European banks may need $517 bn of loss absorbing capital

European banks need to sell hundreds of billions of euros in loss-absorbing liabilities over the next few years to meet European Union rules designed to protect taxpayers from the cost of bank failures. Th e European Banking Authority estimates as much as 470 billion euros ($517 billion) of financing is needed under the most conservative assumptions for what qualifies as “loss-absorbing.” The regulator on July 19 published its first quantitative impact study on the EU’s minimum requirement for eligible liabilities and own funds, or MREL.

“These findings are subject to several methodological caveats and must be treated with caution,” the EBA said. “In the absence of MREL decisions for institutions to date, and given the limited information on authorities’ MREL policy approach, assumptions had to be made as to the scope and calibration of MREL. These assumptions are by definition different from the actual levels of MREL that will ultimately be determined for each institution and group.”

The requirement to have sufficient eligible liabilities to absorb losses and recapitalize a bank is the cornerstone of the EU’s bank-failure legislation. MREL requirements will be set for each bank individually by authorities such as the Single Resolution Board and the Bank of England. It is similar to the global total loss-absorbing capacity standard set by the Financial Stability Board for the world’s biggest banks, including HSBC Holdings Plc and Deutsche Bank AG.

Elke Koenig, head of the Brussels-based SRB, said this month that the euro area’s resolution authority will “cover the main TLAC requirements when setting MREL.” The FSB has given banks until 2019 to meet the initial TLAC requirements. “In practice we think a three- to four-year period will be needed for banks to build up the required MREL in many cases,” she said. Koenig’s SRB is busy setting MREL requirements this year. For the “big banks” — those of global and national systemic importance — Koenig said she’s “convinced” the minimum level will be at least 8 per cent of total liabilities including own funds, even though efforts have been made to water down the standard.

The EBA studied a sample of 114 banks from 18 EU member states, covering about 70 per cent of total EU banking assets, including 13 globally systemically important banks based in the bloc. They have average MREL-eligible liabilities and own funds of 13 per cent of total liabilities and own funds, or 34 per cent of assets weighted for risk, according to the study. If deposits not covered by insurance schemes for consumers are excluded, the ratio is about two percentage points lower, it said. As MREL requirements haven’t been set on an individual bank level yet, the study makes simplified assumptions for how it will be calibrated, causing large variations in the result depending on those assumptions.