Automated bail-in: eliminating regulatory restraints
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Lendermann, Urs B. Article — Published Version Automated bail-in: eliminating regulatory restraints Journal of Banking Regulation Provided in Cooperation with: Springer Nature Suggested Citation: Lendermann, Urs B. (2025) : Automated bail-in: eliminating regulatory restraints, Journal of Banking Regulation, ISSN 1750-2071, Palgrave Macmillan, London, Vol. 26, Iss. 3, pp. 370-391, https://doi.org/10.1057/s41261-024-00266-7 This Version is available at: https://hdl.handle.net/10419/330622 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/
Vol:.(1234567890) Journal of Banking Regulation (2025) 26:370–391 https://doi.org/10.1057/s41261-024-00266-7 ORIGINAL ARTICLE Automated bail‑in: eliminating regulatory restraints UrsB.Lendermann1 Accepted: 16 December 2024 / Published online: 23 January 2025 © The Author(s) 2025 Abstract The Credit Suisse default in 2023 sparked considerable discourse about the absence of bank resolution procedures. Instead of resolution, public guarantees and unconventional emergency liquidity assistance (ELA) were provided. Of course, this occurred nearly two decades after the global financial crisis of 2007–2009, and evidently, there are still lessons to be learned. This study explores the bail-in tool and the total loss-absorbing capacity (TLAC) introduced by the G20 Financial Stability Board to eliminate the need for public bailouts of global systemically important banks in case of failure. Acknowledging the pragmatic standpoint, it is essential to recognise that banks hold divergent perspectives concerning their resolution planning while policymakers continue to grapple with the ‘too-big-to-fail’ dilemma without a discernible pathway for resolution. Thus, this study proposes contractual approaches to enhance the TLAC framework, incorporating a market-based trigger design. These improvements aim to create conditions that enable central banks to provide ELA, thereby averting systemic disruptions during a financial crisis. Keywords Additional Tier 1 (AT1)· Total loss-absorbing capacity (TLAC)· Global systemically important bank (GSIB)· Financial stability· Bail-in· Too-big-to-fail (TBTF)· Emergency liquidity assistance (ELA) JEL Classification E44· F34· G12· G21· G28· K23 * Urs B. Lendermann [email protected] 1 Deutsche Bundesbank University ofApplied Sciences, Hachenburg, Germany
371Automated bail-in: eliminating regulatory restraints Introduction This study proposes amendments to the resolution framework for global systemically important banks (G-SIB) to ensure effective private sector loss absorption during a financial crisis. The ‘too-big-to-fail’ (TBTF) regulatory reforms aimed at G-SIBs were implemented in response to the global financial crisis (GFC) of 2007–2009. These reformshave been scrutinised and continue to warrant close evaluation.1 Bearing in mind the shortcomings revealed during the banking turmoil of March 2023, this study revisits the Financial Stability Board’s (FSB) Key Attributes of Effective Resolution Regimes for Financial Institutions (‘FSB Key Attributes’),2 with a particular focus on the definition and application of total loss-absorbing capacity (TLAC).3 The study advocates for a contractual approach to ensure that significant capital measures are implemented during the recovery phase, effectively averting a default. It proposes reducing authorities’ discretion in initiating the crisis management process by introducing a mandatory, rule-based triggering mechanism with limited flexibility, drawing inspiration from market-based trigger designs. This approach challenges the traditional distinction between going-concern capital (Tier 1) and gone-concern capital (Tier 2 and TLAC-eligible liabilities), aiming to enhance the overall effectiveness of the resolution framework. Additionally, it underscores the need to clarify the creditor hierarchy and reduce the complexity and opacity surrounding TLACeligible instruments. The study pays particular attention to inter-creditor relationships and the ranking of equity shares—issues that sparked significant controversy regarding the loss-absorbing capacity of Additional Tier 1 (AT1) instruments during the recent Credit Suisse default.4 Finally, the study recommends implementing parallel measures to align the loss absorbency framework with central bank emergency liquidity assistance (ELA) provisioning, ensuring a cohesive approach during financial crises. The remainder of this study is organised as follows. Section“Arriving at this point in bank regulation” offers insights into the evolution of TBTF regulation, illustrating the various factors and interests that influence the regulatory process in this context. Building on this, Sect.“Preserving funding cost advantages” addresses how funding cost advantages resulting from implicit state guarantees could have been preserved and inadequate pricing should have been mitigated. Section“Preserving the banking group structure” tackles the impact of the resolution framework on G-SIBs’ international group structures. Section“Shattering the illusion of bailin trigger certainty” analyses the bail-in trigger mechanism and its impact on the decision-making process, contrasting it with the mandatory contractual approach found in Swiss contingent convertible bonds (CoCo). Section“Proposal for enhancing TLAC-eligible liabilities” proposes specific market-based enhancements to the current TLAC terms based on this study’s findings. Section“Conclusion” synthesises the main points. Arriving atthis point inbank regulation Pre‑emptive self‑regulation Keydetails ofthe TBTF regulatory process provide insights intothe proposed resolution measures and evolving frameworks. The GFC precipitated a surge in demand for effective resolution mechanisms as well as several distinct phases of regulatory responses. First, during the crisis, some banks were initially left to fail without intervention for the purpose of establishing a precedent; however, this experience only underscored the urgent need to prevent severe systemic disruptions. Subsequently, banks that were failing or likely to fail received public bailouts at the taxpayers’ expense, leading to political actions to safeguard customers, creditors, the financial system, and the broader economy. Second, in the immediate aftermath of the crisis, public demand for stricter 1 See the FSB evaluation report on the TBTF reforms in the banking sector completed before the G20 Global Summit. FSB, Evaluation of the Effects of Too-Big-to-Fail Reforms (2021) Final Report. At the EU level, the European Commission had produced a report on the new bank resolution regime in 2019, the Report to the European Parliament and the Council on the Application and Review of Directive 2014/59/EU (Bank Recovery and Resolution Directive) and Regulation 806/2014 (Single Resolution Mechanism Regulation) (30 April 2019). 2 The FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions was initially published in October 2011 and adopted by the G20 at the Cannes Summit in November 2011. Adjustments and amendments followed on 15 October 2014, and most recently on 25 April 2024. 3 FSB, ‘Principles on Loss-Absorbing and Recapitalisation Capacity of G-SIBs in Resolution: Total Loss-Absorbing Capacity (TLAC) Term Sheet’ (9 November 2015). 4 Patrick Bolton, Wei Jiang and Anastasia Kartasheva, ‘The Credit Suisse CoCo Wipeout: Facts, Misperceptions, and Lessons for Financial Regulation’ (2023) 35 Journal of Applied Corporate Finance 66 < https:// doi. org/ 10. 1111/ jacf. 12553 > ; Javier Valbuena Paz, and Horst Eidenmueller, ‘Bailout Blues: The Write-Down of the AT1 Bonds in the Credit Suisse Bailout’ [April 1, 2023] European Corporate Governance Institute—Law Working Paper 705/2023 < https:// ssrn. com/ abstr act= 44311 70 > ; Diego Valiante, ‘The last days of Credit Suisse: Banking Crisis Management Under Siege’ [January 2023] Rivista delle Società 244; Zhenyu Wang, ‘CoCo Bonds: Are They Debt or Equity? Do They Help Financial Stability? — Lessons from Credit Suisse NT1 [AT1] Bonds’, [6 April 2023] ECGI < https:// www. ecgi. global/ conte nt/ cocobondsaretheydebtorequitydotheyhelpfinan cialstabi lity > . Footnote 4 (continued)
372 U.B.Lendermann bank regulation emerged, with policymakers promising that such bailouts would never happen again, given their farreaching implications that surpassed mere fiscal concerns.5 However, the third phase witnessed systemically important banks subtly exerting influence over the regulatory process as public attention waned,6 potentially setting the stage for the next financial crisis. Indeed, from 2009 onward, a notable political equilibrium emerged, where the demand for and supply of regulation found a precarious balance. This intricate equilibrium tends to be the result of several factors, including asymmetric information, diverse individual stakes, the influence of political dynamics, and the differing marginal gains associated with regulation.7 Considering the alignment of interests, policymakers faced the Sisyphean task of adequately responding to the unprecedented public bailout that occurred during the GFC. The G-SIBs harboured the gravest fears while awaiting this response, drawing from historical precedents that demonstrated the political will and ability to act (e.g. the breakup of AT&T and the 1933 Glass-Steagall Act8). In this setting, representatives of Credit Suisse offered policymakers a strategic counter-narrative by reframing the concept of a ‘bailout’ as a ‘bail-in’.9 In short, the bail-in tool empowers resolution authorities to have the losses of a failing bank imposed on its investors and creditors either through a writeoff10 or temporary write-down of certain liabilities,11 or by converting them into shares or other capital instruments.12 Through