Positioning in respect of the European Commission s proposal for a recast Directive on Deposit Guarantee Schemes EBF final position.

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1 EBF Ref.: D1325H-2010 Brussels, 12 October 2010 Set up in 1960, the European Banking Federation is the voice of the European banking sector (European Union & European Free Trade Association countries). The EBF represents the interests of some 5000 European banks: large and small, wholesale and retail, local and cross-border financial institutions. The EBF is committed to supporting EU policies to promote the single market in financial services in general and in banking activities in particular. It advocates free and fair competition in the EU and world markets and supports the banks' efforts to increase their efficiency and competitiveness. Positioning in respect of the European Commission s proposal for a recast Directive on Deposit Guarantee Schemes EBF final position. Key Points Coverage Level Support the harmonised coverage level of EUR Consider grandfathering clauses or a transition period instead of national options for higher levels of coverage in certain life situations Foresee a phasing-out period of three to five years for any coverage above EUR 100,000 whether provided by voluntary DGS, mandatory DGS, or institutional protection schemes Scope Allow the setting off of deposits and liabilities as a national discretion Payout should only be required in the national currency of the Member State where the DGS is established. Fast Payout Maintain at this stage the 2009 agreement on a payout timeframe of 20 days to effectively assess the feasibility of further reductions Review the timeframe for payout on the basis of sufficient evidence, at the earliest by March 2012 Funding Consider substantial lower funding requirements than proposed by the EC based on the overall context of new regulatory requirements and initiatives to strengthen prudential policies. Allow Member States to already determine ex ante contributions on the basis of covered deposits and speed up the migration process for the other schemes Target timeframes should be set at national discretion to reflect different starting points and should be at least 15 years. Exclude the possibility of borrowing between national DGS European Banking Federation (a.i.s.b.l.) Page 1 10 Rue Montoyer B-1000 Brussels T: 32 (0)

2 Risk Based Contributions Redesign the methodology for risk-based contributions While fully supportive of a harmonized risk based contribution mechanism, the banking industry wishes to be involved in the analysis and elaboration of such a mechanism. DGS Powers of Intervention Leave the current national mandates of DGS unchanged until there is clarity on the overall crisis management framework Contact Person: Timothy Buenker, t.buenker@ebf-fbe.eu Related documents: European Commission legislative proposal: European Banking Federation - EBF 2010 Page 2

3 General remarks The European Banking Federation attaches great value to well-functioning deposit guarantee schemes (DGS), in view of their important role to both safeguard financial stability and to ensure a high level of depositor protection. The significance of DGS has again been proven in the recent financial crisis. The EBF fully supports the European Commission s objective to enhance the functioning of the schemes. Some of the European Commission s proposals are considered very helpful. Most importantly, the EBF supports the greater harmonisation of many aspects of the schemes. This includes notably the harmonised coverage level. Setting a fully harmonised coverage level of EUR 100,000 will make the systems more transparent and contribute to depositors confidence in the DGS system. A single, fully harmonised system of coverage will also be a stabilising element in turbulent times as there is no incentive for investors to move their funds between banks that belong to different DGS. However, the EBF strongly feels that the European Commission s proposal must be clarified in respect of its application to Institutional Protection Schemes (IPS). It must be made explicit that in the case of a prevented default of a member of such a scheme, investors with deposits in excess of the DGS coverage level would be treated exactly the same as the investors of any other bank, which is allowed to fail. The EBF notes that in some Member States, that the existence of such schemes contradicts the harmonised coverage level of EUR 100,000 as Institutional protection is unlimited coverage for creditors, including depositors. The Commission should consider the impact on competition within such Member States and allow for a gradual transition to a level playing field. The EBF also supports other important aspects of harmonisation, such as the definition of eligible deposits and the setting of harmonised ex ante funds and ex post contributions, albeit over a longer transition period. The purpose of harmonisation would be well served by adding a maximum level for the ex ante funds. However, a number of important aspects of the legislative proposal seem overly ambitious in the context of the current state of play. Adaptations to the current functioning of DGS should be driven by the desire to improve the practical functioning of the schemes. The EBF supports development towards greater harmonisation, but an EU DGS would be premature at this stage and there are important elements of the DGS that should remain subject to national discretion, at least for the time being. Furthermore, there are concerns that parts of the Commission proposal could violate the principle of subsidiarity. The EBF does not believe that aspects of the functioning of DGS such as the timing and frequency of contributions and the way in which customers are informed about the existence and coverage of DGS need to be regulated by EU law in the proposed amount of detail. The adaptations that are required to the national DGS in order to achieve the most pressing objectives are already extremely demanding on the schemes and on banks. There is a risk of overburdening the schemes with additional requirements, including most notably the proposed level of ex ante and ex post contributions and the short timeframe for pay-out. In other areas, there is at a minimum a need for further clarification and specification, including the proposal European Banking Federation - EBF 2010 Page 3

