OREANDA-NEWS. EU countries are adopting diverging paths to establish workable foundations for bank resolution, but coordination is important because national laws and the characteristics of each country's banking system are being married with EU-wide regulation and Banking Union, says Fitch Ratings.

The EU authorities are encouraging countries to explore an EU-wide solution to remove obstacles that could hinder an effective bail-in in the event of bank failure. In September, the Single Resolution Board voiced this opinion in its submissions to a hearing on the German draft insolvency law.

Recent proposals for legislative changes in Germany and Italy provide clues about the likely paths for these countries. Both are opting for statutory differentiation among senior obligations in insolvency or resolution. This contrasts with the UK, which is requiring structural subordination through holding company structures for the country's large banks, as is the case in Switzerland and the US. Other countries favour contractual subordination either by making banks issue higher volumes of existing subordinated debt or by creating a new debt class (senior subordinated or Tier 3), specifically to be bailed-in during resolution and ranking behind deposits and senior debt. This is the case in Spain.

If draft legislation passed by the finance committee of the German Parliament on 23 September is enacted, all other senior bank obligations, including large wholesale deposits and counterparty exposures, would rank ahead of unsecured securities (including plain vanilla senior unsecured bonds) in case of insolvency or resolution.

In early September, the Italian government gave its preliminary approval for amendments to insolvency law applicable to banks. If adopted, this law will go a step further than BRRD in that it gives all deposits held by banks, and not just those belonging to retail customers and SMEs, explicit preferential rights in resolution. This would result in senior unsecured bondholders, both retail and institutional, ranking behind depositors of a failed bank but would not differentiate senior unsecured bondholders from derivative counterparties, which could complicate the resolution process.

Other EU countries have provided little detail about their preferences but they are likely to look at the solutions being considered in Germany, Italy, Spain and the UK. All proposals will have to consider both existing national insolvency laws and the specific features of a country's banking system.

We believe resolution authorities will maintain a high degree of flexibility when dealing with each resolution case for deciding which liabilities will be bailed-in or not transferred to a bridge bank, subject to the overriding 'no creditor worse off than in liquidation' principle. Clear and credible agreed group-wide resolution plans would smooth the process and avoid the additional risk of unilateral intervention by host regulators.

The EU's Bank Recovery and Resolution Directive (BRRD) came into force on 1 January 2015, but measures at national level are needed to ensure that insolvent banks will be resolved as effectively as possible throughout the EU. Some EU countries are still determining what legislative changes, if any, need to be made, while others are already amending national insolvency laws and changing bank group structures.