Making Retail Banks Resolvable

The establishment of Banking Union and the Single Resolution Mechanism (SRM) in the Eurozone constitutes a turning point for the European risk management framework.[1] Bank failures should, in principle, no longer be dealt with taxpayer money but should be instead either liquidated or resolved on public interest grounds with the use of internal and collective industry funding. However, given the deliberate policy decision to minimize the use of collective industry financing in resolution, the success of the EU bank resolution framework depends on the capacity of banks’ internal funding structure to absorb losses and, if need be, recapitalize the bank, coined ‘minimum requirement for own funds and eligible liabilities’ (MREL). According to the European framework, the MREL should apply to all European banks and comprises equity and subordinated debt.

However, resolution experience and evidence thus far, indicate that the current resolution framework might not be enforced effectively on all bank business models, especially on retail deposit-funded banks. Retail banks can be either significant or less significant, are primarily funded through deposits (40%< of total liabilities and own funds), conduct minimal, if at all, trading and wholesale activities, and have historically played a very significant role in the financing of the European real economy, whilst proving resilient during the crisis. Some European national markets comprise entirely retail banks, which makes the issue of their resolvability rather pressing. In this context, I analysed in a recent paper the enforcement of bank resolution on retail banks in order to identify regulatory weaknesses and recommend solutions.

The paper theoretically tests this MREL-based resolution framework by taking all three available scenarios upon a bank’s failure: open-bank bail-in, national liquidation, and transfer-based resolution.

In particular, open-bank bail-in requires significant internal MREL buffers to succeed – likely higher than what is currently assumed by regulators due to the lack of available information on historical losses of European retail banks, and due to a likely underestimation of how many less-significant retail banks may need to enter resolution. High MREL, however, can prove costly for retail banks due to their funding model which relies primarily on deposits and thus does not allow them to offset the higher cost of capital.

Transfer strategies seem indeed more suitable for retail banks, given the higher chances of being sold to a larger competitor in conjunction with the lower MREL requirements attached to them. However, credible collective funding is required to cover resolution costs instead of applying bail-in beyond junior creditors, possibly to unsecured depositors.

Administrative liquidation, even though similar to resolution transfer strategies, provides national authorities with more leeway to circumvent resolution as was the case with the administrative liquidation of the Veneto banks in Italy in 2017. Overall, under different reasoning, all three scenarios seem to lead to a deadlock situation due to the lack of sufficient collective financing available for resolution purposes.

However, transfer strategies are more likely to succeed given the realistic possibilities for the use of the sale of business tool, combined with the use of bail-in to cover losses and part of the recapitalization needs. However, it is of paramount importance that bail-in does not exceed the 8% threshold of the bank’s total liabilities and own funds (TLOF) and does not affect uncovered depositors. Hence, credible resolution financing is required that could exceed the current 5% TLOF limit. Assuming that amending the 5% threshold is not possible, this paper argues in favour of establishing national voluntary collective industry funds, similar or identical to institutional protection schemes, that banks could join in exchange for lower MREL requirements.

Ultimately, using transfer strategies funded through voluntary funds would significantly decrease the overall MREL requirements for retail banks, and would enhance their resolvability without threatening their viability.

Ioannis is a PhD Researcher in Banking and Financial Law at the University of Luxembourg’s Faculty of Law, Economics, and Finance, and an Affiliated Researcher at Goethe University’s Center for Advanced Studies on the Foundations of Law and Finance.

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[1] The EU bank resolution framework comprises: (i) the Bank Recovery and Resolution Directive (BRRD), which harmonizes substantive rules across the EU, and (ii) the Single Resolution Mechanism Regulation (SRMR), which establishes a centralized procedural framework and establishes a European resolution authority, the Single Resolution Board.


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