Abstract
Versatile regulatory approaches exist for Systemically Important Financial Institutions (SIFIs) in the European Union (EU). Bail-ins of SIFIs, however, are still not deemed credible. This analysis starts with the primary purpose of SIFI regulation, explains the destruction of asset value arising from the fire sales that are SIFI bank runs, and introduces a “loss-absorbing capacity” approach to orderly bank resolution in the EU: the Minimum Requirement for (own Funds and) Eligible Liabilities (MREL). Comparable to its international equivalent—Total Loss-Absorbing Capacity (TLAC)—it requires SIFIs to have enough subordinated liabilities with loss-absorbing capacity for lowering barriers or impediments to bail-ins. The article then provides answers to the questions of the responsible supervisor, the supervised entities, characteristics of eligible liabilities, and the economic impact of the regulation. Both concepts MREL and TLAC are then compared. Finally, shortfalls such as the lack of liquidity and recovery for banks in distress, and a pro-cyclical effect are discussed, since they counterfeit the intended implications of those proposals on ending the phenomenon of firms being too big to fail.
Jacob Kleinow is Teaching and Research Associate at Technische Universität Bergakademie Freiberg. This paper was originally prepared for, and presented at, the HTW Berlin Seminar on “The European Institutional Responses to the Challenges of Supervising Financial Markets” in Germany in December, 2014. Special thanks go to Gudula Deipenbrock, Mads Andenas and Andreas Horsch.
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Notes
- 1.
- 2.
European Commission (2014), p. 2.
- 3.
Pflock (2014), p. 51.
- 4.
Claessens et al. (2010), p. 23.
- 5.
European Commission (2014).
- 6.
Financial Stability Board (2014c), p. 5.
- 7.
On recent developments at the major global financial governance institutions, see Willke et al. (2014), pp. 108–114.
- 8.
- 9.
Diamond (1984).
- 10.
Stern and Feldman (2004), p. 12.
- 11.
McAndrews et al. (2014), p. 229f.
- 12.
Dombret and Cunliffe (2014).
- 13.
For further analysis on why bank regulators think standard insolvency law is not appropriate, see Sommer (2014), p. 2010f.
- 14.
Bail-in-able debt refers to liabilities of banks that can be easily written down or converted to equity (bailed-in) upon entry into resolution.
- 15.
McAndrews et al. (2014), p. 229f.
- 16.
Stern and Feldman (2004), pp. 43–59.
- 17.
- 18.
Dombret (2012). To explain that the capital buffer does not fulfil its function since it cannot be used when it is needed, Goodhart (2008), p. 41 uses the metaphor of “the weary traveler who arrives at the railway station late at night, and, to his delight, sees a taxi there who could take him to his distant destination. He hails the taxi, but the taxi driver replies that he cannot take him, since local bylaws require that there must always be one taxi standing ready at the station”.
- 19.
In the short run, resolutions could be more frequent for banks with bail-in-able debt, since both regulatory capital ratios and the government intervention threshold would be lower (assuming that the requirement for uninsured financial liabilities is implemented partially in lieu of the equity requirement). However, assuming that the justified disappearance of weak market participants would be encouraged more in this setting, the frequency and severity of bailouts (in terms of asset values destroyed) would decrease in the long run, and increased financial stability would be the prevailing advantage.
- 20.
One of the first sound proposals for a bail-in-able debt requirement in the EU comes from the Directorate General Internal Market of the European Commission (2011), p. 3; a “Discussion paper on the debt write-down tool—bail-in”: “A tool by which resolution authorities could be given a statutory power, exercisable when an institution meets the trigger conditions for entry into resolution, to write off all equity, and either write off subordinated liabilities or convert them into an equity claim.” It was resumed by the influential Liikanen report (High-level Expert Group 2012, p. III): “The Group strongly supports the use of designated bail-in instruments. Banks should build up a sufficiently large layer of bail-in-able debt that should be clearly defined, so that its position within the hierarchy of debt commitments in a bank’s balance sheet is clear and investors understand the eventual treatment in case of resolution. Such debt should be held outside the banking system. The debt (or an equivalent amount of equity) would increase overall loss absorptive capacity, decrease risk-taking incentives, and improve transparency and pricing of risk”.
- 21.
- 22.
Vickers (2015).
- 23.
Financial Stability Board (2014a), pp. 10–12.
- 24.
Financial Stability Board (2014a), p. 13–21.
- 25.
Regulators may set higher requirements.
- 26.
Financial Stability (2014a), p. 8.
- 27.
BBVA Research (2014), p. 1, PricewaterhouseCoopers, p. 1.
- 28.
Standard & Poor’s Ratings Services, p. 3.
- 29.
European Banking Authority (2014), p. 5.
- 30.
European Banking Authority (2014), p. 18f.
- 31.
In addition, see the Draft Regulatory Technical Standards on criteria for determining the minimum requirement for own funds and eligible liabilities under Directive 2014/59/EU, Art. 7 for the inflationary identification of various types of systemic institutions: “For institutions and groups that have been designated as [global systemically important insurers] G-SIIs or [other systemically important institutions] O-SIIs by the relevant competent authorities, and for any other institution which the competent authority or the resolution authority considers reasonably likely to pose a systemic risk in case of failure, […] consideration shall be given in particular to the requirement that, in resolution, a minimum contribution to loss absorption and recapitalization of 8 % of total liabilities and own funds, or of 20 % of the total risk exposure amount […] is made by shareholders and holders of capital instruments and eligible liabilities at the time of resolution.” The International Association of Insurance Supervisors (IAIS) defines G-SIIs as “insurance-dominated financial conglomerates whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity” (IAIS 2015, p. 3). The European Banking Authority (EBA) defines O-SIIs as “systemically important institutions other than those identified as global systemically important institutions across the EU. The EBA aims to capture the appropriate balance between a European framework ensuring a level playing field and comparability across the Union, on the one hand, and the need to take into consideration specificities of Member States’ individual banking sectors, on the other.” Both assessments are closely related to the Financial Stability Board approach for G-SIFIs.
- 32.
European Banking Authority (2014), pp. 6–14.
- 33.
- 34.
Durand (2014).
- 35.
“‘Where’s the appetite for this stuff?’ […] ‘There is a perception that there is enough appetite in the world to fund the TLAC that’s going to be required,’ […] ‘So where is that capacity?’” [response in an interview of the chairman of HSBC Holding plc], see Glover et al. (2015).
- 36.
Standard & Poor’s Ratings Services (2015).
- 37.
On efficiency as a condition for regulation, see Eidenmüller (1995), pp. 393–411.
- 38.
For an in-depth discussion of the arguments, see Goodhart (2015), pp. 1–4.
- 39.
PricewaterhouseCoopers (2014), p. 2.
- 40.
EBA (2014), pp. 29–40.
- 41.
Avdjiev et al. (2013), p. 56.
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Kleinow, J. (2016). Loss-Absorbing Capacity: The Last Remedy for European SIFI Regulation?. In: Andenas, M., Deipenbrock, G. (eds) Regulating and Supervising European Financial Markets. Springer, Cham. https://doi.org/10.1007/978-3-319-32174-5_17
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