4 for borrowing arrangements between the schemes, the arrangements between home and host DGS, and the methodology to determine banks contributions to the schemes. European banks also believe that more time than currently foreseen must be allowed for the implementation of the new requirements. Harmonisation should remain the objective in the further development of the national DGS. However, banks believe that the current differences between the national systems cannot be overcome as quickly as intended by the Commission. During the transition period, Member States should be given greater discretion in the implementation of the new requirements. In addition, the two issues of DGS and crisis management, including bank resolution, cannot be dissociated from each other. In many Member States, DGS can under certain conditions today be part of a bank resolution scenario. The European Commission issued on 26 May a Communication in which it announced further work on crisis management for the next few months. The EBF would strongly urge that no changes are made to the current national mandates of DGS before the crisis management framework has been defined in a clear and comprehensive manner, namely the way how resolution funds will operate and how its functions will be coordinated with the functions of the DGS in respect of matters such as the events that should trigger the use of DGS and resolution funds respectively. Moreover, the EBF would call on policy-makers not to lose sight of the overall regulatory developments and to design the changes to the DGSD in thorough consideration of the interaction of different policy frameworks and levies or taxes with similar objectives and in the light of the impact of the entire package of regulatory changes on the economy as a whole. In addition to the crisis management arrangements, this includes notably the changes that are being made to the Capital Requirements Directive. Funding all these requirements will not be easy, and tough regulatory requirements and uncertainty about future regulation do not encourage outside investments. Finally, the EBF stresses the importance of prevention, i.e. applying strict conditions before granting new bank licenses; encouraging good risk management by banks; and ensuring proper supervision of the banking sector, so as to promote a stable financial system at the core and limit the cases where DGS have to intervene. DGS powers of intervention The European Commission proposes to restrict DGS use for any other purposes than that of paying out depositors. According to the recast proposal, DGS may only be used for early intervention under certain, tightly defined conditions. While the EBF agrees that DGS should focus on paying out customers and should not be overburdened with additional responsibilities, the restriction is highly problematic in the absence of a clarification of how else early intervention would be organised. The Commission proposal constitutes for many Member States a restriction of DGS powers of intervention, as compared to today s situation. As noted in the General Remarks above, therefore, no changes to the current national mandates of DGS must be made before the EU framework for crisis management has been European Banking Federation - EBF 2010 Page 4

5 comprehensively defined. Work in this area is expected to start within the next few weeks. An overarching framework should focus on possibilities of successful early intervention. As part of the overall framework of crisis management it should then be considered in what exceptional cases DGS might be used for bank resolution purposes. In order to avoid the involvement of DGS in cases that exceed its mandate, it will have to be ensured that DGS remain independent in their decisions from undue outside interference. Governance structures play an important role in this respect. Recommendations: powers of intervention Clarify the arrangements for crisis management Leave the current national mandates of DGS unchanged until there is clarity on the overall crisis management framework Put in place appropriate governance structures to prevent undue outside interference with DGS decisions Scope of coverage The European banking industry welcomes the European Commission s proposals to harmonise the scope of deposits covered by DGS in a way that only entirely repayable instruments would be covered, but no structured products, certificates or bonds. It is also appropriate to exclude financial companies from the scope of coverage. However, it is not the purpose of a DGS to cover the deposits of large corporates. DGS are in principle intended to protect retail depositors. The inclusion of non-financial companies, regardless of their size, is only justified by the administrative difficulties to maintain an updated list of which corporate clients fulfil the criteria of a small or medium-sized enterprise. As an aside, it must be noted that including the monies of all corporate clients in the scope of eligible assets artificially drives up the level of ex ante funds to be built up under the Commission s current proposal. It is therefore all the more important, as the EBF argues below in the section on Financing Arrangements, that the contributions to the schemes are calculated on the basis of covered deposits rather than eligible deposits. However, the EBF is concerned that the proposed definition of covered deposits is too narrow, in that it excludes all types of certificates. It would certainly not be appropriate to exclude registered savings whose existence cannot be proven by a statement of account. Products eligibility should be granted if they are non-tradable, if they are linked to a specific person and if they can be claimed against the bank. The EBF notes that the European Commission furthermore proposes to no longer allow the setting off of deposits and liabilities. This constitutes a radical change as compared to the 1994 Directive, which allowed for all counterclaims (including non-due loans such as mortgages) to be subtracted from a person s deposits when establishing the sum to be paid out to the person. European Banking Federation - EBF 2010 Page 5

