An ugly bank bail-in shows why EU may have to rethink its rules

by Frances Schwartzkopff / BLOOMBERG

IN THE world of bank regulation, Denmark’s claim to fame is that it’s the home of Europe Union’s (EU) first bail-in, in which senior creditors were stunned to realise they could actually lose money.

The issuer in question was Amagerbanken A/S, a small lender based in southeast Copenhagen. Though the designation didn’t exist at the time, Amagerbanken wouldn’t have made it onto Denmark’s list of systemically important institutions.

But the 2011 failure of a local lender showed that small banks can completely upend a whole country’s financial system if they fail. In the event, Amagerbanken’s collapse locked all but the biggest Danish banks out of wholesale funding markets. It also triggered a fivefold spike in the credit default swaps on Danske Bank A/S, Denmark’s biggest financial group, as debt investors panicked.

Too Big to Fail

As a result, Denmark says all banks are essentially too big to fail. The head of the Danish regulator suggests EU’s Bank Recovery and Resolution Directive (BRRD) might be fundamentally flawed for not recognising that idea. He argues the region would be better off setting minimum requirements for own funds and eligible liabilities, or MREL, for all banks instead of only those currently deemed too big to fail.

Doom Loops

The observation is among a list of weaknesses Jesper Berg, DG of the Financial Supervisory Authority in Copenhagen, said risk undermining Europe’s efforts to prevent the next financial crisis. He said loss-absorbing buffers intended to prevent taxpayer rescues could fail because of the way they’re designed. He also warns that a proposed European deposit insurance scheme may backfire by encouraging bankers to take excessive risks.

“I fully recognise that there are a lot of countries that are in a different situation, but unless we get the BRRD right, in the long term we’ll have the same experiences with regard to doom-loops and the tax payer having to step up to the plate and pay,” Berg said.

According to Berg, recent history shows those maturities need to be longer to weather a potential crisis. He said the current set-up creates a new refinancing risk that could force regulators to protect creditors in order to avoid closing a bank. — Bloomberg

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