What Happens When a Bank Fails or Is Likely to Fail?

Due to a sudden disruption in liquidity, the European Central Bank (ECB), which directly supervises Sberbank Europe based in Austria and its subsidiaries in Slovenia and Croatia, announced today that Sberbank d.d. is failing or is likely to fail. The ECB is responsible for such an assessment as the direct supervisor, and since the establishment of the EU banking union in 2014, the ECB has determined that five banks are failing or are likely to fail – one in Spain, two in Italy, one in Latvia, and one in Luxembourg – and one today.

As financial analyst Hrvoje Serdarušić explains, this means that it is assessed that in the near future, that bank will likely not be able to meet its debts or other obligations as they come due. The next step is for the Single Resolution Board (SRB) to confirm the ECB’s assessment and then make a decision on any subsequent steps and their implementation.

– This board will first assess whether there are alternative rescue measures that can be implemented within a reasonable timeframe. These include, for example, acquisition by another bank or recapitalization. If that is not possible, then it is assessed whether the resolution of the bank is in the public interest. If it is not, which usually happens with small or specialized banks, then bankruptcy proceedings are conducted under national legislation. If the resolution of the bank is in the public interest, then some form of resolution action is taken. For example, part of the business may be sold, or a ‘good’ and ‘bad’ bank may be created to retain the healthy tissue – explains Serdarušić.

– As the Russian Federation, which has a majority ownership of Sberbank Europe AG, has been subjected to severe international sanctions, depositors have rushed to the bank for their deposits. This is a classic example of bank run – says Serdarušić, but notes that depositors in Sberbank can be assured that they will receive the insured portion of their deposits up to the equivalent of 100,000 euros.

– Those who have loans should definitely continue to repay their debts. In a scenario where part of the business is purchased by another bank, those who do not repay their debts regularly could find themselves in trouble. For the general public without large deposits, everything remains the same for the time being – says Serdarušić, concluding that 'the lifeblood of the financial system must function despite the sad war'.

As a banking supervisor, the ECB closely monitors how individual banks are coping with the risks they face. Supervisors discuss possible weaknesses with banks and outline their expectations regarding actions that should be taken. The ECB also uses its supervisory powers to ensure banks comply with regulatory requirements. However, supervisors cannot and should not attempt to prevent the failure of every bank. The possibility of failure is inherent in every type of business and is a key element of a well-functioning market economy.

The EU banking union has significantly improved the handling of banks that are deemed to be failing or likely to fail, and they are also working on improvements to further strengthen the European banking framework.