2.7 Conclusion

This chapter started with taking a closer look at the definition of credit institution in banking regulation in order to further understand the term ‘bank’. Interestingly, this term is not as clear as one may expect. Due to a lack of clarification of certain elements of the definition of credit institution at EU level, there remains a degree of divergence between the Member States as to the interpretation of this term. A further complicating factor in understanding what a bank is, is the variety of activities and business models of banks within the EU. Although, ultimately, the purpose of banking intermediation is transforming short-term deposits into a stable and sustainable supply of long-term credit to the real economy, banks involve in all kinds of activities. Some banks have total assets of such an amount that they qualify as global systemically important. Other banks have a more modest balance sheet. While business models and balance sheets of banks differ, they have in common that they all need to comply with the regulatory capital requirements and the MREL.

As a result of the regulatory capital requirements and the MREL, each bank needs to maintain a certain composition of its balance sheet. This should safeguard that the reliance of banks on short-term wholesale funding to finance the expansion of their balance sheets, together with the use of high leverage, supports economically useful banking activities that serve the general interest, while banks are resolvable when they are failing. The bal ance sheets of banks may however not be quite ready for that, because of challenges relating both to the MREL amount and the MREL composition. Banks have a financing need to meet the MREL. In addition, certain banks are characterized by the predominance of deposits covered by a deposit guarantee scheme or preferred retail deposits in the funding structure and limited or non-existent experience in issuing debt instruments. This affects the banks’ abilities to meet the MREL and, in the end, the resolvability of these banks.

If the level of own capital and eligible liabilities is insufficient to absorb losses and recapitalise a failing bank, other funding resources will be necessary to resolve the bank. These may be provided by private market parties, but also by Member States, national central banks, deposit guarantee schemes, national resolution funds, the SRF and/or the ESM. Taking into account that banks are currently still in the initial stage of implementing the MREL, it may be realistic to assume that it will be necessary to use alternative resources in the resolution of banks, in any event, as long as the MREL has not been fully implemented. The MREL requirement is still developing in terms of the minimum required MREL. In addition, although competent authorities have a full set of powers available when regulatory capital requirements are (likely to be) breached, this still needs to evolve in relation to the MREL requirement.

This chapter lastly touched on the tools that a bank can use to restore its balance sheet. Besides funding instruments that address and improve the equity and liabilities side of the balance sheet of a bank in difficulties, there is increased attention for measures that help restore the assets side of the balance sheet. As a result of asset quality reviews and stress tests conducted by the competent authorities, it became clear that banks experience high levels of NPLs. It is generally recognised that NPLs translate into lower interest income and higher loan loss provisions, eventually leading to a deterioration in banks’ profitability and regulatory capital. A number of initiatives have therefore been taken to target a reduction of NPLs.