General approach of the Czech National Bank to setting a minimum requirement for own funds and eligible liabilities (MREL)
The main objectives of resolution, the framework for which is laid down in Directive 2014/59/EU (BRRD),[1] are to ensure the continuity of critical functions, to avoid adverse effects on financial stability, to protect public funds by minimising reliance on extraordinary public financial support to failing institutions and to protect covered depositors, investors, client funds and client assets.
However, resolution in line with these objectives can only be feasible and credible if sufficient internal resources are available to institutions and groups for loss absorption and possible recapitalisation. In order to increase transparency and better inform financial market participants and the professional public, the CNB publishes and regularly updates its general approach to setting a minimum requirement for own funds and eligible liabilities (MREL) under Article 127 et seq. of the Recovery and Resolution Act.[2] It is not the purpose of this general approach to set a specific MREL for individual institutions.
The CNB’s general approach to setting MREL is prepared on the basis of both the legislation in force on the date of its publication and the principles set forth in the Total Loss-Absorbing Capacity standard for global systemically important banks published by the Financial Stability Board (FSB TLAC Standard),[3] Directive (EU) 2019/879/EU[4] amending BRRD, and Regulation (EU) 2019/876/EU[5] amending CRDIV[6]/CRR.[7]
The CNB sets a minimum requirement for own funds and eligible liabilities for institutions at individual level and, where appropriate, at consolidated level. In doing so, the CNB contributes significantly to ensuring the resolvability of Czech banks.
General approach
MREL is an institution-specific requirement, and the CNB will set it so that institutions and groups can be resolved consistently with the resolution objectives under the preferred resolution strategy.
The CNB will use this general approach when setting MREL for all institutions in its area of competence in accordance with the previously published explanatory memorandum, which determines the basic approach and resolution strategy. The CNB will apply the general approach when setting MREL particularly for:
- complex systemically important institutions and groups providing multiple critical functions[8] whose preferred resolution strategy assumes the use of the bail-in tool in the form of write-down or conversion of the relevant capital instruments and eligible liabilities (bail-in or WDCI); and
- non-systemic institutions providing one or a limited number of critical functions (especially in the area of deposit-taking and related payments) whose preferred resolution strategy assumes the use of a transfer of assets, liabilities and/or shares to a private acquirer or a bridge institution (transfer tool).
The setting and structure of the minimum requirement
For the above institutions whose resolution plan assumes the use of resolution measures in the event of their failure, the CNB will set the minimum requirement for own funds and eligible liabilities as the sum of the loss absorption amount (LAA) and the recapitalisation amount (RCA):
- the loss absorption amount will be derived from the current capital requirements based on risk-weighted assets (the TREA[9] in Pillar 1 (P1) and Pillar 2 (P2)) as set by the CNB as the financial market supervisory authority and simultaneously from the leverage ratio requirement based on the total exposure measure (the LRE[10]);
- the recapitalisation amount is derived from the likely capital requirements based on risk-weighted assets after the application of resolution measures (P1 and P2) and simultaneously from the leverage ratio requirements after the application of resolution measures. This amount must enable the institution or group to be recapitalised so that it complies with the conditions for authorisation and maintaining sufficient market confidence after resolution.
MREL levels expressed on the basis of risk-weighted assets and the leverage ratio will be binding on banks, and higher levels calculated using the two approaches will represent a limiting factor.
Under the general approach, the combined buffer requirement (CBR) is reflected neither in the LAA nor in the RCA and must be met additionally to the MREL expressed as a percentage of the TREA (the stacking order approach). Accordingly, Common Equity Tier 1 used to meet the MREL expressed as a percentage of the TREA may not be used to also meet the combined buffer requirements. However, Common Equity Tier 1 used to meet the combined buffer requirements may be used also to meet the MREL expressed as a percentage of the LRE.
Schematically, the general approach of the CNB to setting MREL is as follows:
MREL for entities where the application of resolution measures is not considered in the event of failure
Where the CNB in its resolvability assessment concludes that liquidation of the institution or group under normal insolvency or winding-up proceedings is both feasible and credible, the minimum requirement for own funds and eligible liabilities will be limited so that it does not exceed the amount sufficient to absorb losses set by the supervisory authority. Exceptions may include specific situations where the CNB determines that a positive recapitalisation amount is necessary on the grounds that liquidation would not achieve the resolution objectives to the same extent as an alternative resolution strategy.
Setting MREL according to the resolution tool considered in the resolution plan
Approach based on total risk-weighted exposures (MRELTREA)
When estimating an institution’s regulatory capital needs after the implementation of the preferred resolution strategy and subsequent determination of MRELTREA, the CNB in principle uses the reported amount of the relevant total risk exposure (TREA) relating to the corresponding period in which the resolution plan was prepared or updated and the capital requirements set by the supervisory authority.
