Germany legislators in March penned a draft law that would effectively subordinate senior unsecured debt to other operating liabilities, like senior deposits and derivatives.
The legislation is expected to give German banks a head start in meeting their obligations under the Total Loss Absorbing Capacity (TLAC) and Minimum Requirement for Own Funds and Eligible Liabilities (MREL) regulations.
Some market participants seem convinced that Germany’s legislation is just the beginning and that the rest of Europe — or at least the countries where banks typically don’t have holding company structures — will be quick to follow with similar legislation of their own.
If other lawmakers are rushing to put together imitation proposals, they shouldn’t.
Senior unsecured debt is first and foremost is a funding tool, a way that a bank can raise money to finance its day-to-day operations. Tier one and tier two debts are first and foremost capital instruments, they exist so that a bank can meet its regulatory obligations.
Muddying that water creates issues. Bolting capital-like elements onto a funding tool in order to make it easier for issuers to meet regulatory obligations naturally makes that tool worse for funding. Senior will be pricier and more volatile, and issuers will be more likely to lose market access.
The plan looks great until markets turn sour and suddenly you’ve locked your countries’ banks out of the public bond markets. Whoops.
This isn’t such a problem for German banks. Many, the Landesbanken, for example, aren’t regular issuers of senior debt anyway. They have alternative sources of funding, such as Schuldscheine — unaffected by the draft legislation.
Germany's banking system has other idiosyncrasies that help some of its banks to maintain access to the bond markets Individual institutions within the system of Sparkassen, or savings banks, can buy each others debt with a 0% risk weighting. The same is true for the network of co-operative banks.
At any rate, even with the changes to senior, they still have a “pure” funding instrument. There’s nothing stopping non-German issuers selling Schuldscheine too, but they lack the German banks’ experience in the market and the home-field advantage that helps these issuers appeal to their local investors.
Now, senior would still likely be bail-inable in these other jurisdictions — Moody’s released research this week indicating that they see the German draft law as simply turning the de facto situation into a de jure one — but it doesn’t follow that, say, French legislators should embrace it in the same way as their German counterparts.
The establishment of holding companies (if practical in a particular jurisdiction) or issuing debt contractually subordinated to regular senior debt still has an important role to play even if vanilla senior is subject to bail-in.
Just because an asset class can be bailed in, it doesn’t mean that treasurers — and legislators — shouldn’t be trying their hardest to shield it from that eventuality.