6 In the event of a default, the current Commission proposal means effectively that a DGS would fully pay out the liabilities owed by the defaulting bank to the depositors, while the depositor should make the payments for due claims independently of this pay-out procedure. This is already the case today in some Member States. Essentially, the preference for or against the setting off of due claims is to a large extent explained by the fundamental differences in Member States national insolvency law. This varies notably in respect of whether the liquidator or the DGS itself would have to engage in the necessary steps to claim the loans granted to the client, but also and in respect of other important modalities of the liquidation procedure. Where the DGS has to claim back the money directly, additional difficulties can be expected in the case that a client located outside the EU becomes a debtor to the DGS, as a result of the need to involve a foreign court. The EBF therefore believes that there are strong reasons to maintain the possibility of setting off as a national discretion. The Commission furthermore proposes that payout should take place in the currency in which the account was maintained. This is extremely difficult, in procedural terms, and therefore contrary to the objective of fast pay-out. The EBF would strongly advise that pay-out be exclusively in Euro or the national currency of the Member State where the deposit is maintained. In any case it must be clear in advance for depositors which currency their deposits will be repaid in. That goes particularly for foreign-currency accounts, i.e. accounts that are not denominated in the currency of the country in which the account is maintained. For the sake of clarity, the EBF would in addition suggest that the exclusion of deposits by investment firms in Article 4.1 e) be worded in the same way as the exclusion of deposits by credit institutions. I.e., the text of point (e) should read: (e) subject to Article 6(3), deposits made by investment firms as defined in Article 4(1)(1) of Directive 2004/39/EC on their own behalf and for their own account,. Also, point (k) of Article 4.1 should be clarified in respect of whether it would include socalled certificates of deposit (in registered or bearer form). Recommendations: scope of coverage Exclude tradable certificates from the scope of coverage but include traditional savings books and similar products, bonds and debentures linked to a specific person Allow the setting off of deposits and liabilities as a national discretion Payout should only be required in the national currency of the Member State where the account is maintained. Level of coverage In principle, the EBF welcomes the European Commission s proposal of maximum harmonisation of the level of coverage. This is however subject to a level playing field of all kinds of banks (cf. comments below on institutional protection schemes). European Banking Federation - EBF 2010 Page 6

7 A majority of EBF members disagrees however with the options of higher coverage that the European Commission proposes to grant Member States (Article 5.2), especially in combination with the abolishment of the possibility of topping up. The EBF acknowledges the social considerations behind such exemptions. However, there would be a significant administrative burden on DGS to identify in a short space of time which deposits fall under the exemption, in addition to the difficulty of defining such exemptions in a clear-cut way. The Commission s proposal of a national discretion is preferred by a minority of EBF members. For level playing field reasons, yet other members would prefer that exemptions be altogether abolished, after a transition period. Most EBF members consider that it would be a good compromise to grant grandfathering clauses to those Member States which currently guarantee higher coverage levels in certain life situations. This would allow these Member States to continue with the higher levels of coverage that they currently deem necessary, but would not allow other Member States to introduce new exemptions. As regards the possibility for Member States to establish special systems protecting old-age provision products and pensions, as per Recital 15 and Article 5.3 of the proposed Directive, the EBF believes that further clarification is necessary. According to the Commission, such systems should operate separately from the DGS. It is not clear on what precise basis the distinction would be made and whether such separate systems could be set up to protect only those amounts that exceed EUR 100,000 per depositor, or if they would have to cover the products in their entirety. For non-euro Member States, the Commission proposes that the applicable level of coverage be calculated on the basis of the exchange rate on the date of entry of the recast DGS and may be rounded off by up to EUR 2,500. This is important as uneven amounts make it less easy to explain the coverage to depositors and are less easily remembered by depositors. Most EBF members believe therefore that rounding by EUR 5,000 would be more appropriate. Rounding should be possible on a regular basis, e.g. yearly to adjust for possible valuation changes. Recommendation: level of coverage Consider grandfathering clauses or a transition period instead of national options for higher levels of coverage in certain life situations Consider greater rounding flexibility for non-euro Member States Treatment of Institutional Protection Schemes (IPS) The EBF welcomes the Commission s clarification in Recital 9 that Mutual Guarantee Schemes should be covered by the Directive, as well as the clear requirement that members of Mutual Guarantee Schemes pay contributions to the DGS and the ban of any reference to unlimited coverage of deposits. However, the Federation is unclear how these statements are compatible with maintaining a system where IPSs guarantee the liquidity and solvency of institutions. The EBF would request an explicit statement to the effect that in the case that a member of a Mutual European Banking Federation - EBF 2010 Page 7

