On July 18, 2024, the government introduced the Bank Resolution (Recapitalisation) Bill in the House of Lords. This bill follows proposals made by the previous administration in January and aligns with the new Labour government’s response to that consultation. It is being described as a “targeted enhancement” to the UK’s special resolution regime (SRR), although it hints at more extensive changes to come.
To provide some context, the SRR applies to banks, building societies, and systemically important investment firms designated by the Prudential Regulation Authority (PRA). It was established in response to the global financial crisis to allow the Bank of England (BoE) to manage the rescue or orderly winding down of failing banks without relying on public funds or risking financial stability.
The BoE has five stabilization tools it can employ when a bank faces financial difficulties. The preferred option for the largest banks, those with total assets between £15-25 billion, is a bail-in. These institutions are required to keep liabilities exceeding minimum capital requirements, known as MREL, which can be written down and converted into equity to recapitalize the bank without taxpayer or third-party involvement. Typically, banks satisfy MREL requirements by issuing specific loss-absorbing debt instruments.
For smaller banks with less than £15 billion in assets but a significant number of transactional accounts, the BoE may utilize transfer tools, allowing a transfer to a bridge bank or a private sector buyer. The smallest banks are often placed in a bank insolvency procedure (BIP), which is a modified standard insolvency procedure. Generally, neither category of banks is required to issue MREL, limiting their ability to self-recapitalize.
The impetus for modifying the SRR arose following the resolution of Silicon Valley Bank (SVB) in 2023, which occurred after the failure of its U.S. parent company. Initially categorized as a BIP firm, the BoE shifted strategy during the resolution weekend, transferring SVB to HSBC to preserve banking services and mitigate contagion risks. This indicated that banks not seen as systemic could still present systemic risks due to their importance to specific economic sectors, such as the UK’s technology industry. This situation highlighted the need for the BoE to have more flexibility in using its stabilization tools, enabling transfers instead of potentially chaotic insolvency processes, all while ensuring that taxpayers would not bear the financial burden of recapitalizing failing banks.
The new Bill aims to grant the BoE the authority to require the Financial Services Compensation Scheme (FSCS) to provide funding to recapitalize a failing financial institution under specific conditions. This would typically apply in cases where the BoE uses its transfer powers, which means it will be less relevant to the approximately 15 banks and building societies that follow a bail-in strategy. Instead, the FSCS would recover costs via increases in the levy imposed on the industry.
The Bill reflects the proposals discussed in January, with the key amendment being an exemption for credit unions from any increase in the FSCS levy, as they do not fall under the SRR.
The Bill presents a strong public policy argument, enhancing financial stability and protecting taxpayers from bailouts during financial crises. However, it could lead to contrasting fortunes within the banking sector. Larger banks will face additional challenges, having to issue MREL for their own recapitalization and contribute to the FSCS’s efforts to help smaller banks. Conversely, smaller banks benefit the most, effectively relying on the rest of the industry for their capital needs, which might help stave off calls to lower MREL thresholds to include a larger segment of the sector.
Those in the middle, particularly smaller bail-in banks and challenger institutions near the £15-25 billion threshold, may find themselves at a disadvantage. Their multinational counterparts have the financial strength and resources to meet MREL requirements and access capital markets more readily. These mid-sized institutions might also lose out if larger entities like HSBC engage with the FSCS to recapitalize smaller banks. In contrast, medium-sized banks may struggle to comply with MREL while also managing competitive pressures.
Future adjustments to the SRR could be forthcoming, as several stakeholders in the government’s consultation raised concerns regarding the indicative MREL thresholds that may unfairly penalize medium-sized banks. Some members of the House of Lords echoed these sentiments during discussions about the Bill, citing the “competitive disadvantage” imposed by MREL.
The government appears to be aware of these issues. In its consultation response, it indicated that the BoE would consider whether adjustments to its indicative thresholds might be warranted. On August 6, the BoE announced plans to review its MREL statement of policy, which includes these thresholds in certain areas.
Whether these thresholds will indeed change remains uncertain. However, mounting political and industry pressure suggests the possibility. If adjustments occur, numerous banks might be exempt from MREL altogether, potentially simplifying their operations and fostering growth. Thus, a bill initially viewed as a targeted modification could lead to more significant changes impacting medium-sized banks and the broader UK financial services landscape.