THE European Union's executive has proposed a blueprint that could force those who lend to banks to bear big losses should they fail.
The proposal, which could become law by 2013, would end the privileged position of these creditors, who were left untouched when the banks they lent to failed, while shareholders, taxpayers and governments bore the impact.
It will heap further regulatory pressure on banks, driving up their costs of borrowing, as they face a series of other reforms such as requirements they set aside more capital for an emergency and curbs on cash bonuses to star performers.
Worried about the mounting bill for rescuing the financial sector as well as Europe's debt-laden countries, political leaders are also turning their attention to bank creditors and bond owners – mainly institutional investors such as insurers and pension funds.
In draft rules, the European Commission proposes new power for authorities to force top-ranking creditors, such as bond owners or a bank that has lent money to another bank, to take losses if the institution they lend to comes to the brink of collapse.
Those lenders that receive security against their loan, however, will not be caught by the new regime.
"We must put in place a system which ensures Europe is well prepared to deal with bank failures – without taxpayers being called on again to pay the costs," said Michel Barnier, the top European official in charge of financial reform.
The move, welcomed by financial experts, will be resisted by industry because it will make it more expensive and difficult for banks to borrow as lenders factor in the higher risk that they will not get their money back.
Others indicated that it could hamper efforts by banks to repair their balance sheets by selling loan portfolios secured by withered assets such as property.
EU officials, seeking to calm investors, promised "no surprises" in the new rules that will be phased in up to 2015 or beyond although they conceded that they could apply to existing bank loans should those deals be renewed in the coming years.
City A.M. Reporter