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European banks may need 470b euros of loss-absorbing funds

[VIENNA] 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.

The European Banking Authority estimates as much as 470 billion euros (S$703 billion) of financing is needed under the most conservative assumptions for what qualifies as "loss-absorbing".

Excluding senior unsecured debt could bring the amount to 790 billion euros, the regulator said in 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 recapitalise 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.

Big Banks Elke Koenig, head of the Brussels-based SRB, has said 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.

Ms Koenig's SRB is busy setting MREL requirements this year. For the "big banks" - those of global and national systemic importance - Ms 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 per centage 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.

In the most conservative scenario, MREL was assumed at the greater of twice the current capital requirement including buffers and systemic risk charges, or 8 percent of total liabilities and own funds, the EBA said.

Under this scenario for all banks in the sample, and excluding all deposits, banks would have to add 470 billion euros in funds. If large and corporate deposits are included in MREL, this amount falls to 290 billion euros.

One of the key goals of European lawmakers was to share the losses of failing banks with senior creditors, to make a bigger pool of securities eligible for MREL.

If, contrary to that intention, only subordinated debt was eligible, the shortfall would rise to 790 billion euros.

EU members including Germany, Italy and France have started legislation to make sure senior bonds can be included in MREL, and EU finance ministers are working to harmonise those efforts.

A less stringent MREL requirement, in which capital requirements are doubled but buffers only considered once, leads to a shortfall of 130 billion euros including deposits, or 260 billion euros excluding them.

Resolution authorities and supervisors should get additional powers to police MREL requirements swiftly, the EBA said in the document. While EU law "is clear that MREL is a minimum requirement that must be met at all times, it does not contain specific provisions covering the implications of an MREL breach," it said.

"This may not allow a sufficiently prompt response to a breach of a minimum requirement."

To make MREL more comparable with TLAC, EU lawmakers should consider switching to calculating it as a per centage of risk- weighted assets and of the leverage ratio exposure measure, rather than of total liabilities and own funds, the EBA said.