Czech banks are already well capitalized with very high capital buffers – the D-SIBs have combined buffer requirements of 3.5-5.5% Tier I capital in Pillar I (systemic risk buffers of 1-3% and 2.5% conservation buffer implemented fully since CRD IV came into force) and also high individual Pillar 2 capital requirements (going up to 4.3%), which have to be covered by Tier I capital as well. However these additional buffers and Pillar 2 capital requirements are rather an expression of high risk aversion or macro prudential tools used to counter the build-up of systemic risk than a reflection of the risk profile of the Czech banks, which operate under very simple business model. All Czech D-SIBs are focused on their core business – lending to domestic retail and corporate and are financed predominantly by deposits (The average L/D ratio of the Czech D-SIBs as of as of September 30, 2014 was 78.5%).
Under such specific conditions, simply taking the prudential capital requirements as a basis for setting the LAA leads to a significant overestimation of a loss in resolution. Such an approach implicitly assumes that in the course of potential resolution, the Czech banks lose significantly higher amount compared to institutions with similar business model located in jurisdictions which are less prudent in setting of the total capital requirements. However regular stress tests being performed by the Czech National Bank, which are based on more severe scenarios than those of EBA, demonstrate exactly the opposite - high resilience of the domestic banking sector, primarily D-SIBs, against the chosen scenarios of adverse economic developments.
We suggest as the most adequate default level for the definition of the loss absorption amount the own funds requirements pursuant to Article 92 of Regulation (EU) No 575/2013 (RTS Art. 2, par. 2a; i.e. minimum capital requirement). The inclusion of other elements of capital requirements shall be subject to evaluation of the resolution authority based on the business model, funding sources and the risk profile of an institution.
We believe that the combined capital buffer defined by art.128 CRD IV (art. 2, par 2c of the RTS) is actually not suitable tool for assessment of LAA for an individual bank also due to its purpose and the way how it is defined. It consists of capital conservation and countercyclical capital buffers which should ensure accumulation of a sufficient capital base during periods of economic growth to absorb losses in stressed periods. They are defined as flat across a Member State and as such they do not reflect the individual risk profile of an institution.
The purpose of Systemic risk buffer (SRB) is to prevent and mitigate a risk of disruption in the financial system with the potential to have serious negative consequences for the financial system and the real economy in a specific Member State. Thus the SRB (and also G-SII/O-SII buffers) represent tools for reducing the bankruptcy risk of SII and their sufficient capitalization after a loss absorption (going concern regime).
Therefore these elements (art.2, par. 2b-c) of capital requirements should not be obligatorily included into the institution-specific LAA but might only be included upon assessment of the competent authority.
Besides, the approach we propose would help to eliminate different phase-in periods for implementation of capital buffers by the individual Member States. The existing inconsistencies in introduction of capital buffers and also in determination of additional capital buffer under SREP in individual Member States shall not be transferred into determination of LAA.
As written in the accompanying documents to the draft RTS the aim of EBA was to ensure a sufficient degree of harmonization of required MREL ratios for institutions with similar business model across the Union. This is hardly possible without harmonizing of the phase-in periods for implementation of capital buffers under Pillar I across all Member States. In Member states without the transitional period for capital buffers (for example in the Czech Republic) the draft RTS imposes within a short term horizon significantly more severe requirements (and potentially with more severe consequences) for loss absorbing (and recapitalization) capacity. Thus, banks in these states will not have the same chance to organically increase their capital base through retaining profits until 2019, since they will face significantly larger P/L impact compared to other European peers. This goes against the level playing field on the EU market.
In addition we consider the references to leverage ratio in the RTS on MREL not appropriate before it becomes a Pillar 1 requirement in the European law.
As stated in the answer to Q1, we see as the most appropriate approach to base the assessment of LAA at the level of minimum capital requirement and let the competent authority to decide on the inclusion of other elements of capital requirements into LAA if appropriate, given the institution’s business model, funding sources and the risk profile.