semantics, the bail-in technically negated the TBTF problem.13 Revisiting thetoo big tofail problem The so-called Private Sector Bail-in Initiative, formed by Credit Suisse and joined by several other G-SIBs, later endorsed the bail-in concept, raising questions about its beneficiaries and potential implications. This led to an emerging symbiosis between the industry and policymakers to address their mutual challenge, that is, offering a convincing solution to the TBTF conundrum while ensuring minimal resistance from the financial industry and mitigating political repercussions. The literature on the incentivisation of public officials reveals that ‘bureaucrats’, driven by self-interest and career ambitions, use their discretion to adapt to challenges, expand their agency’s influence, avoid liability, and secure future opportunities, occasionally prioritising personal goals over the public good and even risking regulatory capture.14 This bureaucratic inclination provided a window of opportunity for the regulatory sector, prompting the establishment of specialised resolution authorities and the drafting of intricate rules for recovery and resolution planning, subsequently creating a demand for consultancy.15 Leveraging this environment, members of the private sector managed to persuade policymakers of the advantages of the bail-in mechanism, effectively sidelining drastic measures that were being considered at the time, such as breaking 5 See Gary H Stern and Ron J Feldman, Too Big to Fail: The Hazards of Bank Bailouts (Brookings Institution Press 2004); Frederic S Mishkin, ‘How Big a Problem is Too Big to Fail? A Review of Gary Stern and Ron Feldman’s Too Big to Fail: The Hazards of Bank Bailouts’ (2006) 44 Journal of Economic Literature 988. 6 See George J Stigler, ‘The Theory of Economic Regulation’ (1971) 2 Bell Journal of Economics and Management Science 3–21. 7 See Jean-Jacques Laffont and Jean Tirole, ‘The Politics of Government Decision-Making: A Theory of Regulatory Capture’ (1991) 106 Quarterly Journal of Economics 1089. 8 Specific provisions (Sects.16, 20, 21, and 32) incorporated into the Banking Act, Pub L 73–66, 48 Stat 162 (1933). 9 Paul Calello, former head of Credit Suisse’s investment bank, and D. Wilson Ervin, former CRO of Credit Suisse, publicly claim the invention of the ‘bail-in’ in ‘From Bail-Out to Bail-In’ [28 January 2010] The Economist < http:// www. econo mist. com/ node/ 15392 186 > . 10 A write-off is a reduction of liabilities, which leads to extraordinary income, increasing equity. 11 A temporary write-down is sometimes used when no complete or permanent reduction of liabilities is envisaged or, in other words, if a later ‘write-up’ seems possible. 12 See Ross Leckow, Alessandro Gullo and Ender Emre, ‘Bank Resolution Frameworks: Key Legal Design Issues’ in Simon Brodie (ed), Bank Resolution: Key Issues and Local Perspectives (INSOL International 2019) 10. 13 Termed a ‘radioactive silver bullet’ in Patrick S Kenadjian’s ‘CoCos and Bail-ins’ in AR Dombret and PS Kenadjian (eds), The Bank Resolution and Recovery Directive: Europe’s Solution for Too Big to Fail? (Walter De Gruyter 2013) 231. 14 Tobias H Tröger and Anastasia Kotovskaia, ‘National Interests and Supranational Resolution in the European Banking Union’ (1 February 2023) SAFE Working Paper 340, European Banking Institute Working Paper Series 114/2022, 34 European Business Law Review 781 < https:// ssrn. com/ abstr act= 40243 43 > ; William A Niskanen, Bureaucracy and Representative Government (Aldine Atherton 1971); Gordon Tullock, The Politics of Bureaucracy (Public Affairs Press 1965). 15 On the overly complex rules, see Andrew G Haldane, ‘The Dog and the Frisbee’ (Speech at 366th Economic Policy Symposium, Federal Reserve Bank of Kansas City, 31 August 2012) < https:// www. bis. org/ review/ r1209 05a. pdf > ; Tobias H Tröger, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool Under the European Bank Recovery and Resolution Regime’ (2018) 4 Journal of Financial Regulation 35–72.
373Automated bail-in: eliminating regulatory restraints up the banking group or separating business lines,16 imposing stringent equity capital requirements,17 or limiting the size of banks.18 These measures began to appear unnecessary and inappropriate, given the alternative. Instead, the FSB included the bail-in as a focal point in its proposals for a new resolution regime for G-SIBs and for implementation by the G20 members and other countries. Concurrently, the FSB proposed the issuance of ‘bail-in bonds’, ensuring a credible and feasible process, relying on the concept referred to as TLAC19 and aligning with the Basel capital standards.20 Authorities suggested that the bail-in should be at the core of the resolution tools for institutions,21 with an official of a major resolution authority even terming the bail-in a ‘game changer’.22 Post this accomplishment, regulatory discussions reverted to the traditional focus on the level of risk posed by banks that a society will tolerate, balanced against the essential credit supply to the economy and any other costs associated with it. The exigent TBTF problem was thus essentially reduced to a TLAC issue. Moreover, the circle of people interested in banking regulation, which included nearly all citizens in their capacity as taxpayers, bank customers, and voters during the GFC, was narrowed to ‘expert circles’. Thus, the bail-in successfully achieved its primary goal. Preserving funding cost advantages Dissension overtheimplicit state guarantee Regulatory capital requirements tend to hinge more on political discourse than scientific certainty, despite being veiled in an aura of technical specificity that could theoretically be delineated in an impact study.23 This discourse revolves around wealth distribution, where the interests of G-SIBs (seeking low financing costs) clash with those of debt investors (seeking risk-adequate pricing), competitors (seeking to mitigate unjustified funding cost disadvantages), and taxpayers (seeking compensation for implicit state guarantees). Thus, regulators are uncertain whether eliminating unjustified funding cost advantages for banks should outweigh profitability considerations and concerns about meeting capital requirements. The discussion surrounding the relief measures on the regulatory capital requirements at the solo entity level of Credit Suisse AG, the parent bank, through the so-called regulatory filter implemented by FINMA’s 2017 decision, highlights this dilemma.24 Furthermore, the media release by European supervisory and resolution authorities in response to the banking turmoil of 19 March 202325 to calm the market for banks’ loss-absorbing capital and thus to reduce the risk-adequate premiums that have just emerged from the loss experience of AT1 investors in the case of Credit Suisse,underscores this uncertainty. Nevertheless, regulatory capital instruments and TLACeligible liabilities should no longer rely on an implicit and unconditional state guarantee.26 Investors in those instruments should be aware of the risks associated with their choice and bear responsibility if such risks materialise. This assumes that market discipline operates effectively, supported by comprehensive risk disclosure and appropriate 16 Neel Kashkari, ‘Lessons from the Crisis: Ending Too Big to Fail’ (Remarks at the Brookings Institution, 16 February 2016); Thomas M Hoenig, ‘A Market-Based Proposal for Regulatory Relief and Accountability’ (Speech at Annual Conference, Institute of International Bankers, 13 March 2017). 17 Anat R Admati and Martin F Hellwig, The Bankers’ New Clothes (Princeton University Press 2013); Thomas M Hoenig, ‘A MarketBased Proposal for Regulatory Relief and Accountability’ (Speech at Annual Conference, Institute of International Bankers, 13 March 2017). 18 Andrew G Haldane, ‘On Being the Right Size’ (Speech, Institute of Economic Affairs, 25 October 2012) < https:// www. bis. org/ review/ r1210 30d. pdf > ; Neel Kashkari, ‘Lessons from the Crisis: Ending Too Big to Fail’ (Remarks at the Brookings Institution, 16 February 2016). 19 FSB, ‘Principles on Loss-Absorbing and Recapitalisation Capacity of G-SIBs in Resolution: Total Loss-Absorbing Capacity (TLAC) Term Sheet’ (9 November 2015). 20 Common Equity Tier 1 (CET1), AT1, and Tier 2 capital are subject to the Basel capital standards. 21 Deutsche Bundesbank, ‘Europe’s New Recovery and Resolution Regime for Credit Institutions’ (2014) 66 Monthly Report 31–56. 22 Karl-Philipp Wojcik, ‘Bail-in the Banking Union’ (2016) 53 Common Market Law Review 91–138. 23 BCBS, TLAC Quantitative Impact Study Report (November 2015). 24 Corinne Zellweger-Gutknecht, Legality of the TBTF Decision 2017, legal opinion prepared on behalf of the Parliamentary Investigation Commission (PUK) to examine the conduct of federal authorities in the context of the emergency merger of CS with UBS (1 December 2024) < https:// www. parla ment. ch/ cente rs/ docum ents/ de/ 9.% 20Zel lweger. pdf > ; Urs Birchler, Effects of the Regulatory Filter on Credit Suisse, expert opinion commissioned by the Swiss Parliamentary Investigative Commission on the CS Emergency Merger (12 November 2024) < https:// www. parla ment. ch/ cente rs/ docum ents/ de/ 8.% 20Bir chler. pdf > . 25 ECB Banking Supervision, Single Resolution Board and EBA, ‘ECB Banking Supervision, SRB and EBA Statement on the Announcement on 19 March 2023 by Swiss Authorities’ (Joint Press Release European Central Bank 20 March 2023) < https:// www. banki ngsup er vis ion. europa. eu/ press/ pr/ date/ 2023/ html/ ssm. pr230 320~9f0ae 34dc5. en. html > . 26 Paul Davies and Klaus J Hopt, ‘Non-Shareholder Voice in Bank Governance: Board Composition, Performance and Liability’ in D Busch and G Ferrarini (eds), Governance of Financial Institutions (Oxford University Press 2019) 128 para 6.19.
