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By Bloomberg

German lawmakers are set to discuss a bill on Friday that puts senior creditors in line for losses when banks fail and could serve as a model for other European countries seeking ways to avoid taxpayer-funded bank rescues.

After the European debt crisis turned German taxpayers into bailout masters, the country is trying to make sure more parties are on the hook for losses at failing institutions. The bill is intended to facilitate the implementation of European Union resolution law, which requires creditors to bear losses equivalent to 8 percent of a bank’s liabilities, including senior debt if necessary, before rescue funds can be tapped.

The bill has run into opposition from insurance companies, which say it violates their property rights. German insurers own about 84 billion euros ($94 billion) of senior unsecured bonds issued by the country’s banks, according to industry group GDV. The draft law infringes on creditors’ rights because it would apply retroactively to outstanding securities, the GDV said, arguing that the bill should only target new issues.

“The planned legal subordination interferes with the constitutionally guaranteed property rights of creditors who own senior unsecured bonds and is extremely problematic in terms of protecting trust,” according to the GDV’s comments to lawmakers. The draft law was published on April 30.

Manfred Zoellmer, the lead lawmaker on the file in the Bundestag, Germany’s lower house of parliament, said the insurers’s concerns need to be studied. German insurers are the biggest creditors of the country’s banks with 574 billion euros of claims, and senior unsecured bank bonds amount to 6 percent of their total financial investments, according to the GDV.

‘Serious Concerns’

“We’re going to review closely what the consequences of this subordination are and whether it’s a sensible measure,” Zoellmer said in an interview. “There are comments from the insurance industry that raise serious concerns.”

The bill amends the order in which creditors are served when a bank becomes insolvent. It subordinates senior unsecured bonds, Schuldschein loans -- promissory notes issued privately under German law -- and registered bonds to other senior liabilities such as unsecured deposits and derivatives, clearing the way for writedowns in a crisis.

The legislation would bring Germany’s insolvency code into line with the EU’s Bank Recovery and Resolution Directive, under which the bail-in of creditors mustn’t leave them worse off than they would have been in an insolvency. It could also help European banks to meet requirements for TLAC, or total loss- absorbing capacity, currently under discussion at the Financial Stability Board.

FSB Rule

The FSB, which brings together regulators from the Group of 20 nations, has proposed the world’s 30 biggest banks have loss- absorbing liabilities equivalent to as much as a fifth of their assets weighted for risk.

European banks have warned that they have the largest gap to fill to meet those criteria, and the German law could help address that by making a large chunk of existing debt eligible, according to Koos Timmermans, the vice chairman of ING Groep NV’s banking unit.

“The German proposal is an answer to TLAC,” Timmermans said in an interview. “The Germans are solving, by law, the challenge of how to make debt TLAC eligible, they are saying that the bail-in will happen,” he said, adding that the approach “makes TLAC less costly for banks.”

The government has justified the retroactivity of the law criticized by insurers with the public’s interest in financial stability and in ending taxpayer-funded bailouts.

It has responded to lobbying on the law before. The first draft, released by the Finance Ministry in March, didn’t subordinate Schuldschein loans and registered bonds. Bringing them into line for losses was a suggestion made by the lobby groups for savings and cooperative banks, which rely more heavily on those instruments for their own borrowing, while they are significant owners of the bonds of other banks.

Bond Holdings

Since an initial draft of the bill was published on March 10, investors have ratcheted up their estimation of the extra risk the measure implies for their bond holdings.

While the yield premium demanded to hold senior notes of German lenders rather than government debt has decreased by 5 basis points to 72 basis points, or 0.72 percentage point, that’s the smallest decline among bonds of euro-area banks in Bank of America Merrill Lynch’s Euro Senior Banking Index and compares with an average tightening of 15.6 basis points for peers in the period.