Almost a week after we reported that Eurozone finance ministers will gather in Luxembourg to draw up new rules for the bank bailout, they have finally zeroed in on new rules. Early Thursday, they said that the bank’s creditors and shareholders will take the first and biggest hit when a bank collapses. The new system specifies that the next group of people to incur losses will be uninsured depositors who have above 100,000 euros in bank deposits. Taxpayers will be last to take the hit.


‘Bail In’, Not ‘Bail Out’

Irish finance minister Michael Noonan, who headed the meeting, said that it’s a revolutionary change in the European banking system. Sovereigns will no longer have to make it up when a bank gets into trouble. The fresh approach of “bailing in” instead of “bailing out” will ensure that the Eurozone doesn’t get into the same kind of trouble it has witnessed over the past few years. The crises in Ireland and Cyprus threatened to destroy the single currency. Now the assets of the troubled bank itself will be liquified to solve the problem, says James Kanter of the The New York Times.

The draft bill is yet to be approved by the European Parliament before it becomes a law for 27 countries in Eurozone. Mr. Noonan expects the rule to be in full force by 2018. Depositors holding less than 100,000 euros will be fully protected. The agreement also curbed the belief that European economy has become unmanageable. ECB Governing Council member Ewald Nowotny praised the deal. He said the move will help restore faith in European banking system. Eurozone plans to add Croatia as its 28th member state.

Eurozone to Prevent Doom Loop

Citigroup said in a research note that the deal also requires each member state to set up a resolution fund within 10 years that will be equal to at least 0.8 percent of all insured deposits. Share holders and bondholders of the troubled bank will suffer a loss of at least 8 percent of the total liabilities. Only then banks can tap the resolution fund. The 8 percent threshold is aimed at reducing the vicious link between the struggling banks and their sovereigns.

There will be an extra hurdle as well. Eurozone finance ministers said that the failing bank can receive direct help from European Stability Mechanism, the respective sovereign will have to finance the bank and bring its common equity Tier 1 ratio above 4.5 percent.

The latest rules will avoid the doom loop, where the sovereign takes the country deeper into debt to rescue economically important banks.