374 U.B.Lendermann investment advice that enable informed investment decisions and thenegotiation of adequate risk premiums. Furthermore, investor suitability is essential, as the mis-selling of these instruments can undermine the effectiveness of the lossabsorbing mechanism, potentially heightening the need for a public bailout due to financial, economic, or sociopolitical pressures. The FSB formulated a required subordination approach to segregating all ‘operating liabilities’ from ‘capital structure liabilities’ and consolidating the latter under TLAC for bail-in purposes.27 Three aspects merit closer examination. First, the proposed subordination is only established vis-àvis liabilities excluded from TLAC.28 However, pari passu is not required with the other subordinated debt, which qualifies as AT1 and even Tier 2 capital, if applicable.29 Second, the FSB did not exclusively require contractual subordination but also allowed for statutory subordination.30 Third, alternatively, but not cumulatively, the instruments could be issued out of a top-tier bank holding company (‘structural subordination’).31 Regulatory bodies have been engaging in negotiations over TLAC issues. However, these negotiations have resulted in statutory measures allowing insufficient transparency regarding TLAC-eligible liabilities and funding structures, which impede risk-adequate pricing, coupled with preferential tax treatment, despite the purported aim to reduce the TBTF premium related to implicit state guarantees. Retroactive statutory subordination Various EU member states initially adopted national approaches for issuing TLAC-eligible liabilities, creating a new layer in the creditor hierarchy.32 For instance, in 2017, Germany introduced statutory subordination for specific senior unsecured debt instruments in bank insolvency.33 Likewise, Slovenia introduced statutory subordination alongside a general depositor preference based on a tiered system. In contrast, Italy introduced general depositor preference over non-preferred senior liabilities.34 In France, statutory recognition of a contractual non-preferred senior debt layer was enacted in 2016, which was followed by Spain and Belgium also adopting similar systems in 2017. The statutory approaches allowed certain banks to immediately meet the new TLAC requirements without issuing new bonds during the transition period. In particular, the German law had a retroactive effect and included bonds already issued at the time. The German federal government’s justification, citing ‘superior reasons of financial stability’,35 was an innovative approach to intervening in existing contractual arrangements. However, the affected bondholders were not compensated for their inclusion in the TLAC framework—neither through higher risk premiums from the issuer nor through state compensation for expropriation. This may serve as an example of internal subsidisation within public finance.36 First, lawmakers reduced the implicit state guarantee, ultimately at the expense of the individual bondholders. Second, the demotion in rank for these bondholders directly benefitted other creditors, who were not required to offset their elevated rank with a corresponding reduction in risk premiums. Third, for banks, the segmentation of funding sources into TLAC-eligible bonds and preferred liabilities is not merely a zero-sum game in finance, despite their overall funding costs remaining unchanged. The implicit subsidy for banks lies in the continued funding cost advantages for affected bonds until maturity, despite the new law’s intention to eliminate the TBTF premium.The German initiative, potentially benefiting German banks, was likely welcomed by other member states, as it eased competition for the scarce participants making up the TLAC investor base in European capital markets. ‘Non‑preferred senior’ debt instruments intheEuropean Union Regarding future refinancing rounds, stakeholders in some EU member states have successfully advocated for harmonising the French contractual model of non-preferred senior debt instruments at the EU level. The call for harmonisation came in response to divergent national approaches that have 27 FSB TLAC Term Sheet, 15, para 11. 28 FSB TLAC Term Sheet, 15, paras 1, 10, 11. 29 FSB TLAC Term Sheet, 15, fn 11. 30 FSB TLAC Term Sheet, 15, para 11, ss (a) and (b). 31 FSB TLAC Term Sheet, 15f, para 2, ss (b)-(c), and para 11, s (c). 32 See IMF, ‘Euro Area Policies’ IMF Staff Country Reports 2018/232 (July 2018) 26; Niall J Lenihan, Maike B Luedersen and Martin Schulte, ‘The Hierarchy of Creditor Claims in Bank Insolvency—Recent Developments and the Advisory Functions of the European Central Bank’ (2016) 6 Revue de Droit Bancaire et Financier. 33 Sections 46f (5) and (6) of the German Banking Act (Kreditwesengesetz) were introduced through the Resolution Mechanism Act (Abwicklungsmechanismusgesetz), 2015 BGBl I at 1864, repealed (2018). 34 Marc Dobler and others, ‘The Case for Depositor Preference’ (IMF December 2020). However, for TLAC requirements, operational liabilities, such as payments from derivative contracts, remained on the same level as senior unsecured bank debt instruments. 35 Deutsche Bundesregierung, Government Explanatory Memorandum to the Draft Resolution Mechanism Act (Federal Parliament Publication, 26 May 2015) BT-Drs 18/5009, 77 (KWG). Critically, see Committee Recommendation (2 June 2015) BR-Drs 193/1/15. 36 Richard A Posner, ‘Taxation by Regulation’ (1971) 2 Bell Journal of Economics and Management Science 22–50.
375Automated bail-in: eliminating regulatory restraints exacerbated national fragmentation and created uncertainty for issuers and investors. Just as crucial, the contractual model can empower G-SIBs in tactically balancing cost-efficiency and adherence to regulations when considering refinancing options. As existing statutory subordinated bonds mature, G-SIBs can issue the precise amount of ‘expensive’ non-preferred status bonds required for TLAC compliance, while utilising cheaper preferred senior bonds for additional funding needs. Relevant amendments to the Bank Recovery and Resolution Directive37 required member states to create a legal basis for the new asset class of non-preferred senior debt instruments issued by credit institutions by the end of 2018. This part of the draft legislation was separated from other elements of the EU banking package and was given an accelerated procedure,38 enabling it to come into force just in time for the introduction of the TLAC requirements in 2019. In principle, having multiple layers in the waterfall defining the order in which holders of different types of TLACeligible instruments (CET1, AT1, Tier 2, and TLAC-eligible liabilities) of a troubled bank should bear losses does not inherently pose problems. Similarly, the lower yield of TLAC instruments, compared to that of AT1 and Tier 2 instruments, does not confer a funding advantage, provided that markets price own funds and TLAC-eligible instruments appropriately, according to their ranking and corresponding risk profiles. Moreover, banking literature emphasises that issuing multiple financial claims on a bank’s cash flows aligns with investor preferences and is, therefore, considered efficient.39 However, the more fragmented the creditor hierarchy within different instruments, the greater the challenges with ensuring equal treatment of creditors, including lack of transparency. Notably, the industry uses subtle language, avoiding the term ‘subordinated’ in the context of prescribing TLAC-eligible bonds’ terms and conditions, and even risk disclosures, as the mere inclusion of this word could lead to substantial increases in financing costs of several basis points. This manoeuvre sheds light on the complex interplay between financial regulation and funding strategies, underscoring the importance of language in shaping market perceptions and investor behaviour within the TLAC framework. Beyond these linguistic nuances, the oxymoronic combination of ‘non-preferred’40 and ‘senior’ in the EU legal designation of TLAC-eligible liabilities41 increases opacity and may potentially mislead investors. The EU strategy for open bank resolution primarily relied on using instruments labelled with this term.42 Separation of the issuing entity by way of issuance out of holding companies, as illustrated below by the US concept of structural subordination, is not required. ‘Structural subordination’ throughUS bank holding companies In the USA, bank holding companies (BHCs) are considered a ‘source of strength’ for their operating subsidiaries.43 In resolution, they are replaced by publicly-owned bridge banks, leaving their creditors behind, effectively constituting an economic bail-in.44 Through the peremptory resolution mechanism under Title II of the Dodd-Frank Act,45 debt instruments issued at the BHC level are rendered structurally subordinated to senior debt from operating bank subsidiaries, qualifying them for TLAC. These instruments assume the TLAC risks inherent in the subsidiaries. However, the funding concept of US BHCs has long been familiar to the capital market and rating agencies, which may help explain why the FSB observed lower funding cost advantages associated with structurally subordinated debt.46 Additionally, US regulators had a reputation for imposing losses on private investors,47 at least until the Silicon Valley Bank crisis and events of spring 2023, accounting for the perceived likelihood of loss-bearing by subordinated debt holders, thereby driving the observed differences in funding costs. Regarding structural subordination, the risk associated with opaque intra-group financial relationships challenges investors striving to evaluate funding structures.48 This 37 Directive (EU) 2017/2399, [2017] OJ L345/96. 38 European Commission, Banking Reform: EU Reaches Agreement on First Key Measures (Press Release 25 October 2017). 39 See Arnoud WA Boot and Anjan V Thakor, ‘Security Design’ (1993) 48 The Journal of Finance 1349–78. 40 The introduction of this term might be inspired by the term ‘noncumulative perpetual preferred stock’ under Basel I, see BCBS, ‘International Convergence of Capital Measurement and Capital Standards’ (April 1998) fn 2 < https:// www. bis. org/ publ/ bcbsc 111. pdf > . 41 Directive (EU) 2017/2399, [2017] OJ L345/96, paras 10–12, 14. 42 See Deutsche Bundesbank, ‘The European Banking Package – Revised Rules in EU Banking Regulation’ (2019) 71 Monthly Report 46. 43 Bank Holding Company Act, 12 USC § 1831o-1 (1956). 44 Randall D Guynn, ‘Resolution Planning in the United States’ in AR Dombret and PS Kenadjian (eds), The Bank Resolution and Recovery Directive: Europe’s Solution for Too Big to Fail? (Walter De Gruyter 2013) 145. 45 Pub L 111–203, 124 Stat 1376 (2010). 46 See German Official Journal (BGBl) 2018 I at 1102 (FRG) for legislation as of July 13, 2018. FSB, Evaluation of the Effects of TooBig-to-Fail Reforms (2021) Final Report < https:// www. fsb. org/ wpconte nt/ uploa ds/ P0104 21-1. pdf > . 47 See Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report (US Government Printing Office, 2011) < https:// www. govin fo. gov/ conte nt/ pkg/ GPOFCIC/ pdf/ GPOFCIC. pdf > . 48 Paul Davies and Klaus J Hopt, ‘Non-Shareholder Voice in Bank Governance: Board Composition, Performance and Liability’ in D Busch and G Ferrarini (eds), Governance of Financial Institutions (Oxford University Press 2019) 141, para 6.17ff.
