15 November 2017

Banking: Creditor hierarchy, IFRS 9/large exposures rules approved by the European Council

The draft regulation also contains a phase-out of provisions on the large exposures treatment of public sector debt denominated in non-domestic EU currencies.

Creditor hierarchy in insolvency proceedings

Directive 2014/59/EU on bank recovery and resolution subordinates uncovered deposits (above €100 000) to covered deposits in the event of insolvency proceedings. It establishes a preference for natural persons and SMEs. It does not provide, however, for subordination for senior unsecured debt securities versus other forms of unsecured debt claims.

The draft directive therefore requires member states to create a new class of 'non-preferred' senior debt, eligible to meet the subordination requirement.

It will thereby facilitate the application of EU bail-in rules in cross-border situations and avoid distortions of the EU single market. A number of member states have amended or are in the process of amending their insolvency laws. The absence of harmonised EU rules creates uncertainty for banks and investors alike.

IFRS 9 and large exposures

The regulation will mitigate the potential negative regulatory capital impact on banks of the introduction of International Financial Reporting Standard (IFRS) 9.

Use of IFRS 9 by banks may however lead to a sudden increase in expected credit loss (ECL) provisions and a consequent sudden fall in their regulatory capital ratios. Transitional arrangements are needed from 1 January 2018, consistent with use of the new accounting standard. It was therefore decided to split and fast-track the entry into force of certain provisions from a broader November 2016 Commission proposal amending regulation 575/2013 on bank capital requirements.

The resulting draft regulation will allow banks to add back to their ‘common equity tier 1’ capital a portion of the increased ECL provisions as extra capital during a five-year transitional period. That added amount will progressively decrease to zero during the course of the transitional period.

The draft regulation also provides for a three-year phase-out of an exemption from the large exposure limit for banks' exposures to public sector debt denominated in the currency of another member state.

Press release

November 2017 draft directive on the ranking of unsecured debt instruments

November 2017 draft regulation on transitional arrangements for introduction of IFRS_9

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