The ECB’s temporary capital relief illustrates perfectly the philosophy of the new bail-in regime. As long as it is only temporary, it is neutral from a valuation standpoint.

On 12 March 2020, the ECB announced that banks under its supervision will be allowed to use their capital and liquidity buffers fully. Banks will also be allowed to partially use AT1 and AT2 debt capital to meet the Pillar 2 Requirements (P2R), thus bringing forward a measure that was initially scheduled to come into effect in January 2021.On top of this, on 27 March, the BIS announced that the implementation date of Basel III would be deferred by one year to 1 January 2023.

The ECB’s announcements should not come as a surprise. As stated by the ECB in its press release “capital and liquidity buffers have been designed with a view to allowing banks to withstand stressed situations like the current one”.It reminds that deposit banks are special animals notably because their bankruptcies derives from a regulatory decision not a payment default.

The reason for this is that deposit banks are monetary institutions so solvency issues are not related to liquidity issues. Although, as part of the monetary system, it is important to keep a certain level of diversification. It comes that bankruptcies, which follow a discretionary decision, are rare.

It shows that under the new resolution regime, which aims at avoiding a bail-out, if shareholders have to invest significantly more than before, they will not lose 100% of their investment. Indeed, the recapitalisation will be triggered before the CET1 falls below 4.5% (corresponding to the minimum equity requirement) and in reality earlier (the recapitalisation debt is called at 5%) under conditions which will not be dilutive. Such a recovery rate, which could be up to 50% (i.e. broadly in line with that of a single A debt instrument) should translate into a slightly lower discount rate (cost of equity) than under a bail-out regime.

However, this does not offset by far the impact of having to remunerate a significantly larger equity base.

In this context, we do not see these temporary relaxations as having a positive impact in terms of valuation as long as banks are supposed to re-build the buffers and Basel III is not abandoned.

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