376 U.B.Lendermann mirrors certain funding arrangements in which debt is routed through unregulated intermediate holding companies (IHC), transforming it into equity capital for subsidiaries, resulting in double leverage. This intricate interplay becomes more complex when CET1 instruments are issued to third parties by operating subsidiaries of a resolution group,49 potentially jeopardising the equity buffer for ‘senior bonds’ at the BHC level. While resolution measures are applied solely to the BHC and its creditors, the subsidiary remains operational, leaving its external investors unaffected by these measures. In such cases, external CET1 instruments issued by the subsidiary may still be outstanding and even retain some value, while senior bonds issued by the BHC are held as loss-absorbing. This raises doubts as to whether the pricing mechanism leads to information that can be used for efficient market results, alleviating the prospect of a public bailout.50 Persisting tax preferences forTLAC‑eligible liabilities The general debate positions around the preferential tax treatment of debt in banks are well established in both academic literature51 and practice.52 TLAC-eligible liabilities align with traditional hybrid financing instruments, marketed as debt to tax authorities and investors while simultaneously presented as loss-absorbing capacity to regulators and rating agencies.53 Given this, the US Internal Revenue Service has introduced far-reaching exceptions from the Base Erosion and Anti-Abuse Tax (BEAT) for interest on internal TLAC-eligible instruments issued cross-border to other group entities.54 Through the BEAT, US lawmakers aimed to limit profit reductions when US companies made payments abroad. In contrast, TLAC-eligible instruments must be issued to parent companies abroad, out-streaming losses from the USA in the event of default. Under the BEAT exemption, however, TLAC-eligible instruments can serve as vehicles to out-stream profits to low-tax jurisdictions via high coupon payments. Furthermore, the UK government lobbied successfully to exempt financial services from the minimum tax of the OECD/G20 Base Erosion and Profit Shifting Project in 2021.55 The OECD argued that prudential regulation, such as bank or insurance licensing requirements designed to protect local deposit or policy holders in the market jurisdiction, typically ensures that residual profits are realised mainly in local customer markets.56 Therefore, if substantial interest payments are made by US subsidiaries on internal TLAC to a parent company based in London, such transactions would be exempt from the BEAT, and the UK would not impose any minimum corporate income tax. Not least, TLAC-eligible liabilities largely continue to benefit from various national tax preferences that are commonly provided for debt capital, which in many jurisdictionseven extend to AT1 instruments.57 This approach is considered reasonable, as it aims to stimulate the TLAC market. There is, however, a trade-off between the tax deductibility of coupons and supervisory requirements58 as 49 This is permissible according to the FSB TLAC Term Sheet, para 8, s (a). 50 Tobias H Tröger, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool Under the European Bank Recovery and Resolution Regime’ (2018) 4 Journal of Financial Regulation 35–72. 51 AR Admati and others, ‘Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive’ (2013) Stanford University School of Business Research Paper 2065; Markus Brunnermeier and others, ‘The Fundamental Principles of Financial Regulation’ Geneva Reports on the World Economy 11 (International Center for Monetary and Banking Studies and Centre for Economic Policy Research, June 2009) 33ff.; Neel Kashkari, ‘Lessons from the Crisis: Ending Too Big to Fail’ (Remarks at the Brookings Institution, 16 February 2016). 52 IMF and OECD staff, with input from staff of the other organisations participating in the ITD2009, drafted ‘Financial Institutions and Instruments—Tax Challenges and Solutions’ (Paper for the International Tax Dialogue Conference, October 2009). IMF, ‘Debt Bias and Other Distortions—Crisis-Related Issues in Tax Policy’ (2009) IMF Board Paper. See also FSB, Final Report on Corporate Funding Structures and Incentives (28 August 2015) 11 and Annex C. 53 IMF and OECD, ‘Financial Institutions and Instruments—Tax Challenges and Solutions’ (Paper for the International Tax Dialogue Conference, October 2009) 18. 54 26 CFR § 1.59A-3(b)(3)(v). 55 See ‘Pillar One’ in OECD, Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalization of the Economy (OECD/G20 Base Erosion and Profit Shifting Project, 1 July 2021). However, the IMF stated that the exclusion of regulated financial services might need to be reconsidered. IMF, ‘International Corporate Tax Reform’ (2023) Policy Paper 2023/001, 53. 56 OECD, ‘OECD Secretary-General Tax Report to G20 Finance Ministers and Central Bank Governors: Saudi Arabia’ (July 2020). 57 German Federal Ministry of Finance, ‘Letter Concerning the Income Tax Treatment of the Sample Conditions of the Federal Association of German Banks for Instruments of Additional Core Capital According to Art. 51 et seq.’ (10 April 2014) CRR Administrative Instruction, IV C 2—S 2742/12/10003:002. Under Dutch law (article 29a of the Corporate Tax Act), a similar preference has been abolished as of 1 January 2019. For an overview, see Clifford Chance, ‘Tax Treatment of AT1 and RT1 Instruments Issued by Banks and Insurers in Certain European Jurisdictions’ (July 2022) < https:// www. cliff ordch ance. com/ conte nt/ dam/ cliff ordch ance/ briefi ngs/ 2018/ 07/ taxtreat mentofat1andr t1instr umentsissuedbybanksandinsur ersincerta ineurop eanjuris dicti ons. pdf > . 58 Deutsche Bundesbank, ‘Contingent Convertible Bonds: Design, Regulation, Usefulness’ (2018) 70 Monthly Report 61.
377Automated bail-in: eliminating regulatory restraints well as issues under state aid law.59 Today, the preferential treatment in tax law incentivises bank management to meet TLAC requirements through debt instruments rather than CET1 capital to fully exhaust any funding cost advantages. Introducing anovel regulatory preference forexisting senior debt TLAC diverges from the BCBS’s objective of enhancing the ‘quality, consistency, and transparency of the capital base’.60 TLAC-eligible liabilities, other than eligible regulatory capital instruments, are of lower quality than the former Tier 3 capital.61 TLAC-eligible liabilities come at a lower cost for banks than regulatory capital, regardless of any progress on mitigating the funding cost advantages of G-SIBs, as was suggested in the FSB’s evaluation of the effects of TBTF reforms in 2021. These findings have been assessed and contextualised by various studies.62 Despite it having lower loss-absorbing capacity than regulatory capital, the FSB evenexpects TLAC to consist of at least 33 per cent of eligible debt capital,63 having become an obligation for G-SIBs under US law.64 The origin of this solution can be found in the concept of an ‘internal resolution fund’ and in the trigger calibration. In case of default, there should be a sufficient level of TLAC-eligible liabilities remaining to which a bail-in can be applied. On the contrary, if a bank were to completely and exclusively meet the TLAC requirement with CET1, resolution proceedings on such a bank would have to be initiated if it dropped below a CET1 ratio of 18 per cent of risk-weighted assets (RWA) or a CET1 ratio of 6.25 per cent of the total leverage ratio exposure, which determine the regulatory minimum thresholds for TLAC. Industry representatives felt this would destroy a well-capitalised bank in the ordinary course of business. However, the concern over an overly premature resolution trigger is largely unfounded, as TLAC standards now hold equal importance alongside regulatory capital requirements, and both the FSB Key Attributes 3.1 and Article 18(4)(a) of the EuropeanSingle Resolution Mechanism Regulation (SRMR)65 require resolution to be initiated well before TLAC thresholds are breached. Despite this, counter-arguments have failed to dispel the prevailing narrative. Consequently, policymakers now prefer debt over equity, and the regulatory process is being taken to extremes with argumentation that superficially appears plausible. Closer examination reveals, however, that introducing TLAC regulations in the EU and USA allowed G-SIBs to proceed without making fundamental adjustments to their funding structure. Preserving thebanking group structure Navigating political realities ininternational cooperation The current resolution framework appears to prioritise the objectives of banks in preserving theirglobalfranchise while failing to meet its intended purpose of effectively resolving transnational banking groups. These groups benefit from economies of scale through central treasury functions, cash pooling, and other central services. However, tensions between international cooperation and national fiscal capabilities and interests arise. Considering political realities, it is rational for politicians to prioritise the interests of domestic voters and taxpayers (home bias).66 Regarding these realities, the FSB did not focus solely on the financial group (as the BCBS does)67 but started considering its subgroups and intra-group relationships as well. Depending on the resolution strategy, resolution authorities can apply a single point of entry (SPE) strategy to a single resolution group or a multiple points of entry (MPE) strategy to multiple resolution groups.68 The TLAC requirements apply to each resolution group on a consolidated or sub-consolidated basis. Even in an SPE strategy scenario, the FSB imposes ‘internal TLAC’ requirements to maintain a fallback position should the home supervisor or resolution authority act ‘bad or mad’; that is, regardless of whether they are able to do so, 59 See EU Commission Support Measure SA. 43,504—Tax treatment Contingent convertibles (Coco’s) in the Netherlands (Letter, 1 March 2018) COMP H3/VS/hvds D* 010289/2018 < https:// docs. google. com/ docum ent/d/ 11xjo ecxnK KGTwV HdgKV Kkv98 GZg0b 7RUuq IDkc3 fhcA/ edit > . 60 Basel III, para A1. 61 Tier 3 was a regulatory capital element introduced under Basel I.5 and abolished under Basel III, para9. It consisted of subordinated bonds with an original maturity of at least 2years to cover market risk. 62 For example, Irene Pablos Nuevo, ‘Has the New Bail-in Framework Increased the Yield Spread Between Subordinated and Senior Bonds?’ (2020) 26 European Journal of Finance 1781–97; Martin F Hellwig, ‘Twelve Years After the Financial Crisis—Too-Big-to-Fail is Still with Us’ (2021) 7 Journal of Financial Regulation 175–87. 63 FSB TLAC Term Sheet, para 6. 64 This is a long-term debt requirement under 12 CFR § 252.62. However, under EU law, any part of eligible liabilities can be completely met with CET1, according to Council Regulation (EU) 2019/877, rec 7. 65 Regulation (EU) No 806/2014, OJ L 225, 30.7.2014, p. 1–90. 66 Unequal treatment within the context of sovereign debt restructuring was observed by Federico Sturzenegger and Jeromin Zettelmeyer in ‘Haircuts: Estimating Investor Losses in Sovereign Debt Restructurings, 1998–2005’ (2005) IMF Working Paper WP/05/137, 63. 67 Basel II, para 20; Basel III, para 47. 68 FSB, ‘Recovery and Resolution Planning for Systemically Important Financial Institutions: Guidance on Developing Effective Resolution Strategies’ (16 July 2013) < https:// www. fsb. org/ wpconte nt/ uploa ds/r_ 13071 6b. pdf > .