If nevertheless the default amount of LAA is higher than 8% of RWAs, then the Art 2 should ensure that sufficient flexibility is provided to the resolution authorities to decrease the loss absorption amount. This could be for a purpose of elimination of national discretions (different phase in period for implementation of capital buffers, differences in multipliers on market risk VaR models, LGD floors for specific exposures, etc.), normalization and standardization of Pillar 2 add-ons, or for institution-specific reasons (significant amount of unaudited profit of the current year or previous year which is still not considered in the regulatory capital, embedded profit from the hold-to-maturity portfolio, etc.). The determination of loss absorption amount should take into account different aspects, including the bank business model, its risk exposure, size, funding (both sources and the time structure), deposit base, income diversifications and volatility, the extent of trading activities. All these factors can decrease the amount of potential loss and yet maintain sound capital requirements.
As explained also in the answer to question 1, when linking the loss absorption amount to prudential capital requirements, the most adequate default level for the definition of the loss absorption amount is the own funds requirement pursuant to Article 92 of Regulation (EU) No 575/2013 (RTS Art. 2, par. 2a; i.e. minimum capital requirement). No additional benchmarks should be used.
However, within the time line stipulated by Directive 2014/59/EU (BRRD) Article 45, point 19, we suggest EBA to perform a comprehensive analysis to confirm appropriateness of the loss absorption amount setting for institutions of various sizes and business models, in line with Article 45, point 19(d) and (e) of the Directive. For that analysis, historical losses of financial institutions experienced during last years should be taken as a basis for determining the necessary loss absorption amount. The analysis has to be sufficiently detailed to obtain results that can be analysed by size of bank and by business model. That would allow EBA to properly calibrate MREL in line with the principle of proportionality, applied to all sizes of banks and to different business models.
The recapitalization amount should only include the minimum capital requirements, since the required capital buffers under Pillar 1 or capital requirements under Pillar 2 correspond to the situation before the resolution.
Depending on supervisory approaches, Pillar 2 requirements may include buffers for risks that have actually materialized during the period of stress that led to the resolution event of the institution. Mandatory restructuring of the institution post-resolution should ensure such risks are no longer being taken by the institution and thus there should not be a need to reconstitute these buffers.
The capital conservation buffer is designed to be drawn down in times of stress and then replenished through conservation actions. As resolution represents extreme stress, this buffer can be assumed to be used and then it is entirely credible that a recapitalized institution will not pay dividends or discretionary bonuses while undergoing a restructuring plan. If this was not possible, the entire purpose of the capital conservation buffer would be called into question.
Depending on the resolution strategy, the recapitalised institution may be significantly smaller and less interconnected than before resolution. Thus the required O-SII/G-SII buffer should be reduced (if required at all) and this should be taken into account in the determination of the recapitalisation amount. The change in size may also have an impact on the application of systemic risk buffers, depending on their definition in individual countries.
Moreover, the 8% level of RWA as the recapitalization amount in resolution shall be estimated on the basis of the preferred resolution strategy and should reflect the likely decrease of RWAs in resolution. RWAs and total assets are likely to decrease either prior to resolution via recovery actions, or after the entry into the resolution, through restructuring, which is mandatory where bail-in is applied. Additional capital increase after the resolution should be a matter of a time plan agreed with the competent authority.
Finally, we consider the base assumption that the bank in resolution loses all of its capital as unjustified. Under BRRD the competent authorities have at their disposal tools and power to deal with the banks whose financial conditions deteriorate long before the losses deplete all of their equity. Thus, it is reasonable to assume that the institution going through a resolution will have some equity left.
We do not support the peer group approach in general, since it does not appear reasonable to require that an institution immediately after a resolution which is still undergoing a restructuring program operates with capital levels at the median of its peer group.
This is especially true with the respect to the capital conservation buffer. As referred to the inclusion of the capital conservation buffer into recapitalization amount in Q4, the institution should be allowed to rebuild its capital over time; otherwise it calls into question the entire purpose of the buffer.
It is also quite possible that the institution after resolution will no longer be SII and/or will belong to a different peer group of smaller sized institutions. Thus, to require it to operate immediately after a resolution with capital levels at the median of its former peer group seems to be rather unreasonable.
