OREANDA-NEWS. French banks' Issuer Default Ratings (IDRs) will not be affected if France's plans to create a new class of senior bank debt are implemented, says Fitch Ratings. The proposed new class of senior debt - 'non-preferred senior debt' in this comment - will be subordinated to existing senior debt ('preferred senior debt') and bailed in more quickly in the event of resolution under the EU's Bank Recovery and Resolution Directive (BRRD).

We think the French proposal will provide banks with flexibility in their funding plan, assuming investor demand: non-preferred senior securities could help French globally systemically important banks (G-SIBs) comply with the G20's total loss-absorbing capacity (TLAC) requirements, whereas more cost-effective preferred senior securities would be issued to fund the banks' structural deficit in deposits.

We think BNP Paribas is likely to be an active issuer of the new non-preferred senior debt because its current total capital adequacy ratio, 13.4% at end-September 2015, is far lower than its anticipated TLAC requirements. Other French G-SIBs either have smaller or no TLAC shortfalls. But they might issue some non-preferred senior debt, depending on pricing and market appetite.

This new non-preferred senior debt class would effectively become the reference debt class used by us for setting a bank's IDR. This is because our IDRs rate to the third-party, private sector senior debt category with the highest risk, and the default risk on the new class of non-preferred senior debt would be higher than the risk associated with preferred senior debt and other senior liabilities like large, wholesale deposits.

Hypothetically, if a bank issued very large and stable volumes of non-preferred senior securities and built up a considerable buffer, the default risk of the preferred senior debt would reduce and it could be notched up from the non-preferred debt rating. But we are some way off this, as the French option, proposed in late 2015, still requires debate and we think legislation is unlikely to be passed before end-June 2016.

The G20's TLAC standards for G-SIBs say that TLAC must be subordinated to excluded liabilities, such as insured deposits, preferred liabilities and liabilities that cannot be bailed in. Four of the 30 G-SIBs are French banks and the new non-preferred senior securities would help them comply with TLAC rules.

EU countries are adopting different mechanisms to achieve the subordination of senior debt, as required by BRRD. Germany is ensuring TLAC eligibility of existing senior bank debt by subordinating it to all other senior liabilities from 2017. Italy is considering full depositor preference from 2019, in which case senior bank debt can still be TLAC eligible if equally ranking excluded liabilities are small. In Spain, banks can already issue 'Tier 3' senior debt, which is contractually subordinated to existing senior debt but sits above Tier 2 debt.