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National Liquidity Approaches Challenge EU Banking Union

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Thursday, March 15, 2018 /07:32 AM / Fitch Ratings 

The lack of a centralised approach to liquidity support under the planned EU banking union will mean continued uncertainty over if and when creditors of struggling banks may suffer losses, Fitch Ratings says. National authorities still have a big role in determining banks' ultimate viability depending on whether they are prepared to offer extraordinary liquidity support. This country-level discretion goes against the principle of consistent banking supervision across the eurozone and makes it harder for banks' creditors to assess their risks.
 

Since the EU sovereign debt crisis, banks in several eurozone countries have benefitted from extended discretionary liquidity support in the form of state-guaranteed funding and/or emergency liquidity assistance (ELA) that helped them to continue operating. Liquidity support may prevent a bank from being declared "failing or likely to fail", or may just delay this, and it may not be clear what approach the national authorities will take in a given case. This could reduce transparency over whether and when a bank has reached the point of non-viability, and therefore have implications for creditors' risk assessment.
 

Liquidity assistance to Italy's Banca Popolare di Vicenza and Veneto Banca is a case in point. The Italian state allowed the banks to issue state-guaranteed bonds to help their liquidity, with the European Commission's agreement that they were still solvent. But the ECB subsequently declared the banks as "failing or likely to fail" after they repeatedly breached capital requirements. The banks were liquidated under Italian law rather than resolved under EU-wide rules because they were not deemed sufficiently systemic. However, the Italian government was able to provide liquidation aid to save senior creditors, and only shareholders and junior bondholders bore losses.
 

In contrast, when Spain's Banco Popular suffered a liquidity shortage and the Spanish central bank did not provide further ELA, it was quickly declared "failing or likely to fail" by the ECB due to deteriorating liquidity (but not solvency problems). As a nationally systemic bank, it was placed into resolution, with subordinated debt written off. However, as with the two Italian banks, senior creditors were spared - this time as part of the bank's takeover by Banco Santander.
 

These examples show how national approaches to liquidity support may vary. For debt holders, the outcomes happened to be similar, with senior creditors spared, in one case by a national government decision to grant liquidation aid and in the other by the existence of a willing buyer for the bank. However, debt holders cannot be sure how liquidity shortages at other EU banks - particularly cross-border groups - would be dealt with by national authorities or what the consequences may be for debt instruments.
 

When rating banks, we differentiate between "ordinary support" and "extraordinary support". Ordinary support includes the use of system-wide stabilisation support packages (for example, guarantees of new funding facilities) and the use of secured central bank facilities, if made available to a bank in line with other banks. For most banks in the EU, we believe extraordinary liquidity or solvency support, while possible, cannot be relied upon, resulting in Support Rating Floors of "No Floor" and no rating uplift for a bank's Issuer Default or senior debt ratings above its Viability Rating. However, if a bank is already receiving, or is set to receive, support, we take that into consideration.
 

The Commission's banking reform package does not propose to harmonise ELA, although the ECB Governing Council plans to review ELA rules by end-2019. Without a harmonised approach, risk assessments of struggling banks may continue to vary from country to country.
 

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