Additionally, the actual CET1 ratios of institutions are also a reflection of individual risk appetite, expected future business growth, capital targets, specific Pillar 2 requirements, national buffer requirements (in particular systemic risk buffers and countercyclical buffers) and to some extent business models, making them highly idiosyncratic. Simply requiring an institution to recapitalise to a median of O-SIIs does not take into account any of these factors.
Extension of the peer group approach to O-SIIs would bring additional challenges. One of them might be the likely low number of O-SIIs in some jurisdictions, which might make the calculation of the median capital levels not meaningful.
Other set of challenges is coming from the fact that the O-SIIs in a single jurisdiction might vary significantly in their business models and risk profiles. They would also represent a combination of domestic institutions and subsidiaries of banks classified as either G-SIIs or O-SIIs. Subsidiaries of global/regional institutions may not operate with the same internal buffers as local institutions, since management buffers are more likely to be held at the parent institution. All these factors would distort the sample data for the peer group.
Finally, in the Czech Republic where banks traditionally retain large portion of their earnings and hold significantly higher capital than prescribed by the supervisory authority, the peer group approach would actually discourage such a prudent practice, since it would backfire in spiral increase of MREL requirements for all O-SIIs.
Thus, we recommend especially for O-SIIs the required level of capital in order to achieve sufficient market confidence after resolution to be determined by resolution authority on a case by case basis.
We do not see any information in Articles 2 and 3 related to the differences in consolidated and subsidiary capital requirements and how they should be reflected in determination of the loss absorption and recapitalization amount.
As according to the BRRD the MREL level of a subsidiary will depend among others also on the consolidated requirement that has been set for the group, it is appropriate that RTS addresses how MREL requirement would be differentiated among subsidiary, parent and consolidated level respectively. As a minimum it should clarify the treatment of the intercompany exposures, intragroup guarantees or other form of intragroup support arrangements.
We agree with the de minimis exemption in principle, in order to avoid potentially complex assessment for not very material items. We believe that potential losses in liquidation are significantly higher compared to the losses in resolution, which could justify even higher threshold than 10%.
In cases where the 10% (or higher) limit is exceeded, the resolution authority is obliged to consider whether the exclusion of the particular liabilities from bail in could trigger the NCWO issue. We would prefer a clarification in the RTS on conclusions to be drawn from such an analysis. In any case, there should be no automatic need to increase MREL or require the institution to fulfil MREL through contractual bail-in instruments.
We agree on the point of the draft RTS to pay a special attention to systemic institutions and their MREL. However the RTS should also clarify that there is no automatic need to increase MREL levels for SIIs to 8% of liabilities if the RWA-based determination, as per Articles 2 and 3, resulted in a lower amount. The resolution authority should be required to assess whether the resolution plan can credibly and feasibly be implemented without recourse to the resolution financing arrangements and, if this is the case, no increase of MREL should be required.
Based on Czech Banking Association estimates (see the CZ Case study attached to our response), under the proposed calibration of MREL, the Czech banks will need to raise MREL-eligible liabilities in an amount representing around 5% of their assets, which is disproportionally higher than the aggregate shortfall of 128 EU banks, presented in the cost/benefit analysis attached to the RTS (0.04-0.11% of the assets).
Given the fact, that the Czech banking system is financed predominantly by primary deposits (the L/D ratio as of 30 June 2014 was at 79.8%), the amount of senior unsecured bonds issued by the banks authorized in the Czech Republic is almost zero. Since our domestic market for senior unsecured debt is not sufficiently developed, it will require substantially longer period of time to build the investor base for the required amount of debt to be issued, than the proposed transition period of 48 months.
Thus, we see as absolutely necessary to define the appropriate transition period only after comprehensive market survey, which would assess the depth of the markets for the MREL-eligible instruments, especially for those issuers, which are currently not present in the senior unsecured markets, or those established in jurisdictions where the senior unsecured market is not sufficiently developed.
In general we would recommend EBA to undertake analogue approach to impact assessment studies, accompanying FSB proposal for TLAC.
We believe that there should not be a particular transition period set for MREL, but rather the restructuring plan of the institution should define how the institution plans to rebuild its capital and MREL and also the appropriate timeframe for its implementation. It would better reflect the particular circumstances of the institution in the resolution and the prevailing market conditions.
