The largest U.S. banks would face a $120 billion total shortfall of long-term debt under a Federal Reserve proposal aimed at ensuring their failure wouldn’t hurt the broader financial system.
Banks such as Wells Fargo & Co. and JPMorgan Chase & Co. will be required to hold enough debt that could be converted into equity if they were to falter, according to a Fed rule that was approved by a unanimous vote on Friday. The Fed’s proposal, which applies to eight of the biggest U.S. banks, requires debt and a capital cushion equal to at least 16 percent of risk- weighted assets by 2019 and 18 percent by 2022.
The broad strokes of the proposal, including the lengthy phase-in period and the 18 percent target instead of what some bankers thought could be as high as 20 percent, are easier than many in the industry expected. Fed staffers presenting the proposal at Friday’s meeting said the requirement probably will be manageable for the banks.
The proposal, along with other measures regulators have taken to avoid chaotic bank failures, “would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms,” Fed Chair Janet Yellen said in a statement. The plan “is another important step in addressing the ‘too big to fail’ problem,” she said.
The rule on total loss-absorbing capacity, or TLAC, is a key part of regulators’ efforts to avoid another financial crisis. If U.S. banks were to fail, investors in their stock would lose everything, but the debt would be converted into equity in a new, reconstituted bank under the plan. It’s an element of the so-called living wills banks must submit to the Fed and Federal Deposit Insurance Corp. each year to map out their hypothetical demise.
The reason for the provision: When a bank fails, regulators want it to have a war chest to fund a new, healthy version of the company — hopefully without a dime from taxpayers.
Wells Fargo had been perceived as facing the toughest road under the rule because of its reliance on deposits rather than debt. The bank called the proposal “in line with our expectations” in a statement.
Jaret Seiberg, an analyst at Guggenheim Securities LLC, said in a research note that the Fed “passed up several opportunities to be even more onerous."
The Financial Stability Board, a group of global regulators that makes recommendations to the Group of 20 nations, plans to phase in a TLAC rule requiring long-term debt of at least 16 percent of risk-weighted assets starting in 2019 and 18 percent by 2022, people with knowledge of the rule have said. That would broadly match the Fed’s proposal.
The Fed also approved mandatory levels of minimum long-term debt, which vary depending on how large and complex the banks are. Fed officials said Friday that the types of debt that qualify are tougher than what was proposed last year by the FSB.
Since the financial crisis, the Fed has consistently written rules that have been more stringent than global regulatory accords on capital and liquidity.
TLAC is “the final piece of the puzzle in ensuring that the largest banks will be resolvable at no taxpayer cost," according to Greg Baer, president of the Clearing House Association, which represents the largest banks. But he said in an e-mail the Fed plan “seems to go significantly beyond the types and amounts of loss absorbency required for this purpose, and once again significantly beyond what has been proposed as an international standard.”
Banks will find the requirements more challenging after the Fed raises interest rates, Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics, said in an e-mailed statement.
“Big banks have issued a lot of debt under current rates that, when re-issued to comply with TLAC and meet market demands, will cost considerably more,” Petrou said. The Fed has kept interest rates near zero since 2008, though Fed officials have indicated they may raise rates in December.
The banks subject to the proposal are Wells Fargo, JPMorgan, Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp. The proposal is open to comments from the public until Feb. 1.
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