384 U.B.Lendermann Time inconsistency problem The decision-makers face the ultimate dilemma of achieving two fundamentally incompatible resolution goals simultaneously: maintaining financial stability on the one hand and avoiding a bailout on the other. Returning to the rationale behind the bail-in tool, it can be argued that pre-crisis credibility—or at least constructive ambiguity regarding creditors’ loss-sharing—could suffice to establish ex ante incentives, reduce moral hazard, and limit implicit state guarantees, thereby serving the public interest. As previously shown, however, when areal-lifeapplication arises, politicians might—pragmatically, albeit inconsistently—opt for a bailout to preserve financial stability. At this juncture, the prevailing rationale suggests that the anticipated fiscal implications borne by taxpayers for such interventions may be less consequential than the unpredictable economic repercussions of a bail-in. Nonetheless, it must also be considered that a bail-in may yield ex post efficient outcomes, as it avoids the use of public funds and reinforces the inherent risk-sharing mechanism.122 However, the second-round effects triggered by a bail-in could undermine this efficiency, alongside the legal risks and complexities involved, which may outweigh the effort required to obtain parliamentary approval for tapping into public budgets. It is also important to note that policymakers, while cognisant that a bailout precedent undermines the future credibility of a bail-in strategy, must account for the need to reestablish market access for refinancing rounds immediately following the ‘resolution weekend’. The legal theory of finance proposed by Pistor posits that strict enforcement of contracts becomes increasingly challenging during a financial crisis123; so tends the prospect of a bail-in to fall away at the apex. In systemic scenarios, policymakers often find themselves with no viable alternative but to orchestrate a public bailout. The development of a suitable resolution regime, however, encompasses not only how it should function in normative terms but also how it is expected to operate in realworld scenarios. This dual perspective redirects attention towards the responsibility and utility functions of policymakers who are charged with implementing such measures. It moves beyond the formal, technical objectives of bank resolution, highlighting the significant role of human factors and judgement in the decision-making process.124 From the perspective of responsible risk aversion in safeguarding the public interest, political leaders will tend to eschew the inherent hazards and complexities associated with bail-in measures, gravitating towards the ostensibly secure financial bailout instead. Public choice theory provides additional insights by highlighting the individual political costs politicians face, such as the risk of endangering their re-election. Conversely, the fiscal burden’s impact has less significance for the politician when amortised across a broad spectrum of stakeholders and can be securitised into future fiscal periods, often extending beyond the tenure of the legislative actors— a phenomenon evocative of what Bernstein once called a ‘concentrated benefits–diffuse costs story’.125 In conclusion, it is evident that public decision-makers will remain entrenched in the TBTF dilemma.126 Despite normative aspirations for efficient resolution strategies, practical realities and political considerations frequently steer policymakers towards bailouts, perpetuating the challenges of resolving financial crises effectively. This outcome suggests the strong likelihood that lobbying efforts led to regulatory capture,127 as the financial industry successfully promoted the introduction of the bail-in tool. By doing so, it largely preserved the implicit state guarantee and the associated funding cost advantages for G-SIBs, further entrenching their systemic importance while sidestepping stricter measures necessary to effectively address the TBTF problem. Proposal forenhancing TLAC‑eligible liabilities This study has demonstrated that the regulatory process complexities and the changing interests of regulators during crises make it challenging to find a practical solution 122 See Thomas Philippon and Aude Salord (eds), ‘Geneva Special 4: Bail-Ins and Bank Resolution in Europe’ (CEPR Pr 2017) < https:// cepr. org/ publi catio ns/ booksandrepor ts/ genevaspeci al-4bailinsandbankresol utioneurope > . 123 Katharina Pistor, ‘A Legal Theory of Finance’ (2013) 41 Journal of Comparative Economics 315. 124 Some authors argue, however, that even officials within supervisory authorities may be driven enough by self-interest to fail to take appropriate measures. Tobias H Tröger and Anastasia Kotovskaia, ‘National Interests and Supranational Resolution in the European Banking Union’ (1 February 2023) SAFE Working Paper 340, European Banking Institute Working Paper Series 114/2022, 34 European Business Law Review 781 < https:// ssrn. com/ abstr act= 40243 43 > . 125 Marver H Bernstein, Regulating Business by Independent Commission (Princeton 1955). 126 See Charles Goodhart and Emilios Avgouleas, ‘A Critical Evaluation of Bail-In as a Bank Recapitalization Mechanism’ (2014) Discussion Paper 10,065; Jeffrey N Gordon and Wolf-Georg Ringe, ‘Bank Resolution in Europe: The Unfinished Agenda of Structural Reform’ in Danny Busch and Guido Ferrarini (eds) European Banking Union (Oxford University Press 2015) ch 15. 127 Lobbying efforts often play a large role in ‘regulatory capture’, where regulatory agencies act in the interest of influential groups rather than the public. See Jean-Jacques Laffont and Jean Tirole, ‘The Politics of Government Decision-Making: A Theory of Regulatory Capture’ (1991) 106 Quarterly Journal of Economics 1089–1127.
385Automated bail-in: eliminating regulatory restraints to the TBTF problem. Based on these assumptions, efforts should be made to mitigate the problem by improving the international TLAC definition for G-SIBs on the FSB level. Therefore, it is recommended that authorities’ control over initiating the resolution process be reduced and a mandatory triggering mechanism with limited discretion introduced.128 The tension between rule-based approaches and flexibility in handling specific systemic events is well recognised.129 The legal theory of finance suggests suspending the legal enforcement of contracts that operate as financial assets when the survival of the system is at stake, particularly at the apex of a crisis.130 While Pistor’s conclusion emphasises that flexibility might be necessary to avoid extraordinary risks, it would be particularly paradoxical for the crisis management framework to be suspended precisely during a financial crisis. Flexibility is detrimental to the credibility of the bail-in apparatus, which is crucial for ex ante incentives, curbing moral hazard and propensity to resort to government guarantees. Ensuring private sector loss absorption advances ex post efficient loss-sharing and serves to enhance credibility. The policy trade-offs should be considered, however, as public authority involvement in assessing the financial health and activating loss absorption should be minimised to avoid regulatory forbearance on the one hand and to prevent state liability for wrongful execution on the other. Therefore, the trigger for TLAC-eligible instruments should be automatic, early, easy to assess, quick to adopt,131 and contractual, facilitating compliance with the solvency criteria to ensure access to ELA. The approach should aim to clarify the creditor hierarchy and reduce complexity and opacity while minimising unjustified tax preferences for TLAC-eligible instruments. The clause should be supplemented with a liquidity trigger that activates in case of ELA provisioning from central banks. Finally, parallel measures should be implemented to impose limitations on asset encumbrance to facilitate the collateralisation of ELA. Share price trigger To ensure effective loss absorption, market-based trigger concepts, as suggested by Flannery,132 Pennacchi, Vermaelen and Wolff,133 or Sundaresan and Wang,134 among others, are favoured for inclusion in the TLAC Term Sheet. The more the triggering process is perceived as transparent and free from bias, the greater the acceptance of loss absorption, the lower the risk of litigation, and the higher the likelihood of reestablishing market access in the aftermath. Moreover, credibility can best be reached through an automatic trigger mechanism, as is powerfully demonstrated by the principles of military deterrence. The trigger mechanism should be designed to align with scenarios such as eroding market confidence. The threshold data should be readily available on a daily basis and easily accessible to the public. These conditions are best met by a share price trigger based on official stock market data, notwithstanding its drawbacks.135 While share price triggers are commonly used in mandatory convertible bonds or knock-out certificates, they are criticised when applied to a large volume of AT1 instruments. Despite concerns about the potential risk of abuse and ‘death spiral’ associated with using a market-based trigger,136 as well as pricing uncertainty and wealth transfer from debt to equity,137 these concerns should be given less weight than ensuring the safety and effectiveness of TLAC-eligible liabilities when triggered for recovery purposes to prevent default. 128 Patrick Bolton, Wei Jiang and Anastasia Kartasheva advocate for reduced discretion as well in ‘The Credit Suisse CoCo Wipeout: Facts, Misperceptions, and Lessons for Financial Regulation’ (2023) 35 Journal of Applied Corporate Finance 66. 129 Dalvinder Singh, ‘The UK Banking Act 2009, Pre-Insolvency and Early Intervention: Policy and Practice’ (11 November 2010) Journal of Business Law, Warwick School of Law Research Paper 27/2010 < https:// ssrn. com/ abstr act= 17074 06 > . 130 Katharina Pistor, ‘A Legal Theory of Finance’ (2013) 41 Journal of Comparative Economics 315. 131 See also Edoardo D. Martino, Casimiro Antonio Nigro, and Tom Vos, in ‘CoCos in Europe: What Is Wrong – and How to Fix It?’ (29 April 2024) European Banking Institute Working Paper Series 169, Amsterdam Law School Research Paper 18/2024, Amsterdam Center for Law & Economics Working Paper 09/2024 < https:// ssrn. com/ abstr act= 48107 61 > . 132 Mark J Flannery, ‘No Pain, No Gain? Effecting Market Discipline via “Reverse Convertible Debentures”’ in Hal S Scott (ed), Capital Adequacy beyond Basel: Banking, Securities, and Insurance (Oxford University Press 2005); Mark J Flannery, ‘Stabilizing Large Financial Institutions with Contingent Capital Certificates’ (1 March 2010) CAREFIN Research Paper 04/2010 < https:// ssrn. com/ abstr act= 17986 11 > . 133 George G Pennacchi, Theo Vermaelen and Christian C P Wolff, ‘Contingent Capital: The Case for COERCs’ (23 December 2011) INSEAD Working Paper 2011/133/FIN < https:// ssrn. com/ abstr act= 16569 94 > . 134 Suresh Sundaresan and Zhenyu Wang, ‘On the Design of Contingent Capital with a Market Trigger’ (2015) 70 The Journal of Finance 881–920. 135 Stefan Avdjiev, Anastasia Kartasheva and Bilyana Bogdanova, ‘CoCos: A Primer’ (September 2013) BIS Quarterly Review 43; Deutsche Bundesbank, ‘Contingent Convertible Bonds: Design, Regulation, Usefulness’ (2018) 70 Monthly Report March 53. 136 Charles Goodhart, ‘Are CoCos from Cloud Cuckoo-Land?' (10 June 2010) < https:// cepr. org/ voxeu/ colum ns/ arecocoscloudcuckooland > ; Stefan Avdjiev, Anastasia Kartasheva and Bilyana Bogdanova, ‘CoCos: A Primer’ (September 2013) BIS Quarterly Review 43. 137 Suresh Sundaresan and Zhenyu Wang, ‘On the Design of Contingent Capital with a Market Trigger’ (2015) 70 The Journal of Finance 881–920.
