21st July 2014

GLAC – a beginner’s guide

Written by Adam Cull, the BBA’s Senior Director (Financial Policy and Operations)

This morning’s FT reported that Bank of England Governor – and Financial Stability Board (FSB) Chairman – Mark Carney is spearheading a push to agree new standards for “gone concern loss-absorbing capacity” (GLAC) to be held by Global Systemically Important Banks (G-SIBs). But what is GLAC, and why does it matter so much that the FT have put it on their front page?

Ending the problem of “too big to fail” has underpinned much of the post-crisis regulatory agenda – and a lot of progress has been made. In 2011, the Financial Stability Board agreed on a set of new tools to govern the orderly failure of banks. These rules have now been adopted in many jurisdictions, including the EU through the Bank Recovery & Resolution Directive (BRRD).

The key weapon in regulators’ new toolkit is known as “bail-in”. This grants resolution authorities the power to stabilise a failing bank by imposing losses on its creditors. The power can then be used to convert creditors’ interests into new capital to ensure the restructured entity can continue to provide critical economic functions. It means that banks and their creditors, not the taxpayer, will be responsible for the costs of failure in the future.

The question being debated by the international regulators is: does bail-in need to be accompanied by a guarantee that a minimum amount of “bail-inable” liabilities will be available in the event of failure?

Bail-in imposes losses in accordance with a creditor hierarchy. Losses follow the waterfall from equity through subordinated debt and ultimately to senior creditors. In recognition that not all liabilities can be bailed-in the BRRD excludes some classes from the scope of the power, such as insured deposits and secured liabilities. To ensure there are sufficient resources available on the balance sheet to absorb losses the BRRD requires institutions to hold a minimum amount of their liabilities in a form which can be readily bailed-in (so-called ‘MREL’). This, effectively, is the idea that lies behind GLAC.

The negotiations underway at the FSB are attempting to identify the types of liability that can most credibly absorb losses in resolution via bail-in and should therefore count towards any GLAC requirement. At the same time, the FSB is discussing how much of a G-SIB’s balance sheet should be held in this form and where across the group structure this capacity should be located.

The discussions are challenging given the very different legal and market structures of the FSB countries. Banks also have a range of business models and this translates into varying envisaged resolution strategies for the 29 G-SIBs.

For example, long-term senior unsecured debt is often regarded as the prime bail-in instrument. Indeed it was identified as such by the UK’s Vickers’ Commission. However, many banks in the East and emerging jurisdictions are deposit funded and operate in markets with very shallow capital markets. Not surprisingly, they are opposed to a standard which would require them to issue new debt just to meet this requirement – even if there were the buyers available.

Reaching an agreement on GLAC is important for two reasons.

First it would enhance the credibility of resolution and the bail-in tool. This, in turn, could help to build trust between authorities in different jurisdictions. If successful, it would address the fear that national authorities will seek to protect their own interests in a crisis and will not work together to coordinate the orderly resolution of a cross-border institution. It may even prove to be a way of providing confidence that a group level strategy is optimal and in the interests of all parties.

We’ll just need to wait until November to see whether Dr Carney is as successful at reaching international agreements as he has been on a domestic level.

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