The world’s largest banks will have to boost loss-absorbing liability buffers to see them through a crisis, as regulators move to tackle too-big-to-fail lenders six years after the collapse of Lehman Brothers Holdings Inc.
The Financial Stability Board, led by Bank of England Governor Mark Carney, said Monday that the biggest banks may be required to have total loss-absorbing capacity equivalent to as much as a quarter of their assets weighted for risk, with national regulators able to impose still-tougher standards. The FSB is seeking comment on the rule, known as TLAC, which would apply at the earliest in 2019.
The plans are a “watershed” in regulators’ mission to end the threat posed by banks whose size and systemic importance mean their failure would be catastrophic for the global economy, Carney told reporters Monday in Basel, Switzerland. “The outlines of how we are going to end too-big-to-fail are here.”
The rules are the latest step by the FSB in a five-year quest to boost banks’ resilience in the face of financial shocks. Agreement has already been reached on measures including tougher capital requirements and enhanced scrutiny by supervisors.
The TLAC rules would apply to the FSB’s register of global systemically important banks. The latest list, published last week, contains 30 banks, with HSBC Holdings Plc and JPMorgan Chase & Co. identified as the most significant.
The draft requirements announced by the FSB would measure banks’ ability to absorb losses in a crisis, shielding taxpayers from bailouts.
European banks set to have to issue the most new debt to meet the rule may include BNP Paribas SA, Banco Santander SA, Societe Generale SA, Deutsche Bank AG, Banco Bilbao Vizcaya Argentaria SA and UniCredit SpA, according to analysts at Citigroup Inc.
Spokespeople for Societe Generale, Deutsche Bank and UniCredit declined to comment on the FSB release. A call seeking comment at BNP Paribas wasn’t immediately returned. Monday was a public holiday in Spain.
Satisfying the TLAC requirements could cost European banks as much as 3 percent of their estimated 2016 profits, London-based Citi analysts Andrew Coombs, Kinner Lakhani and Ronit Ghose said in a research note. “Least impacted” are Swiss and U.K. banks, which would benefit from existing holding company structures from which they can issue senior debt, they said.
Once the rules are in force, banks that breach, or are deemed as “likely” to breach, their TLAC requirements would face restrictions from regulators, including curbs on their ability to pay bonuses and dividends.
Banks hit by the rule “may pass on a share of their higher funding costs to their clients, prompting a shift of banking activities to other banks without necessarily reducing the amount of activity,” the FSB said. Also, banks’ “dividends and other distributions, such as employee remuneration, might fall.”
Other side effects could include a decline in funding costs for governments, the FSB said.
Instruments that banks will be allowed to count as TLAC include equity resulting from their issuance of ordinary shares, retained earnings and other securities that can count toward regulatory capital. The definition of TLAC also includes some other liabilities, such as some unsecured debt, where losses could be be imposed on creditors without practical or legal impediments.
While the basic requirement will be set at 16 percent to 20 percent of risk-weighted assets, the final number will be higher because the banks must separately meet other capital buffers already set by global regulators, the FSB said.
The FSB will seek views on the plans and carry out detailed impact studies next year, before completing the rule in time for the 2015 G-20 summit. This further work will allow the FSB to identify a “single specific minimum” requirement.
Carney, who was appointed to a second three-year term as FSB chairman last week, said there was scope within the rules for some senior unsecured debt to count toward a bank’s TLAC.
For debt to count toward TLAC it would have to have a remaining maturity of more than a year, Carney said. “The second thing is it has to be subordinate to other creditors, to creditors who if they were bailed in would contribute to a disorderly resolution,” such as derivatives counterparties, he said.
Senior debt could, for example, count toward a bank operating company’s TLAC if it was issued by the holding company, and the “debt of the holding company is effectively subordinated to the debt at the operating company,” Carney said.
Another way senior debt could be eligible for TLAC is if it “could be subordinated in statutory terms so it could be made clear via statute that senior unsecured creditors could be bailed in before other senior creditors -- the most obvious ones are depositors,” he said.
Some senior debt “currently in issuance” from globally systemic banks “would need to be restructured in order to be eligible as TLAC,” for example to “subordinate it to excluded liabilities,” the FSB said.
In addition to the rule measured against risk-weighted assets, banks will also need to have TLAC equivalent to 6 percent of their total assets. This number could still rise as it is linked to a parallel set of international talks on bank capital rules.
“From the U.S. perspective, the regulators — particularly the Fed — fought very hard for the most stringent approach,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc. While the international standard allows use of equity to meet the demand, the U.S. version will probably focus more on long-term debt -- and be imposed more quickly, she said.
The Federal Reserve has been tailoring that loss-absorbing cushion for banks including JPMorgan, Citigroup Inc., Goldman Sachs Group Inc. and Wells Fargo & Co. The U.S. version “will probably be a little bit more rigorous with respect to some of the qualifying instruments,” Fed Governor Daniel Tarullo, who has coordinated the central bank’s rulemaking, said at last month’s Bretton Woods Committee meeting.
The Fed and other U.S. banking agencies have been tougher on domestic banks in other rules based on international accords, such as recently established capital and liquidity demands. Eric Kollig, a Fed spokesman, declined to comment on his agency’s standard, which is being written with help from the Federal Deposit Insurance Corp.
Banks “headquartered in emerging markets will not, initially, be subject” to the standards, the FSB said. The group added Agricultural Bank of China Ltd to its latest list of systemically important lenders, taking the number of Chinese banks to three.
At least one-third of each bank’s buffer should be made up of debt, the FSB said, to ensure that a failed lender has “sufficient outstanding long-term debt for absorbing losses and/or effecting a recapitalization in resolution.”
Banks would also face curbs on their ability to count debt they sell to each other toward the TLAC requirement, a step meant to “reduce the risk of contagion” if one firm collapses.
These curbs would work by targeting banks whose purchases of shares and TLAC-eligible debt from another globally systemic lender exceed certain levels. In such instances, the purchasing bank would be forced to write down the size of its own buffer of TLAC eligible securities.
The FSB consists of regulators and central bankers from around the world. Carney had committed the group to delivering the TLAC plan by the Nov. 15-16 G-20 summit in Brisbane, Australia.
Banks will have until Feb. 2, 2015, to submit their views on the TLAC plan.
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