When setting the MREL recapitalisation amount, the CNB may also:
- adjust the considered TREA to reflect the change made to regulatory capital needs as an immediate consequence of the resolution measures contained in the resolution plan (TREA adjustment);
- adjust the amount of the Pillar 2 capital requirement derived from the likely capital requirements following the application of resolution measures (adjustment of the P2 requirement);
- increase the recapitalisation amount by the amount necessary to maintain sufficient market confidence after resolution (adjustment by a market confidence charge)
The above adjustments to the MREL recapitalisation amount are strongly affected by numerous factors, such as the institution’s business model, financing model and risk profile, and depend on the type of preferred resolution strategy and the expected implementation of additional resolution powers or tools in accordance with the relevant resolution plan. The CNB takes an individual approach to the application of adjustments affecting the final RCA of institutions. However, it respects the following assumptions:
- although the circumstances preceding or leading to the failure of a institution may theoretically result in a decrease in the institution’s total assets, the CNB – when setting the RCA – then adjusts the TREA only in cases where the resolution plan quantifies the reduction in the TREA resulting from the implementation of the resolution measures contained in the plan with a sufficient degree of certainty. Therefore, in cases of liable entities whose resolution plan assumes the use of
- bail-in or WDCI, the CNB does not generally make this adjustment for prudential reasons, as the evolution of the TREA in response to the adverse macroeconomic developments or the stress situation having caused the failure cannot be quantified with a sufficient degree of certainty.
By contrast, in cases of the use of - the transfer tool, the relevant resolution plans conversely expect and quantify an immediate change in the size of total/risk-weighted assets, so the CNB regards it as acceptable to adjust the TREA by a coefficient expressing the ratio of transferred assets (the debts and/or assets defined by the critical functions identified in the resolution plan) to the total assets of the institution.
- bail-in or WDCI, the CNB does not generally make this adjustment for prudential reasons, as the evolution of the TREA in response to the adverse macroeconomic developments or the stress situation having caused the failure cannot be quantified with a sufficient degree of certainty.
- as the Pillar 2 capital requirements are intended to cover material risks specific to a particular institution, especially those which may not be sufficiently covered by the Pillar 1 requirements, and fulfilment of those requirements is necessary to maintain the institution’s relevant authorisation (licence), the CNB generally regards it as prudent not to adjust the Pillar 2 requirement in advance, as
- where bail-in or WDCI is used, the relevant plan does not expect the institution’s business model, financing profile or overall risk profile to change fundamentally as an immediate consequence of the resolution measures applied, and
- where the use of the transfer tool is planned, which might result in a reorganisation of the institution’s business activity, the private acquirer or bridge institution will also be obliged to meet the Pillar 2 requirement in respect of the assets or debts transferred.
- The CNB thus considers the MREL set in line with this general approach as sufficient to maintain market confidence and ensuring the continuity of critical functions without the need to use contributions from public resources, including the resolution funding mechanism, and therefore does not further increase the recapitalisation amount.
Given the above, the CNB’s general approach to setting MRELTREA is as follows:
| MRELTREA | Preferred resolution strategy and expected resolution tool | ||
|---|---|---|---|
| Bail-in/WDCI | Transfer tool | Liquidation | |
| LAATREA | (P1+P2)*TREA | (P1+P2)*TREA | (P1+P2)*TREA |
| RCATREA | (P1+P2)*TREA | (P1+P2)*TREA*coefficient | N/A |
Approach based on the leverage ratio (MRELLRE)
When estimating an institution’s regulatory capital needs after the implementation of the preferred resolution strategy, the CNB also uses the relevant reported denominator of the leverage ratio (LRE) relating to the corresponding period in which the resolution plan was prepared or updated to set the requirement based on the leverage ratio.
When setting the MREL recapitalisation amount, the CNB may also adjust the latest reported LRE by taking into account changes stemming from the application of the resolution measures contained in the resolution plan (LRE adjustment).
As most of the balance-sheet exposures used to determine an institution’s total exposure amount are at book value, and also with regard to the CNB’s general assumption that an institution’s loss will not exceed the MREL loss absorption amount before the application of resolution measures, the CNB considers it acceptable, in cases of liable entities whose resolution plan assumes the use of
- bail-in or WDCI, to adjust the reported LRE downwards by reflecting the institution’s ability to absorb the loss, i.e. to deduct LAALRE from the initial LRE
- the transfer tool, to adjust the reported LRE by reflecting the expected immediate change in the size of the institution’s total assets as measured by the assets and liabilities transferred. As in the case of setting MRELTREA, the CNB will for this purpose use a coefficient expressing the ratio of identified critical functions to total assets of the institution. However, as the volume of off-balance-sheet exposures that will be legally or economically interconnected with the transferred assets and debts of the institution at the time of resolution cannot be determined with a sufficient degree of certainty, the CNB regards it as prudent to apply the coefficient only to exposures in the institution’s balance sheet.
