The case for a Financial Sector Stabilisation Fund

Transcription

EU Monitor 73
Financial Market Special
April 6, 2010
The case for a Financial
Sector Stabilisation Fund
A “Financial Sector Stabilisation Fund” would constitute a useful
instrument for more orderly crisis management. It should be understood
as one element in a whole range of instruments.
The fund must not be understood as an instrument to bail out failed
institutions. Rather, it should be designed to allow for the orderly wind-down of
a failed bank with a view to minimizing contagion effects on the rest of the financial
system.
The fund should primarily be funded by a levy on the financial
industry. All segments of the financial industry should be obliged to contribute. In
order to assemble a critical mass of funds in a reasonable time span, the state
should make a contribution, too. The latter could be reduced over time, as industry
contributions flow in.
The levy should be reasonable in size and risk-based, recognising the
risk profile of an institution. It must not selectively punish specific business
models or financial instruments, nor exempt certain business lines for political
reasons. In the interest of maintaining the capacity of the financial industry to
provide credit to the economy, the size of the levy must pay due attention to the
industry’s earnings capacity and the burden from new regulation, such as higher
capital requirements.
Preferably, the fund should be established at the EU level. This would be
the best defence against competitive distortions and the most efficient way to deal
with the failure of a cross-border institution. At the very least, there needs to be
international coordination of key design elements, such as the size of the levy,
objectives and access conditions. Financial institutions should be obliged to pay
into their home country’s fund only.
Author
Bernhard Speyer
+49 69 910-31735
[email protected]
Editor
Klaus Deutsch
Technical Assistant
Sabine Kaiser
Deutsche Bank Research
Frankfurt am Main
Germany
Internet: www.dbresearch.com
E-mail: [email protected]
Fax: +49 69 910-31877
Managing Director
Thomas Mayer
We estimate that an EU-level fund would need a target size of around
EUR 120-150 bn. For Germany alone, the figure would probably need to be in
the range of EUR 40-60 bn.
EU Monitor 73
Political attention on recovery and
resolution regimes
Resolution and recovery regimes have become a major issue in the
discussion about the regulatory consequences of the crisis. In
particular, this discussion is focused on the question of how to deal
in a more orderly and less costly way with the failure of large,
complex financial institutions. Several ideas have been put forward
in the context of this discussion. The concept of a fund, which would
provide a standing pool of capital available to deal with the distress
of a large financial institution, is one of the ideas mooted.
Stabilisation fund – financed by levy
on banks – is one element
The idea of such a fund has attracted considerable attention both at
the level of individual states as well as at the EU level. As regards
the latter, it is being discussed in the context of current efforts aimed
at a more efficient and effective system of financial crisis
management in the EU. Furthermore, the discussion of the idea of a
fund must also be seen in the context of the debate about making
the financial sector pay for the costs of the financial crisis. In this
context, the fund is being discussed as one instrument for doing so,
along with a financial transaction tax and a special levy or fee for the
financial and banking sectors respectively.
In the following we explain the rationale and discuss possible design
elements of such a fund. For ease of exposition, we shall call the
fund the “Financial Sector Stabilisation Fund”, or FSSF. This being
said, we are convinced that it should be fully recognised that the
design and structure of the fund will ultimately depend on political
decisions taken by the responsible authorities. Hence, at this stage
it is appropriate (certainly for the banking sector) to discuss options
only.
Objectives
The idea of an FSSF is based on a number of objectives.
Orderly crisis management
— The most important objective is to provide an instrument for a
more orderly and more structured process for crisis management
in the event of a systemic banking crisis.
Fairer burden-sharing
— A second objective is to establish fairer burden-sharing between
the public and the private sector in the event of the failure of one
or more large financial institutions, which threatens the stability of
the entire financial system.
EU supervisory structure
— A third, if indirect objective, is to remove obstacles to establishing
a pan-European supervisory structure, as a fund could also
contribute to solving the perennial problem of burden-sharing
between EU member states in the event of the failure of a large
cross-border institution.
Only one element amongst many
To make it absolutely clear, the FSSF would only be one of many
elements to improve crisis management. It would sit alongside other
instruments such as insolvency regimes, contingent capital
arrangements, more resilient market infrastructures, and special
intervention rights for authorities. The fund is not a silver bullet that
solves all problems which may arise in the context of a bank failure.
Rather, it is and must be regarded as one instrument in a menu of
options that can be deployed. No single instrument will be sufficient
to respond adequately to all possible forms of crises and no single
instrument will be able to solve the problems of a complex financial
institution in distress.
It is equally important to be clear about what the fund is not and
what it will not achieve: The idea is not that the fund should meet all
the costs of a crisis. It must not be understood as a tool for placing
the entire burden of cleaning up the repercussions of a banking
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failure onto the financial sector. On the one hand, it is obvious that
the burden of a failing institution must primarily fall on the owners
and, within reasonable bounds, creditors of a failed institution. On
the other hand, when looking at the amounts that are required to
stabilise the financial system in the event of a systemic banking
crisis, it is obvious that a fund based on levies on the financial sector
itself will never be large enough to cover the repercussions of a
systemic banking crisis.
