On Feb. 28, the ECB determined that Sberbank Europe AG (unrated) was failing or likely to fail (FOLTF) owing to a deterioration of its liquidity situation. This was triggered by a loss of depositor confidence after U.S. and EU authorities imposed sanctions on Russian parent PJSC Sberbank.

Put to the test, the European crisis management framework has functioned as intended and met its primary objective: handling the failed bank with no recourse to taxpayers' money and without jeopardizing financial stability. Deposit guarantee schemes (DGSs) in Austria, Hungary, and the Czech Republic will be exposed to potential shortfalls, but we expect them to be modest or even zero since these subsidiaries failed due to illiquidity--not bad quality assets.

The diverging resolution decisions taken on the group's subsidiaries demonstrate once again that banking groups may be international when a going concern but become national when nonviable. The differing outcomes for Sberbank Europe's subsidiaries (see table 1) need to be seen in their own national context. Still, they show that the European framework leaves considerable room for authorities to take pragmatic decisions, thereby somewhat limiting investors' ability to predict outcomes when banks fail. However, this should be partly addressed by upcoming revisions to the crisis management framework in the EU.

Sberbank Europe Failed Due To A Deposit Run, With Varying Outcomes For Its Subsidiaries

Before its failure, the Sberbank Europe subgroup (wholly owned by PJSC Sberbank) was operating in eight European jurisdictions. Beyond the Austrian parent and its German branch, it had four subsidiaries in EU countries (Croatia, Slovenia, Hungary, and Czech Republic) and three in non-EU countries (Bosnia/Herzegovina and Serbia – see chart 1). As of end-2020, the subgroup's total consolidated assets amounted to a moderate €13 billion, with its EU subsidiaries representing the bulk of these (see table 1). Despite its relatively small size, the subgroup was considered significant due to its important crossborder activities and therefore supervised on a consolidated basis by the European Central Bank (ECB).

Chart 1

Reliable details have not yet emerged about the magnitude of the liquidity run to which the bank was subject in the days leading to its failure. Before its failure, the bank was mainly funded via deposits raised in local markets – direct funding from the Russian parent bank was negligible in size. As of end-2020 (the latest available financial report), it had a loan-to-deposit ratio of 82% at consolidated level, and it held nearly €3 billion of cash liquidity against a consolidated deposit book of about €10 billion.

What makes this failure unusual is that the loss of depositor confidence was not related to (perceived) issues with the quality of the bank's assets, but rather to the reputational risks regarding its foreign parent. Despite its apparently solid funding and liquidity starting point, the bank was declared FOLTF within days of the outbreak of the military conflict between Russia and Ukraine and the imposition of sanctions on the Russian parent.

Upon the banking supervisors' declaration that Sberbank Europe and its subsidiaries were FOLTF, the EU's Single Resolution Board (SRB) and the resolution authorities outside the Banking Union enforced a moratorium, suspending payments for two days. They used that time to consider separately the fate of each subsidiary, taking into account the potential direct and indirect impacts on each national banking market.

Overall, Sberbank Europe held modest or negligible asset market shares in each of the EU banking markets where it operated (see table 1). Despite that, the SRB found that it was in the public interest to resolve the Slovenian and Croatian subsidiaries, though not the Austrian entity. The Serbian and Bosnian authorities (operating under resolution frameworks similar to the EU one) also opted for resolution. The Hungarian and Czech authorities, on the other hand, reached opposite conclusions for their subsidiaries, although they had similar market shares in their respective jurisdictions (around 1%).

For the two subsidiaries that it put through resolution, the SRB opted to use the sale of business tool, transferring all shares in the entities to local banks. This ensured the continuity of services for the banks' customers (assets and liabilities are assumed by the receiving banks) and means that any potential future losses would be borne by the acquirer. The Serbian and Bosnian authorities also opted for sales of business to local players. Other EU entities of the group will now be liquidated.

Table 1

Authorities Took Pragmatic Actions – Although Not Always Consistent And Predictable For Investors

The failure of Sberbank Europe offered a new test for the European resolution framework, after previous failures that included ABLV Bank and PNB Banka in Latvia, Veneto Banca and Banca Popolare di Vicenza in Italy, and Banco Popular in Spain. We believe that the framework functioned as intended. Supervisors and resolution authorities inside and outside the Banking Union delivered well-coordinated action, the failed entities were handled with no recourse to taxpayers' money and without jeopardizing broader financial stability, and insured depositors will not lose out.

For investors, the divergent outcomes for the various Sberbank Europe subgroups points to a flexibility that can feel unpredictable. Understanding the determinants and the timing of resolution decisions by authorities is key to assess default and recovery prospects when they invest in European bank obligations. As we said in the past, each regulatory decision is specific to its circumstances, the resolution framework is no straitjacket, and authorities will navigate the rules pragmatically to achieve their objectives.

