New U.K. bail-in rules for banks will protect taxpayers | Wolters Kluwer Financial Services
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  • New U.K. bail-in rules for banks will protect taxpayers

    By Michael Imeson

    Published January 05, 2017

    The Bank of England’s Minimum Requirement for own funds and Eligible Liabilities (MREL) will reduce the likelihood of taxpayers’ funds being used to save failing banks, writes Michael Imeson

    The Bank of England has published new rules that will make it easier for it to manage failing banks and reduce the risk of taxpayers having to stump up the cost. The rules, published on 8 November, are part of wider reforms to end taxpayer-funded bailouts by the Government of the kind that happened during the 2007/8 financial crisis. Banks then were saved by the taxpayer because they were too big to be allowed to fail, for fear of bringing down the entire financial system. Since then, Government policy has been to get to a position where banks can make greater use of shareholders’ and debtors’ funds, rather than taxpayers’, to pay for any future bailouts.

    The new rules do this by setting a minimum requirement for a bank’s “own funds” (ie equity) and “eligible liabilities” (ie bonds and other forms of debt) that it can use to absorb losses and keep it going until it can be “resolved” (ie saved, or wound up in an orderly fashion) by the “resolution authority” (ie the Bank of England) without threatening financial stability. The process of using these funds and liabilities is known as “bail-in” – in other words, shareholders’ equity and debtors’ loans will be used to keep the bank going before any taxpayers’ funds are used.

    The banking industry accepts that the “Minimum Requirement for own funds and Eligible Liabilities” (MREL) rules are necessary. But even if they objected to them, there is nothing they could do since the UK is required to introduce them as part of the EU’s Bank Recovery and Resolution Directive (BRRD). The EU rules are themselves based on global capital standards set by the Financial Stability Board, known as total loss-absorbing capacity (TLAC).

    The MREL represents one of the final measures in a series of reforms aimed at making banks more resilient to financial shocks, the most important being the Basel III and the Capital Requirements Directive which have forced banks to increase the amount of capital and liquidity they must hold.

    The details 

    The MREL will apply to all banks, building societies and larger investment firms. The Bank of England has three different resolution processes for dealing with these institutions once they fail, depending on whether they are categorised as small, medium or large banks, and the MREL for each bank will be different and based on which process category they fall into.

    Small banks that start to fail will follow a “modified insolvency process” and therefore be allowed to fail, with a pay-out by the Financial Services Compensation Scheme (FSCS) to covered depositors being the Bank’s only resolution objective. The MREL for these banks is simply for each to meet its existing capital requirements.

    Medium-sized banks in trouble will follow a “partial transfer” process. The MREL for each of these banks will be set at a level which permits a transfer of critical parts of the business to another bank or entity to take place; the rest of the bank will be allowed to fail.

    Large banks that get into trouble will be recapitalised by a “bail-in” of shareholders debtors so they continue to meet the Prudential Regulation Authority’s conditions for authorisation, and they will not be allowed to fail. The MREL for each of these banks will be set at a level which allows them to absorb losses and to be recapitalised. “The aim is that the firm is able to operate without public support,” says the Bank.

    Which category a bank falls into is based on asset size or customer account numbers. There are some grey areas so many banks will not know for certain how they will be categorised, until they are informed by the Bank, which should happen before the end of 2016.

    The Bank will set MREL rules for banks in three phases: interim rules will be in place by 2019 for the largest of the large banks, which are those defined as Global Systemically Important Banks [G-SIBs]); interim rules for all the other banks will come into force by 2020; and final rules for all banks will be in place by 2022.

    The final rules for 2022 will be as follows:
    a)    For G-SIBs, the MREL will be the higher of either:          
         i)    two times their pillar 1 and pillar 2A capital requirements; or      
         ii)    two times their leverage ratio requirement, or 6.75% of their leverage exposures, whichever is higher.      
    b)    For all other large banks and medium-sized banks, the MREL will be the higher of either:          
         i)    two times their pillar 1 and pillar 2A capital requirements; or      
         ii)    if subject to a leverage ratio requirement, two times the requirement (eg 6% if the leverage ratio is 3%).      
    c)    For small banks, as already mentioned above, the MREL will be their existing capital requirements. 

    Mark Carney, the Bank’s Governor, describes the MREL as a “significant milestone on the journey to end Too Big To Fail in the UK”. He adds: “The implementation of MREL will ensure that banks that provide essential economic functions hold sufficient resources to be resolved in an orderly way, without recourse to public funds, and whilst allowing households and businesses to continue to access the services they need.” 

    The BBA’s response 

    The banking industry supports the new rules. For example, Simon Hills, Executive Director, Prudential Regulation and Risk, at the British Bankers’ Association, says that MREL will help ensure that in future “the tax payer does not pay for bank’s failure, as happened in a number of instances during the financial crisis, as governments felt compelled to bail out failing banks rather than risk wider impacts on the financial system”.

    Once the MREL rules are in place, “equity holders and the providers of certain types of debt liabilities would be required by the resolution authority [the Bank of England] to absorb losses and recapitalise the continuing business so that it would be able to carry on providing critical [services] to customers,” says Mr Hills

     “These refinements and the certainty that the Bank of England’s statement on its final approach brings are welcome. Banks will now be able to set their strategies for raising the appropriate amount of MREL from debt investors to ensure they reach the minimum MREL requirement by the beginning of 2022 and in the process ensure that never again does the taxpayer have to bail out a failing bank.”

    There is theory, and there is practice

    In theory, once the MREL is in place we should never have to witness another taxpayer-funded bank bailout. But in practice, what if a bank fails so catastrophically that shareholders’ and debtors’ funds are insufficient to ensure a full bail-in and an orderly recapitalisation? Will it be allowed to go-under, or will the taxpayer have to step in yet again? We shall have to wait until the next crisis to find out.

    About the author: Michael Imeson Chartered MCSI is Contributing Editor of The Banker magazine; Senior Content Editor at Financial Times Live where his role is to organise and/or chair events on financial services; and the owner of editorial services agency Financial & Business Publication. Michael is also a regular contributor to Wolters Kluwer’s Compliance Resource Network.

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