A busy day in Threadneedle Street means good news for new and ambitious banks

The Old Lady’s Resolution Directorate had a busy day on 22 July publishing both a consultation paper on the Bank of England’s review of its approach to setting a minimum requirement for own funds and eligible liabilities (MREL) and an operational guide to executing bail-in.

Proposals on MREL

The Consultation Paper on MREL is another example of the increasing flexibility of the UK regulators and of the proportionate application of their powers with a view to fostering innovation. 

The Bank of England proposes to modify the existing approach to setting MREL for “new and growing” banks. (Note that MREL levels are set on a bank-by-bank basis, so what follows is necessarily a somewhat sweeping generalisation.) Currently, a small bank is likely to have a resolution strategy of modified insolvency procedure (the bank insolvency procedure (or BIP) which prioritises a prompt pay-out to depositors through the FSCS) and MREL set at a level equal to its minimum capital requirements. As a firm grows into a medium-sized or “mid-tier” bank (one between 40,000 and 80,000 transactional accounts), the resolution strategy will change to a transfer to a private sector purchaser, while if it has assets of between £15 billion and £25 billion the strategy will be bail-in. In either case, a mid-tier bank’s MREL requirement will increase to twice its minimum capital requirement so that there is enough loss-absorbing capital both to absorb losses and to recapitalise the bank in order to allow it to meet its capital requirements after resolution. 

The Bank of England proposes two significant changes to its framework. First, developments in technology through open banking and “linked account” technology mean that in the event of the failure of a mid-tier bank with a large number of transactional accounts, technology could be used to develop alternative processes to protect depositors. This could reduce disruption to transactional accounts and therefore the impact of such a bank’s failure. This might mean that even a mid-tier bank could be put into a BIP rather than being subject to stabilisation action while still avoiding a disorderly failure.  (To date, a BIP has been considered unworkable where there is a large number of transactional accounts because of the time it would take to pay out depositors.) 

There is much work to be done to ensure that the solutions will be effective, but the use of the linked account is increasingly common, given the increase in the use of apps that enable customers to link different accounts which are available as a result of open banking. The Bank of England will work with the industry, FSCS, FCA and PRA to explore the development of alternative processes to manage the disruption to a significant number of transactional accounts in the event of a bank insolvency. A successful outcome to this work could be very significant for mid-tier banks. Potentially, it would enable the Bank of England to raise the threshold for the level of transactional accounts that could be subject to a BIP. In turn, this could lead to a change in resolution strategy for a mid-tier bank to BIP and to halve the MREL level set for that bank. But they will have to wait. The Bank of England notes that the amount of work required means that any changes to mid-tier banks’ resolution strategies is unlikely to take place before the end of 2022.

The second significant change will benefit those banks whose growth plans involve the balance sheet. The Bank of England remains of the view that where total assets are above an indicative range of £15-25 billion bail-in is the most appropriate strategy, and no change is proposed to that threshold. At present, banks with these plans face a potential cliff edge when they reach that size as the preferred resolution strategy will flip from BIP to bail-in, with an accompanying doubling of the MREL level. The Bank of England recognises this challenge and the difficulty of raising a significant amount of funds quickly and proposes a “stepped glide-path” to the end-state MREL. This would comprise two elements.  First, the Bank of England will give a bank at least three years’ notice before a bank needs to start its transition to a higher MREL level. Second, the Bank of England proposes a new transition period of six years before it will have to meet its MREL in full (with the possibility of requesting a further two year discretionary “flexible add-on” if market conditions or other circumstances warrant an extension). So, a growing bank will have at least three years’ advance notice of an increased MREL level and then a further six to eight years before it will have to meet that requirement in full.

Operational guide to bail-in

The Bank of England’s second publication is equally interesting. While the Bank of England has previously published an overview of the process for conducting a bail-in, it has now published an operational guide on the way in which it might execute a bail-in resolution, and in particular the operational processes and arrangements that may be involved. The Bank of England has also published template Resolution Instruments. A Resolution Instrument is the formal legal instrument made under the Banking Act 2009 through which the Bank of England exercises its resolution powers. 

This transparency is to be welcomed and will help the market to understand how a bail-in process would work in practice. The process is novel and complex, and the more information and understanding that shareholders, creditors and other potential stakeholders have about the process, the fewer surprises there will be if a bail-in resolution were ever to happen. Those who lived through the financial crisis in 2008/9 will remember that the lack of a formal resolution regime or understanding of how the authorities might use their powers under emergency legislation led to a high degree of uncertainty. While each case will be highly dependent on its facts, the Bank of England’s high level of transparency should increase predictability as to the outcome of a bail-in resolution process and in turn increase certainty and confidence in the process.