Underlying rationale and potential use of the fund
Capital injection critical element for
stabilisation
Next to liquidity support and guarantees, fresh capital is a key
element in solving banking crises. In the context of dealing with a
bank in distress, fresh capital is needed for different purposes,
depending on the business model of the institution in question and
the causes of distress: Capital may be needed to restore the capital
base of an institution that has suffered substantial losses and whose
capital levels, as a consequence of these losses, have fallen below
the thresholds that give the institution in question access to financial
markets and enable it to be accepted as a counterparty in money
and derivatives markets. In a broader sense, fresh capital is also
needed to support the transfer of healthy assets to another bank or
to allow for the transfer and, subsequently, orderly winding-down of
impaired assets (i.e. “bad bank” schemes). Finally, fresh capital may
also be needed to allow for the orderly run-down of positions in
derivatives markets, including the obligation to satisfy (higher)
1
collateral requirements.
Standing pool preferable to ad hoc
search
For all of these purposes, an FSSF would provide a standing pool of
funds, out of which measures to stabilise an ailing bank could be
funded or supported. The ad hoc search for funds, often conducted
in the early hours of the morning and under considerable pressure
to act, would be avoided. Given the broad range of potential
purposes, the FSSF’s management should – subject to appropriate
accountability arrangements – have considerable discretion as
regards how to deploy the funds in case of a crisis.
No bail-out, but orderly winding-down
To make it clear, the deployment of fresh funds does not necessarily
imply that the institution concerned will permanently remain in
business, nor that the institution will remain unchanged in its
business model, structure and organisational form. In other words, it
does not constitute a “bail-out” of a failed institution. Rather, fresh
funds are often simply necessary to allow for an orderly windingdown of an institution, i.e. to keep the bank or parts/remnants of it
afloat while the business is wound down. For instance, it is feasible
that the healthy part of a bank in distress is being sold to a peer and
the remainder of the bank, which may, say, consist of a structured
product portfolio, is being wound down in the form of a bad bank.
Consequently, the idea and existence of a fund is fully compatible
with the development of other tools that allow for an effective
reaction to the failure of a large, complex financial institution – tools
such as effective insolvency regimes, bridge banks and limitations
on shareholder rights in the context of state support.
However, the provision of fresh capital is an important pre-condition
for all other measures to work, because sufficient capitalisation is
required to keep a distressed institution afloat, both in terms of
regulatory requirements and, more importantly, in terms of
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April 6, 2010
The establishment of central counterparties (CCPs) would alleviate the challenge
of dealing with open positions in derivatives markets, but would not reliably solve
it.
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Other sources of fresh capital have
limits
counterparties’ willingness to trade with the institution in question. In
times of market stress, financial institutions are usually confronted
with the simultaneous challenges of: (i) losses that erode the capital
base and (ii) an inability to raise fresh capital on reasonable terms in
order to restore the capital base. Recapitalisations are therefore an
essential element in the tool-box for crisis resolution. There are
many ways to engineer recapitalisations, all of which should be
available and should play a role in such a process. However, in and
by themselves, all of them have limits.
— Recourse to existing shareholders/owners: They are often
already unable to advance fresh funds. Furthermore, the
provisions in many countries’ laws on altering a company’s
capital base often make it difficult to raise funds in a short time
span (consent of AGM needed, etc.).
— Contributions from the healthy part of the financial sector: It is
standing practice to ask the peers of a failed institution for
contributions. This is often an effective means of raising funds in
a short time span and it is, to some extent, economically rational,
as the peers have an economic interest in maintaining financial
stability. However, payments by peers, especially in times of
distress, automatically and inevitably imply contagion, as these
supporters are weakened further in an already challenging
environment.
— Mandatory debt conversion: Similarly, a mandatory conversion of
debt into equity inevitably implies contagion, as the status of
creditors is turned into that of equity holders. To the extent that
the value of equity falls subsequently or is even wiped out in the
context of an eventual resolution of a failed institution (neither of
which is entirely unlikely) these creditors-turned-owners will
suffer losses. In addition, to the extent that debt holders are
subject to capital requirements themselves they would take an
additional hit, as debt is converted into equity, which is subject to
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higher capital requirements. Finally, if all (senior) debt were to
carry clauses that allow for a conversion into equity in certain
circumstances, the cost of debt would rise drastically.
Contingent capital: Useful, but
market is probably limited
— Contingent capital arrangements: Contingent capital
arrangements are useful, and should be an element of prudent
and sound capital and risk management. They allow the issuers
to draw capital under pre-defined conditions, thus not only giving
access to fresh funds, but also creating certainty for
counterparties and supervisors about the refinancing costs of an
institution in times of stress. While contingent capital
arrangements are useful, there are limits to the use of such
arrangements. First, the willingness and capacity of investors to
provide contingent capital is limited. This holds true all the more
for providers of contingent capital that are subject to capital
requirements themselves, as these will face higher capital
charges once the debt instruments they hold are transformed into
equity. Second, contingent capital is a comparatively expensive
form of refinancing for financial institutions, because the
conditions under which contingent capital may be drawn are
difficult to define; as a consequence, such instruments are
difficult to price and investors will usually want to err on the side
of caution and demand a premium. Third, contingent capital
2
4
On a more technical level, it should also be realised that, for instance, bond-only
investment funds would be forced to sell their investment upon conversion – and
would probably suffer substantial losses.
April 6, 2010
arrangements automatically create a transmission channel
through which difficulties in one institution are transmitted to
other parts of the financial system.
Taking these limitations on sources of capital, the existence of a
readily available pool of capital such as the FSSF could be useful as
an additional component. What are the advantages compared to the
status quo?
