BANKS COME UP AGAINST TOUGH MARKET FOR BAIL-IN DEBT / THE FINANCIAL TIMES

Banks come up against tough market for bail-in debt

After the crash, banks were ordered to raise a new form of debt. It has not been easy

David Crow


Firm stance: the ECB in Frankfurt supervises eurozone banks © Getty


“Never again will the American taxpayer be held hostage by a bank that is too big to fail,” said Barack Obama in 2010, as he unveiled a series of post-financial crisis reforms designed to make the banking system safer. A decade later, the largest US banks have only become bigger.

In a speech in the City of London last month, Christine Lagarde, managing director of the International Monetary Fund, noted that in the US, “the top five banks now hold about 45 per cent of total banking assets, compared with about 40 per cent in 2007”.

Given the persistence of the “too big to fail” problem, global policymakers have introduced measures designed to ensure that banks facing failure can be saved without resorting to taxpayer bailouts. Chief among these efforts is the introduction of a new type of “bail-in” debt designed to prop up banks in a future financial crisis, known as total loss-absorbing capacity (TLAC) debt.

The idea is that a bank teetering on the edge would first be able to use its equity to absorb the losses and then recapitalise itself by “bailing in” some of its bondholders.

The world’s largest banks, which pose the greatest systemic risk, must raise bail-in debt equivalent to 18 per cent of their risk-weighted assets by 2022, under rules from the Financial Stability Board, the international body that monitors the global banking system.

In the EU, policymakers have gone further by stipulating that most banks — including small and medium-sized lenders — must raise a similar type of bail-in debt known as the “minimum requirement for own funds and eligible liabilities”, or MREL.

Banks in this situation face a daunting task, especially in Europe. Analysts at UBS estimate that EU banks will need to issue €450bn of TLAC and MREL instruments this year to comply with the new rules.

But it is a tough funding market, with investors concerned about low profitability and, in Europe, political volatility. Banks have had to pay more than usual to issue debt. In November, UniCredit, Italy’s largest bank, offered a hefty 7.83 per cent coupon on a so-called senior non-preferred bond, which counted towards its bail-in debt requirements.

Mark Geller, a debt capital markets banker at Barclays, says there has been “robust demand” so far from investors for the new class of bail-in debt.

“There have been periods of market volatility as we saw at end of last year,” adds Mr Geller.

“But I think the fact that banks have been careful around issuing to keep on track to meet their deadlines has given them the opportunity to steer clear of some of the more difficult environments.”

However, there are concerns that bail-in debt, which has proven to be more expensive to issue than many bank executives had hoped, could weigh on profitability at lenders already struggling to generate good returns.

Ironically, although bail-in debt was designed by regulators to insure banks against failures, the process of raising MREL in fact threatens to weaken the viability of some lenders.

Analysts at Barclays reckon that the issuance of bail-in debt could wipe up to 2 per cent off the pre-tax profits of European banks over the next few years, rising to 8 per cent if funding markets were to become more challenging.

There is little need for alarm, argues Thibault Godbillon, a policy expert at the European Banking Authority, the regulator. “You need to be careful when you say ‘banks need to issue new debt’,” he says. “In the majority, banks are replacing existing debt as opposed to issuing new debt. It’s an incremental cost but it’s not an absolute cost.”

Mr Godbillon points out there are “other ways to meet the requirements”, which mainly involve making a lender less risky or combining it with a larger, healthier bank.

“You can merge with another institution, you can reduce your risk-weighted assets, lower your risk profile, maybe make a bit less money,” Mr Godbillon says. “There are other options that are there for sure.”

But Jérôme Legras, head of research at Axiom Alternative Investments, warns that some of Europe’s more fragile banks will find it hard to issue bail-in debt, such as “Italian mid-caps or Greek banks”. He agrees that the MREL requirements will lead to deals in the European banking sector.

“I think it’s going to increase consolidation, and in a few cases where no other options [exist] banks will have to issue new equity, but it will be extremely expensive,” says Mr Legras.

Nor is there any guarantee that bail-in debt will work as planned in the event of the next global financial crisis, when governments may decide that bailing out banks — especially ones of national or global systemic importance — is a better option than relying on an untested system.