(Bloomberg) -- The euro area’s biggest banks will be asked to earmark funds equivalent to more than twice their minimum capital requirements to make sure a possible emergency doesn’t cost taxpayers, according to Elke Koenig, head of the Single Resolution Board.
The Brussels-based SRB, the resolution authority for 142 banks including Deutsche Bank AG and BNP Paribas SA, will use the minimum capital requirement set by the European Central Bank as a proxy for funds that would be needed to absorb losses and allow recapitalization in a crisis, Koenig said in an interview this month. The ECB last year set an average requirement for the highest-quality capital of 9.9 percent of risk-weighted assets.
Requiring banks to have at least the same amount again in loss-absorbing liabilities will ensure that they can recapitalize themselves quickly after restructuring, Koenig said. This minimum requirement of own funds and eligible liabilities, or MREL, is calculated at the “30,000-foot level,” and more precise levels tailored to each bank will follow after the ECB sets new capital requirements and changes are made to capital, bank-failure and insolvency rules, she said.
“We want to avoid confusing the markets by saying, this is our decision this year, knowing that it will be different next year,” Koenig said. “So we take an indicative step this year. For next year, we hope that some of the dust has settled.”
The requirement to have sufficient eligible liabilities to absorb losses and recapitalize a bank is the cornerstone of the European Union’s bank-failure legislation. The MREL requirement is similar to the total loss-absorbing capacity standard set by the Financial Stability Board for the world’s biggest banks.
The European Banking Authority said in July that the region’s banks may need as much as 470 billion euros ($524 billion) in additional MREL-eligible funding under conditions similar to those cited by Koenig. The EBA sample consisted of 114 banks representing 70 percent of the EU’s banking assets, including lenders not overseen by the SRB.
‘Starting a Journey’
Koenig declined to comment on estimates and said the EBA study’s parameters weren’t identical with the SRB’s plans for indicative MREL levels. While EU law doesn’t set a deadline for banks to reach their MREL target, she said three to four years was a realistic assumption.
“We’re telling the banks we’re starting a journey with them, and it is a continuous dialogue,” Koenig said. “Assuming a bank’s eligible liabilities are below what would be the outcome of this purely mechanical calculation, we would at least expect them to start considering mitigating measures.”
Koenig said the planned indicative MREL level will also allow banks to satisfy a requirement in EU law for 8 percent of own funds and total liabilities to be wiped out before access can be granted to rescue funds, Koenig said.
“What we found out, a bit to my surprise, was that the 8 percent becomes a fairly moot point,” she said. “Assuming risk density of 40 percent to 50 percent and SREP ratios of 9, 10, 11 percent, banks have to be there anyway. It’s a real backstop.”
A crucial factor in how hard it will be for banks to reach the target could be changes to insolvency laws that have already started in countries including Germany, France and Italy. The French model, which effectively introduces a new asset class sandwiched between senior and hybrid bonds, could be rolled out throughout the bloc, Koenig said.
“The German law solves the no-creditor-worse-off problem for the entire pile of senior bonds; the French proposal means you need to build it up,” she said. “I don’t doubt that you can build it up, but you can’t do it overnight. The German proposal solves the problem today. But if the Commission and the member states decide they want to go the French way, it’s at least a solution going forward. I hope they will decide soon.”
While Koenig can also live with structural subordination, in which MREL is held at a holding company, she says defining subordination in the terms of an individual debt security has its limits.
“Contractual subordination is, compared to this, an administrative and legal challenge,” she said. “It’s very impractical, to say the least.”