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EU seeks to shield taxpayers from bank failures

By Don Melvin

Associated Press

Published: Wednesday, June 6 2012 9:38 a.m. MDT

European Commissioner for Internal Market and Services Michel Barnier addresses the media on a new framework for bank recovery and resolution, at the European Commission headquarters in Brussels, Wednesday, June 6, 2012.

Yves Logghe, Associated Press

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BRUSSELS — European officials proposed Wednesday a new system of financial regulations that aims to keep bank failures from costing taxpayers billions and bankrupting governments.

Because many European governments are already overburdened with debts, rescuing their failed banks risks bankrupting some of them. Ireland has had to ask for an international bailout for that reason and investors fear Spain may be next.

The banks, in turn, own huge amounts of their governments' bonds, which drop in value when investors lose confidence in the country's financial future. The result is that any fall in confidence in either the banks or the government tends to create a downward spiral requiring foreign financial aid.

Under the European Commission's proposal, banks that posed no systemic risk to the stability of financial markets would simply be allowed to fail. Those whose failure did threaten to become unmanageable would be propped up in part by having unsecured creditors of the bank, such as bondholders and shareholders, take losses rather than having governments give them taxpayer money.

"We're going to break the link between banking crises and public budgets," said Michel Barnier, the European commissioner responsible for the internal market, as he outlined the measures in Brussels. "We don't want taxpayers to have to pay."

If he ever achieves that, however, it will be too late to alleviate the current banking crisis afflicting Europe and one of its biggest economies, Spain, where banks are sitting on huge losses that the government cannot afford to plug. The Spanish government's borrowing rates are at painfully high levels around 6.25 percent on fears it will go bankrupt saving the banks.

The Commission's complex proposal is not scheduled to take effect fully until 2018. In any event, it also needs the approval of the European Council, composed of the leaders of the 27 EU countries, and the European Parliament, and may be significantly altered in the process of gaining approval.

At the moment in Europe there is no central regulator with the power to step in and force weak banks to ask investors for more capital to strengthen finances, or to break them apart and restructure them. There is also no central deposit insurance backstop, making it more likely that a bank failure would exhaust one country's fund to compensate depositors.

In the United States, the Federal Deposit Insurance Corp., like other bank regulatory agencies, sends examiners to banks and assesses their health. Even before a struggling bank is closed, FDIC staff often seek buyers — stronger banks or private investor groups — for its deposits and loans.

Depositors' money isn't at risk. The FDIC guarantees deposits up to $250,000 per account, and no holder of an insured account has lost a penny since the insurance fund was created in 1934.

The FDIC itself doesn't close banks. That decision is made by the state banking regulator, the U.S. Office of the Comptroller of the Currency or the Office of Thrift Supervision, depending on what the bank or thrift's charter. Once an institution is shut down, the FDIC is appointed receiver and takes over the process of selling its deposits, loans and other assets, sometimes keeping a portion of the assets to be sold later.

Barnier was at pains to emphasize that he had been working on the proposals for years, and they were not a response to the banking crisis in Spain or other recent bank bailouts.

While Barnier said the new rules are necessary because so many banks operate across borders, he did not propose setting up a powerful central banking authority, as the Commission had suggested a weak earlier.

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