EU audit: Reconstructing failing banks still work in progress

A new audit report published last week by the European Court of Auditors (ECA) concludes that the special board set up by EU to reconstruct failing banks is still very much work in progress. The Single Resolution Board was established in 2015 in the wake of the 2008 financial crisis and is considered a key element in the European Banking Union.

Its main mission is to resolve failing banks with as little impact as possible on the financial stability and real economy of euro area Member States and others.

The auditors admit that the task of setting up the SRB from scratch in a very short timeframe posed a significant challenge. The SRB became fully operational only in 2016 and maybe it was too early for ECA to carry out an audit.

On the other hand ECA identified so many shortcomings in SRB’s preparation of “resolution” plans that without an external audit they have might passed unnoticed and never been corrected. Kevin Cardiff, the ECA member responsible for the report, does not mince his words: “Although its weaknesses must be seen in the start-up context, there is still a long way to go.”

“Resolution” is defined as the orderly winding-up of a failing bank to ensure the continuity of its essential functions and to preserve financial stability. It aims also to protect public funds by minimizing reliance on extraordinary public financial support. If there is a public interest, the bank is resolved (reconstructed); otherwise, national insolvency procedures apply.

EU itself does not contribute to the funding of resolutions. For this purpose a Singe Resolution Fund has been established. All banks contribute to the fund, which currently has financial means of 10.7 BN EUR. Its target is to collect 1% of the amount of all guaranteed deposits in the Eurozone up to 2024, which equals 55 BN EUR.

As of January 2017 the SRB covered 141 banks, representing over 80 % of total banking assets in the euro area. National resolution authorities are responsible for the resolution of all other banks at national level, approximately 3 250 legal entities. The auditors examined in-depth a sample of 58 complete resolution plans.

What surprises the reader of the audit report is that the resolution plans, so far, did not meet the standards laid down in a rule book which was adopted prior to the establishment of the SRB. A main cause to the low quality of the resolution plans seems to be staff shortages.

SRB has consistently been behind its staffing targets. “The situation is most serious in the recruitment of resolution and policy experts,” says the audit report. But this does not explain all findings in the report. There is obviously also room for improvement in the cooperation with the European Central Bank and the national resolution authorities.

To assess the feasibility of liquidation, the SRB must examine whether the bank’s management information systems are capable of reporting on the total value of covered deposits per depositor. This is needed because failed banks are required to pay out a guaranteed amount of 100 000 euro per depositor within a given timeframe.

The auditors write that they did not find any information in the sampled resolution plans regarding the amount of available deposit guarantee funding to facilitate such an assessment. Asked by The Brussels Times whether the issue was addressed in the report, the audit team replied that the assessment was outside the audit scope.

Resolution plans are important when a bank gets into a crisis, but nevertheless they are “only” plans. Among other points, the auditors write that the SRB has not so far determined minimum requirements for banks’ own funds and eligible liabilities (MREL), based on the so-called Basel standards, to prevent a bank from getting into troubles.

The auditors make a number of recommendations relating to the rules and guidance for resolution plans. They also address issues of staffing and SRB’s legislative framework. The recommendations are largely accepted by SRB but until they are fully implemented there is still room for concern in case of a new bank crisis.

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