Prepared no matter the size – ensuring crisis readiness for smaller banks in the Banking Union

Smaller banks, also known as less significant institutions (LSIs) in the Banking Union, play an important role in the financial ecosystem. They provide essential services that support local economies and communities such as payment services, deposit-taking, and lending to small and medium-sized enterprises (SMEs). 

Regardless of size or business model, it is vital to ensure authorities and banks themselves are ready to deal with shocks. Most of the time, authorities don’t need to be involved in managing market exits in this sector – banks wind down voluntarily, they merge with others or are bought. But for some LSIs, more preparation is needed to ensure that the continuity of critical functions, financial stability, and other resolution objectives can be safeguarded in case of failure.

The Single Resolution Mechanism (SRM)

In the Banking Union, this is the responsibility of the Single Resolution Mechanism (SRM).  National resolution authorities (NRAs) lead resolution planning and crisis management for LSIs. The Single Resolution Board works closely with them in its oversight capacity. This cooperation ensures that high standards are maintained across the 21 participating Member States. Together, we work to apply resolution strategies effectively and consistently, both across smaller banks in different countries and between smaller and larger banks, and support each other by sharing best practices and insights. 

The report published last month sets out our latest view on progress on this journey for the nearly 2,000 LSIs in the Banking Union, and particularly those earmarked for resolution. 

In short:

• All LSIs that had to comply with their final minimum required eligible liabilities (MREL) targets as of 1 January 2024 met their obligations, while the remaining MREL shortfalls are attributed to entities with extended transitional periods. 

• While NRAs continue to phase in and proportionately implement the SRB’s Expectations for Banks, LSIs show good progress on the resolvability expectations prioritised by their respective authorities in 2022-2023.

Let me explore each of those elements further.

No resolution without resources

 Let’s remember that resolution usually means a hole in the financials somewhere. To ensure that losses are absorbed in a safe way, banks in the EU have to hold a minimum amount of so-called eligible liabilities. These are typically capital and long-term debt. How much has to be held depends on the bank and the respective resolution strategies. 

As of 31 December 2023, the MREL capacity of the LSIs earmarked for resolution – this is a group of some 70 institutions –  was EUR 102 billion. Some 60% of this was held in Common Equity Tier 1 (CET1), and just over 20% in senior unsecured liabilities. For most LSIs, CET1 capital is the main source of MREL-eligible instruments used to comply with their (external) MREL requirements.

A few LSIs are on extended transitional paths towards their final MREL requirement. The vast majority has already met their steady state requirement. 

Building resolution capabilities

While resources are important, they are not everything. Both authorities and banks earmarked for resolution need to be ready on many other dimensions. That preparation requires planning, practice and implementation. To progress on this, the authorities need to be clear on what they are expecting – of themselves and of banks. We have made significant progress in this area together. For example, NRAs are phasing in and proportionately implementing the SRB’s Expectations for Banks. While doing so, NRAs prioritise different capabilities that are particularly important for resolvability of their LSIs, focusing on the preferred resolution strategies and tools, but also considering their specific structures and business models.

On the whole, LSIs have made good progress on those capabilities in 2022-2023 [see figure from report]. Besides the already mentioned build-up of MREL resources, on average, the most progress has been achieved regarding the operationalisation of bail-in. This means developing processes allowing a bail-in decision to be effectively executed at short notice, including through relevant governance and communication arrangements.

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As with the larger banks, work continues. For example, as we saw again last year, optionality is important in resolution. We need to be able to implement not only one preferred resolution strategy, but also variant resolution strategies. That means, among others, taking further steps to operationalise transfer tools.

Looking Ahead: Vision 2028

The SRM Vision for 2028 strategy focuses on improving crisis readiness, reflecting the operational nature of resolution. The report on smaller banks highlights the progress made in the 2023 resolution planning cycle and sets the stage for the 2024 cycle, focusing on fostering LSIs’ resolvability and crisis preparedness. 

Overall, we are increasingly moving to a focus on the practical viability of resolution, with dry runs, deep dives by authorities and testing by institutions to ensure that we can deliver on the SRM’s mandate to promote financial stability and protect taxpayers together, no matter the size. Lessons from those efforts also inform our approach to setting of expectations and priorities, helping us to progress. One important dependency for the future is the conclusion of the ongoing review of the crisis management and deposit insurance framework, which seeks to further enhance the framework for smaller and medium-sized banks. A good outcome here would further strengthen the ability of the SRM to deliver on its mandate of promoting financial stability and protecting taxpayers.