Bail-In or Bail-Out? A Survey on the ECB's Role of 'Bank-Loss-Absorber of Last Resort'

The framing of ‘bail-in' as a key resolution tool within the body of the Bank Recovery and Resolution Directive (“BRRD”) has been hailed by many as the end of public bail-outs. For its effective functioning, policymakers and private counterparties have battled to renovate the liability side of banks' balance sheets so as to boost the loss absorbing capacity of these financial institutions. In the EU this aim has been achieved through the enactment of specific prudential rules. These rules provide for the establishment of a minimum buffer of debt instruments — so-called ‘Minimum Requirement for Eligible Liabilities' (“MREL”) — to be wiped out or converted into equity in the event of bank's default. Similarly, the Financial Stability Board (“FSB”) has drafted some international standards demanding global banks to have in their balance sheets a sufficient amount of certain debt instruments having ‘total loss-absorbing capacity' to be used for bail-in purpose. Over the last years EU banks have begun issuing MREL/TLAC eligible instruments in the primary market, so as to comply with the new prudential requirements. In the meantime, the European Central Bank (“ECB”) is playing a prominent role in the secondary market, as bank bonds are still considered eligible collateral for monetary policy main refinancing operations. Against this backdrop, the ECB seems to be assuming on its balance sheet the exponential risk of being bailed-in as a subordinated bondholder. In addition, current discussions upon the extension of the quantitative easing program so as to include bank unsecured bonds may add further concern. Without legal provisions preventing central banks to be treated as a subordinated bondholder, this might turn the ECB in a major banks' losses absorber, thereby revamping events of de facto bail-outs and covered bank recapitalization. The purpose of this paper is to examine the legal ties existing between the EU bail-in rules and the monetary policy framework, shedding light upon the economic and legal implications that MREL/TLAC instruments may have in the ECB's market operations. In doing that we will assess whether — and to what extent — the ECB is potentially bearing the risk of being bailed-in in the event of bank's failures