Bank Bail-In Clash in Sweden Shows Chaos Investors Must Navigate

  • Swedish FSA disagrees with debt office on how to design MREL
  • FSA’s head of banking says MREL debt requirement is too big

One of the world’s most activist countries in bank regulation is split over how to design a new framework for handling failures, with the supervisory authority warning of unintended consequences that risk undermining financial stability.

The disagreement centers on MREL -- or the minimum requirement for own funds and eligible liabilities -- with which all European Union banks must comply. It’s a layer of capital designed to absorb losses so that simple transactions like deposit taking and paycheck transfers can continue even if a bank collapses. For lenders deemed too big to fail, there’s supposed to be enough capital left for the institution to be rebuilt.

Uldis Cerps
Uldis Cerps
Source: Swedish Financial Supervisory Authority

In Sweden, where regulators are further advanced than many of their counterparts elsewhere in designing MREL, there is still considerable disagreement over how to define the requirement. Sweden’s National Debt Office was named the country’s bank resolution authority and so has been put in charge of implementation.

But the Financial Supervisory Authority says an April proposal by the debt office raises some concerns. Uldis Cerps, head of banking at the FSA in Stockholm, warns that the recommended composition of debt and equity in MREL even risks hurting Sweden’s banking system.

‘Probably Destabilizing’

If adopted, the requirement would be “potentially destabilizing” because it “reduces the resiliency of institutions,” Cerps said in an interview.

The debt office has proposed a minimum pool of own funds and eligible liabilities of 32 percent of risk-weighted assets for banks with a capital requirement of 20 percent. That would apply to all four of Sweden’s biggest banks, including Nordea Bank AB. The office said the split should be two-thirds debt, the rest in equity.

But if the calibration between capital and MREL requirements proves wrong, then it will “increase incentives for risk-taking” while making the risk of “bank failure or of banks’ breaching minimum requirements” more likely, according to Cerps. He warns that both the MREL level and the debt proportion are too high.

Debt Subordination?

A 32 percent requirement is so big that banks would be in danger of finding themselves unable to comply, potentially forcing the FSA to pull their operating licenses. By the same token, the debt requirement may expose banks to market refinancing risks when they’re most vulnerable, he said. That’s why the FSA wants a smaller proportion to be in the form of debt and a lower MREL level overall, supplemented by a buffer that “could be used during times of turbulence,” Cerps said.

“Buffers allow the banks themselves, authorities and investors to deal with issues early and in the most appropriate way, with less disruption and risk,” he said. “By improving flexibility for issuers and by making the resolution trigger more remote, refinancing risks are reduced.”

Meanwhile, there’s also uncertainty as to what kinds of securities might be eligible to put in the debt portion of the MREL requirement. The debt office says it wants at least some of the securities to be subordinated, without specifying how much. That’s unsettled investors and banks, with Nordea, Scandinavia’s biggest bank, saying it’s now exploring the option of issuing Tier 3 debt to comply.

Subordinated debt is a better option than senior debt, but banks and authorities need to tread cautiously, according to Cerps.

“We have to be very focused on the market depth for these instruments,” he said. “There are many investor classes that may not be appropriate owners of these instruments in the future –- other banks, retail investors. We don’t know enough about how the market will evolve, and this means we need to be careful.”

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