8 Guarantee Scheme has to be rescued through the system, depositors could only be compensated up to the fully harmonised protection level of EUR 100,000. In addition, the EBF would request that the recast Directive maintain the explicit prohibition of any state guarantee for any IPS (Article 3 of the current Directive). Otherwise, every depositor, and in particular any depositor with deposits in excess of the harmonised coverage level (large non-financial institutions), would have an incentive to move her funds to banks that are part of an institutional protection scheme. The Commission s proposal could be interpreted in this way and thereby also raises serious financial stability and competition concerns. In particular for the special case of Germany there is a real concern that a substantive amount of deposits would be relocated from normal members of DGS to members of institutional protection schemes. This would have worrying consequences for the financial stability in Europe as a whole. The only alternative would be to continuously allow voluntary DGS to provide higher coverage levels than those granted by the mandatory schemes, which would however be inconsistent with the objective of fully harmonising the level of protection. Another case of competitive distortions exists in Sweden, where the National Debt Office (which forms part of the Ministry of Finance and also manages the Deposit Guarantee System) offers savings accounts for private customers as a way to finance the Swedish national debt. These deposits are not covered by the deposit insurance system since they are offered by a state authority. As they are guaranteed by the government, they offer however higher levels of protection for deposits above the harmonised coverage level than could be provided by commercial banks. The EBF believes that a transition period of e.g. five years for the phasing out of any coverage levels above the fully harmonised EUR 100,000 level, whether provided by the existing voluntary DGS, by mandatory DGS, or by institutional protection schemes, would be appropriate to allow for smoother transition into the new regime. Recommendations: institutional protection schemes Clarify in the recast Directive that in the event that a member of a Mutual Guarantee Scheme is rescued by the system, deposits above the fully harmonised EUR 100,000 level would not be protected Foresee a phasing-out period of three to five years for any coverage above EUR 100,000 whether provided by voluntary DGS, mandatory DGS, or institutional protection schemes Timeframe for payout The European banking industry agrees with the European Commission on the importance of fast payout. However, the aspiration that depositors will be compensated within seven days is impractical and likely to be unachievable for most if not all DGS. According to the European Commission s current proposal, DGS would have to complete the following steps: European Banking Federation - EBF 2010 Page 8

9 (i) (ii) (iii) (iv) (v) Determine the global amount of liabilities of the failing bank, in each currency; Determine the failing bank s liability to each individual depositor, also taking into consideration the limit of guaranteed amounts for each depositor; Obtain the necessary global amount in each currency; Carry out the individual payments to each depositor; and The DGS may have to organise for the provision of additional funding in case the funds available in the DGS would not cover the total payout amount needed. Recent experience has proven that even a timeframe of 20 working days is very difficult to comply with. The fastest possible timeframe for payout depends on the specific context and must take account of factors such as the following: The nature of DGS contact with the failed bank s clients. In some countries, there are also limitations on the use of customer data which make it difficult to produce a definitive single customer view. National law in respect of the liquidation procedure. The Directive proposal grants certain powers to the DGS which allow them to intervene in an insolvency procedure. However, this does not guarantee per se that such powers can effectively be used in an insolvency procedure of a failing credit institution. The degree or lack of integration of the banking system. The practicalities of making payments to large numbers of depositors. In addition, it must be borne in mind that the situation for corporate depositors is often particularly complex, e.g. in that corporate often hold multiple accounts with a more complex asset structure. Joint accounts, e.g. accounts held by groups of house-owners where up to 100 persons may be entitled to the deposits, are especially difficult to reimburse. Some actions can be prepared in advance, but others can only be dealt with when a bank has failed. For example, calculation of interests and handling of in-flight transactions can only be handled after the failure. The time that is necessary for these actions depends on the size and structure of the bank but will be in the order of several days in any case. Some Member States have started to test mechanisms that could speed up payout as much as possible, for example by setting up special banks mandated to pay out depositors on behalf of DGS. However, more experience needs to be gained with these mechanisms. In the 2009 revision of the DGS, when the timeframe for payout was reduced to 20 working days it was also agreed that the Commission should review the effectiveness and the timeframes for the payout procedures on the basis of some experience gained with the new timeframes by 16 March 2011, assessing whether a reduction to ten working days would be appropriate. European banks believe that such an evidence-based approach is the right one and should be maintained in principle. In the absence of such an assessment, there is no justification for a shortening of the payout timeframe to 7 days. European Banking Federation - EBF 2010 Page 9

