Europe's systemic banks appear well advanced in becoming financially and operationally resolvable. Resolution and resolvability are complex concepts and a successful outcome would depend largely on market confidence in the process. S&P Global Ratings sees European regulators' resolvability assessments as an important step in improving transparency and enhancing the likelihood of a well-executed resolution, assuming banks go on to address the identified action points. We see these points as areas requiring further work to maximize preparedness rather than material obstacles to an effective resolution.

For most systemic European banks, the slowing macroeconomy and tighter debt market conditions should not significantly hinder the achievement of regulators' resolvability deadlines. Most of the sector already meets the required levels of bail-in capacity, with the main exceptions in southern Europe. Volatile inflation and interest rate expectations hamper primary market access and we anticipate that issuers will take advantage of available funding windows to refinance maturing debt as necessary.

The European Commission is working on proposals to update the EU's crisis management and deposit insurance (CMDI) framework to embed lessons learned since the resolution regime was implemented in the mid-2010s. This exercise is less ambitious than originally envisaged and now excludes the much-discussed prospect of an integrated European deposit insurance scheme (EDIS). Nevertheless, the review has the potential to strengthen the EU resolution framework and possibly broaden the scope of additional loss-absorbing capacity (ALAC) uplift in our ratings. Key aims include bringing more mid-sized banks within the scope of resolution, ensuring greater consistency in the management of failing banks, and unlocking financial contributions from national deposit guarantee schemes (DGSs) and the single resolution fund (SRF).

This article is the latest in an annual series summarizing resolution-related developments affecting European banks over the preceding 12 months and anticipating changes that could affect ALAC uplift.

Banks are making solid progress toward full resolvability

So far this year, the Bank of England (BoE) and Single Resolution Board (SRB) have followed their Swiss and U.S. counterparts' lead in publishing assessments of banks' resolvability. The outcomes underline our view that there is a real alternative to taxpayer-funded bailouts and government support for a failing bank is an uncertain prospect.

Similar to its Swiss equivalent, the BoE publication provided specific comments on each of the eight largest banks in its jurisdiction (see "Bank of England Sees Systemic U.K. Banks As Substantially Resolvable, With Certain Gaps Still To Close," published on June 10, 2022). The SRB published high-level, groupwide findings from its assessment of 120 systemically important banks under its remit (see "Bulletin: Single Resolution Board Says That Banks Must Go The Distance To Ensure Full Resolvability," published on July 13, 2022). Both exercises concluded that banks are well-advanced in becoming resolvable but have residual gaps to address, particularly within operational continuity (including access to financial market infrastructure), funding in resolution, and business restructuring. The regulatory deadlines to achieve full resolvability are the end of this year for the largest U.K. banks and the end of 2023 for banking union peers.

A key precondition for a bank's financial resolvability is sufficient bail-in capacity to absorb losses and fund a recapitalization. European banks are generally well placed in this respect, with a relatively small aggregate shortfall to the regulatory minimum requirement for own funds and eligible liabilities (MREL). The latest data for resolution entities under the SRB's remit showed a small MREL deficit concentrated in certain Greek, Italian, and Spanish banks (see chart 1). Including the combined buffer requirement, the SRB data shows that resolution entities' aggregate MREL targets were just under €2 trillion as of March 31, 2022, and the €36.7 billion shortfall was an insignificant amount in that context.

Chart 1

EU banks' funding plans indicate that issuance of subordinated MREL instruments is intended to increase gradually in 2022-2024 and exceed scheduled maturities in each year (see chart 3). The planned expansion of the MREL stock is intended to support asset growth and fill the current shortfall. Senior holding company and senior nonpreferred operating company debt are the most cost-effective subordinated MREL instruments and EU banks intend to ramp up issuance of these bonds in 2022-2024, which primarily reflects a larger refinancing requirement.

Chart 2

Debt market conditions will largely determine the feasibility of banks' issuance plans. Spreads increased following Russia's invasion of Ukraine, and volatile inflation and interest rate expectations subsequently produced the tightest wholesale funding conditions since the onset of the COVID-19 pandemic (see chart 3). A continuation of these trends would raise the cost of maintaining the MREL stock and the market might effectively close to new issuance at certain times, as it did in February/March 2022. We expect authorities would use the flexibility available to them within resolution legislation if market conditions caused a bank to fall slightly short of its required MREL. Some banks might choose to issue cheaper senior preferred debt in place of senior nonpreferred if their MREL requirements allow this.