Potential advantages
Reduces moral hazard
If an orderly wind-down becomes more likely, because a pre-defined
process for this is available, then the market mechanism is
strengthened, as government can signal more credibly that even
large banks will no longer be considered too big to fail. Put
differently: rather than increasing moral hazard – as is often claimed
(cf. below) – the existence of a fund could actually help to reduce
moral hazard in the financial system.
Reduces uncertainty
What can also help to reduce uncertainty as well as moral hazard is
that the establishment of a fund can provide ex ante clarity on the
terms that would be applied if funds were forwarded. This removes a
potential source of uncertainty in times of stress which may arise if
terms and conditions are set during an acute crisis situation (e.g.
parliamentary intervention; consent of EU competition authorities).
Automatic bail-in
A third advantage is that, in line with the objectives stated above, an
automatic bail-in of the private sector would occur in the context of a
crisis, if the FSSF were (partly) funded by the industry. This ensures
that part of the costs of dealing with a financial crisis is borne by the
industry itself rather than by the public purse.
Lower risk of contagion
Fourth, compared with today, the risk of a contagion of healthy
financial institutions would be reduced: The contribution of healthy
banks to the rescue of a failed institution should be limited to the
3
funds already paid into the recapitalisation fund. Not only would this
avoid a direct contagion effect, it would also help to avoid indirect
contagion. Specifically, refinancing costs of healthy institutions
would not be affected by uncertainties about their potentially being
called upon to rescue failed brethren.
Progress on EU supervision
One final advantage, depending on the institutional design of the
fund, is that the fund would make a pan-European structure of
financial supervision more likely and more feasible. If established at
the EU level, financial means would be available out of which the
rescue or orderly winding-down of a large, cross-border bank could
be funded. This would remove one of the issues, that is currently
often cited as an obstacle to establishing a pan-European
supervisory agency, namely the unavailability of mechanisms for
adequately sharing the burden that stems from the failure of a crossborder financial institution.
Would such a fund give rise to moral hazard?
Moral hazard concerns not an
obstacle
Often, the concern is voiced that the mere existence of a fund would
give rise to moral hazard – though it often remains vague what
exactly is meant by this. Before delving into specific points it needs
to be recognised that moral hazard is an ubiquitous phenomenon,
which must and can be dealt with by adequate institutional
arrangements. Thus, the (presumed) existence of moral hazard is,
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Some limited obligation of financial institutions for topping-up the fund might be
considered. However, the amounts involved must be small, as otherwise the
desirable aim of limiting contagion from the failure of a single institution would be
unattainable.
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by and in itself, not an argument for setting up such a fund, it is
merely an argument for getting the design right.
In the specific case of the fund moral hazard could theoretically
emerge at several points:
— On the part of authorities and politicians: On the one hand,
authorities may be less strict in their supervisory activities. On
the other hand, politicians and authorities might be more willing
to let a financial institution go under than they would be in the
absence of a fund arrangement, knowing that an orderly process
would be in place in case of a bank getting into distress.
The former should not be a source of major concern, as the loss
of reputation for supervisors is linked to a bank getting into
distress irrespective of whether an efficient process of crisis
management exists. The latter is potentially more of a concern as
it may lead to situations where the gravity of the consequences
of an institution’s failure are underestimated by decision-makers
in the belief that an orderly process could be organised. A
suitable safeguard against such an outcome could be an
obligation to consult with representatives of the financial industry
prior to the decision being made. So that there is no
misunderstanding, it is not suggested that the financial sector
has better information or even judgement; but a consultation
process can help to base the decision on a more firmly founded
assessment of the likely consequences of the different courses of
action. Obviously, there is a link with the discussion on the fund’s
governance structure here.
— On the part of peers/creditors: The concern here would be that
creditors, or more generally counterparties and peers may be
less willing to support the survival of an ailing institution (e.g. by
upholding existing lines of credit) if the alternative of an orderly
wind-down is available to them.
The best safeguard against this kind of concern is to emphasise
that the existence of a fund is not tantamount to a bail-out of an
ailing institution. Hence, counterparties must not assume that
they will not suffer any losses in the course of an orderly rescue
or winding-down.
— On the part of a bank’s management: It is often assumed that
banks, once a fund is set up, would engage in riskier activities
based on the assumption that a bail-out is more likely should
things go wrong.
This line of argumentation would only hold true if the fund were to
really provide a full, unconditional bail-out of an ailing institution
without imposing any losses and sanctions on existing
shareholders, existing management and creditors. As long as it is
clear that the fund will not provide an unconditional bail-out, but
will be an instrument for an orderly wind-down and will be linked
to sanctions imposed on those responsible for the problem,
moral hazard on the part of a bank’s management is unlikely to
arise. Similarly, the provision that annual contributions to the fund
are risk based should help to mitigate any moral hazard
concerns.
A European perspective to the issue
In what follows, we discuss the idea of a stabilisation fund from a
European perspective. This reflects our conviction that such a fund
would best be set up at the EU level to safeguard the single financial
market and to establish an adequate structure for crisis
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management and financial stability in the EU. Having said this, we
recognise that plans for levies on the financial industry and for
setting up stabilisation funds are currently being discussed at the
level of various member states (and in the US). We would point out,
though, that the vast majority of design elements discussed in the
remainder of this paper apply in equal measures to EU-level and
national schemes.
