MREL stands for Minimum Requirement for Own Funds and Eligible Liabilities, and it is the minimum amount of equity and subordinated debt a firm must maintain to support an effective resolution in the event of failure.
In simpler terms, MREL is like a financial cushion that banks and other financial institutions are required to have. This cushion is designed to absorb losses if the institution runs into serious financial trouble, preventing taxpayers from having to bail them out. It ensures that the failing institution can be resolved in an orderly manner, minimizing disruption to the financial system and the wider economy.
Key Aspects of MREL:
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Loss Absorption: MREL instruments (like certain types of debt) are written down or converted to equity to absorb losses when a firm is close to failing. This helps recapitalize the firm or facilitate its orderly resolution.
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Recapitalization: After absorbing losses, MREL can be used to restore the institution's capital base to a level that allows it to continue operating or to be sold to a healthier institution.
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Resolution Framework: MREL is a critical component of resolution frameworks put in place by regulatory authorities globally. These frameworks aim to provide tools and powers to manage the failure of financial institutions without resorting to taxpayer bailouts.
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Eligibility Criteria: Not all debt can count towards MREL. Regulatory authorities set eligibility criteria for the types of instruments that can be included, focusing on their subordination (ranking below other debt claims) and loss-absorbing capacity. Common examples include subordinated debt and specific types of senior debt.
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Firm-Specific Requirements: The exact MREL requirements vary depending on the size, complexity, and systemic importance of the financial institution. Larger, more complex, and systemically important institutions generally have higher MREL requirements. Authorities consider factors like the institution's risk profile and business model when setting these requirements.
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Global Implementation: MREL or similar requirements (such as TLAC - Total Loss-Absorbing Capacity) are being implemented globally by regulatory authorities following the 2008 financial crisis to improve the resilience of the financial system.
Why is MREL important?
- Protects Taxpayers: By providing a buffer to absorb losses, MREL reduces the likelihood of taxpayer-funded bailouts.
- Financial Stability: MREL helps maintain financial stability by allowing failing institutions to be resolved in an orderly way, preventing contagion to other parts of the financial system.
- Market Discipline: MREL encourages market discipline by ensuring that investors in MREL instruments understand and price in the risk of loss in the event of resolution.
- Reduces Moral Hazard: MREL discourages excessive risk-taking by financial institutions by ensuring that losses will be borne by shareholders and creditors, rather than by taxpayers.
In conclusion, MREL is a crucial regulatory tool designed to enhance the resilience of the financial system by ensuring that financial institutions have sufficient capacity to absorb losses and be resolved without causing systemic disruption or requiring taxpayer support.
