Delegated Act on ex-ante contributions to the resolution financing arrangements under the Bank Recovery and Resolution Directive (BRRD): Frequently Asked Questions

European Commission

MEMO

Brussels/Strasbourg, 21 October 2014

Delegated Act on ex-ante contributions to the resolution financing arrangements under the Bank Recovery and Resolution Directive (BRRD): Frequently Asked Questions

• 1. 

  What are resolution funds and what are they for?

The Commission has implemented an ambitious financial regulation agenda ( MEMO/14/244) to better regulate, supervise and govern the financial sector so that banks are more resilient to shocks in the future. In particular, the rules imposing stronger prudential requirements on banks (Capital Requirements Directive (CRDIV) - MEMO/13/690) require banks to keep sufficient capital reserves and liquidity. This will make EU banks more solid, strengthen their capacity to adequately manage risks linked to their activities and absorb losses they may incur.

Rules also exist allowing for early intervention when banks face problems (MEMO/14/297). Bank supervisors have an expanded set of powers to enable them to intervene if an institution faces financial difficulties (e.g. when a bank is, or is about to be, in breach of regulatory capital requirements), but before the problems become critical and its financial situation deteriorates irreparably.

If, despite all these preventive measures, the financial situation of a bank deteriorates beyond repair, resolution rules which ensure that failing banks are resolved without taxpayers’ money are now in place. These rules are set out in the Bank Recovery and Resolution Directive (BRRD) which comes into force on 1 January 2015 ( MEMO/14/297). These rules will ensure that shareholders and creditors of the banks pay their share of the costs through a "bail-in" mechanism.

If that is still not sufficient, the national resolution funds set up by BRRD can provide the resources needed to ensure that a bank can continue operating while it is being restructured. Resolution funds are not bail-out funds to rescue failing banks. Their objective is to facilitate the orderly resolution of a bank.

• 2. 

  Why is the Commission adopting this delegated act?

According to Article 290 of the Treaty on the Functioning of the European Union, the co-legislators (the European Parliament and the Council) may empower the European Commission to adopt a delegated act (a so-called level 2 act) to address details of specific provisions of legislation they have adopted . This mandate has to be clearly specified in the text adopted by the co-legislators (the so-called level 1).

The Bank Recovery and Resolution Directive 2014/59/EU ('BRRD') published in the Official Journal on 12 June 2014 sets out new resolution rules for all EU banks. These rules include a national, prefunded resolution fund that each Member State has to establish and build up so it reaches a level of at least 1% of covered deposits within 10 years (according to the data provided by the Member States, as of end 2012 covered deposits in the European Union amounted to nearly EUR 7 000 billion).

The Single Resolution Mechanism Regulation ( MEMO/14/295) establishes the Single Resolution Fund in the Banking Union. It will reach the target level of EUR 55 billion over 8 years (the basis being 1% of the covered deposits in the financial institutions of the Banking Union). Once this target level is reached, in principle, the banks will have to contribute only if the resources of the resolution funds are used up.

In order to calculate the precise amount that individual financial institutions will have to pay each year to their respective resolution funds, the co-legislators empowered the Commission to detail the required contributions in a Delegated Act.

The co-legislators also empowered the Commission to specify the registration, accounting, reporting and other obligations necessary to ensure that the contributions are fully and correctly paid.

• 3. 

  Which entities will contribute to resolution financing arrangements?

All institutions (credit institutions and investment firms) authorised in the Member States, including branches of third country financial institutions, have to contribute to the resolution financing arrangements.

However, many of the risk adjustment metrics set out in this Delegated Regulation are not appropriate to apply directly to the EU branches of third country institutions. Therefore, while EU branches do not fall within the scope of this Delegated Act, they may be subject to a specific regime developed by the Commission in a future Delegated Act.

• 4. 

  How will the annual contributions be calculated?

The delegated act determines how much individual credit institutions will have to pay each year to their respective resolution funds according to the bank's size and risk profile.

More specifically:

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  the size is the main factor determining how much each institution will pay: the contribution of each institution will be pro rata to the amount of its liabilities excluding own funds and guaranteed deposits,

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  the amount will then be adjusted in accordance with the risk profile of each institution with one simple principle: the riskier a bank, the higher its contribution.

Contributions are calculated at individual entity level, i.e. per bank. This implies that for a banking group (a group of institutions subject to the same consolidated supervision), this would lead to a situation where the same liability would be counted twice and the group would thus be called on to pay the resolution financing arrangements twice. Therefore, to avoid double counting and charging the same liability twice, intragroup liabilities created between institutions which are part of the same group are excluded from the basis for calculation of the annual contributions under certain conditions.

This approach also applies to the liabilities created by the institutions which are members of the same Institutional Protection Scheme ¹ because of the similarities between those structures and banking groups.

Each institution will therefore contribute in proportion to its size and its risk profile. This approach is proportionate and non-discriminatory.