Chart 3

Selective increase in ALAC notching in the past 12 months

We include ALAC uplift in our ratings when we think a bank's resolution strategy, bail-in buffer, and other aspects of resolvability are likely to support full and timely servicing of senior unsecured obligations, including senior preferred bonds. Our updated financial institutions rating methodology, published in December 2021, included certain revisions to our ALAC approach, including a stronger focus on gone-concern loss-absorbing capacity and a concurrent reduction in the standard thresholds for rating uplift.

We include one or more ALAC notches in our ratings on 51 banking groups headquartered in 15 European countries. We have positive outlooks on two further banks--Ceska Sporitelna a.s. and Banco de Sabadell S.A.--and a developing outlook on mBank SA, as these banks could gain a first ALAC notch if they deliver on their issuance plans. The annex at the end of this article provides data on European banks' ALAC ratios, thresholds, and rating uplift.

Notable resolution-related rating actions over the past 12 months include the following:

• For most banks, the updated rating methodology did not affect our ratings or our ALAC notching but there were a handful of groups for which we increased ALAC uplift. These included three groups with multiple-point-of-entry (MPE) resolution strategies--Banco Bilbao Vizcaya Argentaria S.A., Banco Santander S.A., and Erste Bank Group AG--due in part to greater consideration of MPE groups' ALAC buffers under the updated methodology (see "Six European Banks Upgraded On ALAC Or Group Support Uplift; Off UCO On Implementation Of Revised FI Criteria," published on Dec. 16, 2021). We subsequently raised the ratings on another MPE group--Nova Ljubljanska Banka D.D.--due to its ALAC build-up (see "Nova Ljubljanska Banka Upgraded To 'BBB/A-2' On Effective Resolution Strategy, Loss-Absorption Buffers; Outlook Stable," published on May 11, 2022). A recently published commentary summarized our analytical approach to MPE groups (see "Multiple Point Of Entry Resolution: Analytical Considerations For Groups Designed To Fragment In Crisis," published on Aug. 11, 2022).
• We increased ALAC notching in the ratings on single-point-of-entry (SPE) groups--AIB Group PLC, Belfius Bank SA/NV, CaixaBank S.A., and Credit Mutuel Group--following the implementation of the updated methodology, partly due to continued buffer building (see "Four European Bank Ratings Raised, One Affirmed On ALAC Uplift; Off UCO On Implementation Of Revised FI Criteria," published on Dec. 16, 2021).
• We affirmed our ratings on UniCredit SpA's German and Austrian subsidiaries in August 2022. Although we think UniCredit group now operates a de facto SPE resolution strategy, we see the two subsidiaries as likely to withstand parental stress given their intrinsic strength, and we rate them above UniCredit SpA's group credit profile (see "Rating Actions On UniCredit’s German and Austrian Banks On Insulation From Parent After Review Of Resolution Approach," published on Aug. 10, 2022).
• We removed ALAC uplift from our ratings on Hamburg Commercial Bank AG after we concluded that its primary resolution strategy was likely to be a modified liquidation rather than an open bank bail-in (see "Germany-Based Hamburg Commercial Bank 'BBB' Rating Affirmed On Removal Of ALAC Uplift; Outlook Stable," published on March 18, 2022). At the same time, we lowered ALAC uplift in the rating on Deutsche Pfandbriefbank AG due to limited visibility on the likely use of resolution tools to ensure continuity of operations (see "Deutsche Pfandbriefbank Outlook To Stable From Negative On Resolution Clarity And Sound Performance; Ratings Affirmed," published on March 18, 2022). For both banks, improvements in the stand-alone credit profiles offset the reduced ALAC uplift and led us to affirm the ratings with a stable outlook.
• In May 2022, we revised our assessment of Iceland's resolution framework to sufficiently effective under our methodology due to the country's progress in developing its legislative and policy frameworks. As a result, we now see sufficiently effective resolution regimes in all Western European jurisdictions that we assess (see chart 4). We do not include ALAC uplift in the ratings on the three systemic Icelandic banks because we do not currently expect them to build sufficient buffers of ALAC-eligible, loss-absorbing instruments to meaningfully reduce default risk on senior preferred liabilities (see "Icelandic Bank Ratings Unaffected By Sufficiently Effective Resolution Regime; 'BBB+' RCRs Assigned; Outlooks Stable," published on May 17, 2022).

Chart 4

Resolution remains a largely untested tool

Banks' progress on resolvability increases the credibility of the resolution mechanism, but open bank bail-in is the primary tool for the largest, systemically-important European banks and remains untested. We see the weakening economy and constrained gas supply as an earnings, not a capital, event for the European banking sector, which benefits from growing net interest income and governments' energy price subsidies.

