Capital and resolution stacks – room for simplification?

Simpler rules are easier to understand and comply with. We see several potential paths to achieve this, but first and foremost, completing the Banking Union, as part of the Savings and Investment Union, would have the biggest impact on both simplicity and boosting the European economy. However, alongside this, there may be scope to implement rules in a simpler way, reducing burdens and improving application. 

In this blog, I want to take a look at the complexity of banks’ capital stacks, – a topic that is raising its head again. This is understandable: banks, regulators and investors have to navigate a maze of acronyms and requirements – why not just simplify? To answer that question, we must first look at the make-up of capital stacks. 

First, there are three types of requirements: 

1. Microprudential - designed to ensure banks’ soundness in going concern;
2. Resolution, aimed at facilitating the internal recapitalisation of failing institutions;
3. Macroprudential buffers to address system-wide risks and pro-cyclical dynamics. 

Second, each field has many layers (P1, P2R, P2G, MREL, TLAC, CCyB, CCB…), with different components (CET1, AT1, T2, other MREL instruments, TLAC instruments, …), different scopes (consolidated, solo…) and consequences for banks’ non-compliance with them.

So, back to our key question, can we have something simpler that remains effective or is even more effective?

Simplifying these stacks is not just about technical tweaks: it raises fundamental issues about how capital is allocated, between going concern and gone concern needs, between targeting different types of risks or focussing on overall capital available, and on managing impacts on different bank business models. The various components of the prudential, resolution, and macroprudential frameworks have developed in parallel, each addressing distinct but complementary objectives – all at the service of financial stability –, financial soundness, loss absorption and systemic risk mitigation. Any attempt to simplify them must therefore consider how these elements interact in practice, ensuring that changes to one layer do not undermine the effectiveness of the others. 

Most notably, resolution requirements were never designed to stand apart from prudential ones. They build on the same foundation, extending the prudential logic into failure scenarios. People sometimes wonder why MREL goes up when going concern requirements go up. That is because MREL reflects the own funds requirements the bank must meet to cover unexpected losses, plus the minimum capital requirements a bank emerging from resolution is expected to meet. The capacity to restore the capital position after failure is key to resolvability and to give market participants confidence to operate with the bank after the failure as well as in business as usual. 

As a result, simplification of the overall capital framework should only emerge as a consequence of reforms to the going-concern regime, rather than as a standalone recalibration of MREL. Adjustments disconnected from the broader capital framework risk undermining trust and resolvability. 

The MREL framework currently reflects also another European policy objective: taking into account access requirements to industry safety nets, which is the Single Resolution Fund  or SRF – in the Banking Union. Access to the SRF requires that shareholders and creditors contribute to the resolution for at least 8% of the bank’s total liabilities and own funds (TLOF). Sufficient MREL ensures that resolution tools can be used credibly and consistently across the Banking Union, avoiding uncertainty about the sufficiency of loss-absorbing resources in stress scenarios.

Any effort to reform the MREL framework must therefore be evaluated against these two criteria: the preservation of credible gone- and going-concern interaction to ensure the solvency of the ‘Monday morning’ bank , that is to say, the bank post resolution decision, and the maintenance of effective total loss-absorbing capacity of at least 8% TLOF to be able to access, if need be, the SRF, when building the resolution scheme. 

There are also many calls to enhance proportionality, which we do support. In fact, the SRB and national resolution authorities consider that there would be no public interest in resolution for many thousands of institutions in the Banking Union and so they are exempted from almost all resolution requirements. 

Furthermore, for banks whose resolution strategy foresees a market exit (e.g., transfer strategies), the MREL is already lower to reflect lower recapitalisation needs post resolution, and they generally do not have to meet subordinated MREL requirements. However, all banks whose failure would provoke financial instability have to comply with resolvability conditions. Therefore, for smaller banks the most effective way to simplify the framework lies outside the capital debate. Progress on national insolvency regimes, faster sale processes, and improved access to funding in insolvency would materially reduce the cost and complexity of managing failure. 

We see no short cut to simplify the capital stack and particularly MREL composition; rather, the debate requires a holistic assessment given that each design feature currently delivers specific policy outcomes. Any attempt to simplify the capital stack must consider how all these elements interact in practice, ensuring that changes to one layer do not undermine the effectiveness of the others. Further, cooperation and trust are critically essential for successful crisis management – our framework must remain firmly anchored in the internationally agreed standards that underpin that cooperation across jurisdictions. 

Simplification should not dilute these objectives or weaken the confidence that market participants and stakeholders place in the EU resolution framework. Instead, it should aim to preserve resolvability while reducing unnecessary operational intricacies.