MREL: A big challenge

In early March 2019, EU authorities reached an agreement on the Bank capital legislative package, including changes to the Bank Recovery and Resolution Directive (BRRD2). The legislation is not yet final as official vote is expected in May 2019.

One of the main components of the legislative package is the setting of the Minimum Requirement of Eligible Liabilities and Own Funds (MREL). The purpose of MREL is to ensure effective implementation of the bail-in tool, that is shareholders and creditors are the first to absorb losses when a Bank fails. MREL was first implemented through the BRRD in 2014 and upcoming amendments are expected to be applicable from January 2024.

The toughest part of the previous years’ negotiations revolved around the issue of capital amount required and the degree of subordination. The MREL is composed of the Loss Absorption Amount (LAA), comprising the Pillar 1 and Pillar 2 Requirement capital, and the Recapitalization Amount (RCA), comprising the Pillar 1, Pillar 2 Requirement and a buffer capital. The issue of subordination relates to how much of the MREL capital requirement will have to be met with subordinated liabilities (ranking below senior debt).

From the above, it is obvious that the MREL implementation is a huge challenge for European Banks, let alone local Banks, both in terms of capital requirement and subordination. For the first, a rough calculation indicates that the MREL capital requirement is expected to be at least twice the capital requirement of the Bank. For the second, it is obvious that issuance of MREL eligible instruments will increase funding costs and consequently impact the profitability of the Bank. It is expected that Banks from peripheral countries, including Cyprus, will display greater MREL shortfalls in comparison with Banks from core countries. These shortfalls are due to the fact that some Banks and financial systems rely to a greater extent on senior debt as their source of funding (core countries) while others tend to focus on deposits (peripheral countries and small Banks). In addition, Banks from peripheral countries have limited access to international capital markets, a fact that will further hamper their efforts to raise the required subordinated debt.

Christina Antoniou Pierides
Christina Antoniou Pierides
Senior Advisor / ACB