MREL: the next steps
The economic shock of the Covid-19 outbreak has put the financial industry again in the spotlight – this time as vital players in mitigating the effects of the crisis, supported by national and European authorities. While the European banking sector entered this crisis in much better shape than it was at the beginning of the previous one, the impact on the banking sector itself is not yet clear and will largely depend on the measures taken to support the real economy and how different industries fare during the crisis. It is realistic to expect that banks with less performing business models and low profitability will be under more pressure, and that non-performing loans will increase. This is why a strong resolution framework that prepares for and can manage bank failures is a key element in mitigating the negative impact of the current crisis.
A major factor for resolvability are the minimum requirements for own funds and eligible liabilities (MREL), the buffer each bank must hold to absorb losses and prevent use of public money if it fails. MREL plays a crucial role in ensuring that banks are resolvable, by which we mean that their failure can be managed in an orderly way, safeguarding financial stability, allowing critical functions to the economy to continue and guaranteeing that losses are borne by shareholders and bondholders, rather than the taxpayer.
The SRB published its updated MREL policy last month. This policy implements the new requirements in the 2019 Banking Package, which introduced a number of risk-reducing measures for the financial sector. The updated policy introduces changes to MREL requirements for large global systemically important banks, integrating the global standard for total loss-absorbing capacity, known as TLAC. There are changes to the way it is calculated and in its quality (subordination). It also sets out dedicated rules for different business models, such as cooperatives, and resolution strategies, such as multiple-point-of-entry (MPE).
A key change is to the deadlines for binding MREL targets. The SRB will decide on the level of MREL that institutions should hold in its 2020 resolution planning cycle. These decisions, which will be communicated to banks in early 2021, will include two binding MREL targets: the binding intermediate target to be met by 1 January 2022 and the MREL (final target) to be met by 1 January 2024. The decisions will reflect changing capital requirements, and will be calibrated taking the most recent information into account, where relevant.
These new targets allow the SRB to take a forward-looking approach to banks that may face short-term difficulties in meeting the existing targets set in earlier cycles, due to the current crisis. We are committed to the continued build-up of MREL, while ensuring that short-term MREL constraints do not prevent banks from lending to businesses and households.
We can see that MREL is being steadily built up in quantity and quality over time. While the Covid-19 crisis has caused market uncertainty and an increase in the cost of subordinated and senior debt, leading to severely reduced new issuances in March and April, there have been signs of recovery in recent weeks. Progress on MREL requirements means banks are more resolvable – and the process of resolution planning has ensured they are more crisis-ready than in the past.
The SRB aims to set ambitious but realistic objectives for the build-up of MREL quantity and quality, taking the situation of financial markets and market capacity into consideration where needed. This loss-absorbing capacity is vital for strengthening resolvability, and, in turn, financial stability.
We will use the flexibility in the regulatory framework – where banking and resolution authorities enjoy discretion – to help the economy recover, while continuing to make progress in banks’ resilience and resolvability.
About the article author
Sebastiano Laviola joined the SRB in 2019, taking charge of resolution strategy and cooperation. This brief covers a range of cross-cutting issues relating to the core resolution activities (policies, standards, methodologies, financial stability) as well as the interplay with relevant stakeholders (NRAs, ECB, EC, EBA). In that capacity, he chairs the SRB Committee on Cooperation between the SRB and the NRAs. He was previously a Central Director of Banca d’Italia, where he served since 1986.