Blog Post

Developing resilient bail-in capital

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

By: Date: April 29, 2019 Topic: Finance & Financial Regulation

The ECB’s March policy meeting announced not just a delay in the expected interest-rate hikes, but also a new round of bank refinancing operations (the so-called LTRO-III). Additional bank funding was justified by substantial amounts of bank bonds falling due just as the previous round of refinancing operations comes to an end. In addition, as of last year, funding policies of European banks have been geared to comply with two new regulations: requirements for long-term liquidity, and also the increasingly prominent need to raise funds with substantial amounts of bail-inable liabilities.

Raising bail-in capital will loom large for Europe’s smaller banks

Bail-in securities are exposed to a write-down once a bank enters a resolution process, and provide an additional buffer against taxpayer-funded bailouts.

The world’s largest banks (‘G-SIBs’, seven of which are headquartered in the euro area) were already required to issue such securities (known as ‘TLAC’) based on standards set by the Financial Stability Board in 2015. The EU bank resolution directive (‘BRRD’) introduced the equivalent concept of ‘Minimum Requirements for Own Funds and Eligible Liabilities’, or MREL.

TLAC and MREL represented a new concept in international debt markets, and required changes in how domestic law defines creditor hierarchies. Most EU countries created a new category of creditors, forcing banks to issue new instruments or convert outstanding liabilities at a cost. Others, most notably Germany, simply subordinated existing liabilities. The so-called banking package adopted by the European Parliament last week has now unified TLAC and MREL, and tightened the requirement for the issuance of sub-ordinated debt. In the euro area the requirement to raise such funds is now gradually enforced by the Single Resolution Board (SRB).

In aggregate, euro-area banks seem to have made good progress in issuing such instruments. The December inter-agency report on risk reduction found that 14 member states exhibited a shortfall relative to targets in effect at end-2017, though this was only about 2% of the total assets.

Europe’s G-SIBs have comfortably met their interim targets for TLAC in January. G-SIBs have kept their bond issuance roughly steady since the financial crisis, though progressively sold more bail-inable securities, which by now constitute half of the roughly €250 billion annual bond issuance.

But Europe‘s smaller banks seem to confront a greater problem. Analysis by the ECB suggests not only that overall issuance by these banks has halved since 2010, but also that bail-in securities amount to only about 20% of this diminished issuance.

For smaller banks the requirement to raise MREL was only gradually introduced following the adoption of the BRRD in 2015, beginning with the more complex banks. The requirements for sub-ordinated debt under the banking package and a new SRB policy are  likely to further raise the requirements for many banks. Crucially, this SRB policy sets requirements not just at group level but also for individual subsidiaries.

These banks suffer from a long-running profitability problem and will now need to issue more costly securities to a relatively inexperienced investor base.

Investors in bail-in securities should make the financial system more resilient

The type of investors that hold MREL will have key implications for how bank funding costs will evolve in the next financial crisis.

Once an individual bank comes close to resolution, short-term investors – such as hedge funds – may flee the asset, leading to a rapid deterioration in funding costs and possibly bringing forward the bank’s point of failure. Moreover, the smaller banks which now begin to sell increasing amounts of MREL will be similar in terms of business model or be exposed to similar asset problems, be it from private-sector excess debt or from concentrated holdings of government securities. A common creditor base of short-term investors could therefore set off contagion – from one institution that comes close to resolution, to others with similar perceived risks, if allocation to the entire asset class is reduced. There will likely be collective bouts of enthusiasm and flight from bail-in securities in individual jurisdictions.

From the outset, BRRD was conceived to deal with idiosyncratic bank failures, and its inherent flaw in dealing with a systemic crisis was well understood. Europe’s short and intermittent history with resolutions as yet does not offer a sufficient case history to assess how investors would behave in a situation of wider banking-sector stress.

Financial-sector supervision should therefore monitor this emerging asset class and its investor base. MREL exposures between banks could aggravate contagion across the banking sector and rightly incur high capital charges. Direct exposures by retail investors should also be limited, and in any case may be exempted from bail-in under the BRRD.

Capital-market regulation should therefore find ways to encourage long-term investors, such as pension and insurance funds, to take on more significant exposures. This could be done, for instance, through requirements for capital coverage and asset valuation in the regulation of insurance funds. As financial system risks have been reduced, and risks have become less correlated between insitutions, bail-in securities could become a more established asset class.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Jul
9
14:00

Tackling too-big-to-fail banks: have the reforms been effective?

