Article by Director Elisa Ferreira in the magazine of the Eurofi conference in Malta: "Financial stability impact and considerations on MREL"
The Minimum Requirement for Own Funds and Eligible Liabilities (MREL) set out in the BRRD is an essential tool for resolution authorities, as it helps to ensure that banks have sufficient loss absorbency capacity under resolution without affecting liabilities that are key to the continuity of the banks’ business and without relying on taxpayers’ money.
However, the design and implementation of the MREL framework was not without its faults. The problems were broadly identified by the European Commission in the legislative proposals presented in November 2016, but further work is still needed.
Firstly, the BRRD failed to fully take into account the fact that banks would not be able to comply with MREL immediately after its entry into force. This is true for banks in general, but more so in the banking systems that are still recovering from the aftermath of the financial and sovereign debt crisis.
Also, the criteria for setting the MREL laid down in the BRRD, and further developed in the Delegated Regulation, may lead to a significant amount of MREL shortfalls. This is especially the case if those criteria are applied mechanically, without taking into account the specific resolution strategy for each bank and national specificities regarding access to markets and debt issuance needs.
These potential MREL shortfalls present significant risks, of a systemic nature. It is unlikely that markets will be able to absorb smoothly such large volumes of debt issuance. It could even be argued that the magnitude of the requirements being imposed on banks might cast doubts on the ability of banks to address them, which in turn would undermine the credibility of the whole MREL process. Moreover, it cannot be excluded that, if trapped between large MREL requirements and an inability to access financial markets, and given the current low interest rate environment, there might be a perverse incentive for banks to expand their balance sheets and aggravate their risk profile to offset higher funding costs, with riskier practices that would endanger financial stability.
At international level, it also cannot be ignored that the scope of the MREL requirement goes beyond that of the TLAC. Whereas the TLAC applies only to G-SIBs, the MREL requirement applies to all credit institutions in the EU, regardless of their size. Proportionality is thus crucial, in order not to compromise the level playing field.
Taking all of this into account along with the experience gathered so far, it is important that a proper transitional period is provided for, covering the compliance timeline, composition of MREL and location of loss absorbency capacity within the resolution group. In this way, banks would have enough flexibility to adapt their activity and funding structure in a manner that could be accommodated and would not promote unintended behaviours. This would allow systemic impacts arising from the MREL to be taken into account.
In conclusion, the importance and benefits of MREL are indisputable. But, in its design and implementation we must weigh the possible negative spillovers arising from large MREL shortfalls and consider the overarching principles that presided over the creation of the resolution framework, with the ultimate goal of not endangering financial stability.