The Financial Stability Board’s proposal for bail-in debt appears ill-suited to continental European banking group structures.
What is it?
In November 2014, the Financial Stability Board (FSB) issued a consultation paper on total loss-absorbing capacity (TLAC) to be held by banks to ensure adequate resources to recapitalise a bank in resolution. Ministers from the G20 countries welcomed the proposal, but asked the FSB to undertake detailed impact studies to refine the plan for approval at the next G20 meeting, in Turkey in November 2015.
The FSB proposed that global systemically important banks (G-SIBs) should hold TLAC equivalent to 16% to 20% of risk-weighted assets, or 6% of unweighted total assets using the leverage ratio definition. Part of this buffer should be transferred downstream to “material subsidiaries”, so that they hold 75% to 90% of what their standalone TLAC requirement would be. The rest can be held at the parent company. At least one-third of the TLAC must be in the form of debt that can be subject to bail-in, with the rest held as equity. Implementation would take place in 2019.
What’s the problem?
Chinese regulators are evidently concerned that the proposals will not suit the three state-owned Chinese banks on the G-SIB list, and the FSB specifically proposed excluding them from the first wave of compliance. But continental European banks also believe that the proposals bear the hallmarks of their key architects, the Bank of England’s Mark Carney and US Federal Reserve’s Daniel Tarullo.
“The TLAC proposal is compatible and shaped on US and Anglo-Saxon organisational models, organised under a pure holding company, but it is a substantial burden for the majority of other banks in Europe. This should carefully be analysed during the calibration period,” Santiago de Lis, chief regulatory and financial systems economist at Spanish G-SIB BBVA, noted in a research report.
Many European banks are structured as groups of operating companies, which makes it difficult to issue TLAC from a vehicle that does not also contain liabilities ineligible for bail-in, such as corporate operating deposits or derivative payables. Dutch bank ING has a holding company, originally as the ownership vehicle for the group’s separate bank and insurance components. Even for European banks with a holding company, however, the transition to TLAC will not be trouble-free according to Koos Timmermans, vice-chairman of the board at ING Bank.
“If the bank issues senior debt for TLAC from that holding company but at the same time it still has existing subordinated debt at the operating company level, it is not going to make the corporate finance structure any clearer for investors to understand,” he says.
What if you don’t issue bonds?
A further difference between US and European models is that with the exception of Citigroup, US banks have tended to grow organically through overseas branches. By contrast, European groups have emerged by cross-border acquisitions, retaining a network of subsidiaries that would need to hold their own downstream TLAC. But many of these subsidiaries are funded purely by local deposit-taking. ING Bank Slaski in Poland, which accounts for almost 3% of the group’s total assets, has a loan-to-deposit ratio of less than 70%.
“If a subsidiary is fully deposit funded and has no need to issue debt securities, having a TLAC requirement is not ideal,” says Mr Timmermans.
What’s the answer?
European banks feel they already have one: the EU’s Bank Resolution and Recovery Directive (BRRD). This contains the concept of minimum own resources and eligible liabilities (MREL) that can be bailed in. At least 8% of liabilities must fall into this category. Crucially, MREL will introduce bail-in of existing senior unsecured debt by statute.
Since TLAC is intended to apply across many jurisdictions rather than one, the FSB proposals are based on contractual rather than statutory bail-in of liabilities. But James Longsdon, a managing director in the financial institutions team at Fitch Ratings, suggests it may only be possible to make existing senior debt eligible as TLAC through statutory changes that explicitly subordinate the paper to all the excluded liabilities specified by the FSB.
“Otherwise, senior debt tends to rank alongside items such as structured notes that are excluded from TLAC,” says Mr Longsdon.
The ability to transform existing debt into TLAC is especially important for European banks, because in many cases their balance sheets are growing very slowly at best, so issuing new paper is not practical. Mr de Lis points out that the European Commission and the European Banking Authority (EBA) are empowered to review BRRD and MREL by the end of 2016. The FSB has proposed that TLAC comes into force only in 2019.
“It seems that the MREL may evolve towards the TLAC global framework after the EBA and European Commission review in 2016. Therefore, the risk is low of having two different ratios in Europe in the long term,” says Mr de Lis.
