As the single supervisor it is the ECB’s job to encourage a safer European banking system by smoothing the path for banks to comply with the Bank Recovery and Resolution Directive.
One way it can do this is to ensure banks build up sufficient capital and other loss absorbing liabilities. These requirements are laid out in rules governing minimum requirement for own funds and eligible liabilities (MREL) and total loss absorbing capacity (TLAC).
MREL and TLAC qualifying debt is issued to help ensure the smooth recapitalisation of a failing bank and it should safeguard against banks becoming ‘too big to fail.’ As the single supervisor it is also important that the ECB encourages banks to place as much of this debt as possible outside the banking system. Otherwise there is a danger that the losses caused by one failing bank are passed onto another — increasing the risk of a systemic collapse of the banking sector.
Most European regulators have introduced, or are poised to introduce, new forms of subordinated debt that will be eligible for MREL and TLAC. However the ECB says this paper is not be eligible for repo. In other words, if a bank is unable to sell these bonds to real investors, it will not be able get around the rules by simply issuing the debt and retaining it for repo purposes.
In contrast to the rest of Europe, German lawmakers have gone down their own route with the statutory subordination of all outstanding and newly issued German senior debt. That decision may have seemed like a simple and effective response to BRRD at the time. However, because this paper now serves the same function as subordinated tier three bonds, it is ‘senior’ only by name. By nature it is capital.
For that reason alone these bonds should be ranked alongside other bail-inable debt and should not be eligible for repo, which initially was the case. But in early October the ECB reversed its position, bowed to pressure from the German Landesbank and savings bank community, and allowed this debt to become eligible for repo. This means German banks can happily continue to invest in each other’s debt, in stark contrast to the rest of Europe.
The ECB’s special carve out for German senior debt highlights that its role as single supervisor does not sit comfortably with its other responsibility to conduct monetary policy. If the ECB were inadvertently to become the main investor of this bail-inable ‘senior’ debt by pursuing ultra-loose monetary policy, it could theoretically become one of the largest investors — undermining its efforts to make banks safer.
The ECB is undoubtedly the institution in Europe with the best ability to absorb banks’ losses because it can print as much money as it likes and it can never go bankrupt. But that would go against the spirit of regulations that are designed to ensure banks themselves are responsible for ensuring they are safe and not the state or its agencies.
After private investors have taken their share of losses, and faced with a systemic banking collapse, the ECB would have justifiable reasons to bail out Europe’s banks. But that should not be its intention from the start — which would be the case if it became the de-facto ‘private investor’ of repo-eligible German vanilla ‘senior’ debt.
Otherwise there really isn’t much point to the BRRD.