10 The current timing of revision, March 2011 is proving too early for a review. Further experience and thorough system testing is necessary to assess how even the current timeframes can be consistently met, and then be reduced in a next step. This analysis will also have to be undertaken in light of the important further adaptations to the regime that are now being proposed, whose impact on the feasible timeframe for payout can be both positive and negative. This will have to include careful consideration of inter alia, national liquidation procedures and data protection concerns in cross-border situations or situations involving third countries. It would be much more detrimental to the public confidence in the financial system if the required timeframes could not be met, than to allow for some more days for payout. The EBF would consider March 2012 or preferably, March 2013 the earliest possible date for a meaningful analysis. Recommendations: timeframe for payout Maintain at this stage the 2009 agreement on a payout timeframe of 20 days Review the timeframe for payout on the basis of sufficient evidence, at the earliest by March 2012 Automatic reimbursement The requirement that DGS reimburse customers automatically will constitute a great challenge for most DGS. In any case, automatic reimbursement can only be undertaken if all necessary data is available, notably an alternative account number to which the money can be transferred. Care will also have to be taken to avoid any conflict with other applicable law, for example in respect of anti-money laundering and anti-terrorist financing. Financing arrangements The EBF is supportive of a proportionate and long-term approach in reaching the goal of harmonised DGS funding in Europe based on a mixed model of ex ante and ex post contributions, while considering the national circumstances and individual funding implications in light of other proposed regulatory measures. Furthermore, clarity on the role of deposit guarantee schemes in the overall crisis management framework will help to determine the appropriate financing arrangements for DGS, in addition to other aspects of DGS functioning. Basis for calculating the ex-ante funds The basis for calculating the size of the funds and the contributions is of essential importance for the functioning of the DGS. The currently proposed basis for determination exaggerates considerably the actual funding needs. Eligible deposits include all deposits that are in principle subject to the Directive (synonymous with protected or insured deposits), whereas covered deposits (or guaranteed or re-fundable deposits) exclude all deposits that lie above the EUR 100,000 level of coverage. The difference can be significant, especially bearing in mind that the Directive covers all assets of non-financial companies which often have deposits well above the EUR 100,000 coverage level. The below table illustrates the difference on the basis of figures available in some Member States. European Banking Federation - EBF 2010 Page 10

11 Examples of the difference in eligible deposits vs. refundable deposits Country Austria (2009 figures) Approx. 65% France (2007 figures) 74.61% Malta (2010 figures) 38% Netherlands (2007 figures) 76.84% Norway (2010 figures) Approx. 58% % Covered deposits/ Eligible deposits Naturally, meeting the target level is easier for those schemes where eligible deposits vary relatively little in relation to refundable deposits. In those countries where deposits frequently and substantially exceed the EUR 100,000 level of refundable deposits, meeting the target level is relatively more difficult. The EBF recognises that the reason for the European Commission s decision not to refer to covered deposits lies in the fact that many DGS cannot currently provide the necessary data about covered assets. This is not sustainable. Ex ante funds and contributions must be calculated on the basis of covered deposits as quickly as possible. Calculations on the basis of eligible deposits should only be allowed on a temporary basis. The EBF remains committed to the objective of increasing harmonisation over time, including on the financing of the schemes. In light of the current significant differences between the national DGS and the corresponding varying levels of impact of the Commission s proposals on the national schemes, however, the EBF considers that Member States should have greater discretion on the way of implementing the new requirements. Member States could then base the timing and fund size calibration on the structure and risk profile of their respective banking system and on the relative starting point in building up the fund. A more flexible approach would also mean that schemes that do not currently base their calculations on eligible deposits would not have to do so for an interim amount of time, but could directly base their calculations on covered deposits. As part of a regime with more flexible interim arrangements, Member States should be given the option to already base the calculations on covered deposits. Quicker transition towards calculation of the ex ante requirements on the basis of covered deposits, instead of eligible deposits, would also alleviate the burden for many banks and DGS. Pre-funding requirements The European Commission proposes funding mechanisms which would require national DGS to build up ex-ante funded pools corresponding to 1.5% of eligible deposits over a transition period of ten years, with regular contributions of at least 0.25% of eligible deposits until the funds has reached a size of at least two thirds of its target size. This would imply a huge cost on banks and their customers, in particular where banks have so far contributed ex-post; in a time where banks are already under much pressure to fund higher capital requirements and European Banking Federation - EBF 2010 Page 11

12 other new regulatory requirements. Also, the ex post funding requirements are very high and unrealistic. It should also not be forgotten that DGS funds may be diminished by new payouts during the accumulation phase. Institutions would have to make up for this diminishment by making higher contributions in order to reach the target level within the prescribed period. Some preliminary calculations have demonstrated that if the Commission s proposal was implemented as drafted, for some banks and schemes this would lead to fold increases of banks regular contributions to the DGS. The EBF is interested in the extent to which the Commission has considered the policy implications of ex-ante and ex-post funding in addition to the policy requirements stemming from the new Basel capital and liquidity framework. As European banks have frequently pointed out, in aggregate these requirements could significantly constrain lending as well as banks ability to participate in a pre-funded scheme. Moreover, ensuring that DGS financial means be proportionate to their potential liabilities does not justify such a high target level. Such a level seems to ignore current and forthcoming policy initiatives to strengthen crisis prevention and establish an effective crisis management framework, which, among others, would aim at ensuring minimum disruption to depositors should their bank be failing, including transferring their deposits to another bank (private or bridge bank for instance). All these should limit cases when the DGS would need to intervene. The EBF notes, furthermore, that the proposed level of funding indeed also lies well above those required by other schemes world-wide. Therefore, the EBF is firmly opposed to the level of ex ante target funds proposed by the European Commission. The final calibration of the funding target level needs to take account of the structure of the national banking systems and other funding requirements for banks on financial stability, and should be subject to appropriate timing and phasing in. The timeframe in which Member States should build up their ex-ante funds needs to be flexible to take into account different national circumstances and starting points. This allows financial institutions to spread the financing burden over a manageable period of time. A timeframe of at least 15 years time or longer, calculated from the adoption of the Directive, instead of ten years would be more appropriate in many Member States. This will allow a smoother transition towards the largely ex-ante funded systems for those countries where the system was so far exclusively or to a large extent ex post funded. The percentages for yearly contributions foreseen in Article 9 of the draft recast Directive, of 0.25%, should also be scaled down. Going forward, once the national DGS have reached sufficiently high ex ante levels, the systems should be designed so as to evenly distribute banks contributions over time, instead of requiring high contributions in some years and low contributions in others. This comment notwithstanding, for level playing field reasons the EBF believes that it would be appropriate to determine a maximum fund size above which DGS may not raise any European Banking Federation - EBF 2010 Page 12