Proliferation of national schemes
sub-optimal to EU solution
More importantly, we point out that a proliferation of national
schemes is suboptimal compared to a European solution. Not only
would the co-existence of national schemes ignore the European
dimension to financial stability which should be obvious in light of
the single financial market and the dominant role that large, crossborder groups have for its stability. More importantly, such a coexistence would probably result in competitive distortions, as, on the
one hand, banks domiciled in different jurisdictions could be faced
with different obligations for paying dues and, on the other,
conditions and criteria for access to the fund could differ.
At a minimum, harmonisation of key
design elements
Establishing an EU-level fund would obviously solve these problems
and establish a level playing field. It is recognised that EU-level
4
approaches are inevitably more complex and that some member
states have already started to design, or even to run, such schemes.
At a very minimum, therefore, it must be ensured that there is a
harmonisation of key features of bank levies as well as stabilisation
funds. It must also be ensured that financial services firms are
required to pay into only one scheme, i.e. the principle of
consolidated supervision and home country control should also
extend to this area. In light of the global nature of the financial
industry and in order to safeguard the international competitiveness
of EU-based financial services companies, consensus on these
features must be achieved within the G20.
Conceptual elements
Required volume
Discussion on the target volume must start from the premise that the
idea is not to save an unsound institution from failure nor to cover
the entire costs of a banking crisis, but to allow for an orderly
recovery and resolution process. Hence, the amounts needed are
sizeable – given that the fund is designed to deal with the effects of
a systemic crisis – but they are not excessive as one might surmise
when looking at the cost of cleaning up the banking crisis.
Consequently, a plausible dimension for the size required can be
gleaned by looking at comparable arrangements: (i) Germany’s
SoFFin has allocated funds corresponding to around 1.5% of GDP
for recapitalisation purposes; (ii) the target size for the FDIC fund
represents about 0.3% of US GDP, but has proven far too small to
cope with this crisis; (iii) in Sweden, the bank resolution fund is
targeted to grow to a maximum of 5% of GDP.
Target volume for EU:
EUR 120-150 bn
Based on these numbers one would arrive at a target volume in the
range of EUR 120-150 bn for the EU as a whole; for Germany
alone, the number would probably be in the range of EUR 40-60 bn.
These dimensions sound plausible also in light of the capital actually
invested by EU governments in institutions in distress during this
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April 6, 2010
In addition, it is obviously more attractive for national politicians to be seen to be
“doing something” in the national policy arena rather than to wait for consensus to
emerge at the EU level.
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crisis. Across the EU, capital injections by governments into banks
have amounted to some EUR 140 bn.
Review mechanism needed
It should be obvious that a regular review process would need to be
established in order to assess whether the target volume is still
adequate in light of market developments, including the size of
financial institutions and market infrastructures as well as
institutional arrangements which are relevant for the resilience of the
financial sector.
Funding
Funding predominantly from financial
industry
Funding of an FSSF would predominantly come from the financial
industry itself. This is the appropriate way to formulate the right
incentive structures. Contributions to the fund will ensure that banks
have a financial interest in working on strengthening their own
resilience to financial shocks as well as the resilience of the financial
system as a whole. It will also give banks an incentive to monitor the
performance and risk management of their counterparties more
closely.
Who from the financial sector should pay? In principle there are two
feasible options.
— Either, payment could be limited to large, systemically important
institutions. The – doubtful – intellectual underpinning for this
would be the argument that systemically important institutions
enjoy an implicit subsidy stemming from the perception that they
are too big to fail. Even leaving aside that “too big to fail” has
always been a dubious argument, this intellectual underpinning is
doubtful to the extent that many of the regulatory measures
currently designed – including the idea of a fund – seek to
eradicate the too-big-to-fail assumption. As discussed above, the
idea of the fund is to allow governments to credibly signal that
even large institutions can fail. In other words, limiting the fund to
systemically important institutions would make it address an
issue that no longer exists.
All institutions should be obliged to
pay
An EU-level levy?
If the FSSF were established at the EU level,
the legal question would probably arise
whether an EU-level institution would be
entitled to directly levy contributions from the
private sector, which might be regarded as
tantamount to a direct taxation by the EU,
which of course is currently prohibited. It is
probably possible to get around this issue by
creating an EU institution, based on an intergovernmental treaty, possessing a statute and
being endowed with the right to levy
contributions from a clearly-defined set of
institutions in a clearly-defined process.
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— Alternatively, all financial institutions would be obliged to pay. The
intellectual case for this approach is the argument that all parts of
the financial system benefit from an orderly resolution process.
This includes all institutional investors, such as insurance
companies, as well as large and small banks alike. In fact, as
could be seen in the practical cases arising in this crisis, the
rescue of even mid-sized financial institutions such as IKB was
driven largely by concerns about the potential impact of failure on
the creditors of these institutions.
A variant of this model could foresee that contributions are
differentiated between groups of financial institutions. In
particular, those institutions that are likely to be direct
beneficiaries (i.e. are likely to receive capital injections) could be
forced to pay more than those that would only benefit indirectly
(i.e. as creditors).