Evaluation of the global reforms implemented to deal with "too-big-to-fail banks".

Speakers: Alexandre Birry, Claudia M. Buch and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Blog Post

The Wirecard debacle calls for a rethink of EU, not just German, financial reporting supervision

The spectacular collapse of Wirecard AG should serve as a wake-up call for the European Union on the need to pool the relevant supervisory mandates at EU level.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: June 30, 2020
Read article Download PDF
 

Policy Contribution

Is the COVID-19 crisis an opportunity to boost the euro as a global currency?

The euro never challenged the US dollar, and its international status declined with the euro crisis. Faced with a US administration willing to use its hegemonic currency to extend its domestic policies beyond its borders, Europe is reflecting on how to promote it currency on the global stage to ensure its autonomy. But promoting a more prominent role for the euro is difficult and involves far-reaching changes to the fabric of the monetary union.

By: Grégory Claeys and Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 5, 2020
Read article More on this topic
 

Opinion

The Independence of the Central Bank at Risk

The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy.

By: Peter Bofinger, Martin Hellwig, Michael Hüther, Monika Schnitzer, Moritz Schularick and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 2, 2020
Read article Download PDF
 

Policy Contribution

COVID-19’s reality shock for external-funding dependent emerging economies

COVID-19 is by far the biggest challenge policymakers in emerging economies have had to deal with in recent history. Beyond the potentially large negative impact on these countries’ fiscal accounts, and the related solvency issues, worsening conditions for these countries’ external funding are a major challenge.

By: Alicia García-Herrero and Elina Ribakova Topic: Finance & Financial Regulation, Global Economics & Governance Date: May 28, 2020
Read article Download PDF More by this author
 

Policy Contribution

European Parliament

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate

To keep the euro-area economy afloat, the European Central Bank has put in place a large number of measures since the beginning of the COVID-19 crisis. This response has triggered fears of a future increase in inflation. However, the ECB's new measures and the resulting increase in the size of its balance sheet, even if it were to be permanent, should not restrict its ability to achieve its price-stability mandate, within its legal obligations.

By: Grégory Claeys Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: May 20, 2020
Read article More on this topic More by this author
 

Opinion

The message in the ruling

The German Constitutional Court's ruling on the ECB's asset purchase programme is open to much criticism but it can hardly be blamed for raising an important question.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: May 12, 2020
Read article More on this topic More by this author
 

Blog Post

Banking regulation in the Euro Area: Germany is different

Despite progress in recent years towards a single banking policy framework in the euro area – a banking union – much of the German banking system has remained partly sheltered from uniform rules and disciplines that now apply to nearly all the area’s other banks. The resulting differences in regulatory regimes could generate vulnerabilities in the still-incomplete banking union, which is being tested in the context of the COVID-19 pandemic.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: May 7, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

An analysis of the German Constitutional Court's ruling on the ECB QE programme

The German Constitutional called today on the ECB to justify its bond-buying program. What does today's ruling of the German Constitutional Court mean for the ECB's QE program? Could such a decision open a precedent when it comes to contesting EU law? Today, Giuseppe Porcaro and Guntram Wolff are joined by Franz Mayer, chair of Public Law at the University of Belefield, to analyse the German Constitutional Court's ruling.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: May 5, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: An analysis of the German Constitutional Court ruling on the ECB QE programme

What does today's ruling of the German Constitutional Court mean for the ECB's Quantitative Easing programmme

Speakers: Franz Mayer, Giuseppe Porcaro and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 5, 2020
Read article More on this topic
 

Opinion

Monetisation: do not panic

The extraordinary operations that are under way in most countries in response to the COVID-19 shock have raised fears that large-scale monetisation will result in a major inflation episode. This column argues that so far, there is no evidence that central banks have given up, or are preparing to give up, on their price stability mandate. While there are obviously some reasons to worry, central banks are doing the right thing and the authors see no reason to panic.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: Finance & Financial Regulation Date: April 14, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: The macroeconomic policy response to the COVID-19 crisis

Which macroeconomic policy response is the best option to deal with the crisis currently unfolding and will ensure that the recovery will be as quick as possible?

Speakers: Grégory Claeys, Giuseppe Porcaro, Lucrezia Reichlin and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2020
Load more posts