13 additional contributions. For example, the EBF would suggest a maximum fund size, with a grandfathering clause for schemes that have already built up higher funds. Funding by means of pledge The EBF suggests that a certain share of the ex-ante required funds in the order of one third or one half of all funds required could be provided by means of pledge. Funding by means of pledge would make it easier and therefore faster to build up the target funds. Assets acceptable as pledge should not only include government bonds, but a sufficiently wide range of securities, including at a minimum those that are accepted as collateral for loans from the Central Bank. The pledged securities could be used by the DGS for extraordinary funding, facilitating alternative borrowing arrangements. The modalities of pledging arrangements should be clear and harmonised across the EU. Initial contributions The EBF does not understand the Commission s reasoning in forbidding any requirements for initial contributions from banks when joining the DGS. Moreover, it is questionable whether this aspect of the functioning of DGS has to be harmonised at EU level. Entry fees could serve to adequately cover the additional risk caused to DGSs by newly admitted members. Newly established banks often entail higher risk during the start-up period. On the other hand, for competitive reasons some Members believe the maximum size of initial contribution or entrance fee should be regulated by the directive. Investment requirements for the ex ante funds The EBF agrees, as a matter of principle, that DGS should adopt a reasonably risk-averse investment policy. Nevertheless, the proposed restrictions for the way in which DGS may invest the ex ante funds are overly intrusive, in the view of European banks. Most importantly: Article 9.2 of the proposed Directive, requires DGS to diversify their portfolios so as to hold not more than 5% of their financial means in securities issued by any one issuer. It does not seem appropriate to require DGS to invest their assets in securities of at least 20 different issuers and to thereby prevent them, for example, from investing a considerable share of assets in bonds issued by their own government. The maximum thresholds should rather be calculated on a risk-adjusted basis. The definition of available financial means in Article 2.1 (e) new restricts low-risk assets to securities that have a maximum residual maturity of 24 months. Such low maturities are overly restrictive. They could prevent DGS from making sufficient returns on their assets for the purpose of funding the running of the schemes. The proposed definition would be sufficiently conservative without the maturity restriction. The definition of available financial means should include funds that invest into lowrisk assets, in addition to direct investments in low-risk assets. European Banking Federation - EBF 2010 Page 13

14 In the view of European banks, investment guidelines for DGS could be left to the national transpositions of the Directive. Alternative borrowing arrangements As regards the percentage of ex-post funding where needed, it must be noted that 0.5% of eligible deposits is an enormous amount of money which could difficultly be made available within the foreseen timeframe for payout. More importantly, there would be significant P&L and capital impact which could lead to financial stability concerns. The EBF proposes that in the event that existing funds are not sufficient to cover a bank failure, DGS be in a first instance allowed to make use of alternative borrowing arrangements. Notably, this would include the possibility of borrowing from the capital markets or the Central Bank. DGS and banks could thus spread the extra-ordinary contributions over a longer period of time, e.g. three years. Banks contributions As regards the respective contributions to be paid by banks and institutional protection schemes, the EBF would require clarification of the Commission s objectives. The Commission seems to propose that members of institutional protection schemes may pay lower contributions than other banks, but different statements have been made orally. Members of institutional protection schemes should not generally pay lower contributions than other banks. Instead, the contribution level should solely depend on the individual institution s degree of risk. Acceptance that being a member of an institutional protection scheme is enough to reduce contributions to the DGS is overly simplistic and assumes that the institutional protection scheme can be relied upon to effectively protect the DGS from having to pay out. There is however no guarantee that this is the case, especially if multiple firms are in distress simultaneously or in short order. Therefore this should not be taken into account for the purposes of calculating contributions. It is also no longer the case that there is significant differentiation in the risk-profiles of the different types of banks. It was apparent through the crisis that banks which would traditionally have been thought of as simpler savings banks also had significant exposure to risky assets. All firms benefit equally from reducing financial instability; particularly given the interconnectedness of institutions. In any case, if the minimum level for members of institutional protection schemes is set at 37.5%, then the same minimum level should also apply for other banks with a comparable firm-specific risk profile. The alternative approach would be to allow that the risk-based contributions of the members of institutional protection schemes in some way take account of the consolidated balance sheet of the respective institutional protection scheme to reflect the collective risk. In that case, the same criteria should apply as for other banks and banking groups. European Banking Federation - EBF 2010 Page 14