A side-effect of a large base of contributors into the fund would of
course be that a critical mass in fund volume would be assembled
more quickly. It needs recognising, though, that the question of who
contributes to the fund cannot be entirely separated from the
question of for which purposes and for which institutions funds from
the FSSF could be used. As a general rule, the use of the funds
should be limited to those institutions that paid into the fund;
otherwise the risk of moral hazard on the part of those institutions
which paid nothing, but benefitted from the fund’s existence would
April 6, 2010
Constitutional law aspects
According to German constitutional law as
specified by the German Federal
Constitutional Court, levies are generally
subject to strict prerequisites: (i) the levy
serves a specific objective which goes beyond
the mere raising of funds, (ii) it burdens a
specific homogenous group of persons, (iii)
the group bears specific responsibility with
regard to the objective set by the levy, and (iv)
the group is the beneficiary of the levy so that
the burden caused by the levy is balanced by
benefits allocated to that group. Furthermore,
the levy must comply with the principles of
proportionality and equal treatment.
With regard to the envisaged FSSF, the
composition of the group burdened with the
levy must be aligned with the objective of the
FSSF. Given that the levy serves to provide a
means for the orderly wind-down of failed
institutions and the stabilising of the financial
system as a whole, in contrast to a bail-out
mechanism, the burdened group should be
the entire financial industry rather than
specific financial institutions or limited to
institutions with specific business models.
Benefits should be precisely allocated within
the group and the potential use of funds
clearly defined. In the interests of proportional
sharing of responsibility within the group, the
levy should be risk-based so that it provides
an incentive to set up the best industrystandard risk management systems.
Some contribution by state
necessary
The Swedish Stability Fund
In 2008, the Swedish government set up a
special Stability Fund as part of a broader
stability plan. The plan gives the government
a broad mandate to deal with situations that
might cause a serious disturbance to the
Swedish financial system. The purpose of this
fund is to finance measures needed in order
to counteract the risk of such disturbance.
The Stability Fund is financed ex ante and,
based on experience from earlier domestic
and foreign financial crises, is targeted to
reach 2.5 per cent of GDP within 15 years. It
will mainly be built up by a special Stability
Fee paid by banks and other credit
institutions. The Swedish government has
initially allocated funds from the central
government budget to the fund (SEK 15 billion
or ca. EUR 1.5 billion), but the aim is that the
rest of the financing should be carried by the
industry itself. The Stability Fee was
introduced in 2009 and will be paid annually.
However, because of the current situation in
financial markets, only fifty per cent of the fee
will be charged on the 2009 and 2010 balance
sheets.
Source: Sveriges Finansdepartementet/Swedish Ministry of
Finance
April 6, 2010
be real. The flip-side of course is: the more institutions pay into the
fund the greater the potential number of institutions for which the
fund could be used. This means that while more payers would be
conducive to amassing larger amounts in a short span of time, the
number of potential beneficiaries would also rise. 5
Payments should be made in the form of annual contributions. 6
They could be based on various parameters, such as total (riskweighted) assets 7, total (non-bank) deposits or capital. As a general
rule, it should also be realised, however, that financial institutions
will be more likely to game the system the more selective the basis
is. Furthermore, the base must not be so selective as to be
tantamount to a levy on certain activities, business models or even
individual financial institutions. The more neutral the levy is, the
better can it be justified economically as well as legally.
Contributions should be differentiated depending on the risk profile
of a financial institution. This is already standard practice in the case
of deposit insurance schemes. Again, this helps to address
concerns about moral hazard. Financial institutions would be
bucketed depending, e.g., on the quality of the portfolio, the quality
of risk management and the solidity of the capital base. However, a
wholesale exemption of entire portfolios (e.g. SME lending) for
political reasons, would be inappropriate.
As regards the setting of the amount of annual contributions, this
must take into account different objectives: On the one hand, it
would need to be ensured that a sufficiently sized fund could be
assembled over a reasonable period of time. On the other, the
burden on the financial industry must be within bearable and
reasonable limits that duly take into account the industry’s earnings
capacity and its attractiveness as an investment.
Keeping this in mind, it is hard to escape the impression that while
the majority of funding should come from the financial industry, cofinancing by the private sector and government ultimately seems
necessary. This is so for two reasons: first, it is unrealistic to assume
that the financial sector itself would be able to accumulate sufficient
amounts in a reasonable span of time. To illustrate: Commerzbank
in Germany required a capital injection of roughly EUR 18 bn – even
in a good year such as 2006, post-tax profits of the entire German
banking sector amounted to just EUR 22.2 bn. On the basis of
annual contributions and using the Swedish fund, where banks pay
an annual fee of 0.036% of liabilities (ex equity and subordinated
debt) as a benchmark, such a formula would result in an annual
contribution in the range of EUR 2.4 bn p.a. for the German banking
system. To raise the volumes cited above would therefore take
5
6
7
For practical purposes one further aspect may be relevant. Politically, it is probably
the case that the smaller the number of payees, the easier it will be to make the
fund a reality.
In a discussion note, colleagues from Unicredit have recently proposed that the
industry should only provide the core equity of a fund (plus some core equity paid
in by the state), which would then be topped up by borrowing from capital markets,
if need be. A leveraging of the equity base by a factor of 10 is envisaged (e.g.
maximum total fund size could be EUR 20 bn on the basis of EUR 2 bn equity).
Raising capital from the markets would potentially be supported by public
guarantees. While this proposal has the obvious advantage that contributions of
banks are more limited, the snag that we see with this proposal is that it requires
the raising of capital from investors at a time of market stress. As the current crisis
has again underlined, in such a situation, investors are usually reluctant to invest
in anything but straight, high-quality government debt.
Using RWA rather than nominal assets would be consistent with the objective of
differentiating payments into the fund according to the riskiness of an institution.
