The Council of the European Union and the European Parliament have struck a deal to reform the crisis management and deposit insurance (CMDI) framework for banks in the EU.
European Union’s two co-legislators forged a ‘political agreement‘ on Thursday about bank crisis management, bringing the bloc’s banking union closer to—so far elusive—completion. The aim is to enhance financial stability and ensure that bank failures can be managed without resorting to taxpayer bailouts.
The reform promises to improve the resolution process, particularly for small and medium-sized institutions. The effort represents another step toward enhancing the Union’s financial resilience. Technically speaking, the CMDI review amends Directive 2014/59/EU (the Bank Recovery and Resolution Directive or ‘BRRD’), Regulation (EU) No 806/2014 (the Single Resolution Mechanism Regulation or ‘SRMR’) and Directive 2014/49/EU (the Deposit Guarantee Schemes Directive or ‘DGSD’).
Bridging the gap
At its core, the new agreement facilitates failing banks’ access to industry-funded safety nets, including national resolution funds and the Single Resolution Fund (SRF) for members of the banking union. This framework allows the use of deposit guarantee funds to “bridge the gap,” ensuring that a bank’s own loss-absorbing buffers can be bolstered when necessary. Ultimately, this means businesses and ordinary depositors can feel secure, knowing that bail-ins—where depositors absorb losses—may not be the necessary outcome of a crisis.
However, the specifics of these changes are where things become complex. The resolution procedure can only commence if deemed in the public interest. As part of the CMDI, the legislation clarifies how authorities should conduct public interest assessments. The broad criteria introduced prioritise resolution over liquidation, but crucially, they still maintain liquidation as the default option for most small and medium-size banks.
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Challenges to financial stability
The legislation includes a harmonised approach to the ‘least cost test’. This test determines whether a failing bank can tap into deposit guarantee schemes (DGS) as an alternative to other means, such as liquidation. Importantly, the agreed text maintains the current preference for the repayment of protected depositors in the first instance, followed by household and SME depositors not covered by DGS.
Despite the optimism surrounding these reforms, the fundamental concern of a “funding gap” persists. Critics argue that the CMDI framework, established in the aftermath of the 2008 financial crisis, has often fallen short in practice. Small and medium-sized banks struggle to meet the Minimum Requirement for Own Funds and Eligible Liabilities (MREL) due to their heavy reliance on deposits and limited access to capital markets. Such funding shortcomings have frequently led national authorities to opt for liquidation or state aid when the resolution process falters—ultimately undermining the CMDI’s effectiveness.
Political and economic tensions
Paschal Donohoe, President of the Eurogroup, extolled the reform’s virtues effusively. „This reform significantly enhances the EU’s ability to respond to bank failures in a proactive, credible, and efficient manner—protecting depositors and safeguarding financial stability. It reflects the Eurogroup’s consistent view that deepening the banking union is essential to strengthening the euro area’s resilience and competitiveness and to enhancing the international role of the euro.“ The general assertions, however, leave little room for the realities of insufficient funding options that many banks face.
A stronger banking sector is a win for all—financial markets, our businesses and our citizens. – Andrzej Domański, Polish minister for finance
The European Commission hopes the reform to address various other points of critisism as well. One of them is that the CMDI appears overly influenced by political constraints, resulting in suboptimal solutions that fail to tackle the root causes of financial instability. Critics have argued that national authorities have often avoided using the resolution framework due to insufficient funding options, turning instead to liquidation or state aid.
Andrzej Domański, Polish minister for finance, hailed the reform as one of the last acts of the Polish Presidency of the EU Council. “For Europe to reinforce its competitiveness, we need a stable, trusted and resilient EU banking sector. (…) A stronger banking sector is a win for all—financial markets, our businesses and our citizens,“ he said.
Scepticism remains
The changes aim to introduce additional financing options for banks, but whether they really mitigate the moral hazard associated with bank failures is yet to transpire. With the new framework potentially shifting burdens onto deposit guarantee schemes, voices of concern grow louder regarding its impact on taxpayer liabilities and long-term financial resilience. A suspicion lingers that these reforms may merely recreate the conditions that necessitated them in the first place.
Increasing the application of resolution tools to smaller banks with regional business models could lead to compliance costs that pressure them to focus on resolvability over innovation. Furthermore, if these banks find themselves navigating more complex regulatory waters without the necessary resources, they may struggle to remain competitive. The ask becomes greater when their ability to attract investors or depositors is already under strain.
Criticism of the CMDI framework
The reform of CMDI seeks to address most of the following issues:
Funding gap, reliance on bailouts:
The CMDI framework has struggled with a persistent “funding gap,” leading national authorities to avoid using the resolution framework and opting instead for liquidation or state aid.
Potential for increased liquidity risk:
The current framework may shift depositor preferences, leading to mispricing of deposits and heightened liquidity risks that undermine financial stability.
Incomplete harmonisation:
Significant differences in national practices hinder the intended harmonisation of bank resolution and deposit insurance across the EU, potentially complicating cross-border cooperation.
Political constraints:
Critics highlight that existing solutions may be overly influenced by political limitations, compromising their effectiveness in addressing fundamental issues in the banking sector.
Impact on smaller and medium-sized banks:
The CMDI framework may impose additional compliance costs on smaller banks, pressuring them to prioritise regulatory requirements over competition and innovation.
While the reform of the CMDI framework is a crucial step towards enhancing the EU banking sector’s stability, it must grapple with entrenched issues that could undermine its success. The balance between safeguarding depositors, ensuring financial stability, and minimising moral hazard is delicate and fraught with complexity. The true efficacy of these reforms will only emerge as the EU endeavours to implement and adapt them in the face of future banking challenges.