15 Dates for banks contributions As a more technical point, the EBF notes that the requirement, in Article 9.1, that DGS raise regular contributions from their members on 30 June and 30 December of each year can be problematic. Generally, the EBF is not convinced that bi-annual contributions are appropriate, from an administrative point of view. The EBF would suggest that DGS be given flexibility to decide on the specificities of raising contributions, but at least annually. Furthermore, in a strict reading, the current wording would require the execution of payments on these exact dates, even when these coincide with a week-end. This could be easily adjusted by requiring that contributions be paid as per the end of June and December of each year. The proposal also stipulates that banks should provide the future European Banking Authority (EBA) with monthly reports on the amounts of covered and eligible deposits. The EBF does not believe that monthly reports would be justified, in terms of proportionality and associated costs. It is furthermore not clear why the reports should be provided directly to the EBA. The EBF believes that it would rather be appropriate that banks report directly to their national DGS, on a bi-annual basis. Disclosure of key information We believe in this context that disclosure of key information on the strength of DGSs to the general public would be highly counterproductive in achieving the goals of improved financial market stability and strengthened depositor confidence. A DGS s reserves are always low compared to the amount of covered deposits, something which is likely to seriously worry consumers in a financial crisis. If at all, such a requirement should only apply once the target level of funds has been reached. Recommendations: financing arrangements Consider substantial lower funding requirements than proposed by the EC based on the overall context of new regulatory requirements and initiatives to strengthen prudential policies. Allow Member States to already determine ex ante contributions on the basis of covered deposits and speed up the migration process for the other schemes Grant Member States greater flexibility for the financing arrangements for a period of at least 15 years or longer Determine a maximum size of ex ante funds above which no further contributions may be raised from banks Allow partial funding by pledge Leave investment requirements and the possibility of initial contributions to national discretion. Otherwise, give at least more flexibility in respect of the investment requirements European Banking Federation - EBF 2010 Page 15

16 Borrowing between schemes European banks disagree with the European Commission s proposals in respect of borrowing between the national schemes. Generally, DGS should not act as lenders of last resort. This role is best fulfilled and can only be fulfilled in a way that effectively protects financial stability by central banks and finance ministries. Allowing borrowing between schemes without many precautions furthermore implies the risk of moral hazard, bearing in mind that some schemes today are in a much better situation than others. The EBF is also unsure that the proposed borrowing arrangements are consistent with existing EU law and its no bail-out provision. If national DGS need additional financing, the Federation suggests they be required to make additional efforts to raise funds at national level, including lending from the Central Bank or taking deposits or loans from the public or the national government. Recommendations: borrowing between schemes Exclude the possibility of borrowing between national DGS Require DGS to exploit all available fund raising tools at national level Risk-based contributions The EBF supports risk-based contributions on the principle of fairness, i.e. risk-based contributions would be justified in view of the higher probability that more risky banks become pay-out cases for the DGS. However, European banks are greatly concerned by the European Commission s specific proposals in respect of risk-based contributions. Ideally risk-based levies should follow the principles of - but not duplicate - the prudential capital regime (Basel 2-3/ Capital Requirements Directive 3-4). Nor, of course, should risk-based contributions stand in contradiction with the methodology to calculate capital requirements. Any model for risk-based contributions will have to carefully balance effectiveness, complexity, clarity and fairness. While a higher degree of complexity can allow a more faithful estimate of the genuine risk posed by any individual bank to the DGS, it must be carefully evaluated whether the associated higher costs and administrative burdens would be justified from a cost-benefit point of view. In other words, a balance needs to be struck between the fairness and the efficiency of the system. Any model for risk-based contributions should demonstrate satisfactory capacity to forecast bank failure, while also demonstrating sufficient added value to justify the higher costs involved. Furthermore, the calculation methodology must be transparent so as to avoid any misuse of the system. The Commission s current proposal is unsatisfactory in that it is relatively complex, but nevertheless proves to be of very low relevance in practice. Back-testing in respect of institutions that failed in recent years shows that these institutions would not have been required to pay higher contributions to the DGS. In turn, the proposed methodology would require higher contributions from firms that are not perceived to be particularly risky, when European Banking Federation - EBF 2010 Page 16

