Who bears the losses in case of bank failure? The ECB is clear: shareholders first

Controversies continue about the terms of the rescue Credit Suisse. An entity, which will be absorbed by its rival, ubs, It went from a market capitalization of $90 trillion in 2007 to less than $5,000 before the acquisition this Sunday, March 19.

Both the stock market crash and the 60% discount that UBS will apply to the Credit Suisse stock swap have caused multi-billion dollar losses for shareholders. However, a great deal of dust arose when moving on to the details of the operation. And that is that, according to the entities, they agreed with the Swiss regulatory authorities, Holders of high-risk bonds (AT1, also called Cocos) will see more than €16,000 million disappear before the consumption of capital of the main shareholders.

The maneuver will affect, among others, Pacific Investment Management, Invesco and BlueBay Funds Management, according to Bloomberg. Goldman Sachs is preparing to file lawsuits.

It is a forced and unusual hairstyle which, as explained by the European Central Bank (ECB) this Monday, would be unthinkable in the eurozone, where the pyramid haircut requires shareholders and creditors to lose money first.

“The framework for resolution in the European Union established the order according to which shareholders and creditors of the failed bank should bear the losses. In particular, common equity instruments are the first to absorb losses and only after their full recovery would additional use of Tier 1 (AT1, used to finance the commercial activities of the entity’s customers) be required. This approach has been applied in previous cases and will continue to guide the bank supervision actions of the Single Resolution Board and the ECB in crisis interventions”, the organization hastened to explain this Monday to try to put the country in the center with the management purchase of Credit Suisse.

Press Release: ECB, SRB and EBA Banking Supervision Statement on Swiss Authorities Release March 19, 2023 https://t.co/mY2QM507r0 pic.twitter.com/TUbMXYG5Pc

—European Central Bank (@ecb) March 20, 2023

“Additional Tier 1 is and will continue to be an important component of the capital structure of European banks”, they added. What is Tier1? This is the share capital, that is, ordinary shares and reserves of the bank.

What about deposits?

In the case of Credit Suisse, UBS will be in charge of managing them once the purchase is formalized. In regards to eurozone, all deposits up to 100,000 euros are guaranteedregardless of whether they are depositors or companies, and would not cause any problems in case of bank liquidation.

National authorities would be in charge of rescuing that money. In Spain, the responsible body is the Deposit Guarantee Fund.

Although there were attempts to create a mutual deposit guarantee fund in the frame Banking Unionnot yet achieved. Germany torpedoed all attempts, and 2025 is taken as the date of introduction at the earliest.. In practice, this means that each state will have to take over that capital in case of bankruptcy bankregardless of the health of your finances.

The European Commission did not want to clarify whether there will be changes in the calendar for the completion of the banking package. Regarding the joint deposit guarantee, they limited themselves to repeating that they were “working on it” but did not set a date for presenting the proposal.