EU Banking’s ‘Twilight Zone’: Fixing What’s Broken Before Crisis Hits

Hey there! Let’s talk about something that sounds a bit technical, but is actually super crucial for keeping our banks, and frankly, our wallets, safe. We’re diving into what folks in the know call the ‘twilight zone’ of bank crisis management in the EU. Trust me, it’s less sparkly vampires and more tangled regulations, but fixing it is seriously urgent.

You see, after the big financial mess back in 2007-2009, everyone focused on the giant banks – the ones deemed ‘too big to fail’. And fair enough, they caused a stir! This led to fancy frameworks like the BRRD and SRMR, all about ‘resolution’ – basically, how to sort out a failing big bank without taxpayers footing the bill. But here’s the kicker: we got so fixated on the giants that we kind of messed up the rules for everyone else, especially the smaller and medium-sized banks. And guess what? They matter too! A bunch of smaller banks going wobbly at once can cause just as much chaos, sometimes more, because they’re often quite similar and exposed to the same local bumps in the road. Think about the savings and loans crisis in the US or even the recent Silicon Valley Bank saga – mid-sized banks can totally spark systemic panic.

So, while ‘resolution planning’ became this annual ritual for the big guys, focusing on things like how much cushion (TLAC/MREL) they need, the real nitty-gritty for the smaller players is in this ‘twilight zone’. This is the critical period from when a bank starts looking a bit shaky (that’s ‘early intervention’) right up to the point where the authorities have to step in and manage its exit from the market (‘resolution’). Getting this bit right is like having a good fire escape plan – essential. Mess it up, and the whole system gets rigid and clunky, making it harder for even the best tools to work.

Sadly, the current BRRD framework is, well, a bit of a dog’s breakfast in this area. It’s got overlaps, things it completely misses, and rigidities that make you wonder if it’s easier to just make things up as you go along rather than follow the rules. Now, there’s a proposal from the European Commission to fix the CMDI framework, and it takes a good swing at these ‘twilight zone’ problems. It’s faced some pushback, often for reasons that feel more political than practical, but honestly, the case for fixing this specific bit is pretty much undeniable. Let’s dig into why.

The Current Mess: Overlaps, Gaps, and Rigidities

Alright, let’s get into the weeds a little, but I promise to keep it as straightforward as possible. The problems in the ‘twilight zone’ basically boil down to three main areas: early intervention, preparing for resolution, and pulling the trigger on resolution.

Early Intervention: Tools Nobody Uses?

When a bank’s finances start looking rough, the BRRD and SRMR have these things called Early Intervention Measures (EIMs). They give supervisors powers like telling the bank to sort itself out, firing the management, or bringing in a temporary administrator. Sounds good, right? Problem is, these measures are barely used. Why? Because they often overlap with standard supervisory powers that authorities already have under other rules (like CRD or SSMR). It’s like having two sets of keys that open the same door, but one set is just way more complicated and comes with confusing instructions.

The triggers for EIMs are also a bit of a muddle. They overlap with supervisory triggers, sometimes with pointless differences in wording. For instance, both might kick in if a bank is ‘likely to breach’ requirements, but one says ‘in the near future’ (interpreted as 12 months) and the other says ‘in the following 12 months’. Why the difference? No clear reason! There’s even a weird trigger based on a bank’s capital plus 1.5 percentage points that authorities are reluctant to use or build upon, even though the rules *suggest* flexibility. It’s rigid where it should be flexible and confusing everywhere else.

To make things worse, the rules for escalating measures are fuzzy. The law implies you have to try less intrusive EIMs before the big ones like removing management or appointing an administrator. The European Banking Authority (EBA) says, “Nah, not always necessary,” but national laws transposing the rules aren’t always clear. This legal uncertainty makes authorities hesitant. And spare a thought for the ECB – it supervises many banks but doesn’t have a harmonized legal basis for EIMs, relying instead on potentially different national laws. This led to a real headache in the Corneli case, where a court’s strict reading of Italian law seemed to contradict the spirit of the EU rules, leaving the ECB in a tough spot and creating legal risk.

Resolution Preparation: The Secret Handshake?

Getting a bank ready for resolution, especially if you plan to sell off parts of it, takes time and effort. You need to figure out what assets and liabilities go where, find potential buyers, share information confidentially, and run a bidding process. This requires planning and getting the resolution authorities involved early. But the current framework doesn’t explicitly acknowledge this preparatory work *before* a bank is officially deemed ‘failing or likely to fail’ (FOLF). The supervisor determines FOLF and whether there are private alternatives, often late in the game, leaving resolution authorities scrambling with little prep time. The system relies heavily on independent valuations as a safeguard, which are important, but they won’t magically make someone buy a struggling bank if they don’t want to.

