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This time around, they are pushing much more aggressively on loss-absorption. In the quest to prevent taxpayers being on the hook, regulators are pulling in senior creditors, who from 2018 will be subject to bail-in in resolution – although bankers fully expect banks to create a layer of short-dated subordinated loss-absorbing non-regulatory capital to protect them.
This whole debate is taking place, of course, in the midst of a eurozone sovereign crisis which is inexorably tied via a-sometimes pernicious negative feedback loop to the banking sector. Writing at the end of July, it’s far from clear what the EU-level sovereign and bank rescue apparatus will finally and formally resemble (will the ESM will be granted a banking licence, for example?); how far the European Central Bank is prepared – or allowed – to go in primary and secondary market government bond purchases; where the debate around banking union as a sub-set of broader fiscal union will lead and how long it will take; or what the wider impact will be of the EU’s bail-out of the Spanish bank bailout.
That’s a lot of micro-uncertainties. And with no economic growth coming through in Europe, and a widening North-South divide, there are a lot of macro uncertainties, too.
Back to the specifics and technicalities of bank capital, the FIG specialists at IFR’s Roundtable were broadly-speaking relatively clear on what the instruments will need to look like, whether it be core Tier 1 or innovative forms of hybrid capital albeit with some important nuances and residual uncertainties including: how temporary write-downs will work for Additional Tier 1; the specifics of PONV language; the utility of Tier 1 instruments with a 5-1/8% trigger; the position of AT1 holders vis-a-vis shareholders; how dividend stoppers will work.
And they’re fairly confident that there will be investor take-up of them, notwithstanding some work will need to be done do among buyside firms around the wording of investment mandates. That said, Georg Grodzki of Legal & General IM, a participant at the discussion, has a very bleak outlook. Grodzki has “grave doubts about the potential for the amount of capital that is supposed to be provided by the markets to be made available”. He also has grave doubts about banks’ business models, which is another central theme surrounding the capital debate.
The banking industry is undergoing a period of seminal change; the deleveraging cycle is in process while bank strategies and business-line selection is in a state of flux. The cost of equity is rising; returns on equity are declining. Second-quarter bank earnings evidence an industry in turmoil. Restricted RWA growth will help the quantum of capital underpinning required, but with so many moving parts, it’s a confusing world out there.