17 evaluated against a wider set of criteria. This is worrying in particular in light of the important competitive implications of risk-based contributions. In addition, the model proposed by the Commission is fundamentally flawed in respect of the interaction of an individual bank s contributions and the overall target level for the size of the ex ante funds. Based on the formula proposed by the Commission, the contributions of an individual institution depend not only on its own risk weight, but also on the risk weights of other members of the same DGS. Therefore, a bank with exactly the same risk weights and the same level of deposits would have to pay different contributions to different DGS in the same or different Member States. A possible solution could be to riskweight the calculation base (deposits) according to the contributing bank s risk profile, and to also calculate the ex ante target level in relation to risk-weighted deposits. As an important detail, furthermore, banks strongly feel that it is not appropriate that contributions to the DGS should be linked to profitability. Profitability is also not part of supervisors prudential analysis of banks risks. In this light, European banks would call for substantial amendments to the proposed methodology for risk-based contributions. In the process of redefining the system the Commission should also undertake model calculations to test the relevance of the proposed system. The industry is keen to engage in this debate and to provide practical feedback on an appropriate methodology. One of the options that could be considered is that of a system that is based on Tier 1 capital. This is a straight-forward measure which according to some recent tests, seems to be quite accurate in estimating banks risk of failure. 1 Going forward, the EBF supports a greater harmonisation in the funding of the schemes recognising that this will take time and happen gradually. However, the Federation believes that national banking systems today still differ too much for a system where 75% of the contributions would be determined at EU level, and only 25% at national level. Importantly, these differences include accounting differences, besides the structure of the banking system, which have to be considered to ensure a level playing field. The Federation suggests that the starting point should rather be the other way round. The percentage of funding that is determined in a harmonised way can be gradually increased afterwards, in line with practical experience that demonstrates the relevance and universal applicability of the EU methodology. The EBF also notes that the basis of consolidation for the evaluation of the risk criteria will have to be clarified. Clearly in the view of the European banking industry, all criteria should be applied at the consolidated level in order to mirror banks practical functioning. Banks consolidate the activities of their subsidiaries and it would be difficult to calculate the various risk criteria at the level of the individual legal entities. Recommendations: risk-based contributions The banking industry prefers a scoring mechanism which has no pro-cyclical impact. 1 Cf. for example: Susanna Walter and Matthias Schaller, forthcoming research paper An alternative way of calculating pragmatic risk-based premiums (forthcoming research paper, working title). European Banking Federation - EBF 2010 Page 17

18 Redesign the methodology for risk-based contributions Balance the system s capacity to accurately predict bank failures against the additional costs of a more complex system Replace the profitability criterion with more relevant risk indicators Carry out a range of model calculations, in parallel to redefining the methodology Allow an appropriate transition period in which Member States should have much more flexibility to determine contributions that fit the national banking context and reflect accounting differences While fully supportive of a harmonized risk based contribution mechanism, the banking industry wishes to be involved in the analysis and elaboration of such a mechanism. Cross-border cooperation The European Commission proposes that the host DGS would serve as a single point of contact for depositors, acting on behalf of the home DGS. This would include communication with depositors but also paying out on behalf of the home country DGS. The EBF supports the Commission s objective that DGS and banks should work in the best interest of their customers and that unnecessary complications for customers should be avoided. Nevertheless, European banks consider the current proposal problematic, all the more so in view of the objective of fast pay-out. Channelling information from the home DGS through the host DGS to depositors would take additional time and would further complicate the arrangements. Payout would also be delayed as a result of the fact that the host DGS would either have to wait for the money to be transferred to it from the home DGS, or would have to request unconditional guarantees for the funds to be paid in the interim period. Furthermore, there should be clarity for depositors about the competent scheme. The host DGS should not be made responsible for a process that is for the largest part dependent on the home DGS. It must in addition be borne in mind that under the current arrangements proposed by the Commission, the failure of one bank could involve up to seven or eight DGS, depending on the set-up of the failing bank. The EBF suggests that as a general rule, the home DGS should retain full responsibility for the process and especially for paying out depositors. In some cases, arrangements similar to those proposed by the Commission could be possible already today. However, for the time being the EBF would recommend that much more flexibility be left for cross-border cooperation between schemes. Cooperation arrangements should be decided case-by-case, on the basis of bilateral arrangements. In addition, the European Federation of Deposit Insurers (EFDI) is currently working on multi-lateral model agreements for cooperation between national DGS, which are expected to be finalised shortly. These agreements should be used as the starting point for further work on the multi-lateral cooperation between DGS. Should the European Parliament and Council consider otherwise, then at least a number of important clarifications will be necessary. In particular, it should be specified whether the host DGS, when acting as a paying agent for the home DGS, might have to start pay-out before having received the funds from the home DGS; and if so, how re-imbursement would be European Banking Federation - EBF 2010 Page 18