Europe wants to make it easier to wind down medium-sized banks

European officials have been working on the issue for years, yet their efforts are more in focus after a rapid rise in interest rates sparked the collapse of several smaller banks in the US.

The European Union wants to make it easier to wind down medium-sized banks that fail by tapping national deposit guarantee systems for funding, according to people familiar with the matter.

In a proposal due around mid-April, the European Commission would faciliate using these funds to bridge gaps at banks that don’t have sufficient reserves and avoid tapping uninsured depositors, said the people, who asked not to be named because the plan isn’t yet public. The option would be limited to banks that will leave the market, the people added.

Europe came up with new rules for failing banks to avoid a repeat of the taxpayer-funded bailouts that followed the 2008 financial crisis.

Yet the strict bail-in framework — where non-insured depositors with more than €100,000 ($108,740) in holdings may be forced to bear some of the losses — has not worked well in practice. Bigger lenders can easily issue stock or bonds but the system doesn’t sufficiently address the risk posed by small or medium-sized banks.

European officials have been working on the issue for years, yet their efforts are more in focus after a rapid rise in interest rates sparked the collapse of several smaller banks in the US. While those were special cases, investors are questioning whether individual lenders in Europe could face similar fallout.

The deposit guarantee funds would be used at banks that don’t have enough equity and bonds to wipe out. Those losses have to reach 8% of a lender’s liabilities before the industry-financed Single Resolution Fund can be used. Yet many smaller lenders have struggled to close the gap to their requirements given how costly it is to raise their own buffers to be used. Discussions are still ongoing and the final proposal could vary ahead of the publication date, expected for April 18, the people said.

In a nod to hawkish countries such as Germany, using the deposit guarantee systems would be subject to strict conditions. They would only be intended to preserve the value of the failing bank’s assets before they are transferred to a new entity, according to the people.

The European Commission declined to comment.

Last June, euro-area finance ministers agreed to harmonize the use of national deposit guarantee funds outside payout to guaranteed depositors up to €100,000, “ensuring appropriate flexibility for facilitating market exit of failing banks in a manner that preserves the value of the bank’s assets.”

The Single Resolution Board, a EU body, had proposed facilitating the use of deposit guarantee schemes so that small and medium-sized banks could access funds in resolution and bridge the gap until the use of the Single Resolution Fund is possible.