The euro area's biggest banks will be asked to earmark fundsequivalent to more than twice their minimum capital requirements tomake sure a possible emergency doesn't cost taxpayers, according toElke Koenig, head of the Single Resolution Board.

The Brussels-based SRB, the resolution authority for 142 banksincluding Deutsche Bank AG and BNP Paribas SA, will use the minimumcapital requirement set by the European Central Bank as a proxyfor funds that would be needed to absorb losses and allowrecapitalization in a crisis, Koenig said in an interview thismonth. The ECB last year set an average requirement for thehighest-quality capital of 9.9% of risk-weighted assets.

Requiring banks to have at least the same amount again inloss-absorbing liabilities will ensure that they can recapitalizethemselves quickly after restructuring, Koenig said.This minimum requirement of own funds and eligibleliabilities, or MREL, is calculated at the “30,000-foot level,” andmore precise levels tailored to each bank will follow afterthe ECB sets new capital requirements and changes are made tocapital, bank-failure and insolvency rules, she said.

“We want to avoid confusing the markets by saying, this is ourdecision this year, knowing that it will be different next year,”Koenig said. “So we take an indicative step this year. For nextyear, we hope that some of the dust has settled.”

The requirement to have sufficient eligible liabilities toabsorb losses and recapitalize a bank is the cornerstone of theEuropean Union's bank-failure legislation. The MREL requirement issimilar to the total loss-absorbing capacity standard set by theFinancial Stability Board for the world's biggest banks.

The European Banking Authority said in July that the region'sbanks may need as much as 470 billion euros ($524 billion) inadditional MREL-eligible funding under conditions similar to thosecited by Koenig. The EBA sample consisted of 114 banks representing70% of the EU's banking assets, including lenders not overseen bythe SRB.

Koenig declined to comment on estimates and said the EBA study'sparameters weren't identical with the SRB's plans for indicativeMREL levels. While EU law doesn't set a deadline for banks to reachtheir MREL target, she said three to four years was a realisticassumption.

“We're telling the banks we're starting a journey with them, andit is a continuous dialogue,” Koenig said. “Assuming a bank'seligible liabilities are below what would be the outcome of thispurely mechanical calculation, we would at least expect them tostart considering mitigating measures.”

Koenig said the planned indicative MREL level will also allowbanks to satisfy a requirement in EU law for 8% of own funds andtotal liabilities to be wiped out before access can be granted torescue funds, Koenig said.

“What we found out, a bit to my surprise, was that the 8%becomes a fairly moot point,” she said. “Assuming risk densityof 40% to 50% and SREP ratios of 9, 10, 11%, banks have to be thereanyway. It's a real backstop.”

Senior Bonds

A crucial factor in how hard it will be for banks to reach thetarget could be changes to insolvency laws that have alreadystarted in countries including Germany, France and Italy. TheFrench model, which effectively introduces a new asset classsandwiched between senior and hybrid bonds, could be rolled outthroughout the bloc, Koenig said.

“The German law solves the no-creditor-worse-off problem for theentire pile of senior bonds; the French proposal means you need tobuild it up,” she said. “I don't doubt that you can build it up,but you can't do it overnight. The German proposal solves theproblem today. But if the Commission and the member states decidethey want to go the French way, it's at least a solution goingforward. I hope they will decide soon.”

While Koenig can also live with structural subordination, inwhich MREL is held at a holding company, she says definingsubordination in the terms of an individual debt security has itslimits.

“Contractual subordination is, compared to this, anadministrative and legal challenge,” she said. “It's veryimpractical, to say the least.”

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