Blog Post

Not SIFIs but PIFIs

The EU bank resolution framework deals in principle with risks from SIFIs, or systemically important financial institutions, but might have overlooked PIFIs - politically important financial institutions.

By: and Date: March 6, 2015 European Macroeconomics & GovernanceFinance & Financial Regulation Tags & Topics

The EU bank resolution framework deals in principle with risks from SIFIs, or systemically important financial institutions, but might have overlooked PIFIs — politically important financial institutions.

Over the weekend of 28 February to 1 March, the Austrian government refused to help Heta Asset Resolution fill a capital hole discovered by the financial regulator. The refusal was an about-turn following almost 10 years and billions of euros of public assistance to Heta and to Hypo Alpe Adria – the bank that Heta was created to help restructure.

Public sector bailouts of nationally or globally systemically important financial institutions (SIFIs) can be justified. Without intervention, the financial sector of a given country might collapse and bring the whole economy down. For this reason, Basel III now requires SIFIs to meet higher capital requirements than other banks. In the United States, Dodd-Frank obliges such banks to design contingency plans in case they get into trouble. In Europe, the roughly 130 largest banks that are systemically important face supervision by the European Central Bank’s Single Supervisory Mechanism (SSM), while the Single Resolution Mechanism (SRM) prescribes when to assist a failing bank and under what terms.

But the decision on whether to let a bank fail rarely depends alone on whether it is a national or global SIFI. Politicians also care about the local effects of a bank failure. Where banking regulation is sub-national and matches electoral boundaries, a given bank might be inconsequential for the health of the overall national economy, but critical to politicians making the decision on how to proceed with a given troubled bank. In such cases, politically important financial institutions (PIFIs) might receive benefits they otherwise would not get.

The PIFI logic drove the series of bank assistance packages in Germany[1]. Despite a popular perception of Germany as an adamant opponent of bank bailouts, considerable public support was given to German banks during the euro-area crisis. In fact, only three very small banks were initially allowed to fail. The structure of German federalism and politicians’ banking sector competencies explain this apparent contradiction. German banks, such as WestLB and HSH Nordbank, that were not systemically important from a national perspective were nonetheless prevented from failing at the onset of the recent crisis because they were important to Länder-level politicians.

We are seeing the same dynamic unfolding in Austria with Hypo Alpe Adria. The Austrian state of Carinthia part-owned the lender, provided it with generous guarantees, and used it for pet projects of the party in power, namely Jörg Haider’s FPÖ. A German Landesbank, Bayern LB, bought the bank in 2007. When it got into substantial trouble during the 2008-09 financial crisis, Hypo Alpe Adria remained politically important and it received public financial support from both the state and national governments. It was ultimately nationalised in 2009.

The story, however, has a new twist. The 28 February-1 March revaluation of the remaining assets in Hypo’s bad bank Heta Asset Resolution means that the national government is theoretically on the hook for an additional €7.6 billion. This time, the national government baulked at supporting the institution, which has become a political liability. A true bail-in would mean that the Landesbank based in Munich would be expected to pay something like €2 billion. A series of lawsuits has followed.

Of course, some in other EU member states might experience schadenfreude over the banking problems in northern ‘surplus’ countries. But they should be careful. While this case involved Carinthian and Bavarian state governments, one can imagine a parallel with the European Union. A national government is concerned about one of its banks and takes measures to help it. The bank gets into even worse trouble, and the euro-area single supervisor orders that it be resolved. At the beginning of the process, the SRM expects a bail-in of shareholders. One can imagine a scenario in which a true bail-in would hurt significant shareholders, and hence politicians, in a neighbouring country. Would they simply pay up, or would there be the same sort of legal fights one now sees in Austria and Bavaria, with any true resolution still some years away?

Also, note that the Hypo Alpe Adria funding gap is now bigger than it should have been precisely because the bank was a domestic PIFI. This meant that its lending decisions suffered from moral hazard and it was given public support to enable it to hobble along for much longer than it should have. Once again, the parallel to the European level is clear. If a troubled bank is not part of the original 130 under the SSM, it could be that European authorities only learn about its problems after much delay and when the overall losses are much bigger precisely because it was not wound up earlier.


[1]    As we detail in: Deo, Sahil, Christian Franz, Christopher Gandrud, and Mark Hallerberg (2015) ‘Preventing German Banks Failures: Federalism and decisions to save troubled banks’, Politische Vierteljahresschrift 2/2015, forthcoming.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
Zsolt Darvas

European spring - Trust in the EU and democracy is recovering

Trust in the EU and satisfaction with democracy are returning in southern European countries, where citizens’ confidence in European institutions was dented during the crisis years.

