Stress tests and TLAC will transform bank funding markets
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Stress tests and TLAC will transform bank funding markets

Bankers are looking past Sunday's publication of the stress-test results and the TLAC requirements that will follow to a substantial change in how banks fund in the capital markets and maybe even new forms of senior debt.

Investors, bankers and analysts are braced for a busy Sunday afternoon examining results of the European Central Bank's (ECB) asset quality review of the euro-area’s biggest banks and any capital shortfalls after attendant stress tests. 

Full results will be posted on the ECB’s website at noon on Sunday. Leaks, rumours of leaks and pure speculation abounded, as banks were each informed of their own results on Friday.

Deutsche-CEO-Anshu Jain1
 We have had five or six years of rules and regulations, but at some point we must focus on making the world grow

Anshu Jain

RBS Credit strategists ran a simplified stress test on European banks after the EBA methodology and its projections in the adverse scenario. 

Alberto Gallo, credit strategist at RBS, says: “Based on our results, we think a majority (70%) of banks are likely to pass the ECB test comfortably, with 18% on the border and 11% at high risk of failing. 

“The weakest are generally mid-tier banks in Italy, Cyprus, Portugal and Germany with relatively small balance sheets – one exception is Monte Paschi in Italy. Total assets of banks that are most likely to fail account for only 2.9% of total bank assets in the test.”

RBS expects the total remaining capital shortfall to be just €10.2 billion under the adverse scenario, which appears quite manageable, given that European banks have already raised €40 billion of equity and €31.2 billion of AT1 CoCos in 2014. 

So while there is always the risk of short-term market surprises if the ECB stretches to appear tough, bankers are already looking past the stress test and wondering how bank funding markets will change in the weeks ahead. 

A big source of remaining uncertainty is the proposals on total loss-absorbing capacity (TLAC) for the 29 global systemically important banks, of which 16 are based in Europe. The delta for expectations of what will be unveiled at the G20 Brisbane summit in November is extraordinarily wide, ranging from 16% to 25%.

Sam Theodore and Thue Sondergaard at Scope Ratings suggest: “Once the new TLAC norms are firmed out, the market – investors, analysts, rating agencies – will increasingly consider TLAC coverage as a key risk-protection metric for banks, alongside CET1 or leverage ratios.” 

Scope Ratings suggests there could be some big shortfalls to a 25% ratio of TLAC to risk-weighted assets, which might leave BNP Paribas, for example, needing to issue €56 billion more of capital instruments and subordinated debt, HSBC €51 billion and Santander €45 billion.

Greater risk

And while banks hope to build their TLAC reserves overwhelmingly out of equity, new capital instruments and subordinated debt, there is the obvious chance that the higher the standard set for TLAC, the more likely that senior unsecured debt – and even deposits – will be seen to be at greater risk of bail-in and so will re-price to banks’ substantial disadvantage. 

Coupons on AT1 deals that had been coming at 5.625% earlier in the year now require 7.5% to 8% to win investors, and the market is not working well.

“This could trigger a sea-change in the way banks fund themselves,” one head of DCM at a large bank tells Euromoney. “We’re seeing discussion of many banks each needing to raise €30 billion or more of CoCos and tier 2, but I don’t understand this obsession only with subordinated debt. 

“A portion of TLAC has to comprise senior unsecured and the market has to find a price for that.”

Behind the scenes, there has been discussion of whether losses to restore a bank to viability might be applied to just a specified portion of their senior unsecured debt, say 2.5%% to 3%. 

“And we have been talking about a new special category of senior unsecured debt that is bail-inable, possibly with shorter maturities and regularly rolled over,” says the DCM head.

The single supervisory mechanism should do away
with regulation by nods and winks between
national banks and local regulators


How might markets price this? Another banker says: “You have to see the asset quality review, the stress test and the single supervisory mechanism in Europe all as part of a process that also includes resolution regimes. 

“OK, it has taken six years in Europe to achieve what the Americans seemed to do in six months in 2008 and 2009, but this process has vastly improved the stability of European banks. In 2007, the banks funded for five years through senior unsecured at spreads around 15 basis points while operating with just 2% of equity. Today, senior trades at 45bp, but banks have 10% equity.” 

He adds: “And more than that, the single supervisory mechanism should do away with regulation by nods and winks between national banks and local regulators. I work for a French bank, whose primary contact at the new supervisor is a Spaniard who in turn reports to an Italian.”

The banker tries to end the argument on a hopeful note: “Maybe after the markets absorb the stress tests, improved supervision, comparable regulatory standards and the TLAC requirements, then even if that includes 3% of senior unsecured, maybe senior spreads sink to 35bp.”


However, there is another worry: if the outcome of all this is that analysts and investors downgrade actual and implied ratings of senior debt funding and more banks become dependent on high-yield investors. That is a smaller pool of money and one overseen by specialists that are not experts in analyzing banks.

And policymakers have another concern: slowflation, the combination of slowing growth and increasing fears of deflation in Europe

Anshu Jain, co-chief executive of Deutsche Bank, on an Institute of International Finance panel on the future of banking at the Washington IMF meetings, declared: “We have had five or six years of rules and regulations, but at some point we must focus on making the world grow. 

"In Europe, 80% of credit creation is via bank lending. Of the multiple factors impacting European growth, contraction of bank balance sheets is definitely one.”

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