DEVLHON Consulting Deciphers: Banking Crisis Resolution – Assessment and Outlook Based on Banque de France Analysis
Since the 2008 financial crisis, the management of banking crises has significantly evolved, with banking resolution now central to strategies that secure the financial sector without systematically relying on public funds. In this article, DEVLHON Consulting presents an analysis from Banque de France, offering an assessment of the banking resolution framework in Europe and insights from recent financial crises.
Foundations of Banking Resolution: Protecting Public Finances
The 2008 crisis left financial systems with complex challenges. At the time, governments had no choice but to bail out struggling banks at the taxpayers’ expense or let them fail, risking prolonged economic instability. Since then, banking resolution mechanisms have been implemented, allowing authorities to restructure or even liquidate failing banks in a controlled manner, minimizing public impact.
The Banque de France’s analysis highlights the central role of banking resolution within the European Union, which rests on three pillars: the resolution mechanism itself, centralized banking supervision, and harmonized deposit insurance. These tools allow authorities to secure banks while ensuring that shareholders and creditors are the primary contributors in case of bank failures.
Banking Resolution Instruments in Europe
European banks can be placed in resolution through two main avenues:
Bail-in: This internal recapitalization mechanism requires shareholders and creditors to absorb the losses of a struggling bank before public funds are mobilized. This preferred approach limits the impact of banking crises on public finances.
Transfer Operations: In certain cases, it is possible to transfer healthy assets and activities to an acquirer or a “bad bank,” thereby isolating compromised assets and stabilizing the remaining institution.
Funding Banking Resolution Through Mutualization
Funding resolution efforts is essential to limiting the impact of banking crises. The Single Resolution Fund (SRF), funded by bank contributions, is used in Europe to limit direct state intervention. In its analysis, Banque de France points out a significant difference with the American model, where authorities have access to a more flexible federal fund, enabling quicker interventions.
In Europe, authorities favor an approach that breaks the link between banks and states, requiring national banking sectors to pool their efforts within the SRF, which may limit intervention speed. Thus, before public funds can be used, banks must demonstrate their loss-absorbing capacity, in accordance with MREL (Minimum Requirement for Own Funds and Eligible Liabilities) standards, which are more stringent than the American TLAC (Total Loss Absorbing Capacity) standards.
Lessons from the 2023 Banking Turmoil
The recent bank failures in Europe and the United States in 2023 provide valuable lessons for the European resolution framework, according to Banque de France. While European mechanisms have proven effective, certain aspects require adjustment. Recent crises, such as the acquisition of Credit Suisse, demonstrated that interventions must be able to proceed swiftly, especially when facing massive deposit withdrawals driven by digital tools.
In this context, the United States was able to intervene quickly using federal liquidity facilities. In Europe, however, banks lack access to such liquidity facilities in times of crisis, which could jeopardize the stability of the European financial sector.
Banque de France Recommendations to Strengthen Banking Resolution
To address current challenges, the Banque de France’s analysis recommends improvements to the European resolution framework:
Strengthening Capital Requirements: Imposing higher loss-absorption capacity on small and medium-sized banks, in addition to large institutions, to reduce contagion risks.
Diversifying Resolution Tools: Using a combination of resolution instruments (bail-in, asset transfers) to adapt to new forms of crises, including geopolitical, climate, and digital risks.
Establishing a European Emergency Liquidity Facility: Creating a dedicated European liquidity facility would support banks without threatening market stability during periods of massive deposit withdrawals.
Conclusion
In just over a decade, banking resolution has solidified its place in the architecture of the European Banking Union. However, as Banque de France points out, the current framework must evolve to adapt to new vulnerabilities in the banking sector. Reinforcing loss-absorption standards, adopting a more flexible approach, and providing emergency liquidity would ensure the financial sector’s resilience in the face of future crises.