Following the 2017 resolution of Spain's Banco Popular, in which ownership transferred to Banco Santander, liquidity pressures on Sberbank Europe presented the SRB with its second resolution action earlier this year (see "The Failure Of Sberbank Europe: International In Life, National In Death," published on March 4, 2022). Both cases were a success in terms of protecting senior creditors, mitigating financial stability spillovers, and avoiding taxpayer funding. Sanctions imposed on Russia complicated the Sberbank Europe resolution and the SRB's treatment of the regulated banking entities varied across the region. The SRB transferred the Croatian and Slovenian subsidiaries to local competitor banks but decided that a resolution action was not necessary for the Austrian entity, which was placed into insolvency with eligible deposits protected by the national DGS. Similarly, outside the banking union, resolution authorities in Bosnia Herzegovina and Serbia transferred Sberbank's local subsidiaries to peer banks while their counterparts in Czechia and Hungary placed their local Sberbank entities in liquidation, with insured deposits covered by the national DGSs.

The Sberbank Europe resolution highlighted the fragmentation of national DGSs within Europe in the absence of EDIS. The risk to the DGSs in Austria, Czechia, and Hungary was low since Sberbank Europe failed due to illiquidity in the wake of Russia's invasion of Ukraine, not poor quality assets. In different circumstances, where national DGSs may have faced material losses, resolution authorities would have faced a more difficult decision.

The forced restructuring announced today of troubled Polish bank Getin Noble comes as no surprise to us. It is another reminder that even midsize banks will be allowed to fail but resolution authorities will act to preserve critical functions (see "There's No Easy Way Out Of Getin Noble's Troubles," published on May 6, 2022).

Keenly awaited review of the EU's CMDI framework

The European Commission is currently reviewing the EU resolution framework to take on board the lessons of bank failures since the introduction of the first Bank Recovery and Resolution Directive. This exercise was originally intended as a broad range of measures to deliver a comprehensive banking union, including EDIS as its third pillar. However, the Eurogroup (which comprises member states' finance ministers) narrowed the ambition in June 2022 and opted to focus solely on the CMDI framework, with four inter-related priorities:

Broader application of resolution tools at regional and national levels.   The SRB noted at its recent annual conference that, of the total risk-weighted assets held by the banks under its remit, 97% are earmarked for resolution in the event of failure and the remainder for liquidation. However, there are regionally important banks that, recent experience has shown, are too big to liquidate and the Eurogroup intends to bring these within the scope of resolution. We imagine that the primary resolution strategies for such firms are more likely to be partial transfer or sale of business than open bank bail-in.

A clarified and harmonized public interest assessment.   Currently, one of the conditions for resolution under EU law is that the resolution authority deems it to be in the public interest. To date, the SRB has determined that this condition was met for Banco Popular and Sberbank's Croatian and Slovenian subsidiaries; it was failed in the cases of Italy's Banca Popolare di Vicenza and Veneto Banca, Latvia's AS PNB Banka, and Sberbank's Austrian entity. The latter institutions were managed under national insolvency laws, with inconsistencies in creditor outcomes and government bailouts. The likely outcome of the CMDI review is that resolution actions are more frequently determined to be in the public interest and applied more consistently. EU state aid rules are under review in parallel and there should be less need for taxpayer funding if the updated CMDI framework meets the Eurogroup's aims.

Harmonized use of national DGSs in resolution.   The Federal Deposit Insurance Corporation is commonly involved when a U.S. bank fails, using its resources to support insured deposits while the firm is wound down. Although legally permissible, it is difficult for EU national DGSs to play a similar role because of their super-priority in the creditor hierarchy. This means that a contribution to a preventative resolution funding package is unlikely to cost less than reimbursing insured deposits following liquidation. Addressing this constraint could enable DGSs to bridge the gap to the point where the SRF can deploy its resources. The SRF cannot contribute to a resolution unless 8% of a failing bank's total liabilities (including own funds) have already been absorbed, which is a high threshold. With €66 billion of resources, the SRF is well funded and poised to meet its target of 1% of covered deposits, which is about €80 billion.

