8% – We had a deal!

Europe’s “8% rule” requires bank shareholders to cover losses on up to 8% of the bank’s balance sheet. It is the embodiment of the EU’s promise that taxpayers would “never again” pay for banks’ under-capitalised risk-taking. The European Commission’s latest proposal on crisis management and deposit insurance (CMDI) would effectively drop that rule from the statute book. This must not happen!

Remember the financial crisis? 

Fifteen years ago, EU taxpayers were asked to write a ‘blank cheque’ to shore up the financial sector, especially some of Europe’s biggest banks, when they ran into trouble following a decades-long run of deregulation and unbridled risk-taking. That cheque ultimately turned out to be for roughly one million million EuroThe cost includes direct financial support and the guarantees extended to banks – estimation as per the Banco de España study by Milarruelo & del Rio, 2017. – and that was barely enough to cover the direct cost, not to mention the final cost of the ensuing Eurozone debt crisis. A “lost decade” of low growth, zero-interest rates and ballooning central bank balance sheets may have permanently altered the political and economic stability of the continent.

What went wrong? 

It turned out that banks, in Europe and elsewhere, had been allowed to operate with levels of capital that were nowhere near sufficient to absorb the losses taken during the crisis. Especially the biggest banks had been happy to take on risk, safe in the knowledge that they were ‘too big to fail’ and would be rescued by their home-country governments – which means, in reality, the taxpayer.

Have policymakers addressed these risks?

When EU lawmakers went about fixing the legal framework it became clear that they had to firmly draw a line in the sand so that taxpayers would no longer have to shoulder such losses. Under the new rules, the Bank Recovery and Resolution Directive (BRRD), bank shareholders and other investors, usually bondholders, are now required to cover the bank’s losses up to 8% of its balance sheet total. Based on precedents from this and earlier banking crises, including Lehman Brothers, this was a level that regulators thought would be adequate to cover a bank’s losses in most instances and keep it afloat long enough to either put it back on an even keel or sell it to another, more stable institution.

What has happened since?

Not surprisingly, ever since the “8% rule” came into force lobbyists for the banking industry have been chipping away at it. And with some success: in 2016, the Commission decided – after a very public falling-out with the supervisors at the European Banking Authority (EBA) – that banks would not be required to meet the 8% requirement with equity capital and standard debt securities –  so-called eligible liabilities, which could be written off or readily converted into equity. It was left to the EU and Member-State authorities, notably the Single Resolution Board, to ensure, on a case-by-case basis, that banks had enough of the right types of equity and debt capital to ensure that the “8% rule” could be implemented.

The legislative proposal on improving Crisis Management and Deposit Insurance (CMDI), presented by the Commission in April 2023, is the latest attempt to render the “8%-rule” meaningless, and effectively scrub it from the statute book. According to that proposal, Member States would be allowed to tap into their respective national deposit guarantee funds to bridge any gap between the funds available from the bank’s investors, i.e. eligible liabilities, and the 8%-threshold, beyond which support from taxpayers can be used.

What would it mean to lose the “8% rule”?

In other words, since the fund’s contribution would count towards the 8% requirement, banks would no longer need to comply with the “8% rule”. Apart from the fact that deposit guarantee funds are meant to serve a different purpose – that is, to protect depositors from losing money if a bank fails – getting rid of the “8% rule” in practice would fatally undermine its original objective and encourage banks once again to take on more risk than they can carry.

Our insistence on keeping the “8% rule” alive is not a symbolic policy – it is about the economic reality of who will shoulder the cost of the next banking crisis. Fifteen years ago, policymakers promised that taxpayers would “never again” foot the bill for the mistakes made by bank managers and investors. The “8%”-rule is the embodiment of that promise. It must not be quietly abandoned.

Help Finance Watch defend the “8% rule” during CMDI negotiations!

Finance Watch is a European non-profit NGO and membership association founded in 2011 to defend the public interest in the field of financial regulation.

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Thank you for your support.

Christian M. Stiefmueller

Senior Advisor, Finance Watch

See also Finance Watch’s public hearing at the EESC on CMDI

Source: Public hearing by the European Economic and Social Committee  on “Bank crisis management and deposit insurance scheme. A step towards the completion of the Banking Union