To the unwitting bank investor, the post-crisis environment has become a hellish twist on the old ways of doing things. A decade ago, a simple bank could make a decent margin, paying less for its own funds than it received from the loans or securities on its balance sheet. Now, negative interest rates and quantitative easing are making the maths far more challenging.
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.
Deutsche Bank, caught in a feedback loop of punishment and demands from authorities in the US and Europe, is a sorry example. Its capital buffers, already relatively weak, would be blown apart if the US Department of Justice presses ahead with a threatened $14bn fine for mortgage securities abuses. Under attack from short-selling investors, Deutsche’s shares fell a further 6 per cent in morning trading on Monday, hitting another record low.
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.
So far, so reassuring. But MREL is dividing the European banking establishment. A bearish faction is alarmed by the sheer scale of MREL securities issuance. Some analysts estimate that EU banks may need to issue more than €3tn-worth. They question whether investor demand would be sufficient, and at what cost to the banks.
New research by Morgan Stanley is less alarmist. Its base case is that only €376bn of issuance would be required by the EU’s top 32 banks. On a net basis, assuming that MREL debt replaces maturing senior debt, there would be no overall shortfall, according to Morgan Stanley’s estimates. Nearly €200bn more senior debt matures by 2019 than would need to be issued under its MREL projections.
Santander’s estimated issuance requirement
A few banks stand out with large estimated issuance requirements: Santander (€54bn), BNP Paribas (€53bn), UniCredit (€37bn) and BBVA (€32bn). But, on a net basis, even they have modest shortfalls of between 0 (UniCredit) and €20bn (BBVA). “MREL figures should be a relief, not a scare,” the Morgan Stanley note concludes.
Not everyone is convinced. 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.