BRUSSELS Europe overhauled the rules covering state aid to struggling banks on Wednesday, in a major policy shift that will put the burden on shareholders and junior debt holders when it comes to restructuring an unstable institution.
From August 1, any bank in the European Union that needs help from the state will first have to present a detailed restructuring plan that ensures its viability before any aid can be disbursed. Currently, aid comes before a restructuring plan.
And the burden on financing the overhaul of an institution will fall first on its shareholders and junior bondholders before any taxpayer money can be used.
"Today's changes of the crisis rules are based on the good practices of the last years in dealing with bank bailouts and restructuring," said Joaquin Almunia, the European commissioner in charge of competition policy.
"In particular, bank owners and junior creditors will need to contribute before any more taxpayers' money is spent on bank bailouts," he said.
The rule changes are an attempt by the European Commission, the EU executive, to level the playing field among banks located in different member states and reduce fragmentation in the banking sector.
Currently, a troubled bank in one country might receive strong support from the state, protecting shareholders and creditors, while another in a separate country might get marginal assistance.
The changes meant that, in theory, all banks will be treated equally and taxpayers will be better protected.
"This will lead to swifter and more efficient restructuring," Almunia said in a statement.
The changes to the state-aid rules are separate from on-going discussions about banking union, including new rules for winding up troubled banks across the euro zone and wider EU, although the two regimes are related.
The European Commission set out its plans for banking resolution on Wednesday, including proposals to establish an agency to salvage or shut down bad banks.
The banking union rules will only come into force from 2018 and will be far more comprehensive in terms of establishing how bank resolution takes place across borders, including how senior bondholders and even bank depositors could be affected.
The new state-aid rules come into effect in three weeks' time and apply only in the case of government assistance to a troubled bank. They also stop short of including senior bondholders or depositors in any bank restructuring.
Earlier this year, after the euro zone provided a bailout to Cyprus, including a fundamental restructuring of its banks, EU officials were at pains to say the rescue was a one-off and did not set a precedent or model for the future.
However, it has become clear that what happened in Cyprus will end up occurring in other countries if the problems in a particular bank are so bad that shareholders and junior bondholders need to be wiped out in order to recapitalize it.
Under the new state-aid rules unveiled on Wednesday, the Commission said there would now be strict limits on executive pay at any bank receiving assistance.
It is the third time the Commission has revised the state-aid rules since introducing the banking assistance framework after the collapse of Lehman Brothers bank in 2008.
The Commission said the overriding aim of the revisions was to make the rules more consistent across all 28 EU member states and ensure taxpayers were not left on the hook for problems created by bad decision-making in banks.
While from now on any capital shortfalls in banks will have to be made up, in the first instance, by shareholders and junior debt holders, the Commission will make exceptions in any cases where the wider stability of the financial system is in doubt.
"Exceptions would be possible where financial stability is at risk or where a bank has already managed to significantly close the capital gap," it said. "The rules will apply as long as required by market conditions," it added.
(Reporting by Foo Yun Chee; Writing by Luke Baker; Editing by Barbara Lewis and Elaine Hardcastle)