386 U.B.Lendermann The calibration of the share price trigger represents the most significant challenge. It should ensure its threshold is early enough to allow timely reactions. This proposal acknowledges that significant resolution measures must be taken during the recovery phase to prevent a default event, even if not explicitly referred to as such. Early triggers are essential for creating the necessary breathing space for timely reorganisation in a going-concern scenario, helping to preserve franchise value. This study advocates for a straightforward approach: setting the share price trigger at a fixed minimum threshold where the bank’s shares qualify as penny stocks, as defined by the US Securities and Exchange Commission (SEC)—companies trading for less than 5 US dollars per share.138 While this approach may face criticism for its simplicity compared to more sophisticated proposals, such as those incorporating market-to-book value ratios139 or dynamic price trends, the penny stock level represents a well-known psychological threshold. It provides a quick and easy assessment, requiring no reliance on complex calculations, intermediate steps, or third-party involvement, making it a practical and independent benchmark. Furthermore, the likelihood of manipulation or misconduct driving a share price to a level classified as a penny stock is relatively low. Several events support the proposed threshold. For example, Credit Suisse Group entered penny stock status on 15 July 2022, when its share price dipped to an intra-day low of 4.99 Swiss francs on the Swiss Stock Exchange.140 From 1 September 2022 onward, the share price consistently hovered around a 5 Swiss francs threshold,141 further highlighting its significance as a critical benchmark. Before its collapse in March 2023, Silicon Valley Bank’s stock price sharply declined from more than 100 dollars per share on 9 March 2023 to below 1 dollar per share from 28 March 2023 onward, after a period of suspended trading.142 First Republic Bank immediately fell from two-digit share prices to an intra-day low of 4.76 dollars per share on 26 April 2023, and consecutively closed below that level from 3 May onward.143 An earlier example is provided by Bear Stearns, whose stock price plummeted from 30.85 dollars per share on 14 March 2008 to penny stock levels by 17 March 2008, when it traded at an intra-day low of 2.84 dollars and closed at 4.81 dollars per share.144 Over that weekend, Bear Stearns’ acquisition by JP Morgan Chase was already announced at an initial price of 2 dollars per share, which was later revised to 10 dollars per share.145 After a volatile week, trading around or below 10 dollars per share, Lehman Brothers’ stock reached penny stock levels on 15 September 2008, opening at 0.89 dollars, closing at 0.23 dollars per share, and remaining below that level for the future.146 Triggering TLAC-eligible liabilities at this juncture might not have presented a clear recovery scenario those days, as Lehman Brothers Holdings—as the only bank to do so during the GFC—announced its Chapter11 bankruptcy filing on the early morning of 15 September 2008. Citigroup’s stock price fell sharply during the end of the GFC, trading at an intra-day low of 4.44 dollars per share on 14 January 2009, and remained at a penny stock level until 2011.147 Bank of America saw its shares dip below 5 dollars during the crisis as well, trading at an intra-day low of 4.62 dollars per share on 4 February 2009 and subsequently recovering,148 possibly due to the public bail-out measures. Conversely, Lloyds Banking Group had already fallen into penny stock territory long before the GFC,149 while UBS did not reach penny stock levels150—despite, or perhaps because of, state intervention during the GFC. This analysis underscores the importance of careful trigger design, balancing early intervention with practical considerations. This study aligns with work by Perotti and Martino, who argue that supervisors lack effective tools and incentives for early intervention, primarily due to fears of triggering bank runs, and propose pre-emptive partial bail-ins of investors or uninsured depositors as stabilising measures during significant outflows.151 Meeting stock price thresholds in a going-concern scenario would not directly trigger a catastrophic event for the respective bank. Instead, it would automatically bolster equity capital through the conversion or write-off of TLAC-eligible liabilities, thereby 138 See 17 CFR § 240.3a51-1. 139 George G Pennacchi, Theo Vermaelen and Christian C P Wolff, ‘Contingent Capital: The Case for COERCs’ (23 December 2011) INSEAD Working Paper 2011/133/FIN < https:// ssrn. com/ abstr act= 16569 94 > . 140 Data acquired through LSEG. 141 Data acquired through LSEG. 142 Data acquired through LSEG. 143 Data acquired through LSEG. 144 Data acquired through LSEG. 145 Andrew Ross Sorkin, ‘JP Morgan Pays $2 a Share for Bear Stearns ‘ The New York Times (17 March 2008) < https:// www. nytim es. com/ 2008/ 03/ 17/ busin ess/ 17bear. html > . 146 Data acquired through LSEG. 147 Data acquired through LSEG. 148 Data acquired through LSEG. 149 Emma Dunkley and Patrick Jenkins, ‘How Lloyds Came Back from the Brink’ Financial Times (17 May 2017) < https:// www. ft. com/ conte nt/ 34e57 e763a8711e7821a6027b 8a20f 23 > . 150 Data acquired through LSEG. 151 Enrico C Perotti and Edoardo D Martino, ‘Containing Runs on Solvent Banks: Prioritizing Recovery Over Resolution’ (16 February 2024) Amsterdam Law School Research Paper 05/2024, Amsterdam Center for Law & Economics Working Paper 02/2024 < https:// ssrn. com/ abstr act= 47291 10 > .
387Automated bail-in: eliminating regulatory restraints addressing market doubts. Concerns about adverse market reactions should not deter the implementation of a marketbased trigger mechanism, as a share price decline is an unavoidable consequence in the absence of effective mitigation measures. The proposed market-based trigger improves solvency assurance by leveraging declining share prices to counteract negative risk perceptions. Establishing this mechanism would enhance transparency and reinforce the TLAC investor base’s understanding that this unique hybrid instrument operates similarly to equity shares and is exposed to associated risks of losses in a financial crisis. TLAC-eligible instruments are devalued prior to the trigger event being reached, and the stock price aligns with CET1 instruments beforehand—similar to knock-out instruments or mandatory convertibles. A market-based share price trigger, if implemented, could have influenced management’s governance and behaviour by encouraging proactive measures to mitigate risks of prospective acquirers engaging in excessive bargaining or coercive tactics. Such a trigger would incentivise management to maintain a substantial buffer above penny stock levels, effectively aligning the preservation of shareholder value with the objectives of banking regulation. Supervisors, in turn, should be encouragedto proactively anticipate market movements. However, there is also a potential for misuse of this mechanism, and it is advisable to mitigate this by incorporating contractual safeguards. For instance, implementing observation periods of two days to one week can provide a buffer to assess stability, ensuring the mechanism is not triggered prematurely in the absence of sharp declines, trading suspensions, or public interventions during that time. Liquidity trigger ELA from central banks remains indispensable and the most pressing concern in a banking crisis. The Credit Suisse case has disproven the notion that a capital increase is unsuitable for addressing liquidity issues. Despite being distinct in theory, liquidity and capital are interconnected in practice. For central banks, it is not justifiable to provide ELA to an insolvent bank. Instead, the bank must remain a going concern to qualify. To ensure this, it is recommended to introduce an additional trigger specifically suited to situations where banks apply for ELA under the newly established solvency criteria within the Eurosystem’s ELA framework. Under this framework, ELA can now be extended to banks that fail to meet the harmonised minimum regulatory own funds requirements, ‘if there is a credible prospect of recapitalisation […] by which harmonised minimum regulatory own funds levels would be restored within 24weeks after the end of the reference quarter of the data that showed that the bank does not comply with harmonised regulatory minimum standards; in duly justified, exceptional cases the Governing Council may decide to prolong the grace period of 24weeks.’152 Triggering the contribution of TLAC-eligible instruments to CET1 items may lead to a credible prospect of recapitalisation by way of restoration of the own funds level in this sense, thereby indirectly enhancing the liquidity position as it establishes the necessary conditions for accessing ELA. Liquidity is often required in the form of foreign currency as well. However, in the case of smaller countries, where banks are too big to save, this support will not even be extended through swap transactions with the respective central bank. At its apex, the Credit Suisse case finally highlighted the lack of ELA from the Fed to the group’s US entities, and the demand for US dollar-denominatedliquidity from the Swiss parent, underscoring the critical need for stronger international cooperation among central banks. Recapitalisation, in the manner outlined earlier, would serve as a confidence-building measure to facilitate such collaboration. Another rationale for a liquidity trigger is that it serves to ensure that holders of TLAC-eligible instruments do not benefit from ELA provided to banks. Without ELA during a crisis scenario, creditors would, in turn, face further declining asset values due to fire sales when banks are no longer operational, ultimately leaving them worse off than they would have been had ELA support been provided. Thus, it is justified that the market price of TLAC-eligible liabilities during a crisis should reflect public perceptions of the bank’s liquidity position. The PONV clause in the BCBS regulatory framework concerning capital instruments should be amended accordingly, clarifying that ELA can be regarded as a form of public support, particularly when the minimum own funds requirements are not met. Currently, the clause defines a trigger event as ‘the earlier of: (1) a decision that a writeoff, without which the firm would become non-viable, is necessary, as determined by the relevant authority; and (2) the decision to make a public sector injection of capital, or equivalent support, without which the firm would have become non-viable, as determined by the relevant authority.’153 However, the clause should be amended to include a third trigger event: ‘the provision of Emergency Liquidity Assistance from Central Banks to a firm whose Common 152 European Central Bank’s instructions to the national central banks responsible for ELA within the framework of its mandate. Agreement on Emergency Liquidity Assistance (27 September 2024) para 4.1, s (b). 153 Basel III, para 49, fn 9 and BCBS, ‘Basel Committee Issues Final Elements of the Reforms to Raise the Quality of Regulatory Capital’ (Press Release 03/2011, 13 January 2011).