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EU Monitor 73
around 20 years. In fact, the question might even be raised whether
even this is a sufficiently conservative estimate given that an annual
contribution of EUR 2.4 bn looks like stretching the current capability
of the banking system. To put these numbers into perspective: EUR
2 bn is equivalent to about a fifth of estimated 2009 profits and after
all, it needs to be kept in mind that banks will be faced with the
challenge of building higher capital bases in the near term in order
to satisfy new capital requirement rules. Hence, a fee in the range of
0.01-0.02% of banks’ liabilities (or a corresponding measure for nonbank financial institutions) is probably more realistic, yielding annual
sums in the range of EUR 700-1400 m.
It goes without saying that the smaller the base of contributors, the
more difficult it will be to amass a sufficient fund volume in a
reasonable span of time. For instance, if the group of payees were
to be limited to systemically important financial institutions – the
number of which in Germany is in the single digits – assembling a
sufficient fund would take correspondingly longer. By the same
token, if all financial institutions contribute this would markedly
reduce the time needed to amass a sufficient fund volume.
Second, as this crisis has demonstrated, in the event of a financial
crisis of systemic proportions, there is no alternative to support from
the state. Indeed, maintaining systemic stability is a public good and
hence, at least partial financing of this public good is economically
8
justified and warranted.
Several options for state contribution
How could the state’s contribution be organised? There are a
number of feasible options:
— The first model is an annual contribution from the public sector.
This is probably the most basic and simplest form. The
advantage of this form is its simplicity and transparency, which
helps to create certainty. It will also help to keep the burden on
the public purse to manageable proportions. A potential risk is
that an annual contribution by the government may not be
sufficient to raise the fund’s size to a critical mass in a
reasonably short period of time.
— Another model would be a one-off payment of appropriate size
9
into the fund. It is feasible that existing arrangements, which
have been set up in the context of fighting the financial crisis,
such as Germany’s SoFFin, might be leveraged for this purpose.
A one-off payment would have the obvious advantage that a
critical mass of funds could be assembled quickly. However, it
would have some political disadvantages: (i) Politically, it would
probably be hard, if not impossible to find acceptance for this. (ii)
Economically, it would entail payment(s) that would burden public
budgets at a time when they are already under stress (even
though the setting-up of a fund is economically neutral, of course,
until the fund is activated.) (iii) In addition, payments into the fund
would count in the calculation of current deficits under the
Maastricht rules.
8
9
10
Besides, it could well be argued that the causes of the crisis include factors that
fall under the responsibility of the public sector. Deficiencies in supervision,
weaknesses in regulatory schemes – such as those pertaining to capital
requirements – wrong incentives set by housing policies, too loose monetary policy
and too great a role for rating agencies are just some examples of these. Hence,
even under a strict “polluter pays” principle, it could be seen as being unfair to
place the burden exclusively on the financial industry.
The term “one-off” should not be taken literally here. Rather, it should be seen as a
convenient short-hand for large-sized official payments into the fund, which may,
however, be spread over a small number of years.
April 6, 2010
A variant of this model could be that the amount put into the fund
by the public sector could be gradually reduced over time as
payments made by the banks flow in. This way, a crucial mass
would quickly be assembled while, on the other hand, funds
could regularly be returned to the general budget over time.
— The state contribution to the recap fund could take the form of a
government back-up guarantee (akin to the back-up line that the
FDIC has with the Fed or to the authorisation given to the
German Finance Ministry to issue debt to fund the SoFFin for the
purpose of funding rights issues or the acquisition of doubtful
assets). The upside of this alternative is that it does not require
the official sector to come up with money upfront, which may
make the idea politically more acceptable. However, a guarantee
is less likely to create certainty than an available pool of funds,
especially considering that parliaments may always decide to
revoke the guarantee or to alter the conditions for it. In a crisis
situation, money needs to be available without delay in order to
enable authorities to act quickly; this condition can only be
guaranteed by ex ante schemes. More importantly, the back-up
guarantee would impose an additional burden on public budgets
during a crisis situation.
— A fourth model might be to have the fund issue (perpetual) bonds
which would be mandatory for banks to buy. A possible
advantage might be that the banks could potentially use these
bonds to discount them at central banks. Against this stand
potential disadvantages: (i) The debt issuance would probably
fall under the Maastricht guidelines on public debt. (ii) In
Germany, the arrangement would presumably be illegal under
the recently introduced constitutional “debt brake” which prohibits
the government from setting up shadow budgets.
Only ex ante payment creates
certainty
The question might be raised: is it necessary at all for the state to
pay in ex ante? Put differently: even if one acknowledged that some
form of official sector contribution may be necessary in the end,
would it not be sufficient to have that arranged if the need arose (i.e.
if a fund filled by private sector contributions were depleted and
could not be refilled in short time)? While possible in principle, there
are arguments against it: First, one of the great advantages of the
fund would be lessened, viz. the immediate availability of funds. If
instead government – and possibly parliaments – had to decide on a
discretionary basis whether or not to provide funds, time would
again be wasted and uncertainty would be introduced into the
process. Second, uncertainty might also arise as regards the
conditions which would be attached to the funds forwarded on a
discretionary basis.
What would the proceeds be invested in?
Setting aside 2% of GDP or more for a FSSF would add up to a
fairly sizeable amount. This makes the question of how the funds
are invested all the more pertinent.
