Eugene Grygo, Chief Content Editor, FTF News
Although Halloween has just passed, the U.S. Federal Reserve this past Friday officially proposed a new rule that would in theory prevent big domestic and foreign banks operating in the United States from relying on “extraordinary government support or taxpayer assistance.”
In other words, the Fed is taking on firms that are “Too Big to Fail,” a frightening act for which there is no costume yet. (The 45-page PDF of the proposal is scary enough.)
By the way, the proposal is “pursuant to section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related deduction requirements for all banking organizations subject to the Board’s capital rules,” according to Fed officials.
The Fed would apply the proposed rule to “global systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs,” according to Fed officials.
The GSIBs would be the household names that might bring down your household if they fail miserably.
“These institutions would be required to meet a new long-term debt requirement and a new ‘total loss-absorbing capacity,’ or TLAC, requirement,” according to the Fed.
“To reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function,” Fed officials say. “Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms’ critical operations during resolution.”
For domestic GSIBs, the Fed proposed a long-term debt requirement that would set “a minimum level of long-term debt that could be used to recapitalize these firms’ critical operations upon failure,” officials say. “The complementary TLAC requirement would set a new minimum level of total loss-absorbing capacity, which can be met with both regulatory capital and long-term debt.
In particular, domestic GSIBs would have to hold at a minimum:
- A long-term debt amount of the greater of 6 percent plus its GSIB surcharge of risk-weighted assets and 4.5 percent of total leverage exposure;
- And a TLAC amount of the greater of 18 percent of risk-weighted assets and 9.5 percent of total leverage exposure
The long-term debt requirement “combined with our other work to improve the resolvability of systemic banking firms, would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms,” says Fed Chair Janet L. Yellen in a prepared statement. “This is an important step toward ending the market perception that any banking firm is ‘too big to fail.’ ”
The Fed, again with orderly resolutions in mind, is also proposing to require the parent holding company of a domestic GSIB “avoid entering into certain financial arrangements that would create obstacles to an orderly resolution,” officials say.
These are “clean holding company requirements” that would ban issuance of short-term debt to external investors and on entering into derivatives and certain other types of financial contracts with external counterparties.
The intentions of these requirements are to cut the risk of “destabilizing funding runs at the holding company” and to reduce holding company complexity while enhancing “the resiliency of operating subsidiaries during an orderly resolution,” officials say. The proposal also covers regulatory capital deductions for board-regulated banking firms that hold unsecured debt of the parent holding companies of domestic GSIBs.
“To mitigate the threats to U.S. financial stability from the failure of a large foreign bank, the proposal would also establish long-term debt and TLAC requirements for the U.S. operations of foreign GSIBs,” Fed officials say.
“However, the long-term debt and TLAC would be required to be issued internally, from the U.S. operations to the foreign parent, rather than sold to external investors,” the Fed says. “This feature of the proposal would help ensure that the U.S. operations of a failed foreign GSIB could be recapitalized and kept operating in the event of resolution of the foreign bank by its home resolution authority.”
The U.S. operations of foreign GSIBs generally would be required to hold at a minimum:
- A long-term debt amount of the greater of 7 percent of risk-weighted assets and 3 percent of total leverage exposure and 4 percent of average total consolidated assets;
- And a TLAC amount of the greater of 16 percent of risk-weighted assets and 6 percent of total leverage exposure and 8 percent of average total consolidated assets.
You can send your opinions on whether this is a trick or a treat from the Fed until February 1, 2016. If the rule passes, it will come into full effect January 2022.
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