388 U.B.Lendermann Equity Tier 1 capital ratio, Tier 1 capital ratio, Total Capital Ratio, or leverage ratio, as reported on either an individual (if applicable) or consolidated (if applicable) basis, do not comply with the harmonised minimum regulatory own funds levels (namely 4.5%, 6%, 8%, and 3%, respectively).’ Rank, transparency, event ofdefault, andtax preference The equal ranking of TLAC-eligible liabilities with Tier 2 instruments is advocated to reduce opacity and fragmentation of the creditor hierarchy. Establishing a well-defined subordination requirement and ensuring transparency of TLAC-eligible liabilities in the TLAC term sheet is crucial. The transparency regarding the issuing structure and disclosure of capital and risk, as per Basel II, pillar 3, should be expanded to encompass the issuing entities on a standalone basis. Furthermore, the distinction between going-concern capital (Tier 1) and gone-concern capital (Tier 2 and TLACeligible liabilities) could be eliminated, as it seems artificial unless it can be proved that G-SIBs can be resolved in an orderly manner.154 Thus, triggering TLAC-eligible liabilities should not be considered an event of default and, in particular, it should not trigger early termination rights or any credit default swaps (CDS). The purpose of such liabilities is precisely to mitigate the risks associated with this event for the financial system’s stability. OTC derivatives are of significant concern for financial stability and are only held up for a short time by any temporary stay, as suggested by the FSB Key Attributes. Extending the application of the Tier 1 capitalstandards set forth in Basel III, holding that neither non-payment nor cancellation of discretionary payments should constitute an event of default,155 to encompass any TLAC-eligible liabilities (including Tier 2), thereby levelling the distinction between goingand gone-concern capital, is suggested as a more favourable approach compared to imposing temporary stays on early termination rights. Furthermore, driving down the stock price to generate profits from credit default swaps on TLAC-eligible liabilities no longer provides incentives. Statutory tools currently available to enable competent authorities, such as the PONV and the bail-in, may remain unaffected. The activation of the market-based trigger, as defined, should result exclusively in the incurrence of losses by instruments qualifying for TLAC, without necessarily compelling the initiation of resolution proceedings, which ought to be considered separately. While harmonising the tax treatment of debt poses a significant challenge, any tax preferences associated with TLAC should be offset by a reduction in eligibility using a regulatory filter. This will promote a more equitable international regulatory environment by addressing the disparate tax incentives offered to their domestic industries by individual countries. It should be recognised that the legal requirement to hold sufficient TLAC alone should be sufficient motivation for compliance. Interplay betweencreditors andshareholders In the context of Credit Suisse, the discourse revolved around the interplay between creditors and shareholders rather than the appropriateness of assigning losses to AT1 instruments. Following the triggering of the PONV clause in March 2023, concerns emerged indicating the need for the complete elimination of equity shares before assigning losses to AT1 instruments.Like several other G-SIBs, Credit Suisse did not utilise genuine CoCos to meet the AT1 criteria, instead relying on write-off instruments. These instruments differ fundamentally from CoCos. CoCos convert into shares, diluting existing shareholders while ensuring that CoCo holders become shareholders with equal rank post-conversion. By contrast, write-offs do not convert into shares, thereby lacking any potential upside and the critical ‘principle of hope’. Moreover, given that these instruments are completely written off while the bank retains a CET1 ratio of 5.125 per cent of RWA, they are, in effect, subordinate to equity shares.156 This hierarchy persists unless the competent authority intervenes by eliminating outstanding shares andmandating the issuance of new shares to the write-off holders through a statutory order,157 thereby overriding the instruments’ terms and conditions that preclude such holders from claiming these shares. The underlying motive for such intervention is to reinstate the presumed order of seniority, wherein AT1 instruments should rank senior to equity shares in the capital structure.158 154 Cf Edoardo D. Martino, Casimiro Antonio Nigro, and Tom Vos, in ‘CoCos in Europe: What Is Wrong – and How to Fix It?’ (29 April 2024) European Banking Institute Working Paper Series 169, Amsterdam Law School Research Paper 18/2024, Amsterdam Center for Law & Economics Working Paper 09/2024 < https:// ssrn. com/ abstr act= 48107 61 > . 155 Basel III, para 53.6 and para 55.7, s (b). 156 See Urs Lendermann and others, Banking Union Essential Terms: A Study Requested by the ECON Committee (European Parliament July 2018) IP/A/ECON/2016–07 PE 619.028, 58 < https:// www. europ arl. europa. eu/ RegDa ta/ etudes/ STUD/ 2018/ 619028/ IPOL_ STU(2018) 619028_ EN. pdf > . 157 Bank Recovery and Resolution Directive (EU) 2017/2399, [2017] OJ L345/96, art 60. 158 See European Central Bank Banking Supervision, Single Resolution Board and EBA, ‘Banking Supervision, SRB and EBA Statement on the Announcement on 19 March 2023 by Swiss Authorities’ (Joint Press Release, 20 March 2023) < https:// www. banki ngsup ervis ion. europa. eu/ press/ pr/ date/ 2023/ html/ ssm. pr230 320~9f0ae 34dc5. en. html > .
