Recent banking troubles in Europe have exposed significant inadequacies in the EU’s Single Resolution Mechanism (SRM). Designed to absolve states of the responsibility to bail out banks, the SRM is supposed to bail in shareholders, bondholders and private creditors to protect taxpayers and promote financial stability. However, far from being a cure-all, in its current form it has proven itself the opposite: a potential cause of panic and disruption in the banking system.
The first reason for this is that the SRM is unclear about precisely who gets bailed in when a bank is about to fail. While in principle it is apparent that shareholders and bondholders lose their money before anybody else, in practice, bondholders are very often ‘mom and pop’ investors who stand to lose everything. This presents serious political challenges for activating the SRM. We saw this in November 2015, when the Bank of Italy imposed losses on bondholders of four small local banks and a customer of troubled Banca Etruria committed suicide after losing his life savings. He had invested all his wealth in bonds, which were wiped out.
