Speech by SRB Vice Chair Jan Reinder De Carpentier at the SRB-FBF academic event: Bank resolution in times of COVID-19
[Check Against Delivery]
Thank you Elena, Good morning ladies and gentlemen,
I am sorry that our Chair, Elke KÖNIG could not be here this morning. As Vice-chair of the SRB, I want to thank you for your interest and for your work on the area of resolution. Bank resolution is a relatively new field and your research, thoughts and ideas will no doubt feed into future policy decisions be it in Europe or elsewhere in the world.
First of all, I’ll look at the impact of the Covid crisis on the financial sector and the response of the SRB to the pandemic;
Then, I will outline the SRB priorities for the coming years, with a particular focus on the SRB’s MAP or multi-annual work programme for 2021 to 2023, which is hot off the presses this week;
Finally, I’ll share some thought on changes that could be made in the current resolution framework.
So, with that, let’s take a look at the impact of Covid. The pandemic represents an unprecedented shock for the European economy and worldwide. The Autumn Economic Forecast of the European Commission, published this month, is broadly in line with the ECB’s GDP forecasts. The euro area economy will contract by 7.8% in 2020 and will recover by 4.2% in 2021. It is clear that we are in a crisis, and if one were to look at these figures alone, we could say it is a more severe drop in GDP compared to the crash of 2008/2009, when GDP has fallen by 4.5% in the euro area.
However, there are some key differences: vaccines are on the horizon, recovery is expected to be much quicker than the last crisis, and, of course, the banking sector is not the cause of this current crisis. Banks are much stronger today in terms of capital and liquidity, thanks to the regulatory reforms introduced, including the Banking Union and the SRM.
So what impact is the crisis having on resolution?
If we look at the build-up of the MREL first: it continued in the current year, although at a slightly slower rate; in the first two quarters of 2020 banks issued almost 180 billion euro in eligible funds, an amount just 4.7% lower than in the previous two quarters of 2019. A slowdown, yes, but not as severe as might have been expected and since Q3 markets are definitely “back to normal”.
After the volatility of funding costs – of subordinated and senior bonds – and yield-to-maturity of subordinated debt peaked in March, the cost of funding materially decreased over the summer period until mid-September 2020. Clearly, banks must keep up the momentum on increasing MREL since it is vital to strengthen resolvability and, especially given the new obligations in the BRRD2, and banks should tap the market to build-up MREL. [To be clear: any responsible manager knows that he cannot just wait for better times. If banks struggle with building up MREL they might have to consider whether they need to adapt the business model and not whether the SRB needs to lower the bar for them.]
Overall, the vulnerability assessment carried out by the ECB in early summer shows good signs of a resilient banking sector. However, there is no reason to sit back and relax. For example, under the more adverse – much less probable – scenario, capital depletion could lead to an average decline of 5.7 percentage points in core capital – the Common Equity Tier 1 ratio - with a potential increase of non-performing loans (NPLs) to around €1.4 trillion, which would be much higher than in the great financial crisis. [This might be a worst case scenario, but the only logical conclusion is that banks need to focus on their risk management and need to address the topic at first sight. Again, wait and see is normally not a successful strategy.]
The uncertainty caused by Covid is a threat to financial stability, so all the more reason for strengthening our resolution framework, so we can manage bank failures effectively if and when the need arises.
However, if banks work now on issues such as provisioning for NPLs and continuing to build up MREL, then the risk of bank failures will decrease.
[SRB and Covid-19 / Flexibility of the SRB within the current framework]
As regards the response of the SRB to Covid, we had to balance the need to provide relief to banks to face the current economic challenges, and the need to make progress on the requirements to become “resolvable” – which is more important than ever. On the operational side, we postponed less urgent information or data requests, in line with the EBA’s recommendations. On the whole, banks managed to respect the limited extension of the deadlines, therefore our 2020 resolution planning cycle remains well on track.
In terms of MREL requirements, since the legislation envisages that the capital buffers are added on top of MREL, the SRB has implemented the capital relief measures taken by some national macro-prudential authorities. In addition, as regards existing binding MREL targets, i.e. those set under the BRRD1 rules, the SRB announced that it would have taken a forward-looking approach to banks that may face difficulties in meeting these targets before new MREL decisions under the new BRRD 2 rules take effect.
The SRB will also continue to monitor carefully market conditions and reflects the potential impact on transition periods needed for the build up of MREL in its 2020 MREL decisions.
This pragmatic approach provides banks with the flexibility they may need in the coming months, but I want to be clear, flexibility cannot be at the expense of our core mission – to promote financial stability and protect the taxpayer from having to bail out banks.
[2. SRB priorities / MAP]
Now, ladies and gentlemen, I want to move to my second point: the SRB’s programme for the coming years. Indeed, in the coming days we will publish our multiannual work programme, covering the period 2021-23. I might take you through a few of the key points.
On resolvability, the focus will be on the implementation of the Expectations for Banks. It is the SRB’s guidance for banks to increase their resolvability gradually to become fully compliant by 2023 and it is translated for individual banks in annual tailor-made work programmes by the SRB. These are known as the priority letters. The next resolution planning cycles will be crucial to reach that deadline of 2023, which is also the deadline for the MREL targets to be met and we will be monitoring progress and clamping down on breaches. In the coming three years, the SRB will refine and update the MREL policy to complete the implementation of the banking package, including guidance to respond to MREL breaches, implement the new provisions of the eligibility framework as well as the EBA RTS on various MREL-related aspects. The SRB will also use the tools at hand for banks not making sufficient progress, such as the impediments procedure. The SRB will continue to focus on policy development of our core resolution principles in the next three years.
On crisis preparedness, a key focus will be on resolution tools other than bail-in. In 2021, work will concentrate in particular on the operational preparatory steps for the sale of business tool. In addition, we continue to perform crisis simulations, so-called ‘dry-runs’ – a very valuable exercise to identify areas for improvement.
[3. Resolution Framework Improvements]
The completion of the Banking Union, over a decade since the last crisis, is overdue. There are a number of issues the SRB would like to see dealt with.
We still have different national insolvency rules and this causes a number of issues as you all are aware. Not least, the no-creditor-worse-off principle (NCWO) – which seeks to ensure that the treatment of creditors in resolution is not worse than the treatment they would have received under normal insolvency proceedings – becomes very difficult to assess and to meet with different national procedures, and for cross-border banks may result in different outcomes depending on the home country of the institution.
A second topic which is also under discussion among policy-makers concerns the challenges faced by medium-sizes deposit-funded banks that lack an easy access to wholesale funding markets and could be too small to be resolved, but too big to be liquidated. We have an issue in the Banking Union where some banks are too critical to be put into national insolvency proceedings, but yet cannot be burdened with requirements such as MREL. However, all banks under the SRB’s remit must be resolvable, either by using resolution tools or under the national insolvency procedure.
A possible solution to these gaps would be to establish a harmonised administrative liquidation regime backed by a common insurance scheme to finance the transfer of assets and liabilities (transfer strategy tools). The creation of a fully mutualised deposit insurance scheme remains a priority for the SRB. Another area we would like to see progress on is the further development of the CMU.
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I will come to a conclusion, ladies and gentlemen. Looking at the response of European authorities, I think we can say it was swift and coordinated. I hope that we will use this crisis to come out the other side with a stronger resolution framework and I have no doubt that academic research combined with the real world pressures owing to the pandemic will help in this process. So, I want to thank all of those conducting research in the area of resolution – it is very useful in our work.