The provisional agreement on minimum levels of bail-inable subordinated debt in the EU’s Bank Recovery and Resolution Directive (BRRD) may leave senior creditors of medium-sized banks more exposed if those banks fail, Fitch Ratings says. This could include, in extremis, wholesale depositors.
Minimum subordinated debt requirements may be amended to apply only to global systemically important banks (G-SIBs) and “top-tier” banks with assets above EUR100 billion, according to a statement from Gunnar Hoekmark, the EU Parliament’s rapporteur, on his website last Thursday. This would be consistent with a draft proposal discussed by the European Council in May.
As we noted in May, limiting bail-able debt requirements to the largest banks could mean medium-sized banks’ senior creditors miss out on the protection that subordinated debt buffers would provide. The agreement could make it more difficult to apply the EU’s bail-in framework to medium-sized banks, for example if there were legal challenges from bondholders that are bailed in while equally ranking creditors (such as wholesale depositors) are not.
Alternatively, if equally ranking retail bondholders and wholesale depositors were bailed in alongside institutional bondholders, this could create financial stability risks. The European Commission will assess whether all deposits should be preferred in an insolvency by December 2020.
The protection provided by minimum requirements is reflected in our bank ratings. Once subordinated bail-in and other unused debt buffers junior to preferred senior debt (for instance, unused additional Tier 1 and Tier 2) have been sufficiently built up, senior ranking debt can be rated one notch above the senior bail-inable debt.
The EUR100 billion cut-off is particularly relevant to less-concentrated banking systems, for example in Italy and Spain, and to smaller EU countries. For banks below the threshold, it could be challenging and costly to issue large amounts of subordinated debt, particularly for smaller banks that are less frequent borrowers in the debt capital markets. This is likely to explain why southern EU member states want to limit the application of minimum subordination requirements to avoid forcing any but the largest banks to build subordinated debt buffers.
For this reason, we expect the final rules will give national resolution authorities the option to request subordinated minimum required eligible liabilities and own funds (MREL) for banks which they deem systemic – but this will not be automatic, as it is for the top-tier banks and GSIBs. This will lead to variations in the approaches of EU member states to ensuring banks have sufficient loss-absorbing debt.
The provisional agreement to amend the BRRD also proposes a discretionary cap for the requirement for subordinated MREL at 27% of a bank’s total risk exposure. This would limit the associated costs for large systemic banks, but would leave their senior creditors less well protected in the event of outsized losses. The full rules, as part of the broader EU banking legislation package, are now likely to emerge before the end of this year.