389Automated bail-in: eliminating regulatory restraints The banks’ preference for write-offs over CoCos can be attributed to their shareholder resistance against dilution caused by CoCo conversions into new shares, striving to avoid any erosion of control, while the Board is cautious about the complexities associated with contingent capital through shareholder resolutions.159 The reliance on writeoffs highlights the relative weakness in creditor governance, a deficiency that became evident even in Credit Suisse’s interactions with professional investors. From a regulatory perspective, the central concern lies in the efficacy of going-concern loss absorption of TLACeligible instruments, as Martino, Nigro, and Vos have highlighted regarding CoCos,160 while flexibility in the contractual arrangements between banks and investors generally aligns with a philosophy favouring restrained regulation. However, in the Credit Suisse case, the US SEC deemed statutory conversions of AT1 instruments into CET1 instruments as public offerings, requiring additional disclosures and approvals. Importantly, however, the contractual and market-based mechanism proposed in this study does not involve the peremptory expropriation of shares before triggering TLACeligible instruments. Nor does it include any statutory debt-to-equity swap that might be required to ensure equity shares remain available for ownership and governance if TLAC-eligible liabilities consist solely of write-offs. Both actions—expropriation and debt-to-equity swaps—would necessitate official intervention by public authorities, which is not contemplated in the proposal of this study. Ensuring at least equal treatment of TLAC-eligible liabilities and CET1 instruments in the event of a trigger can thus only be achieved by opting for a CoCo design rather than a write-off approach. The CoCo design offers distinct advantages over writeoffs. While this study finds no normative principle prohibiting the subordination of TLAC-eligible liabilities to CET1 instruments, CoCos provide reduced litigation risk due to their higher perceived fairness in the ranking structure, lower losses, and potential upside opportunities for investors. Additionally, CoCos enhance market discipline by engaging shareholders during issuance and enabling governance changes upon triggering, as new shareholders entering the ownership structure are likely to advocate for restructuring measures with greater determination. Importantly, the complexity often associated with converting liabilities into equity through statutory debt-to-equity swaps is mitigated by the proposed contractual triggering mechanism, which involves no greater complexity than that of ordinary mandatory convertibles. For these reasons, there is a compelling case for mandating the incorporation of CoCo designs into TLAC frameworks rather than relying on write-off mechanisms. Restrictions onasset encumbrance Collateralised loans and covered bonds provide banks with a cost-effective source of funding and serve as safe assets for investors. However, higher levels of asset encumbrance asymmetrically transfer risks to unsecured creditors, increase the cost of unsecured funding, and heighten banks’ vulnerability during crises.161 The introduction of the bail-in tool and TLAC requirements—as anticipated over a decade ago by the FSB TLAC working group and highlighted in the literature162—has incentivised banks to adjust their funding strategies towards cheaper covered bonds. This trend intensifies during pre-crisis periods, as banks increasingly rely on pledgeable assets to secure funding, a pattern observed in previous crises.163 Moreover, this shift reduces the availability of unencumbered assets that central banks rely on as collateral to manage the risks associated with ELA provisioning.164 However, 159 See Deutsche Bundesbank, ‘Contingent Convertible Bonds: Design, Regulation, Usefulness’ (2018) 70 Monthly Report 60; Stefan Avdjiev and others, ‘CoCo Issuance and Bank Fragility’ (2017) BIS Working Paper 678. 160 Edoardo D. Martino, Casimiro Antonio Nigro, and Tom Vos, in ‘CoCos in Europe: What Is Wrong – and How to Fix It?’ (29 April 2024) European Banking Institute Working Paper Series 169, Amsterdam Law School Research Paper 18/2024, Amsterdam Center for Law & Economics Working Paper 09/2024 < https:// ssrn. com/ abstr act= 48107 61 > . 161 Pierre Berthonnaud and others, ‘Asset Encumbrance in Euro Area Banks: Analysing Trends, Drivers and Prediction Properties for Individual Bank Crises’ (August 2021) ECB Occasional Paper 261/2021 < https:// ssrn. com/ abstr act= 39152 74 > ; Albert BanalEstanol and others, ‘Asset Encumbrance and Bank Risk: Theory and First Evidence from Public Disclosures in Europe’ (25 August 2021) Banco de Espana Working Paper 2131 < https:// ssrn. com/ abstr act= 39112 25 > ; Toni Ahnert and others, ‘Asset Encumbrance, Bank Funding and Financial Fragility’ (2016) Bundesbank Discussion Paper 17/2016 < https:// ssrn. com/ abstr act= 27985 35 > . 162 Peter N Posch, Johannes Luebbers and Joachim Erhardt, ‘BailIn and Asset Encumbrance: Implications for Banks’ Asset Liability Management’ (2017) 18 Journal of Banking Regulation 149– 62 < https:// doi. org/ 10. 1057/ jbr. 2016.4 > . 163 Jorge Antonio Chan-Lau, and Hiroko Oura, ‘Bail-In Power, Depositor Preference, and Asset Encumbrance: The End of Cheap Senior Unsecured Debt? A Structural Pricing Perspective’ (1 March 2016) < https:// ssrn. com/ abstr act= 27859 92 > ; Hiroko Oura and others, ‘Changes in Bank Funding Patterns and Financial Stability Risks’ IMF Global Financial Stability Report (IMF October 2013) < https:// ssrn. com/ abstr act= 23383 07 > . 164 See for example, European Central Bank’s instructions to the national central banks responsible for ELA within the framework of its mandate. Agreement on Emergency Liquidity Assistance (27 September 2024) para 8.1.
390 U.B.Lendermann the increased demand for collateral during crises raises critical questions about how limited unencumbered assets should be allocated—balancing the need to maintain market accessibility and avoid exorbitant refinancing costs against the need to ensure adequate liquidity provision. During the GFC, central banks were compelled to loosen their lending policies to address these challenges,165 a trend repeated during the banking turmoil in spring 2023. For example, under the Bank Term Funding Program introduced by the Federal Reserve on 12 March 2023, certain securities were accepted as collateral at 100 per cent of par value, disregarding their potentially lower true and fair value.166 At the same time, Credit Suisse lacked enough unencumbered assets to meet the collateral requirements for sound ELA provisioning. As a result, an ‘additional emergency liquidity assistance’, or ‘ELA+’, of up to 100 billion CHF thus had to be granted based on a newly introduced emergency law,167 without any state guarantee or collateral. To counteract the trend of increasing asset encumbrance during crises and ensure the prerequisites for ELA provisioning, this study proposes introducing a limit on the pledging of banks’ assets. This approach, previously advocated by IMF staff and academics,168 would transform existing EU reporting obligations169 into a concrete regulatory requirement, extending beyond the high-quality liquid asset buffers currently mandated by the liquidity coverage ratio (LCR). Notably, as LCR buffers are designed to be utilised during periods of stress to cover net liquidity outflows, it is critical that the required stock of unencumbered assets remain available to support central bank interventions at this juncture. The exact requirement for unencumbered assets should at least cover the expected cash outflows under stress conditions for the duration of a restructuring period. Conclusion In the aftermath of the GFC, amid asymmetric information, and varying political influence and regulatory powers, the conditions driving bank regulation reached an equilibrium. G-SIBs and regulators successfully navigated their shared task of addressing the TBTF issue at hand—presenting a credible solution to the public. Subsequently, the newly introduced bail-in became a euphemistic antonym for a public bailout of failing banks. The broad scope for assessment and enormous discretion form a gateway for the time inconsistency of responsible politicians who find themselves trapped in this state, thereby rendering a bail-in conceptually compatible with a bailout—an observation that evidences the presence of cognitive dissonance. It has been shown that TLAC, the complementary term, has led to the issuance of opaque bail-in bonds, marketed as loss-absorbing capacity in a bank resolution to both home and host regulators, while being presented to investors and tax authorities as debt instruments. These bonds can retain funding cost advantages over regulatory capital, even if the implicit state guarantee were curtailed. Hyperbolically, it can be argued that the current bail-in concept effectively serves its intended objectives as long as its activation remains unnecessary. Drawing upon these findings, this study acknowledges the enduring nature of the TBTF dilemma and highlights that the existing regulatory processes do not sufficiently address or alleviate it. In response to this challenge, this study advocates for reducing the authorities’ discretion when activating the additional loss-absorbing mechanism of TLAC. This can be achieved by implementing a mandatory, market-based trigger design, inspired by the contractual approach advocated by the Swiss Commission of Experts in its 2010 Final Report. The primary concern surrounding bank failures lies in the erosion of market confidence, which is revealed through declining stock prices and liquidity shortages. This study recommends incorporating a share price trigger linked to predetermined stock market thresholds that align with these indicators and establishing a liquidity trigger as a condition for ELA provision by central banks. Furthermore, equal ranking should be established for Tier 2 instruments and TLAC-eligible liabilities (other than Tier 1 instruments) to enhance clarity and reduce complexity associated with the fragmented creditor hierarchy. It is suggested that the TLAC terms be amended accordingly, explicitly specifying that the occurrence of a triggering 165 Francois Koulischer and Daan Struyven, ‘Central Bank Liquidity Provision and Collateral Quality (1 September 2014) 49 Journal of Banking and Finance < https:// ssrn. com/ abstr act= 22136 90 > . 166 Board of Governors, Press Release and Term Sheet on the Bank Term Funding Program (Federal Reserve System, 12 March 2023) < https:// www. feder alres er ve. gov/ newse vents/ press relea ses/ monet ary20 23031 2a. htm > . 167 Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans from the Swiss National Bank to Systemically Important Banks of 16 March 2023, as amended by Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans from the Swiss National Bank to Systemically Important Banks Amendment of 19 March 2023, both of which are based on the Swiss Federal Constitution, art 184, para 3 (‘safeguarding the interests of the country’), and art 185, para 3 (‘counter existing or imminent threats of serious disruption to public order or internal or external security’). 168 Hiroko Oura and others, ‘Changes in Bank Funding Patterns and Financial Stability Risks’ IMF Global Financial Stability Report (IMF October 2013) < https:// ssrn. com/ abstr act= 23383 07 > . 169 See Regulation (EU) 575/2013, art 443; EBA/GL/2014/03 (27 June 2014); European Systemic Risk Board Recommendation ESRB/2012/2 (20 December 2012) OJ C 119, 25.4.2013, 1 on the funding of credit institutions.
391Automated bail-in: eliminating regulatory restraints event should not be construed as a default event. Introducing this provision would remove the artificial distinction between goingand gone-concern capital, which proves ineffective for banks that cannot be resolved in an orderly manner. This approach ensures that TLAC effectively contributes to financing resolution, while providing central banks with the necessary confidence to offer ELA. Ultimately, these measures aim to restore market discipline and safeguard the stability of the financial system. Acknowledgements The author thanks Corinne Zellweger-Gutknecht, Wolf-Georg Ringe and Heinrich Nemeczek for their valuable feedback. This research benefited from discussions at the 6th Conference on Law and Macroeconomics at Tulane Law School (2–3 November 2023) and the Sydney Banking and Financial Stability Conference (8–9 December 2023). Special thanks are extended toAnna Gelpern, Eduardo Martino, Geordie Reid, Albert Choi, Jeffery Zhang, Richard Senner, and other participantsof these events for their thoughtful comments and suggestions. Finalised on 31 December 2024, this paper reflects information available as of that date. The views expressed in this articleare solely those of the author and donot necessarily reflect thoseof the Deutsche Bundesbank or its staff. Funding Open Access funding enabled and organized by Projekt DEAL. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the material. If material is not included in the article’s Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http://creativecommons. org/licenses/by/4.0/. Publisher's Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Urs B. Lendermann is a Professor of European Banking and Business Law at the Deutsche Bundesbank University of Applied Sciences since 2014. Previously, he served as a senior specialist in banking regulation at Swiss Financial Market Supervisory Authority FINMA, working on Basel III reforms and the FSB’s Key Attributes of Effective Resolution Regimes. A certified German lawyer with a doctorate from the University of Zürich, his research encompasses financial stability, capital markets, and banking regulation.