Total loss absorption capacity-Towards a simple and effective methodology

Abstract

A successful resolution of a banking entity is linked to the level of capital and loss-absorbing debt instruments available at the time when the resolution is triggered. This article aims to propose an alternative methodology to determine the minimum requirement of loss absorption and recapitalisation capacity for banks. The model proposed uses probability of default and loss given default data together with a series of adjustment factors to estimate the necessary requirement of loss absorption capacity. One of the main advantages of this method is the simplicity and transparency of the model. The second part of this document is focused on applying the methodology proposed to a sample of Spanish banks composed of entities with total assets above EUR200bn. Results of the analysis point out that total loss absorption and recapitalization capacity of 27.5%-34% over risk-weighted assets is desirable. This range is above the current loss absorption requirements set by most of the international regulatory and supervisory bodies. The results presented in this paper are meant to be especially relevant to banking regulators and supervisors, since propose an alternative methodology for calculating the loss absorption requirements.