RPT-Fitch: Level and Mix of G-SIFI Debt Buffer Key Rating Variables
Sept 6 (Reuters) - (The following statement was released by the rating agency)
The level and mix of gone-concern loss-absorbing capacity (GLAC) to be proposed by the Financial Stability Board for global systemically important financial institutions will be the key rating variables, Fitch Ratings says. If it is sufficiently large and met with junior debt, it could prove positive for senior debt default risk because it would increase the possibility of restoring a bank's viability without hitting senior debt.
This week the FSB said it would prepare proposals by end-2014 so that G-SIFIs in resolution would have adequate loss-absorbing resources to recapitalise at a level that promotes market confidence and meets regulatory capital requirements. It is unclear whether only subordinated debt would count towards the GLAC or whether unsecured senior debt eligible for bail-in can be included, as is possible under the UK's primary loss-absorbing capital proposals, for example.
In the US, where the Fed and FDIC are developing rules on minimum holding company debt requirements, holding companies issue substantial amounts of group senior and subordinated debt, all of which may qualify as GLAC. The clearest beneficiaries of holding company debt and GLAC rules among US G-SIFIs will be depositors in operating banking subsidiaries. Assuming GLAC has to be met with debt securities, the requirement will be positive for all G-SIFI depositors.
But it is unclear how the G-SIFI requirement might interplay for EU global systemically important banks (G-SIBs) with the minimum eligible liabilities and own funds requirement and write-down of capital instruments provisions in the EU's Bank Recovery and Resolution Directive proposals, for example, or with GLAC-like policies in jurisdictions such as the UK and Switzerland.
In countries where the bank resolution agenda is well entrenched, we believe bank capital management may increasingly focus on secondary capital buffers as well as primary common equity-based measures. This is already the case in Switzerland, where the two large global banks have to build loss-absorbing junior debt and equity up to 19% of their risk-weighted assets (RWA) over the next five years. G-SIBs may look to cover their GLAC requirement with junior debt to improve protection for senior unsecured creditors, but investor appetite for significantly higher levels of junior debt has yet to be tested and may prove insufficient.
The location for GLAC within group structures also has to be determined. The positioning of the buffer will vary depending on the preferred approach to resolution: a "single point of entry" through the parent or holding company will presumably require the GLAC to be at that level, making its mix neutral to creditors of subsidiaries; a "multiple point of entry" approach will logically require the GLAC to be issued by a group's material subsidiaries, making its mix more important for senior creditors. We expect some shifts in the location of junior debt when these details are clarified.
GLAC requirements could be tiered for the G-SIBs, like the five buckets for common equity capital buffers. GLAC principles could also be adopted more broadly by national supervisors for their domestic systemically important banks. Levels of junior debt vary across the banking industry. For example, we estimate a sample of the largest European banking groups held junior debt securities on average equivalent to around 6% of RWA at end-2012. But the level of the potential secondary capital buffer varied from around 2% to as high as 11%.
Equity conversion of junior debt in mid-to-high single digit percentages of RWA would have been sufficient to restore viability to many high-profile banks in the most recent crisis. For example, the RBS public sector bailout was 6%-8% of RWA, depending on treatment of its (unused) asset protection scheme; for Commerzbank 6%, KBC Bank 4%, Lloyds 4% and UBS 2%.
The cost of recapitalising several European banks, notably in Spain and Ireland, has exceeded these levels, and expectations around viable core equity solvency levels for G-SIFIs are now higher than before. But measures to reduce idiosyncratic and systemic bank risks - such as Basel III and, in the euro area, Banking Union - ought to reduce the likelihood of such spectacular bank failures in future.
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