Harmonization of certain features of national insolvency laws.  Several EU countries--including Greece, Italy, and Portugal--have already introduced a general depositor preference and this measure appears likely to be extended across the bloc at the same time as the DGS super-preference is removed. This change is unlikely to affect our ratings directly because we do not see it meaningfully changing banks' ability and willingness to service senior preferred debt and other senior unsecured obligations. Although the recovery prospects for senior preferred bonds may decline, our bank ratings reflect the likelihood of default and do not assess loss-given default (see "Extending Depositor Preference To All Depositors Would Not Trigger Rating Changes On Spanish Banks," published on Nov. 25, 2020).

In combination, these changes have the potential to create a more predictable and consistent resolution framework across the EU and reduce the need for taxpayer-funded support such as that extended to Banca Popolare di Vicenza, Monte Paschi di Siena, and Veneto Banca.

Potential resolution-related rating drivers in the coming 12 months and beyond

For most European banks, the extent of ALAC uplift in our ratings is likely to remain stable but there may be selected cases where we see grounds for change. In particular, we could revise upward or downward ALAC notching if selected banks strengthen or deplete their buffers of eligible instruments. We are alert to the possibility that an EU-wide general depositor preference could facilitate a bail-in of senior preferred bonds. In turn, this could lower resolution authorities' subordinated MREL requirements in the medium term and alter banks' issuance plans. Should this scenario occur, we could reduce ALAC notching in our ratings on banks that increase reliance on senior preferred debt to meet their MREL requirements.

For the majority of European banks with ALAC uplift in our ratings, the primary resolution strategy is open bank bail-in. We are cautious in considering ALAC uplift in the ratings on banks with a full or partial sale of business or a bridge bank as the primary strategy. For sale of business, this is because we question whether there would necessarily be a willing buyer, and therefore we also take into account the fallback resolution plan. For bridge bank strategies, our caution reflects uncertainty over whether all senior preferred debt and equal-ranking liabilities would necessarily transfer to the acquirer and continue to be serviced in full and on time. We reflect these reservations by limiting ALAC uplift to either one notch or zero, depending on the circumstances. However, we continue to engage with stakeholders on this subject, and could adapt our approach if we see a greater chance that senior unsecured creditors would continue to be paid on time and in full under these resolution strategies.

Under our rating methodology, we could lower a bank's ALAC threshold if a prefunded resolution fund has the potential to increase the effective loss-absorbing capacity and if the fund ensures full and timely payment of senior unsecured obligations. There are currently no cases where we make a threshold adjustment for this reason. Within the banking union, this is due to the practical limitation on the use of the SRF's resources, as the Eurogroup and SRB have acknowledged. If the CMDI review meets its aim of unlocking the SRF, we would consider whether threshold adjustments are warranted and how we would quantify them in view of the large number of banks that could draw on the SRF's resources.

Related Criteria

• Financial Institutions Rating Methodology, Dec. 9, 2021

Related Research

• Multiple Point Of Entry Resolution: Analytical Considerations For Groups Designed To Fragment In Crisis, Aug. 11, 2022
• Rating Actions On UniCredit’s German and Austrian Banks On Insulation From Parent After Review Of Resolution Approach, Aug. 10, 2022
• Bulletin: Single Resolution Board Says That Banks Must Go The Distance To Ensure Full Resolvability, July 13, 2022
• Bank of England Sees Systemic U.K. Banks As Substantially Resolvable, With Certain Gaps Still To Close, June 10, 2022
• Icelandic Bank Ratings Unaffected By Sufficiently Effective Resolution Regime; 'BBB+' RCRs Assigned; Outlooks Stable, May 17, 2022
• Nova Ljubljanska Banka Upgraded To 'BBB/A-2' On Effective Resolution Strategy, Loss-Absorption Buffers; Outlook Stable, May 11, 2022
• Deutsche Pfandbriefbank Outlook To Stable From Negative On Resolution Clarity And Sound Performance; Ratings Affirmed, March 18, 2022
• Germany-Based Hamburg Commercial Bank 'BBB' Rating Affirmed On Removal Of ALAC Uplift; Outlook Stable, March 18, 2022
• The Failure Of Sberbank Europe: International In Life, National In Death, March 4, 2022
• Six European Banks Upgraded On ALAC Or Group Support Uplift; Off UCO On Implementation Of Revised FI Criteria, Dec. 16, 2021
• Four European Bank Ratings Raised, One Affirmed On ALAC Uplift; Off UCO On Implementation Of Revised FI Criteria, Dec. 16, 2021
• The Resolution Story For Europe's Banks: More Resolvability, Consistency, Credibility, Oct. 5, 2021
• Bulletin: Extending Depositor Preference To All Depositors Would Not Trigger Rating Changes On Spanish Banks, Nov. 25, 2020

Annex

Table 1

Table 2