arising from these changes, the Commission specifies that a resolution strategy that used the DGS to access resolution funding would require the failed bank to exit the market.

In order to simplify the treatment of depositors in resolution, the proposal introduces amendments that create a single tier of depositor preference in the creditor hierarchy (instead of the current three-tier system). If adopted, both insured and uninsured depositors would rank above ordinary unsecured claims in insolvency (whereas presently, in most EU Member States, they rank pari passu). In the Commission’s view, this will facilitate the use of DGS funds to support resolution and will reduce the risk of financial stability repercussions arising from imposing losses on depositors. In particular, it is expected to limit the risk of No Creditor Worse Off (NCWO) challenges to bridge bank resolution strategies where all depositors of a failing bank are transferred to another institution.

A number of other amendments are included with the view to operationalising the resolution and MREL frameworks more effectively, including one that allows resolution authorities to permit banks to comply with the MREL subordination requirement using structurally subordinated liabilities that qualify as loss absorbing under the CRR de minimis exemption. Other amendments to the BRRD focus on clarifying and limiting the circumstances under which authorities would be permitted to carry out a precautionary recapitalisation of a bank. Further amendments to the DGSD standardise the scope of coverage for depositors with temporary high balances; strengthen the coverage of depositors in branches of a bank which has passported into another Member State; and clarify the circumstances under which a DGS can cover deposits made in a non-EU branch of an EU bank.

Beyond the proposals included in the CMDI framework, the Banking Union will remain incomplete as it is still missing its third pillar: the EDIS, where the Commission’s 2015 proposal has long been stalled in legislative negotiations. The smaller changes proposed in the CMDI revisions are a tacit acknowledgement that more targeted revisions to the EU crisis management regime are now being prioritised over pushing for a breakthrough on EDIS.

...and why they will matter

The proposed review does not completely overhaul the approach already established in the CMDI framework, rather it aims to harmonise a number of existing practices and enhance the credibility of certain resolution strategies for a wider set of banks. The Commission has also proposed these changes in order to push for a more consistent use of resolution strategies for failing banks across Member States.

Some of the proposed changes in the CMDI framework could have significant implications for how banks carry out their resolution planning, with potential consequences for their costs and capital structure.

• A wider framework scope. The amendments to thePIA will put further pressure on NRAs to widen the scope of banks that have resolution strategies as their preferred approach. This will likely increase consistency in the use of resolution tools across the EU banking sector, creating a more level playing field among some banks. However, small, and medium-sized banks that are newly identified by resolution authorities as being likely to be subject to a resolution strategy in failure will face higher near-term compliance costs. They are also likely to face increased MREL funding requirements (as well as the need to issue debt in more challenging funding markets) if resolution authorities set higher MREL targets to reflect the change in their preferred resolution strategy.
• An enhanced protection of depositors against the risk of bearing losses. The change of depositor preference in the creditor hierarchy aims to enhance and harmonise the protection of depositors by distinguishing deposits from other liabilities that can bear losses in case of failure. It is also meant to reduce substantially the risk of NCWO challenges to resolution strategies that transfer all deposits (insured and uninsured) from a failing bank to a bridge bank. Any change to the creditor hierarchy/depositor preference rules, however, may come at a high cost for some banks, as this may have a significant impact on existing claims and funding including funding costs for ordinary unsecured claims.
• Access and contribution to DGS funds. The proposed revisions to the DGSD clarify the conditions under which the use of the DGS is allowed, for example to support a transfer transaction that includes covered deposits. The Commission’s aim here is to enhance the credibility of resolution strategies, particularly for medium-sized banks, and allow resolution authorities to act more quickly and effectively. The need for speed has been underlined by recent events in the banking sector that have shown that bank failures can happen rapidly and require a very timely response by authorities. The amendment allowing DGS contributions to count towards the 8% TLOF minimum makes the target more achievable in some cases, but it may be seen by some as a distortion of incentives for banks to build up sufficient MREL – indirectly penalising those banks’ that already have enough loss absorbing capacity to meet the TLOF minimum.
• Resolvability. Where new banks are assessed to come under the scope of resolution strategies due to the proposed amendments to the PIA, they will then need to undertake considerable and ongoing work focused on improving their resolvability. The demands they will face to demonstrate their resolvability are likely to be in line with the SRB’s “Expectations for Banks” requirements for entities under the Banking Union umbrella. A key challenge for banks newly falling in-scope of resolution strategies and stabilisation powers will be determining how to meet these expectations in a timely and proportionate manner.

Next steps

The review of the CMDI has been long in the making and political scrutiny of this proposal will likely be heightened given the recent turmoil in the banking sector. Additionally, these proposals are expected to raise concerns on politically sensitive issues (such as the broader scope of the resolution framework, use of DGS funds and the potential impact of the changes on Institutional Protection Schemes). This means that the CMDI proposal arrives in a legislative climate where some legislators and Member States already have significant reservations about it.

It is unlikely that this file will make rapid legislative progress and we expect negotiations in the European Council and Parliament to proceed slowly and extend over the course of this year and next. With the end of the current EU political cycle in sight (June 2024), we expect an agreement before this point to be difficult to reach. If negotiations end up continuing into the term of the next European Parliament, the timing and path forward for an agreement becomes significantly less clear.