The EU needs to fine-tune some of its banking resolution rules, including providing compensation for legal challenges for lenders who take over a failed bank and clarity over when it needs to wind down a bank, according to bankers and regulators.

The EU's agency in charge of failing banks, the Single Resolution Board, or SRB, undertook its first banking resolution in 2017 after the ECB said on June 6, 2017, that ailing Spanish lender Banco Popular Español SA was failing or likely to fail. The bank was sold to Banco Santander SA for €1 on June 7.

While some say Banco Popular is a textbook case of a successful resolution, others have begged to differ, including junior bondholders and shareholders who lost about €3 billion after the lender was wound down. The process is now the subject of legal action in the European Court of Justice, Spain and New York.

Lessons to be learned

"It has gone reasonably well from many points of view, but still there are lessons to be learned from our experience with Banco Popular," Belén Romana Garcìa, an independent nonexecutive director at Santander, told an SRB conference in Brussels on Oct. 15.

"We are in a middle of a long list of judicial processes and we will see what comes out of that and for the next deal having some kind of partial indemnity [for the companies that take over the liabilities of distressed banks] would be helpful," she said.

Romana Garcìa said a funding backstop was required for banking resolution to help speed up the process and give liquidity to the market.

"It should come when the private sector is exhausted and is not ready to give additional funding," she said, adding that the ECB should be the lender for last resort for the industry.

In late June, EU leaders delayed making a decision on the details of a backstop until December. The backstop would provide a buffer of up to €60 billion to beef up the Single Resolution Fund, which is funded by banks and used to finance bank resolutions.

Liquidity

SRB board member Dominique Laboureix said the agency had to "gain clarity" about the timing of a resolution so that it did not intervene too early or too late.

"The question about the moment we can trigger in market conditions….is a very complex one," he said.

"What matters from our perspective … is to gain clarity that we can insert in our resolution scheme a solution also on the liquidity side," Laboureix said.

Although Banco Popular was in financial difficulties, its downfall was exacerbated by a bank run and an ensuing liquidity crisis, rather than a solvency crisis. Banco Popular did not technically breach minimum capital levels before regulators deemed it nonviable.

Moral hazard

Ignazio Angeloni, a member of the ECB's supervisory board, said it was impossible to rule out risks when it comes to resolution.

"You cannot completely rule out the possibility that the moral hazard mechanism can also develop in the case of banking resolution depending on how it is handled," he said.

Shareholders and creditors can try to learn from experience, Angeloni said, but noted that each case would be different.

"One has to look at the specific situation but I wouldn’t rule out upfront that some risks can arise in the case of resolution," he said.