In many respects, we believe that the management of Sberbank Europe's failure largely confirms many of our longstanding observations about the operationalization of the bank resolution framework in Europe:

• A bank can be declared failing while still being technically solvent. FOLTF determinations by regulators broadly fall within three categories: capital shortfall/insolvency, liquidity squeeze, and/or material deficiencies in risk management. Any of these deficiencies is sufficient for a bank to be considered as failing.
• European authorities have discretion about the timing the FOLTF determination. Although we do not have the details about the deposit outflows to which Sberbank Europe was subject, we understand that the ECB stepped up as liquidity stress mounted but before the bank effectively missed a payment and the buffers were exhausted. This would have helped to preserve value in the subsidiaries.
• Banks can operate as groups in life but are treated as national legal entities in death. Therefore, the divergent treatment of each subsidiary is not a surprise when different authorities are involved and each reviews the impact of failure on each local market separately.
• National factors still matter despite the common EU resolution framework. Authorities may take different views or interpretations about key aspects, such as the FOLTF determination or the public interest assessment (which opens the door to the use of resolution tools). Even within the Banking Union where the SRB is directly responsible, we see that the failure of banks with as little as 1% domestic market share can be considered as posing a financial stability risk, thereby triggering a resolution.
• If a reliable buyer is ready and willing to acquire the shares of the failed institution, the authorities are likely to opt for that solution, and to do that first they need to determine that there is a public interest to put the bank into resolution.

We see regulatory pragmatism in this case resulting in the divergent outcomes for the EU subsidiaries. The Slovenian entity held a somewhat bigger market share in its local market and, according to the resolution authority, performed a critical function (lending to small and midsize enterprises). It is therefore less surprising that resolution tools were used.

But we see the outcomes for the other subsidiaries as more interesting. For example, the Croatian, Hungarian, and Czech subsidiaries held relatively similar (and very small) market shares. Therefore, it is difficult to argue that these subsidiaries posed materially different risks to financial stability in their local markets, justifying different public interest assessments. We rather believe that the decision to opt for a resolution of the Croatian subsidiary as opposed to liquidation was largely driven by the availability of a local player ready and willing to receive the business of the failed subsidiary. This was likely not the case for the Hungarian and Czech subsidiaries, for example. And to gain the power to effect the sale of business, the Croatian authorities found it in the public interest to open a resolution, arguing financial stability concerns.

We believe that such pragmatism is unavoidable in the management of bank failures, and somewhat necessitated by the current construction of the crisis management framework (see for example, our previous observations on similarly variable decisions on failed banks in Europe in "The Resolution Story For Europe's Banks: More Flexibility For Now, More Resilience Eventually," published on RatingsDirect on Sept. 28, 2020). However, this variability clouds the consistency of resolution decisions and outcomes.

The Update To The Crisis Management Framework Should Enhance Consistency

The ongoing review of the EU crisis management and deposit insurance framework, due later in 2022, is likely to address some of the many complexities and obstacles in the current framework (see "The Resolution Story For Europe's Banks: More Resolvability, Consistency, Credibility," Sept. 30, 2021.) Notably, we expect it to deliver a partial improvement in the consistency of resolution actions.

Of specific relevance to the Sberbank Europe case, one of the main outcomes is likely to be a change that allows resolution authorities to undertake U.S. Federal Deposit Insurance Corp.-style purchase and assumption transactions (selling books of assets and liabilities to other banks), aided where necessary by funding from DGSs. This tool would be available when any bank fails, not only for those theoretically more systemic banks that are seen to pass the public interest assessment. The use of resolution tools, such as bail-in, would therefore be reserved for the banks that undertake critical functions and pose a serious risk to financial stability. A related important aspect would be the harmonization of the national insolvency frameworks which are applicable in case of liquidation.

In the case of Sberbank Europe, the risk of losses for DGSs in Austria, Hungary, and the Czech Republic is likely to be small or even zero since these subsidiaries failed due to illiquidity--not bad quality assets. In other words, once the subsidiaries' assets are monetized through liquidation proceedings, the schemes might receive a full payout. This likely positive outcome for the respective DGSs must have facilitated the authorities' decisions to put the respective entities into liquidation. This is especially the case for the Austrian DGS, which also covers deposits placed in the German branch and which following some recent bank liquidations appears to have financial resources below the target of 0.8% of covered deposits.

In a less benign case where national deposit schemes would have faced material losses, resolution authorities would have been confronted with tougher decisions. In theory, the much-discussed but never-delivered creation of a pan-European deposit guarantee scheme (EDIS) would address this problem by spreading the burden of such failures across more banks. It would also support greater confidence in crossborder deposit-taking in the EU, particularly for banks domiciled in smaller markets. As the failure of the Icelandic banks showed in 2008, when a bank with lots of branches outside its domicile fails, a small national DGS can struggle to absorb the weight of the losses. However, given the lack of progress on related topics such as the bank-sovereign doom loop, we remain gloomy about the prospects that policymakers will break the political deadlock over this third pillar of the Banking Union.

Related Research

• The Resolution Story For Europe's Banks: More Resolvability, Consistency, Credibility, Sept. 30, 2021
• Europe's Middle Ranking Banks Face A Peculiar Resolvability Conundrum, Dec. 3, 2020
• Bulletin: Extending Depositor Preference To All Depositors Would Not Trigger Rating Changes On Spanish Banks, Nov. 25, 2020
• The Resolution Story For Europe's Banks: More Flexibility For Now, More Resilience Eventually, Sept. 28, 2020
• Gone But Not Forgotten: Orderly Failure Of Latvia's ABLV Bank Leaves Ripples Of Discontent, Feb. 27, 2018
• Italian Bailouts Show EU Authorities Walk A Tightrope While Banks Transition Toward Bail-ins, July, 4, 2017
• Eurozone Bank Resolution Framework Passes The Banco Popular Test, To A Point, June 19, 2017