Banks to Face Tough Loss-Absorbing Requirement, EU's Koenig Says

  • New bank-failure agency to demand more than global minimum
  • Standard for most banks seen at 8% of total assets or more

The euro area’s largest banks probably will need to build up more loss-absorbing capacity under European Union rules than is required under a global standard intended to prevent taxpayer bailouts, Single Resolution Board President Elke Koenig said.

One of the main jobs of Koenig’s fledgling agency, which takes up full powers Jan. 1, is to determine the level of capital and bonds EU banks must have available to be wiped out or converted into equity if the bank gets into trouble, she said in an interview in her Brussels office. While work on the so-called MREL standard isn’t finished yet, Koenig said requirements may exceed what’s needed under a minimum standard set for the world’s biggest banks.

“You have to make sure that MREL is set in an adequate fashion to make the bank resolvable,” Koenig said. For many banks, that will be a baseline of 8 percent of total assets, because that’s the amount of “bail in” required by the EU’s Bank Recovery and Resolution Directive, she said. For the euro area’s most interconnected banks, the requirement could be far higher.

Regulators worldwide have taken measures to prevent taxpayers from being on the hook again when banks fail. The EU’s MREL is a minimum requirement for own funds and eligible liabilities for all banks, while the Financial Stability Board, the global regulator led by BoE Governor Mark Carney, demands minimum total loss-absorbing capacity, or TLAC, from the world’s top 30 lenders.

Similar Ideas

The idea behind TLAC and MREL is similar -- to create a cushion of securities whose owners know they face loss or conversion on failure. Yet the definitions are different. TLAC applies to the world’s biggest banks, and it needs to be at least at 16 percent of risk-weighted assets from 2019, and 18 percent from 2022.

On the other hand, resolution authorities will set MREL bank by bank. Koenig’s agency will primarily deal with the 120 or so banks considered systemic enough to qualify for direct European Central Bank supervision, along with other banks that do cross-border business. The SRB expects to make its MREL plans public next month, after it’s had a chance to meet with the industry.

The 8 percent requirement in the EU’s resolution rulebook means the biggest banks will have to have more capacity in place than they need under TLAC. “On nine out of 10 occasions” the MREL requirement will be higher, because 8 percent of a bank’s total balance sheet is roughly equivalent to 24 percent on a risk-weighted basis, Koenig said.

‘Question of Complexity’

“The question of ‘far above’ 8 percent is in particular a question of the complexity of the organization,” Koenig said. “Don’t focus entirely on the size of the organization, focus more on how complex is it, how much cross-border activity do you have in whatever jurisdiction.”

For many smaller and less connected banks, MREL could use a baseline of 8 percent of total assets, because that’s the amount of “bail in” required by the EU’s Bank Recovery and Resolution Directive, she said. For the most interconnected banks, the requirement could be far higher.

In the U.K., which is outside the SRB’s realm but also covered by the MREL standard, the Bank of England estimated the biggest banks would need to issue 26 billion pounds ($39 billion) of new securities to meet the standard.

The EU resolution agency also will look at the composition of bank balance sheets to gauge whether they meet requirements. This means examining whether enough loss-absorbing securities are subordinated to make sure there’s a clear hierarchy of creditor writedowns, Koenig said.

“MREL needs to be intelligently disclosed, and when I say intelligently disclosed, it means any creditor needs to know where in the hierarchy is his or her instrument,” Koenig said. “I would not bet my fortune on whether every deeply subordinated creditor knows that he’s deeply subordinated.”

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