Bank resolution EU style 16 March 2015 4:46PM Philip Bayley A potential legal dispute over the resolution of an Austrian bank could provide the test case for how well the European Union's Bank Recovery and Resolution Directive, which came into effect at the beginning of the year, will work in practice. At the start of this month Austria's banking regulator, Finanzmarktagentur (FMA), informed senior creditors of Hypo Alpe-Adria Bank International AG, who were owed some €11 billion, that it had declared a moratorium on payments on the monies owed until May 2016. The bank, which found itself in financial strife in 2008, has already cost Austrian taxpayers €5.55 billion to resolve, to the point where Heta Asset Resolution AG (the 'bad bank') was set up last year to manage the remaining assets, valued at €18 billion at the time. A recent review of the remaining assets identified a capital shortfall of as much as €7.6 billion in the bad bank. The Austrian Finance Ministry has refused to put more taxpayer funds into the resolution of the bank and the FMA must find a way to resolve the bank without any additional costs to taxpayers. This has raised fears among Heta's senior creditors and bank creditors generally, that Heta will become the first bank to be resolved under the EU's Bank Recovery and Resolution Directive.Provisions of the directive that cover the bail-in of creditors and which must be in effect by 1 January 2016 at the latest, were implemented in Austria in February. The Austrian government's action, which raises questions about retrospectivity, will no doubt trigger sizeable lawsuits from creditors bailed-in to rescue the bad bank or who otherwise feel they have suffered unjustified losses. Heta Asset Resolution AG could provide the test case for how well the EU's Bank Recovery and Resolution Directive will actually work in practice. It would be a good test case from the point of view that Hypo Alpe-Adria -Bank International AG (and its successor, Heta Asset Resolution AG) was a relatively insignificant bank that was not systemically important outside of Austria. It got itself into trouble providing consumer finance in Eastern Europe backed by guarantees from the regional government of its Austrian home base. Nevertheless, failure to resolve Heta will point to massive problems should a systemically important bank in Europe find itself in difficulty. It will also validate the concerns of other bank regulators unconvinced that statutory bail-in of creditors is a useful tool for resolving failing banks. The Australian Prudential Regulation Authority has said that a statutory bail-in is attractive because it provides a means to transfer the risk of a bank failure away from the public sector to the bank's creditors.However, it carries costs and risks and therefore APRA does not advocate any particular framework for loss absorption and recapitalisation of a failing bank. The nuances of different approaches are not yet well understood. Similarly, the Reserve Bank has cautioned that bailing in unsecured senior creditors could reduce the fiscal cost of a systemically important bank's resolution but carries the risks of deepening the institution's financial distress and spurring contagion to the broader financial system. The RBA recommends that the design and use of bail-in policy options be approached cautiously.