Funds must be invested into liquid
and risk-free assets
April 6, 2010
The obvious necessity is that the funds are available at short notice
and without causing market disruptions if they are liquidated to fund
support action. This would argue for either depositing the funds with
central banks or for investing them into government securities to the
extent that these (i) provide a liquid market and (ii) do not constitute
credit risk themselves. By way of comparison, it is instructive to note
that the funds raised by the FDIC may only be invested in US
sovereign debt or in paper that carries a government guarantee. It
should also be noted that if the fund volume were invested in
11
EU Monitor 73
government securities, this would actually lower financing costs for
the sovereign – which would constitute a sort of positive side-effect
for the sovereign. The preconditions mentioned rule out investments
in private-sector debt securities or depositing the proceeds with
private banks. The latter, in particular, would entail an outflow of
funds from banks in times of stress.
Using highest-quality government paper is also sensible with a view
towards the question of how the invested funds can be used to
support ailing institutions if need be. In order to recapitalise an ailing
institution, the fund would either (i) have to sell part of its portfolio to
invest the proceeds into equity issued by the ailing institution, (ii)
support a capital increase against non-cash contribution by means
of giving parts of the fund’s assets to the bank in exchange for
newly-issued equity, or (iii) it would need to post its assets as
collateral to raise money from the market which would then be
invested subsequently into newly issued equity. Whichever of these
alternatives is chosen, it is obvious that investments must be held in
high quality, highly liquid assets, as otherwise there would be an
undesirable market impact on the asset market in question or,
equally undesirable, the fund would not be as effective as it could be
(e.g. if lower-quality assets resulted in less funds being available for
stabilisation operations).
Activation
Separate from defining the terms and conditions under which funds
would be forwarded, it must also be defined how, when and by
whom the fund would be activated. In principle, two different models
are feasible:
— On the one hand, payments from the fund could be initiated
automatically, once certain triggers (e.g. capital ratios) are
activated.
— On the other hand, activation of the fund could remain at the
discretion of the authorities.
Authorities should have discretion to
decide upon usage
The first option would, prima facie, seem to have the advantage of
providing more clarity and hence greater certainty for market
participants. However, as the current crisis has again underlined,
crises vary in their characteristics making it difficult to set triggers
that would appropriately capture all possible and relevant
circumstances. Some discretion may therefore be sensible, so that
authorities can react flexibly to circumstances. Moreover, it can be
argued that retaining some constructive ambiguity as regards the
activation of the fund may be useful to avoid moral hazard on the
part of the potential beneficiaries of such a fund.
On balance therefore, it would seem advisable to leave the
activation of the fund to the discretion of the authorities, subject to
10
an appropriate establishment of accountability rules.
Access conditions
It is an important advantage of the fund idea that access conditions
can be set ex ante. The arrangement therefore provides clarity for all
10
12
It should be evident that this accountability must not allow an ex post challenging
of the decisions taken by the fund. Decisions taken by the fund, in particular as
regards the provision of funds to an ailing institution, must remain final, even if they
turn out to be based on false premises, misjudgment or turn out to have
undesirable effects. Market participants and, in particular, counterparties of the
supported institution must have certainty as regards the fund’s decisions. This
does, of course, not rule out to making the fund’s management and authorities
accountable or even liable for misconduct or mistakes.
April 6, 2010
market participants under which conditions institutions in distress
will have access to the funds. This will help create certainty for the
institutions concerned as well as for its counterparties.
Access conditions will need to clarify
— in which circumstances banks will be allowed to approach the
fund with a request,
— what the conditions will be as regards interest charged (on
subordinated debt or silent participations), dividend policies,
haircuts for creditors, and other conditions, e.g. on remuneration.
Questions might be raised as to whether the names of those
institutions that contribute to the fund should be made public, if not
all financial institutions are required to pay into the fund. On the one
hand, there is a strong inclination on the part of both the private and
the public sector not to denote individual institutions as systemically
important, not least because of the difficulty involved in defining
11
systemic importance. On the other hand, given the amounts
involved banks would probably have to disclose to their
shareholders how much they contributed to the fund anyway.
It needs pointing out that eligibility to draw is not equivalent to being
entitled to draw automatically. In other words, there must not be a
presumption that banks will have access to the funds under all
circumstances. Such a quasi-automatic access would be
incompatible with the desire to limit moral hazard. Whether or not
the fund is being activated in the context of a rescue operation
needs to be decided on a case-by-case basis and be left to the
discretion of authorities.
Access to information / coordination with 3L3 and ESRB
Close cooperation with other
authorities needed
In order to be able to take informed and appropriate decisions on a
payout, the fund must have full access to all the necessary
information. Consequently, if the fund is activated, it must have full
access to the information possessed by both macro- and microprudential supervisors. It is important to stress that both types of
information must be available, as the discretionary decision must
take into account the specific situation of the institution in question
and its counterparties as well as the state and stability of the
financial system as a whole. Specifically, the fund must be able to
assess what impact the failure of the institution would have on the
rest of the financial system, in order to choose the best option for
dealing with the institution in terms of finding the right balance of
instruments.
Similarly, any action taken by the fund should be closely coordinated
12
with the 3L3 / new European Supervisory Agencies (EBA; ESMA;
EIOPA) and the supervisory college set-up for the institution in
question. In order to assess and take into account the broader
repercussions of the rescue operation as well as to decide upon the
optimum form of intervention in light of the overall stability (or lack
thereof) of the financial system, decision-taking should be preceded
by a joint assessment of the situation together with ESRB and the
ECB.