In the Banking Union, the national resolution funds set up under the BRRD as of 1 January 2015 will be replaced by the Single Resolution Fund as of 1 January 2016 and those funds will be pooled together gradually. Therefore, as of 2016, the Single Resolution Board will calculate, in line with a Council implementing act, the annual contributions of all institutions authorised in the Member States participating in the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).

4.1. What is the proposed risk range for the adjustment of contributions?

The basic contribution already reflects certain elements of risk, as it is lower the more capital and deposits banks hold. In addition, a risk adjustment is applied to them. The Delegated Act introduces a range of 0.8-1.5 so that the total, risk-adjusted contribution of each institution may not be lower than 80% of the basic risk contribution or higher than 150% of it. The proposed risk range would lead to a sufficient modulation of the risk posed by an institution while ensuring sufficient predictability as regards the amount of the annual contribution to be paid by the banks. A review clause in the recitals indicates that once sufficient experience is gathered with the new system, the range will be revised and could be enlarged.

4.2. Which are the risk pillars and risk indicators used in the methodology for the calculation of contributions?

The resolution authorities will assess the risk profile of institutions on the basis of the following four risk pillars, each of which contains a number of specific indicators:

• 1. 

  risk exposure ²; this pillar aims to capture the risk exposure of an institution and its capacity to sustain it;

• 2. 

  stability and variety of sources of funding ³; this pillar aims to capture the stable funding resources of an institution;

• 3. 

  the importance of an institution to the stability of the financial system or economy ⁴; this pillar aims to capture the relevance of an institution for financial stability; and

• 4. 

  additional risk indicators to be determined by the resolution authority ⁵. This pillar contains indicators for which a specific assessment of the resolution authority will be required. It grants limited discretion to the resolution authorities to assess the risk of a number of extra risk indicators. When making that assessment, the resolution authorities will have to consider the importance of those indicators in light of the probability that the institution concerned would enter resolution and of the consequent probability of making use of the resolution financing arrangement if the institution were to be resolved.

4.3. Does the Delegated Act provide for special treatment for small credit institutions?

Yes. The Delegated Act takes into account the fact that small institutions do not generally have a high risk profile, are often less systemically risky compared to large institutions, and, in many cases, the impact of their failure on the wider economy is lower than that of large institutions. This reduces the likelihood that they will need access to the resolution financing arrangements compared to large institutions. Therefore, under the Delegated Act, the annual contribution of a small institution will consist of a lump-sum only which is proportionate to its size.

Institutions are considered to be small institutions if they meet a double threshold:

• a) 

  institutions whose total liabilities (excluding own funds) less covered deposits are equal or less to EUR 300 million, and

• b) 

  institutions whose total assets do not exceed EUR 1 billion (Member States can extend this threshold to up to EUR 3 billion).

Small institutions are classified in six categories according to their size. Depending on their size, their annual contributions range between EUR 1 000 (for institutions whose total liabilities, less own funds and covered deposits, are equal to or less than EUR 50 000 000, and whose total assets are less than EUR 1 000 000 000) and EUR 50 000 (for institutions whose total liabilities (excluding own funds) less covered deposits are above EUR 250 000 000 but equal to or less than EUR 300 000 000, and whose total assets are less than EUR 1 000 000 000).

In some cases, if a small bank has a particularly high risk profile and poses more substantial risks to financial stability, the resolution authority may decide that it should be treated like a bigger bank rather than benefit from the simplified lump sum regime.

4.4. Does the Delegated Act provide for specific treatment for institutions that are members of Institutional Protection Schemes (IPS)?

Yes. First, membership of an IPS is one of the risk-mitigating elements set out in the BRRD and this is also reflected in the Delegated Act. Belonging to an IPS means that an institution counts as being less risky - the exact risk factor attributed to it is then decided by the resolution authority. Second, membership of an IPS is also reflected in the way the basic annual contribution is calculated, as liabilities created by an institution which is a member of an IPS through an agreement with another institution which is a member of the same IPS are excluded from the amount of liabilities considered for the calculation of the basic annual contribution.

4.5. How much will small, medium-sized and big banks pay?

On the basis of the available data provided by Member States, and under the assumptions and methodology described in the Commission Staff Working Document accompanying the Delegated Act, it is estimated that, in the euro area, the largest banks representing 85% of total assets would pay around 90% of total contributions, while the smallest banks representing 1% of total assets would pay around 0.3% of total contributions.

4.6. Why are derivatives subject to a special regime?

As all liabilities, liabilities arising from derivatives are a part of the contribution base.

Accounting for derivatives is not harmonised in the EU with respect to individual accounts, and because of the specific nature of derivatives, different approaches to acounting for them lead to very different outcomes.

To avoid an unlevel playing field in the determination of the basis for the contributions, the Delegated Act requires derivatives to be accounted for as they are in the leverage ratio under the Capital Requirements Regulation. This will ensure a harmonised approach in the treatment of derivatives. However, in any case the harmonised treatment cannot lead to significant reductions of more than 25% of the value accounted for.

• 5. 

  How is this methodology implemented in the context of the Single Resolution Fund?

