The issue is that the Bank of England has found wording in the details of the EU’s Bank Recovery and Resolution Directive (the bank bail-in plans) which could prohibit governments from protecting central banks against losses when they provide emergency lending to banks in a crisis. Quite a surprising find given that the final text has just been passed (the error was found with only weeks to spare).
This is the Emergency Liquidity Assistance (ELA), which we have covered here and here. As a recap, this is the lending which a central bank takes on in a crisis and offers to banks at less favourable rates if they have no other choice to avoid a liquidity crisis. As might be expected it was used heavily by the UK and many eurozone countries during the crisis.
Essentially, the concern is that it could expose the BoE to greater risk since it will not have the backing of the UK treasury when extending liquidity assistance, which is risky and can be very large when a financial sector the size of the UK’s is in crisis.
In fact the story now seems to have run through its full lifecycle:
- The BoE located the problem and alerted the European Parliament (EP) and other member states, while requesting to reopen the text of the legislation to amend the wording.
- The EP accepted and even published a revised text to take account of the concerns - see article 27 (2).
- In the end, however, the move was formally vetoed by the Netherlands, Finland and the Czech Republic due to concerns that reopening the text would lead to a raft of other demands, notably by France, Italy, Sweden and Portugal who were seeking further assurances that they could issue guarantees for bank bonds without requiring bank bail-ins first.
However, this episode also speaks volumes about how EU rules are decided and assessed - and, in this instances, doesn't necessarily reflect well on the Treasury and the BoE:
- That the deal isn't now re-opened despite an obvious flaw in the legislation is symptomatic of EU law - the constant fear of reopening deals or reassessing them due to uncertainty over what countries might begin to demand. This too often used as an argument against reform, when in fact it should be one in favour of reform. It highlights the need for a broader overhaul of the legislative approach and the need for a clearer structure and mechanism to reassess legislation. All too often this fear paralyses the process of improving or changing the EU.
- That said, looking at the revised EP text, there do seem to be a huge amount of changes (the text in bold and italics). This seems to highlight some severe concerns with the original agreement and again brings home concerns over the level of uncertainty - what is a precautionary recapitalisation? - that continues to dog the agreement.
- The alliances that built up on this issue are also interesting and somewhat unusual. The UK had the support of the European Parliament and even France and Italy, although they seemingly wanted to reopen the text for other reasons. However, Netherlands and the Czech Republic were firmly against, while Germany was very hesitant. The UK should take comfort in this. On this particular issue, the divide wasn't eurozone versus non-eurozone - that potential divide remains one of the biggest liabilities in the UK-EU relations, particularly in financial services.
Credit to the Bank of England for at least detecting it. Better late than never (well, sort of, in this case).