In our opinion the draft RTS disproportionally affects banking sectors, which are highly capitalized and significantly penalizes particular business models – especially deposit funded banks focused on lending to domestic retail and corporate clients. Thus the proposal neither adapts MREL to the business model of individual institutions, nor promotes consistency in MREL setting across resolution authorities.
By ignoring the vast differences across jurisdictions with respect to the capital requirements imposed by supervisory authorities, the current RTS proposal actually exacerbates the existing divergent practices (by using the prudential requirements as the basis for both the loss absorption and recapitalisation amounts).
As a result, the MREL requirement for Czech D-SIIs could end up well above 30% of RWA, which highly likely exceeds the TLAC requirements for G-SIIs. This indicates significant competitive disadvantages for Czech banks rather than consistent approach across the Union.
Primarily, as MREL is going to be set for individual entities, the final impact assessment should not be conducted only at the level of the EU parent banks. Otherwise it leads to severe misinterpretations in terms of the impact in individual jurisdictions and/or on individual institutions.
Additionally, the impact analysis should consider Pillar 2 capital requirement, otherwise it vastly underestimates the actual MREL requirements and resulting shortfalls. As indicated in our answer to question 1, Pillar 2 add-ons in excess of 4% are not uncommon, which in case of D-SIIs focused on core business (and thus barely decreasing their size during resolution) would add 8% of RWA to total MREL requirement for the institutions concerned, i.e. 100% of their current Pillar 1 minimum own funds requirement!
As already mentioned in the answer to question 9, the final impact assessment should be accompanied by a comprehensive market survey, which should assess capacity of the debt markets in the countries with significant MREL shortfall. This should inform as to whether the demand of the institutions for MREL eligible liabilities could even be met within predefined transition period at reasonable costs for the institutions.
Additional issues to be considered
Using RWAs as the denominator for MREL
Based on Article 45, point 19(i) of Directive 2014/59/EU (BRRD), EBA shall assess by October 2016 whether it is more appropriate to use the institution’s risk-weighted assets or total liabilities and own funds as the denominator for the requirement. We would appreciate EBA performs this assessment as soon as possible and preferably reflects it in the technical standard from the very beginning. We believe that using RWAs as the denominator would better reflect the economic reality, and avoid some of the challenges connected with the current concept. Specifically:
• Using the total liabilities and own funds as the denominator can be misleading for some types of financial institutions /e.g. wealth managers/private banks), whose level of liabilities is very volatile. On the other hand, we believe that the standard should be kept simple and the basic calculation rules should not differ between various types of institutions.
• The current concept will cause problems also for banks, which might face large liquidity inflow (for example due to retail clients transferring money from mutual funds during a period of market turbulence, or from another bank hit by a crisis). Such a liquidity inflow might be difficult to manage and it would lead to a certain paradox, when the banks facing the liquidity inflow would have to issue new eligible liabilities on the market to restore MREL ratio.
• The prudential capital requirement is (naturally) based on RWA. RWA clearly indicates a level of risk the bank is taking. From a practical perspective, using the same denominator as capital adequacy ratio would make both the interpretation and the planning of MREL easier. Moreover, banks do typically have a capital planning process in place which also works with scenarios of a sudden RWA increase – and banks are able to assess a need to hold a (voluntary) capital buffer for this purpose. Should RWA be used as the denominator in MREL computation, it shall be easier to extend this concept to the planning of MREL.
• Another practical point is the fact that TLAC ratio is also going to use RWA as the denominator – thus, using RWA would make it easier for interpretation and comparability of the two indicators across banks in various jurisdictions.
Deposit guarantee scheme contribution to be clarified
From the RTS it is not clear, whether the resolution authority may reduce MREL by potential contribution from the DGS only in the case of institutions, which can be liquidated under normal insolvency proceedings (as specifically pointed in Art. 4 par. 3). To limit this possibility only to this specific situation would mean, that for these institutions the MREL requirement would be set below the total capital requirement (since AoR for institutions which can be liquidated under normal insolvency proceedings is zero) and this does not make sense. Thus it seems that the paragraph 3 is redundant. However we would welcome clarification whether adjustment of MREL by the potential DGS contribution is applicable for all resolution strategies.
