Czech bankers fear EU bail-in rules’ impact

The facade of the Czech National Bank. [CNB]

New EU rules that will force losses on big depositors and bondholders over the heads of national regulators could detstabilize banks in some countries and pose a systemic risk at the European level, Czech bankers have warned. EURACTIV Czech Republic reports.

Work on new European standards for national regulators is underway. But the Czech Banking Association (?BA) said if real risks, specific business models, and other country specific elements are not properly addressed, market stability could be hit.

“If [the standard] is approved in the form in which it was initially drafted, we will see convergence of business models across the EU,” Monika Laušmanová, chairwoman of the committee for banking regulation of ?BA, said.

“But while it makes western European banks more stable, Czech banks will go in the opposite direction. The market will get riskier,” she added.

The European Banking Authority (EBA) is a pan-EU supervisor, which is tasked with ensuring effective and consistent prudential regulation.

Early in July, the EBA submitted a draft regulatory standard on how bank balance sheets should be structured so that they are resilient to shocks to the European Commission.

The standard seeks to clarify rules outlined in the EU’s Recovery and Resolution Directive (BRRD) adopted in 2014.

Regulators are expected to tell banks what are the minimum requirements on “eligible liabilities” (MREL) they are supposed to have, so that they are ready for any future failure.

According to the BRRD directive, eligible liabilities generally involve own funds (equity) and long term debt (bonds).

An initial draft proposal that was submitted for stakeholder consultation at the end of the last year went through considerable changes.

Although, the current version allows for more flexibility and let national regulators to take account of national specificities, Czech bankers are worried that the battle has not been won yet.

David Rozumek is executive director of the Czech National Bank’s Financial Market Supervision Department. He is also a member of the Board of Supervisors at EBA.

He told EURACTIV that further changes to the draft standard cannot be ruled out. There are still many conflicting opinions and it is likely that some countries or institutions would attempt to make some last minute changes to the text before it is finally adopted by the Commission, he said.

“The previous draft proposal on MREL was formed in a way that would effectively weaken financial position of Czech banks,” Rozumek said.

Such a consequence would be “absurd” given the intention of regulators to bring more stability to the sector, he said.

What is at stake?

Although the latest draft was softened, bankers are still trying to raise awareness of unintended effects that, in their view, might materialize if the standard is not properly calibrated.

Bankers claim that if regulators were not allowed to take into account local market conditions, their business model that proved to be successful during the last financial crisis will be turned upside down.

Unlike other European banks, the Czech banking sector sailed through the financial crisis virtually unaffected.

While banks in the Eurozone sought public help to avoid default and their returns were modest (at best) Czech banks experienced double digit rate of returns (Return on Equity, ROE, ranged 16.2-26.4 % between 2008 and 2014).

“The Czech banking sector has a very conservative business model,” Laušmanová explains. “Banks concentrate on the local market and at the same time, satisfy most of its financial needs. Banks are predominantly financed by equity and primary deposits and have high levels of liquidity.”

While Eurozone banks have, on average, more loans than deposits, Czech banks are in the opposite situation.

“[Czech banks] are also prudent and do not invest large volumes in high-risk assets. Our banks had only a negligible quantities of toxic assets in their portfolios”, Laušmanová said.

Prudent regulator

The Czech National Bank sets much stricter capital requirements than regulators in other EU countries. But more regulation does not mean that there is more risk in the market. According to ?BA, it rather reflects pridential behaviour of central bankers.

But capital requirements and reserves are important also in the context of the new standard. As described in a draft text, all capital requirements and buffers are major variables that regulator needs to consider when setting a level of minimum requirement of eligible liabilities (MREL).

For systemically important banks, rules should be even stricter. While smaller banks will be required to have enough equity and long term debt to cover incurred losses, systemically important banks should have enough resources to cover not only losses but also costs of recapitalization.

According to the draft, large banks are expected to raise total volume of eligible liabilities to a level that equals double the amount of all capital requirements, reserves, and buffers that are currently prescribed by the national regulator.

In other words, if set in this way, new MREL standard would mean that Czech banks would need to exert much greater effort than other European banks with a similar risk profile but less stringent regulation.

Unnecessary debt can jeopardise market stability

But there is yet another potential consequence of setting the MREL standard too high. “Czech banks simply do not have the kind of liabilities that could be qualified as eligible,” Laušmanová said.

If the regulator is really obliged to count all capital requirements in the MREL, Czech banks would need to raise their debt considerably. ?BA estimates that an average bank would need to raise the debt by 4.9 % of total assets, although they don’t need it.

Czech banks would need to go international in terms of their investments. With a new debt comes a new liquidity and that will need to be invested somewhere. The problem is that there are almost no opportunities on the local market, bankers claim. Since banks will need to recover higher costs related to the new debt, they will need to invest in riskier assets, ?BA said.

Bankers therefore believe that if the regulation is too tight, it might worsen stability of the local banking sector. On top of that, higher interdependence with other countries can adversely impact stability of the European banking sector.


The draft proposal gives national regulators more opportunity to consider local market conditions. But Czech bankers and their regulator remain concerned that flexible arrangements might get weakened before the final text is adopted.

However, David Rozumek, who is responsible for financial market supervision at the Czech National Bank, was ready to clarify that more flexibility for the regulator does not necessarily mean that banks will get around the obligation to issue a new debt.

“It would not be right to conclude that by allowing certain flexibility within a technical standard, all institutions can be sure to satisfy MREL without a need to issue new debt or equity,” he stressed. On the other side, he claims, with less stringent rules, regulators will be able to take into account specific market conditions.

The EBA draft standard is with the European Commission. If it is adopted, it will go to the European Parliament and Council for consultation. If there are objections, the Commission can ask the EBA for redraft. The standard is expected to enter in force from 2016.

In response to the financial crisis that forced taxpayers to shore up European banks, the EU adopted a range of legislative measures with the aim to prevent, or at least minimize, risk of future bailouts.

In line with the updated rules of the Basel Committee on Banking Supervision, known as Basel III, EU adopted a new regulation and a directive on capital adequacy (CRR, CRD IV). Enacted in 2013, the legislation equipped national regulatory bodies with additional means to strengthen resilience of banks to future shocks. Based on these rules, national regulators can order banks to increase their levels of capital that would help them to cope with market risks.

The new Banking Recovery and Resolution Directive (BRRD) introduced the bail-in principle in the banking regulation in 2014. While in the past, systemically important banks often needed public money in order to survive their default, in the future, losses and costs of restructuring should be “bailed in”. Once the directive is fully in force, not only a bank's shareholders but also bondholders and even large depositors would have to lose money. Although the directive was adopted in 2014, there is still some time before it gets fully implemented in 2016.

The European Banking Authority (EBA), whose mission is to “ensure effective and consistent prudential regulation and supervision across the European banking sector“, has prepared a draft of delegated act that has specified detailed rules for all member states. A new standard would tell national regulators how to determine a minimum level of so called “eligible liabilities” (equity and bonds that can be used for purpose of bail-in) for individual banks.

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