Given the above, the CNB’s general approach to setting MRELLRE is as follows:
| MRELLRE | Preferred resolution strategy and expected resolution tool | ||
|---|---|---|---|
| Bail-in/WDCI | Transfer tool | Liquidation | |
| LAALRE | 3% * LRE | 3% * LRE | 3% * LRE |
| RCALRE | 3% * (LRE - LAALRE) | 3% * (LREon-B/S*coefficient + LREoff-B/S) | N/A |
Additional remarks
The requirement may be met with own funds (capital) and eligible liabilities as defined in the applicable legislation. In line with the findings of the resolvability assessment, and in order to achieve the resolution objective effectively and implement the preferred resolution strategy successfully, the CNB regards as eligible only such liabilities of the institution that are simultaneously subordinated to other unsecured liabilities of that institution, in the case of institutions whose resolution plan assumes the use of bail-in. This means that a claim corresponding to a written-down liability intended for fulfilment of the minimum requirement must be satisfied, pursuant to Act No. 182/2006 Sb., on Insolvency and the Methods of its Resolution (“Insolvency Act”), after the satisfaction of the claims of other unsecured creditors. This requirement for the subordination of eligible liabilities does not apply to eligible liabilities issued by institutions whose resolution plan assumes the use of the transfer tool.
In accordance with Article 77(2) CRR, institutions shall obtain the prior permission of the resolution authority to call, redeem, repay or repurchase those eligible liabilities instruments that are not subject to Article 77(1) CRR before their contractual maturity date. The types of permissions and the conditions for granting them are regulated in Article 78a CRR. According to the CNB's interpretation, the obligation to obtain prior permission applies to those instruments (or liabilities that are not included in equity) that, at the time of issue or acquisition, met the eligibility requirements in accordance with the relevant CNB decision setting the minimum requirement. Commission Delegated Regulation (EU) 2023/827 of 11 October 2022 specifies the procedures for granting permissions, including deadlines and information requirements, and the procedure for cooperation between resolution authorities and competent authorities. Institutions intending to apply for permission under Article 77(2) CRR should therefore submit an application to the CNB that complies with the substantive requirements of the regulation (EU) 2023/827, in particular Articles 32d to 32e, and will be submitted within the deadlines specified in Article 32g.
CNB will allow selected banks to meet internal MREL in the form of a guarantee (pdf, 173 kB) pursuant to Art. 131b of the Recovery and Resolution Act.
The CNB also perceives increased risks arising from the acquisition and holding of external MREL eligible instruments issued by other institutions and therefore considers it beneficial to limit such investments in an appropriate manner. To this end, the CNB has published a document entitled External MREL Holdings and assumes that institutions will start meeting the expectations formulated therein as of 1 January 2022.
The CNB sets MREL for institutions in its area of competence on an annual basis. The requirement must be met on 1 January 2024 at the latest. In order to ensure a steady increase in own funds and eligible liabilities to the required level, the CNB also sets a binding intermediate target in accordance with the requirement of Directive (EU) 2019/879. Institutions are obliged to meet this target as of 1 January 2022 at the latest. In the case of meeting MREL, institutions shall use a similar approach to when meeting capital requirements, i.e. they shall meet the requirement continuously based on the current situation of the institution. In order to increase transparency and market discipline, liable entities, in accordance with the requirements of Regulation 2021/763[11], regularly make available information on MREL, current amount and structure of eligible instruments, including their position in the insolvency hierarchy. When determining the order of creditors from MREL-eligible instruments, liable entities use the standardised order of claims according to the Insolvency Act.
The CNB is publishing this general approach to setting MREL for institutions under its direct supervision in an effort to set expectations for all relevant entities. Although the CNB does not expect to depart from this general approach, there may be specific individual cases requiring minor adjustments in order to increase resolvability. The CNB may therefore modify this general approach so that it takes into account the specific situation of individual institutions or groups. In addition, this general approach may be revised in light of changes in the regulatory environment.
[1] Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council plus an amendment by Directive (EU) 2019/879 (BRRD II) of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms.
[2] Act No. 374/2015 Coll., on Recovery and Resolution in the Financial Market, as amended.
[3] Available online at http://www.fsb.org/2015/11/tlac-press-release/.
[4] Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms and Directive 98/26/EC.
[5] Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012.
[6] Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC.
[7] Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending regulation (EU) No 648/2012.
[8] Critical functions as defined in Article 2(1)(u) of the Recovery and Resolution Act.
[9] The total risk exposure amount calculated in accordance with Article 92(3) of Regulation (EU) No 575/2013.
[10] The total exposure measure calculated in accordance with Articles 429 and 429a of Regulation (EU) No 575/2013.
[11] Commission Implementing Regulation (EU) 2021/763 of 23 April 2021 laying down implementing technical standards for the application of Regulation (EU) No 575/2013 of the European Parliament and of the Council and Directive 2014/59/EU of the European Parliament and of the Council with regard to the supervisory reporting and public disclosure of the minimum requirement for own funds and eligible liabilities.