Monitoring period would be appropriate before strict rules for MREL are implemented
Based on Art.45 of BRRD, EBA is mandated to draft an RTS specifying the assessment criteria mentioned in Par. 6 (a)-(f), on the basis of which MREL is determined. Subsequently the EBA is mandated according to BRRD Art. 45 Par. 19 to submit by 31 October 2016 a report to the European Commission on how the MREL has been implemented at national level, including divergences in the levels set for comparable institutions across Member States and the appropriate level of the minimum requirement for each of the business models. Only afterwards, if appropriate, the Commission should submit by 31 December 2016 to the European Parliament and the Council a legislative proposal on the harmonized application of the MREL.
In our view, given the existing detailed proposal for setting the MREL, EBA is rather ignoring the monitoring period and the calibration process, during which the resolution authorities are expected to determine MREL of individual institutions based on the criteria in Art. 45 par. (a)-(f) reflecting the institutions´ particular business model and funding model.
We consider that before setting strict rules a certain monitoring period is absolutely necessary as it will enable EBA to collect sufficient data about MREL levels of institutions with various business models, funding models and the risk profile across the Union and assess their adequacy and subsequently adjust the requirements in a way which leads to a harmonized approach across the Union. This impact study should be accompanied by a market research, assessing the absorption capacity of the market for the MREL instruments, especially for the issuers, which are currently not present in the senior unsecured market or those established in jurisdictions where the senior unsecured market is not sufficiently developed.
Additional benefit of such an approach would be a possibility to harmonize the MREL requirement with final FSB proposal on TLAC of G-SIBs, which would be released in the meantime.
In the meantime we believe that the goal of a harmonization of the MREL requirement for similar institution will be better achieved by giving sufficient flexibility to the resolution authorities to determine the MREL in a process of an intensive dialogue in the resolution colleges.
Proportionality is crucial
The RTS leads to serious competitive disadvantages for deposit funded banks with simple business models. The application of the RTS on MREL should not force them to issue MREL eligible debt instruments, which they do not need. Those banks may have no appropriate assets, which would be in compliance with their conservative business/investment strategy, to be funded by the additional liquidity.
Inadequately high MREL levels would lead in the Czech Republic to artificial expansion of the banks’ balance sheet and deterioration of their risk profile, since they would be forced to invest the funds into riskier assets (due to lack of assets with acceptable credit quality in the domestic market, or in order to compensate for increased funding costs). The negative impact on profitability from higher funding costs would also significantly affect their capital generation capacity.
Low levels of eligible liabilities (senior unsecured bonds, long-term funds from institutional investors and large corporates) in the Czech market would additionally lead the banks to search for funding in a foreign currency which would induce FX risk or extra costs for hedging.
Thus we propose in order to reflect specific business, funding models and/or various stages of market development for resolution authorities to retain sufficient flexibility to decrease MREL under the following circumstances:
• In a case the final MREL level would lead to undesirable consequences, contradicting the prudential requirements (higher leverage, increased interconnectedness of the financial sector, necessity to bring FX risk into balance sheet in case of undeveloped local market for MREL-eligible liabilities, increased riskiness of the balance sheet of the institutions concerned, etc.)
• In a case of institutions with specific business model implicitly assuming financing by retail deposits acquired from private individuals and investing within limited range of highly liquid assets defined by legal framework (i.e. building societies). This would help to ensure level-playing field with mortgage banks financed by covered bonds, which are exempt from MREL requirement
Such flexibility could be justified by
• reflecting intra group guarantees/ payment commitments provided to the institution by the parent company
• reflecting the size of other bail-in-able liabilities, which do not qualify for MREL (especially in the markets with limited amount of contractually long-term liabilities)
• institutions’ recovery plan being sufficiently credible that it is reasonable to assume, that the probability of the institution entering resolution is substantially reduced and any worsening of financial position or excessive risk taking by the institution will be detected sufficiently in advance before all the own funds are depleted