10, 2017 / 9:16AM / Fitch Ratings
The EU's recent agreement to introduce a new
debt class, non-preferred senior, is an important step towards clarity on how
troubled EU banks will be resolved, Fitch Ratings says. Non-preferred senior
debt will help shield preferred senior obligations from default in a
resolution. We expect it to become a material component of banks' minimum
requirement for own funds and eligible liabilities (MREL), which will reduce
the need to use state resources to protect financial stability. EU member
states will have to implement the new debt class into their national
legislation by January 2019. Notably, France has already done this and Italy
started the process last week.
Once banks have built up sufficient subordinated and non-preferred senior
liabilities to meet MREL, or the similar total loss-absorbing capacity (TLAC)
requirements for global systemically important banks, bail-in under resolution
should be easier to apply without threatening financial stability. It is likely
to be more palatable for authorities to bail in non-preferred senior debt,
assuming it is not widely distributed to retail investors. Contagion risk is
likely to be limited given that the purpose of the new instrument is to act as
a buffer for other senior creditors in resolution or insolvency, particularly
uninsured deposits and senior operating liabilities.
Alignment of creditor hierarchies across member states will reduce the risk of
legal challenges, particularly for resolution of cross-border banking groups.
The treatment of troubled banks in Spain and Italy this year raised questions
about the consistent application of EU rules and approaches to failing and
Senior creditors of Spain's Banco Popular were spared losses when the bank was
sold to Banco Santander under the resolution process, following an extreme
liquidity crunch, with losses borne by shareholders and junior bondholders
being sufficient to meet its estimated equity shortfall.
Italy's Banca Popolare di Vicenza and Veneto Banca were able to issue
state-guaranteed bonds to support liquidity; their failure related to solvency.
Shareholders and junior bondholders bore losses but state funds were used in
the national insolvency process applied to these banks and senior creditors
State aid in conjunction with avoidance of losses by senior creditors may
appear to go against the EU's principle that a high degree of losses should be
imposed on creditors before state funds are used. Italy justified the state aid
on the grounds that regional contagion risk that could have arisen from a
disorderly wind-up would be mitigated by enabling another bank, Intesa
Sanpaolo, to purchase parts of the two banks' activities.
The Italian authorities were particularly
reluctant for senior debt to be bailed in, as many retail investors in Italy
hold senior debt, and losses for them could hit financial stability. Senior
bondholders would have been vulnerable to losses if the banks had been put into
resolution, given their thin junior debt buffers.
The Banco Popular resolution and the use of sovereign funds to prevent senior
debt default at the Italian banks do not change our view that extraordinary
support for senior creditors of the vast majority of EU commercial banks, while
possible, cannot be relied upon. EU bail-in rules, liquidation risk and the
phase-in of non-preferred senior debt - a reference liability for our Issuer
Default Ratings (IDRs) - mean a high likelihood of some form of default at the
IDR level when a bank fails.
The agreement to create the new debt class was
reached by the European Parliament, European Council and European Commission on
25 October. It will be subject to a plenary vote in the European Parliament