By: Uuriintuya Batsaikhan and Zsolt Darvas Topic: European Macroeconomics & Governance Date: March 24, 2017
Read article More on this topic More by this author

Podcast

Podcast

Special edition - The Treaty of Rome at 60

The 60th anniversary of the Treaty of Rome presents an opportunity to reflect on the progress of European integration so far, and to discuss what the future will bring for Europe. We explore these topics in this special edition of The Sound of Economics.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 22, 2017
Read about event More on this topic

Past Event

Past Event

Conversations on the future of Europe

On the occasion of the 60th anniversary of the signing of the Treaty of Rome, we held an event of four conversations between Bruegel scholars and European thinkers.

Speakers: Maria Demertzis, Ivan Krastev, Emmanuel Mourlon-Druol, Johanna Nyman, André Sapir, Catherine Schenk, Andre Wilkens and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 22, 2017
Read about event More on this topic

Upcoming Event

Mar
31
10:30

Central bank communication in a low interest rate environment

At this event, we are pleased to welcome Mr. Benoît Coeuré, Member of the Executive Board of the European Central Bank at Bruegel.

Speakers: Benoît Coeuré and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More by this author

Policy Contribution

PC 09 2017 coverEuropean Parliament

Carving out legacy assets: a successful tool for bank restructuring?

Separating ‘legacy assets’ from banks’ core business is central to the rehabilitation of Europe’s banking system. How can Europe progress in its ongoing effort to rid the financial system of legacy assets, and equip it with renewed growth?

By: Alexander Lehmann Topic: European Parliament, Finance & Financial Regulation, Parliamentary Testimonies Date: March 21, 2017
Read about event

Upcoming Event

Apr
5
09:30

Micro- and macro-based methods in assessing the impact of investment

This workshop will discuss methods for accurately evaluating the performance of public and private investment initiatives.

Speakers: Sabine Bernabe, Francesco Di Comite, Grégory Claeys, Zsolt Darvas, Helmut Kraemer- Eis, Aron Gereben, Simon Mizrahi, Amine Ouazad, Debora Revoltella, John K. Swales, Simone Signore, Natacha Valla, Georg Weiers, Marcin Wolski and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Policy Contribution

PC 08 2017 cover

The case for a common European refugee policy

This Policy Contribution discusses the needs for a European migration policy, and considers where more policy coordination is actually needed.

By: Massimo Bordignon and Simone Moriconi Topic: European Macroeconomics & Governance Date: March 20, 2017
Read about event More on this topic

Upcoming Event

Apr
6
12:30

Can EMU survive a multi speed Europe?

On 6 April Bruegel, as in previous years, will host the presentation of the Euro Yearbook, a collection of experts’ insights on the construction of the European Monetary Union through 2016.

Speakers: Pablo Zalba Bidegain, Maria Demertzis, Fernando Fernandez, Javier Méndez Llera, Karl Pichelmann and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Silvia Merler

The inflation basket case

Inflation in the euro area has finally reached 2%. But Draghi is right to warn that the underlying dynamics do not point to this being a self-sustaining trend. Breaking down the numbers shows that many inflation basket items are still showing weak price growth or even deflation.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 17, 2017
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

What future for Europe?

The Commission's White Paper on the future of the EU sets out five scenarios, but misses the fundamental questions facing Europe. How should the EU interact with its neighbourhood? How can we manage the tensions created by multi-speed integration? And above all how can the Euro be made sustainable in the absence of a major step towards fiscal union?

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 16, 2017
Read article Download PDF More on this topic More by this author

Policy Contribution

PC 07 2017 cover

What happened to global banking after the crisis?

The global financial crisis allegedly led to the end of global banking. However, Dirk Schoenmaker finds that reports of the demise of global banking are premature.

By: Dirk Schoenmaker Topic: Finance & Financial Regulation Date: March 14, 2017
Read article More on this topic More by this author

Blog Post

Grégory Claeys

Debunking 5 myths about Frexit

French elections are fast approaching and the debate on euro membership is now in full swing. ‘Frexit’ supporters promise that the benefits of leaving the euro would be substantial for the French economy, that economic policy would be greatly improved, and most importantly that the exit process would be a piece of cake. This blog post shows that these claims are greatly exaggerated if not outright lies.

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: March 10, 2017
Load more posts