In June Banco Popular Espanol (“BPE”) was sold to Santander for €1, with Santander taking over all the assets and senior liabilities of BPE. Crucially BPE depositors with over €100,000 in their accounts were not bailed-in – they did not have the excess converted into “capital-like instruments” in the recovering/resolved bank. The holders of share capital, subordinated and mezzanine debt in BPE (i.e. holders of Tier 1 and Tier 2 capital in the Basel lexicon), on the other hand, had their investments expunged.

At the time the deal was hailed as a triumph of the new EU single supervisory body for the banking sector in enacting a deal in line with the EU Bank Recovery and Resolution Directive, even though:

• BPE had not actually gone “in the tank”, and then recovered and been resolved based on its own resources, as were the Directive’s trigger point and objectives
• BPE passed its European Banking Authority stress tests
• It was compliant with Basel III targets for Tier 1 and Tier 2 capital, for overall leverage, for liquidity below 30 days and for stability of funding for one year

Little attention was paid in June to the important parties spared embarrassment by the deal:

• The Spanish depositor compensation scheme was not called upon to reimburse depositors up to €100,000 each in the sixth largest Spanish bank
• The Eurosystem (the ECB plus all the national central banks) did not have to default its loans to BPE and try to cover them from the collateral BPE had pledged
• Other institutions were not asked to withdraw the BPE collateral they had pledged to the Eurosystem to secure loans, and replace it with collateral of solvent counterparties

In other words the deal avoided a meltdown: the Eurosystem would have been selling off the collateral BPE had pledged, and other institutions would have been selling off BPE bonds, in large amounts and into a market where there is only big buyer: the Eurosystem itself. Prices of bank bonds would have gone into a tailspin, requiring institutions to top up the collateral they had pledged to the Eurosystem or reduce their loans – which they would try to do by selling off further bonds for cash, exacerbating the tailspin.

Now that the backslapping within the Eurosystem has died down along with the sycophantic articles in the financial press, the deal has begun to unravel. The holders of the Tier 1 and Tier 2 capital in BPE have lodged 51 lawsuits against the European authorities, resting on two basic points:

• BPE was not insolvent: the conditions precedent were not met for the EU single supervisory body to intervene and invoke the EU Bank Recovery and Resolution Directive;
• Even if the conditions precedent had been met, the EU single supervisory body should have invoked all parts of the EU Bank Recovery and Resolution Directive, including a bail-in of depositors with more than €100,000 in their accounts, and not used its discretion to expunge certain classes of creditor/shareholder whilst completely sparing others.

These are very strong arguments: the enforcer of the law is bound by its terms just as the enforcee is.

None of the bank rescue deals mounted since the EU Bank Recovery and Resolution Directive was passed have enforced the bail-in of depositors with more than €100,000 in their accounts, because it is regarded as political dynamite.

If it now turns out that the authorities cannot either (i) step in to pre-empt a bank’s collapse; or (ii) line up a deal with a “white knight” like Santander in BPE's case without the deal being successfully challenged in the courts; or (iii) invoke the EU Bank Recovery and Resolution Directive without invoking the bail-in of depositors, then the Directive is unusable in practice.

In that case the EU single supervisory body has no tools in its box and the EU Bank Recovery and Resolution Directive itself is a dead letter.