11
12
April 6, 2010
It should be noted that institutions were rescued in this financial crisis that were not
being considered systemically important before the crisis.
In case of a European FSSF, it might actually be useful to have the heads of the
ESAs represented in the management of the fund.
13
EU Monitor 73
Replenishment
Proceeds from winding-down to flow
back into the fund
An FSSF should be designed as a revolving fund. In other words,
funds paid out should be replenished by the annual contributions
from the financial industry and by those countries that have
benefited from the rescue/orderly winding-down of the bank
supported. (As far as state contributions are concerned, such an
arrangement would have the advantage that squabbling over the
shares to be paid by individual states could occur during calmer
times, rather than in the midst of crisis.) Proceeds from the windingdown of an institution (to the extent that there is a positive residual)
should flow into the fund. Thought might also be given to the option
that institutions that have been nurtured back to health thanks to the
support of the fund be obliged to pay a share of their future profits
into the fund.
Governance
The governance that is acceptable and appropriate will obviously
have to correspond to the financing structure, the exact mandate of
the fund and its geographic reach (national vs. EU). Some general
principles can be identified, though:
Fund could be located at FMSA
— The management of the fund should be in the hands of a neutral,
technocratic institution. This will help shield the fund from
politically motivated interference. At the same time, it is obvious
that if public funding is being provided an appropriate
parliamentary accountability mechanism must be established.
At the national (i.e. German) level, the already existing
institutional arrangement centred on the Financial Market
13
Stabilisation Agency (FMSA) could be used, though it needs to
be kept in mind that decision-making rests in the hands of the
Steering Committee, rather than the FMSA.
At the EU level, the choice of institution is not obvious. The EIB is
a potential candidate with its experience in managing EU-level
funds, but it lacks experience of dealing with financial crises. The
forthcoming EBA could develop into an adequate institution, but
currently lacks the capacity, mandate, trust and experience
required. The European Commission would qualify as a
technocratic, neutral institution, but would need to beef up its
expertise to perform the task. In addition, it might be difficult to
obtain member states’ acceptance.
— Separation could and probably should exist between the
institution that is the custodian of the funds while the money is
not needed and the body that decides upon the use of money
from the fund in times of distress. For the custody of the funds in
normal times, a central bank is probably the best choice.
— A case can be made that if the private sector provides a
substantial part of the funding, then it should have an active
stake in the governance of the fund. Politically, it will probably be
unacceptable to have representatives of the financial sector
decide on assistance to the financial sector; this will probably
hold true all the more if public money flows into the fund. It is
equally true, though, that it would be hard to justify the private
sector being denied a say in an arrangement to which it makes a
substantial contribution. Against this background, some kind of
non-voting representation of the financial sector in the
governance structure of the fund would seem to be justified.
13
14
Finanzmarktstabilisierungsanstalt.
April 6, 2010
Link to deposit insurance systems
It is theoretically feasible to integrate existing deposit insurance
systems into the fund. In fact, it may be noted that mandate of some
existing deposit insurance funds (e.g. the FDIC and the
Einlagensicherungsfonds of Germany’s private banks) at present
allow for some activities that could become part of the remit of the
fund, e.g. providing finance for a bridge bank solution or providing
capital guarantees/injections that allow for the transfer of parts of the
failed institution to a healthy peer. In addition, it could be argued that
it would be easier to engineer a comprehensive, integrated crisis
management if all different elements and instruments are being
deployed by a single institution.
ESSF should be kept separate from
deposit insurance schemes
In practice, however, a number of arguments would support the
notion of keeping deposit insurance systems separate from the fund.
— First, the narrower and simpler concept of deposit insurance
systems is arguably easier to understand for the wider public
than the more encompassing fund concept and may therefore be
more conducive to bolstering the trust of the wider public into the
safety of their deposits.
— Second, to the extent that the remit of deposit insurance systems
is defined narrowly (i.e. essentially being limited to paying out to
a clearly defined range of depositors of a failed institution), the
co-existence of the fund and of deposit insurance schemes
would not make the process of crisis management markedly
14
more difficult.
— Third, with a view to the option to establish the fund at the EU
level it needs to be recalled that efforts to harmonize, let alone to
integrate existing deposit insurance systems in Europe have
repeatedly failed due to the complexity of dealing with rather
different legacy systems as they currently exist.
Conclusion
A Financial Sector Stabilisation Fund would constitute a useful
instrument for more orderly crisis management. It should be
understood as one element in a whole range of instruments. If
applied with appropriately strict conditions, such a fund would not
create moral hazard; instead, it would complement the authorities’
tool-box to wind down failed institutions in a way that minimizes the
repercussions on the rest of the financial system. The design of the
FSSF, especially the financial industry’s funding obligations, should
pay due attention to the international character of the financial
industry and its earnings capacity. If these conditions are fulfilled, an
FSSF can become one of the building blocks for a more resilient
financial system.
Bernhard Speyer (+49 69 910-31735, [email protected])
14
April 6, 2010
Note that the wider mandate that some deposit insurance schemes currently enjoy
and which has been useful would then probably have to be narrowed. However,
this is acceptable to the extent that these beneficial effects can then be generated
by the fund.
15
EU Monitor
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The case for a Financial Sector Stabilisation Fund

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