The methodology developed in the Delegated Act also applies to the calculation of the contributions in the euro area. The Single Resolution Board - the resolution authority of the Banking Union - will have to apply the methodology set out in the Delegated Act when calculating the contributions of institutions authorised in the Member States participating in the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). The Implementing Act that the Council is empowered to adopt under Article 70(7) of the SRM Regulation on a proposal of the Commission, will ensure that the methodology of the Delegated Act is applied within the Banking Union and will allow the Board to calculate and allocate to each institution the contributions to the Single Resolution Fund. The Commission committed to adopt the Delegated Act and the proposal for a Council Implementing Act at the same time. As the empowerment to adopt a proposal starts only on 1 November 2014, the Commission has adopted today only a draft proposal, which is due to be formally adopted in the coming weeks.

• 6. 

  Why does the draft proposal for a Council Implementing Act provide for an adjustment mechanism?

Under the BRRD, the target level of the national resolution funds is set at national level and calculated on the basis of deposits covered by deposit guarantee schemes. Under the SRM, the target level of the Single Resolution Fund (SRF) is European and is the sum of the covered deposits of all institutions established in the participating Member States. This results in significant variations in the contributions by the banks under the SRM as compared to the BRRD. As a consequence of this difference, when contributions will be paid based on a joint target level as of 2016, contributions of banks established in Member States with a lot of covered deposits will sometimes abruptly decrease, while contributions of those banks established in Member States with fewer covered deposits will sometimes abruptly increase. In order to prevent such abrupt changes, the draft proposal of the Commission for a Council Implementing Act provides for an adjustment mechanism to remedy these distortions during the transitional period by way of a gradual phasing in of the SRM methodology.

• 7. 

  What process did the Commission follow in preparing this act and what data has been used to estimate the potential impacts of the methodology for calculating the contributions?

The European Commission organised a series of meetings with the Expert Group on Banking, Payments and Insurance, made up of representatives of the Member States, to discuss the elements of the Delegated Act. In June 2014, the Commission organised an online public consultation on the key elements of the determination of contributions of institutions to the resolution financing arrangements. ⁶ It received more than 3 500 responses.

The Commission’s Joint Research Centre (JRC) built a database with the relevant data on credit institutions. The Commission also worked in close cooperation with the European Banking Authority and the European Central Bank in the preparation of the Delegated Act.

A first preliminary analysis of the distribution of contributions to the resolution financing arrangements was conducted by the Commission on the basis of commercial, publicly available data (the so-called Bankscope database) available to the JRC. As this data had its limitations, the Commission services requested Member States' representatives in the Expert Group to provide further data in order to analyse the impact of the proposed methodology. The final database is much improved with respect to publicly available data, both in terms of reliability (figures are provided directly by competent authorities) and in terms of coverage, increasing from around 3 200 to around 4 600 banks and from around 74% to around 83% of total assets. The key steps of analysis are included in the Commission staff working document.

• 8. 

  Entry into force of the Delegated Act

The Delegated Act should be applicable by 1 January 2015 when the BRRD becomes applicable, as the methodology for the calculation of the annual contributions of the banking sector to the resolution financing arrangements established under the BRRD is necessary to ensure the proper implementation of that Directive.

The Delegated Act adopted today by the Commission is subject to a right of objection by the Council and the European Parliament within three months, extendable by a further three months.

A Delegated Act enters into force after its publication in the Official Journal, after the period for objection has expired or where both the European Parliament and Council have signalled their “early approval”.

¹ :

(IPS are loose groupings of banks of similar business profile in one Member State (e.g. Germany or Austria) which have arrangements amongst each other to transfer funds and provide support to avoid the bankruptcy of a member-bank.)

² :

The ‘Risk exposure’ pillar consists of the following risk indicators (relative weight 50%):

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        Own funds and eligible liabilities held by the institution in excess of Minimum Requirement of Eligible Liabilities;

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        Leverage Ratio (Tier 1 capital divided by a measure of non-risk weighted on- and off-balance sheet items) ;

      • - 

        Common Equity Tier 1 Capital Ratio (this allows an institution to continue its activities and helps to prevent insolvency);

      • - 

        Total Risk Exposure divided by Total Assets.

³ :

The ‘Stability and variety of sources of funding’ pillar consists of the following risk indicators (relative weight 20%):

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        Net Stable Funding Ratio;

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        Liquidity Coverage Ratio, the short-term (over a thirty day period) resilience of the liquidity risk profile of financial institutions.

⁴ :

The ‘Importance of an institution to the stability of the financial system or economy’ pillar consists of the indicator ‘Share of interbank loans and deposits in the European Union’ (relative weight 10%).

⁵ :

The ‘Additional risk indicators to be determined by the resolution authority’ pillar consists of the following indicators (relative weight 20%):

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        Trading activities, off-balance sheet exposures, derivatives, complexity and resolvability;

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        Membership in an Institutional Protection Scheme;

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        Extent of previous extraordinary public financial support.

⁶ :

For the online survey as well as a summary of the responses, see: http://ec.europa.eu/internal_market/consultations/2014/credit-institutions-contributions/index_en.htm