BoE: Setting the Minimum Requirement for own Funds and Eligible Liabilities

The Bank of England have now set out the Bank’s final Statement of Policy on maintaining a minimum requirement for own funds and eligible liabilities (MREL). 

Bank of England (the Bank) published a consultation paper(1) in December 2015 describing its proposed policy for exercising its power, under the EU Bank Recovery and Resolution Directive (2014/59/EU) (BRRD) and associated UK legislation, to direct institutions to maintain a minimum requirement for own funds and eligible liabilities (MREL) and to take other steps for that purpose under section 3A of the Banking Act 2009 (Banking Act). 

The Bank’s power of direction applies to: (i) banks, building societies and certain investment firms(2) (institutions) that are authorised by the Prudential Regulation Authority (PRA) or Financial Conduct Authority (FCA); (ii) parent companies of such institutions that are financial holding companies or mixed financial holding companies (holding companies); and (iii) PRA or FCA-authorised financial institutions that are subsidiaries of such institutions or such parent companies.

The purpose of MREL

Resolution is the process by which authorities can intervene to manage the failure of an institution. During the financial crisis, governments felt compelled to bail out failing banks, rather than risk the negative consequences their disorderly failure would have on the wider economy and financial system, as there were no effective arrangements for resolution in place.

Following the financial crisis, there have been a number of legislative changes to build comprehensive resolution frameworks. The Bank has published a document setting out its approach to resolution, which describes the UK resolution regime.(3)

Under the BRRD the Bank, as UK resolution authority, must develop a preferred resolution strategy for each institution. For smaller institutions, this strategy may simply involve them entering a modified insolvency process together with a pay-out of covered depositors by the Financial Services

Compensation Scheme (FSCS)

For larger institutions, for which the use of a modified insolvency process would not meet the resolution objectives due to the potential scale of disruption that would cause, the strategy is more likely to involve the use of stabilisation powers to maintain the continuity of its critical economic functions. In such cases, a necessary condition for resolution to be effective is that a firm’s capital position can be stabilised. Any losses incurred on the institution’s assets, both before and in resolution, need to be recognised. Once this has been done, and if required by the institution’s resolution strategy, the institution’s capital position must be restored to a sufficient level to ensure that the institution (or any successor entities) meets any necessary regulatory requirements and commands market confidence. This puts the institution into a stable position from which a reorganisation to address the underlying causes of its failure can be carried out, while maintaining the institution’s critical services to depositors and to the wider economy.

MREL is a minimum requirement for institutions to maintain equity and eligible debt liabilities. The purpose of MREL is to help ensure that when institutions fail the resolution authority can use these financial resources to absorb losses and recapitalise the continuing business. As a result, MREL is a critical element of an effective resolution strategy.

The Bank will set MREL for individual institutions by reference to three broad resolution strategies. These strategies reflect our legal obligations, judgement of risk over the potential disruption to critical economic functions and need to apply a proportionate approach.

A modified insolvency process is proposed for small institutions,which do not provide services of a scale considered critical and for which it is considered that a pay-out by the FSCS of covered depositors would meet the Bank’s resolution objectives. These institutions will have MREL set at the same level as regulatory capital requirements.

(1) Bank of England (2015), The Bank of England’s approach to setting a minimum requirement for own funds and eligible liabilities (MREL): Consultation on a proposed Statement of Policy

(2) For the purposes of the United Kingdom special resolution regime, the term ‘investment firm’ means those firms that are required to hold initial capital of €730,000. The majority of such firms are those that deal as principal and are prudentially regulated by the Financial Conduct Authority; the largest, more complex investment firms are prudentially regulated by the Prudential Regulation Authority.

(3) Bank of England (2014), The Bank of England’s approach to resolution; will meet their MREL simply by meeting their existing regulatory capital requirements.

• Partial transfer—where institutions are considered to be too large for a modified insolvency process but where there is a realistic prospect that critical parts of the business could be transferred to a purchaser, MREL will be set at a level which permits such a transfer to take place.

• Bail-in—the largest and most complex institutions will be required to maintain sufficient MREL resources to absorb losses and, in the event of their failure, be recapitalised so that they continue to meet the PRA’s conditions for authorisation. Bail-in is designed to stabilise the institution, providing time to enable it to be restructured in order to address the underlying causes of its failure. The aim is that the institution, or its successor, is able to operate without public support.

MREL is necessary to make resolution plans credible. It ensures that institutions have a minimum amount of liabilities that can credibly bear losses before and in resolution. Not all types of liabilities are suitable for this purpose. Some are not in scope of all of the Bank’s stabilisation powers or may be difficult to apply the powers to in practice. Others are connected to critical economic functions, or will not be reliably available at the point of resolution.