November 9, 2017 / 10:51 AM / 2 years ago

Fitch: Non-Preferred Senior Will Aid EU Bank Resolution

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: FAQs - EU Bank Resolution/Insolvency Actions here LONDON, November 09 (Fitch) The EU's recent agreement to introduce a new debt class, non-preferred senior, is an important step towards clarity on how troubled EU banks will be resolved, Fitch Ratings says. Non-preferred senior debt will help shield preferred senior obligations from default in a resolution. We expect it to become a material component of banks' minimum requirement for own funds and eligible liabilities (MREL), which will reduce the need to use state resources to protect financial stability. EU member states will have to implement the new debt class into their national legislation by January 2019. Notably, France has already done this and Italy started the process last week. Once banks have built up sufficient subordinated and non-preferred senior liabilities to meet MREL, or the similar total loss-absorbing capacity (TLAC) requirements for global systemically important banks, bail-in under resolution should be easier to apply without threatening financial stability. It is likely to be more palatable for authorities to bail in non-preferred senior debt, assuming it is not widely distributed to retail investors. Contagion risk is likely to be limited given that the purpose of the new instrument is to act as a buffer for other senior creditors in resolution or insolvency, particularly uninsured deposits and senior operating liabilities. Alignment of creditor hierarchies across member states will reduce the risk of legal challenges, particularly for resolution of cross-border banking groups. The treatment of troubled banks in Spain and Italy this year raised questions about the consistent application of EU rules and approaches to failing and failed banks. Senior creditors of Spain's Banco Popular were spared losses when the bank was sold to Banco Santander under the resolution process, following an extreme liquidity crunch, with losses borne by shareholders and junior bondholders being sufficient to meet its estimated equity shortfall. Italy's Banca Popolare di Vicenza and Veneto Banca were able to issue state-guaranteed bonds to support liquidity; their failure related to solvency. Shareholders and junior bondholders bore losses but state funds were used in the national insolvency process applied to these banks and senior creditors were spared. State aid in conjunction with avoidance of losses by senior creditors may appear to go against the EU's principle that a high degree of losses should be imposed on creditors before state funds are used. Italy justified the state aid on the grounds that regional contagion risk that could have arisen from a disorderly wind-up would be mitigated by enabling another bank, Intesa Sanpaolo, to purchase parts of the two banks' activities. The Italian authorities were particularly reluctant for senior debt to be bailed in, as many retail investors in Italy hold senior debt, and losses for them could hit financial stability. Senior bondholders would have been vulnerable to losses if the banks had been put into resolution, given their thin junior debt buffers. The Banco Popular resolution and the use of sovereign funds to prevent senior debt default at the Italian banks do not change our view that extraordinary support for senior creditors of the vast majority of EU commercial banks, while possible, cannot be relied upon. EU bail-in rules, liquidation risk and the phase-in of non-preferred senior debt - a reference liability for our Issuer Default Ratings (IDRs) - mean a high likelihood of some form of default at the IDR level when a bank fails. The agreement to create the new debt class was reached by the European Parliament, European Council and European Commission on 25 October. It will be subject to a plenary vote in the European Parliament this month. Fitch's report "FAQs - EU Bank Resolution/Insolvency Actions" is available by clicking the link above or at Contact: James Longsdon Co-Head, EMEA Financial Institutions - Banks +44 20 3530 1076 Fitch Ratings Ltd 30 North Colonnade London E14 5GN Monsur Hussain Senior Director, Financial Institutions - Banks +44 20 3530 1793 David Prowse Senior Analyst, Fitch Wire +44 20 3530 1250 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. 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