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From 1 July 2017, the finance and banking industry operating in the UK will be represented by a new trade association, UK Finance. It will represent around 300 firms in the UK providing credit, banking, markets and payment-related services. The new organisation will take on most of the activities previously carried out by the Asset Based Finance Association, the British Bankers’ Association, the Council of Mortgage Lenders, Financial Fraud Action UK, Payments UK and the UK Cards Association.x
On Friday the Bank of England published indicative MREL numbers for UK banks.
This confirms what we already knew – the huge scale of the future “minimum requirement for own funds and eligible liabilities” (MREL), trailed by the Bank in November last year.
But the publication is also a landmark.
The numbers define the home straight of the long journey out of quicksand that nearly swallowed the banking industry in 2008.
That journey will end on 1 January 2022, when each large firm will hold twice as much MREL as its total minimum capital requirement (Pillar 1 plus Pillar 2A).
This level is in line with the international standard for systemically important banks, and so not in the Bank or England’s gift.
But the Bank has set a qualifying threshold of between 40,000 and 80,000 active accounts, which catches medium-sized banks in the requirement. We welcome the Bank’s having made this more flexible, compared to an original hard cut-off of 40,000 accounts. However, there is still a risk that this may discourage smaller banks from growing, and so weaken competition.
Why does MREL matter?
MREL is loss-absorbing capacity. Having enough MREL means that if a bank fails, its investors pay to resolve it, not the taxpayer.
This works because MREL is a mix of equity and unsecured debt. When a bank goes into resolution this unsecured debt is “bailed-in” (converted into equity). Shareholder capital can then be written off to cover the bank’s losses and to re-capitalise its surviving business, providing critical economic functions such as deposit-taking and payments. All this would be done without disrupting the bank’s customers, or reducing the supply of credit to the economy.
MREL is the last step in fixing “too big to fail”.
What do the numbers tell us?
By 1 January 2022, the six largest UK banks will hold MREL equivalent to between 21.6% and 25.9% of their Risk-Weighted Assets (RWAs). RWA is a measure of a bank’s assets or off-balance-sheet exposures, weighted by how risky they are. Banks have different MREL requirements because each has an individual resolution plan, with specific funding needs, that MREL aims to meet.
The average requirement for smaller banks is 22% of RWAs. These are Clydesdale Bank, Coventry Building Society, Metro Bank, Skipton Building Society, Tesco Bank, Virgin Money, and Yorkshire Building Society.
The burden on these smaller banks is too heavy. We have voiced concern before about the impact of MREL on banks that are not systemically important. We hope that the Bank of England will re-visit the 40,000 to 80,000 active account threshold in the future.
What happens next?
Banks will gradually build their stock of MREL-qualifying liabilities. We have to wait and see if the market has enough capacity to cover the scale of MREL needed over the next five years – across the EU, this may be €300bn.
The Bank of England plans to review the level of MREL requirements by the end of 2020, when it will set final MRELs. It may then take into account any difficulty banks have had in issuing qualifying liabilities.
The cost of MREL is unknown. The EBA has suggested that in the worst case it will approach the cost of equity, which it estimates as 8%. MREL is expensive for banks because investors have to be compensated for the risk of being bailed-in.
The home straight
With the finishing line in sight, the banking system is already much stronger than it was before the 2008 crisis.
As Mark Carney has noted, the resilience gained by higher loss absorbing capacity comes at a cost to us all. In a letter to Andrew Tyrie, the Chairman Treasury Select Committee, he said:
“…bank capital is not costless to society. If capital requirements are increased, some of those costs will be passed on to households and businesses in the real economy“.
He then stressed that the targets for loss-absorbency (MREL plus capital buffers) are already much higher than those original proposed by Sir John Vickers, through the Independent Commission on Banking.
The balance has been now been struck, at a certain cost to society.