Financial services

EU response to the financial crisis: protecting taxpayers

The financial crisis highlighted the effects of banks that had grown “too big to fail”, putting the financial system as a whole at risk. Their size meant that they were insulated from the natural consequences of taking risk, and it would be difficult to let them fail – a form of “moral hazard”. The European Commission will seek to address this issue through new crisis management legislation in Spring 2011.

The Commission’s objective is to reduce the expectation that UK or European governments will support individual firms in the event of a financial crisis. It will do this by establishing various tools and mechanisms that will allow a financial institution to fail in an “orderly” fashion in the future, minimising the impact on the rest of the financial sector, the wider economy and the taxpayer.

Areas of discussion examined in the European Commission’s consultation paper (20 October 2010) are:

Enhanced preventative and early intervention powers to allow supervisors to respond quickly to emerging risks posed by firms;
Resolution tools and powers to enable swift and effective resolution of failing banks. The UK has already made provisions in this area through a Special Resolution Regime for banks. This comprises various tools to stabilise and restructure a failing bank, and ensure speedy redress for consumers through a deposit guarantee scheme;
Cross-border Recovery and Resolution Plans (RRPs), to be drawn up by the end of 2010. The UK has led the way in requiring firms to draw up RRPs – better known as “living wills”. These allow regulators to monitor and assess how easily banks can recover from stress, or be resolved;
Deposit Guarantee Schemes. Through its Deposit Guarantee Schemes Directive, the European Commission is strengthening its rules for schemes that provide deposit protection for retail customers. In the UK, we have the Financial Services Compensation Scheme (FSCS). The European Commission is also examining Guarantee schemes for insurance and investors; and
Cross-border cooperation. The European Commission’s intention is to strengthen European-level crisis management arrangements to ensure a more co-ordinated response to a bank failure across Member States.