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But what has really upended the world of banking is the reformed regulatory landscape. How a bank is positioned with the authorities — both the prudential and the conduct supervisors — is now a decisive factor in determining whether it is a decent investment.
And, in less than a month, the next phase of the regulatory crackdown begins. EU authorities will tell the banks what their debt funding requirements are, under incoming rules on Minimum Required Eligible Liabilities.
MREL is the EU version of the global TLAC standard, governing banks’ Total Loss Absorbing Capacity. Not only are the acronyms annoying, but the rules themselves are fiendish and the planned implementation methods are inconsistent across different countries.
However, the basic MREL principle is straightforward: in one of the last steps by policymakers to make the banking system safer, lenders will be forced to issue a certain amount of loss-absorbing debt. This should ensure that banks — especially large, systemically risky ones — are not only funded with solid levels of equity capital, but have large buffers of debt that can flip into equity in an emergency. Some bonds, such as “cocos”, will aid last-ditch rescue efforts. Others, such as the “tier 3” instruments that are due to be defined in MREL requirements, will be a means to liquidate a bank that has failed.
Spanish regulators, for example, are worried that if the final rules are at the stricter end of the possible range, they could be disruptive to the system. Concern is focused not on the likes of Santander and BBVA, but on midsized institutions that could find it hard and costly to comply. In Spain, as in Germany and Italy, there are large numbers of smaller lenders. It is still not clear which of them will have to issue MREL. Those that do will find the cost eats into already thin lending margins. Ironically, their ability to survive could be threatened by a systemic safeguard.
However, on MREL at least, Deutsche should have little to fear. Although the market seemed spooked by reports that the German government will not help it with the DoJ, some aid has been forthcoming. Thanks to a change in German law, banks’ senior debt will be made subordinate to other senior creditors, automatically making it MREL-compliant. That change should logically have hurt the valuation of Deutsche’s bonds, especially if the bank has no future, as its equity valuation — equivalent to just 23 per cent of its book value — suggests. So far, it has not.
Full article on Financial Times (subscription required)