Triggers: Too Late and Too Cautious

Resolution is often triggered too late. The FOLF assessment, while forward-looking, feels like a death sentence authorities are scared to pronounce too early, meaning they usually do it too late. It carries a weight of irreversibility. Recent court cases have offered some clarity, suggesting FOLF is a factual assessment, not about blame, which might help, but it’s still a cautious step.

Then there’s the Public Interest Assessment (PIA). This is where authorities decide if resolution is better than just letting the bank go bust under normal insolvency law. In theory, this should be flexible, considering regional impact or whether using deposit insurance funds in resolution is better than a chaotic payout. In practice? It’s been applied inconsistently and conservatively. It’s like a ghost from the past, haunted by old fears of giving authorities too much ‘discretion’. This has meant resolution is used less within the EU Banking Union than outside it, and less by the EU’s Single Resolution Board (SRB) than by national authorities. While the SRB is getting a bit more flexible now, expanding the PIA through interpretation is slow and uncertain.

Finally, there’s a big problem with coordination. The ABLV case is a classic example: the bank was correctly found FOLF with no private alternatives, but the PIA was negative. So, it should have gone into insolvency. But it didn’t meet the threshold for insolvency under national law (which wasn’t forward-looking like the bank rules), leaving it in a bizarre legal limbo. Not ideal, to say the least!

The Market Abuse Headache

Here’s a real pickle: early intervention measures and resolution prep often involve sensitive information about a bank’s shaky state. If this information gets out, it can cause panic, a bank run, and torpedo any efforts to fix things. But under market abuse rules (like MAR), information that could significantly affect a bank’s share price (which this definitely is!) must be disclosed to the market ASAP. MAR has a narrow exception for banks, allowing delayed disclosure *on their own responsibility*, mainly for temporary liquidity issues. This puts the bank’s board in an impossible position: disclose and risk collapse, or delay and risk legal liability to investors. The MAR rule is too narrow, too focused on liquidity, and puts the onus on the bank itself, which might not have the incentive or legal cover to delay disclosure for broader financial stability reasons. It’s a total clash between crisis management goals and market transparency rules, and the current fix is just a flimsy patch.

Enter the Reform Proposal: Shining a Light?

Okay, deep breath. The good news is the Commission’s CMDI reform proposal looks squarely at these problems in the ‘twilight zone’ and offers some genuinely needed fixes. It’s not perfect, but it’s a massive step in the right direction.

Clearing the EIM Fog

The reform tackles the EIM/supervisory measure overlap head-on. It aims to eliminate useless triggers and overlaps and create a clear escalation path. EIMs would kick in *after* supervisory measures have been tried or if the situation is deteriorating too fast for them to work. They’d ditch confusing triggers like the ‘own funds + 1.5 points’. The assessment of ‘unsound management’, currently a weird SSM-only trigger, would be treated as equivalent to a regulatory breach, making more sense. The reform also clarifies that breaching investment service rules (MiFID/MiFIR) can trigger EIMs, which fits if EIMs are an escalation from both banking and investment service issues.

Crucially, the proposal treats measures like management removal and temporary administration as part of the standard toolkit, not separate, rigid steps you *must* take in order. Authorities can pick the most proportionate measure for the situation. This adds much-needed flexibility. And for the ECB? The reform would give it a harmonized legal basis for EIMs directly in the SRMR, bypassing messy national transpositions. This is a huge win for clarity and effectiveness.

Acknowledging Reality: Preparing for Resolution

The reform finally acknowledges that preparing for resolution needs to start early. It introduces an ‘early warning’ system. Supervisors have to tell resolution authorities when they take supervisory measures, when EIM thresholds are met, or when there’s a *material risk* of the bank becoming FOLF. This isn’t just a heads-up; it sets a timeframe for the resolution authority to assess the situation and start preparing. It’s like a formal handover zone in that relay race we talked about.

The proposal also explicitly allows for early marketing efforts. Resolution authorities get powers to market the bank or make the bank do it, and set up virtual data rooms. It clarifies that you don’t need to have used EIMs first to start resolution prep. This stuff is practical and essential for finding a buyer and maximizing value in a transfer. While tensions between recovery efforts and transfer prep might still pop up, this formal acknowledgment is a big improvement.

Smarter Triggers: Framed Discretion and Fairer PIA

Instead of rigid triggers or vague discretion, the reform goes for ‘framed supervisory discretion’. The early warning system means the FOLF assessment becomes a cooperative process between supervisor and resolution authority, not just the supervisor passing the buck. The resolution authority has all the info and can set timelines if the bank’s state is endangering resolvability. This makes the FOLF trigger less of a scary, isolated decision.

The PIA gets a much-needed overhaul too, pushing it beyond its initially cautious interpretation. It clarifies that insolvency should *only* be chosen if it achieves resolution objectives *better* than resolution (not just equally well), shifting the burden of proof. It also expands the assessment of ‘critical functions’ to include regional impact and clarifies that using deposit insurance funds in resolution is preferable to taxpayer money. The PIA would also have to compare *all* public support in both scenarios, including potential liquidation aid in insolvency. And protecting depositors means minimizing losses for the deposit guarantee scheme, favoring resolution if it’s cheaper for them. This makes the PIA assessment much fairer towards resolution.

Avoiding Limbo: Better Coordination

To prevent ABLV-style limbo, the reforms improve coordination between resolution, insolvency, and license withdrawal. If a bank is FOLF with no private alternative but gets a negative PIA, the supervisor can initiate winding-up proceedings. A FOLF finding, no alternatives, and a negative PIA would be enough to withdraw the bank’s license, and that license withdrawal would be sufficient to start insolvency. This creates a clearer path out of the market, even if resolution isn’t used.

Still Some Shadows: What the Reform Misses

Okay, so the reform does a lot of good stuff in the ‘twilight zone’. But it’s not a silver bullet, and there are a couple of areas where it doesn’t quite hit the mark.

The Market Abuse Problem Lingers

Despite acknowledging the conflict with MAR, the reform’s fix is pretty weak. It grants the resolution authority the power to request a delay in disclosure *on behalf of the institution*. This sounds helpful, but it still relies on the bank’s *own* limited right to delay under MAR. What if the bank’s board, worried about their fiduciary duty to investors, disagrees? The provision is fuzzy on this. Plus, it seems this power only kicks in *after* the ‘material risk of FOLF’ is notified, meaning disclosure of earlier EIMs, which could also be sensitive, might not be covered. It feels like they punted on tackling the fundamental conflict head-on, perhaps to avoid a political fight about whether bank stability trumps market transparency. It leaves banks and authorities in a tricky legal spot.

Market Forces Still Feel Like an Afterthought

While crisis tools are there because markets can go haywire, you can’t just ignore market forces entirely. A transfer needs a buyer, and buyers need incentives (like profit!). The reform, while improving things, still feels a bit ‘statist’. Value maximization is more of a procedural requirement than a core objective alongside public interest goals. The focus remains heavily on formal ‘valuation’ and procedures, as if a fancy report will convince someone to buy a failing bank out of civic duty. An efficient system needs to explicitly value maximizing sale proceeds, as it’s the best protection for creditors too. This rebalancing isn’t fully there yet.

Conclusion: Why This Matters, Urgently

Look, this isn’t just academic jargon. The ‘twilight zone’ is where the rubber meets the road in banking crises. It’s about having the right tools, knowing when and how to use them, and being able to act fast before a shaky situation turns into a full-blown panic that costs everyone. The current system is ineffective because it’s rigid, confusing, and makes authorities hesitant. This is bad for big banks, but potentially disastrous for smaller ones, who might not have the same cushions or operational space.

The Commission’s reform proposal for the CMDI framework, especially concerning early intervention, resolution preparation, and triggers, is a necessary and largely effective response to clear, well-known flaws. It brings much-needed clarity, flexibility, and better coordination. It moves from pointless overcautiousness to a system with greater discretion balanced by accountability and proportionality. This is a sign of the framework ‘coming of age’.

Yes, there are limitations, like the lingering market abuse issue and the framework’s hesitant embrace of market forces. And yes, these reforms face political hurdles – some countries might be wary of giving EU authorities more power, while others might prefer the current rigid system because, paradoxically, it allows them to improvise outside the rules when needed. But letting ‘mysterious motives’ derail these specific reforms would be frankly absurd. Everyone agrees on what’s wrong here and what needs fixing. Reforming the ‘twilight zone’ provisions is a litmus test for whether the EU is serious about building a crisis management framework that actually works when the chips are down. It’s urgent, it’s necessary, and it’s time to get it done.

Source: Springer