WASHINGTON — The Federal Reserve Board is slated to vote next week on a final rule meant to help regulators recapitalize a major U.S. bank if it should run aground, one of the last significant capital regulations that the agencies have yet to complete.
The rule, known as Total Loss Absorbing Capacity, or TLAC, was proposed more than a year ago and is an instrumental part of the Basel III strategy for preventing taxpayer bailouts of failing major banks. The board will meet Dec. 15 to vote on the final rule.
The plan would require the largest U.S. banks — known as global systemically important banks — to hold certain levels of unsecured debt. If the bank fails, that debt could then be converted into equity, thus turning the debtholders into stakeholders in a successor institution and giving the Federal Deposit Insurance Corp. a runway with which to seize and unwind the failed bank.
Under the Fed's proposal, a G-SIB would have to hold either 18% of total risk-weighted assets or 9.5% of total leverage exposure in Tier 1 capital, in addition to a 1%-4.5% surcharge required as part of a separate rulemaking. The Fed estimated the funding cost of the rule to the G-SIBs at $680 million to $1.5 billion.
The proposal would also require TLAC debt to be issued by a "clean" bank holding company, meaning the overall parent entity of a G-SIB or the U.S. subsidiary of a foreign G-SIB would be prohibited from issuing short-term debt to third parties, holding derivatives or other contracts with external counterparties, holding liabilities guaranteed by its subsidiaries or guaranteeing its subsidiaries in such a way that creates "disruptive default, set-off, or netting rights for subsidiaries creditors." Other noncontingent junior liabilities unrelated to TLAC or long-term debt would also be capped at 5% of the holding company's TLAC under the proposal.
Banks have bristled at the proposed rule, particularly the requirement that the debt be held as Tier 1 capital rather than as common equity Tier 1 capital, which would be a far less costly solution, and some of the stipulations on how the debt must be structured. And congressional Republicans have favored a regulatory approach that would bypass the TLAC requirement altogether in favor of a single, relatively high leverage-based capital ratio.
But Federal Reserve Gov. Daniel Tarullo has defended the concept of TLAC and criticized the idea of simply requiring higher capital. In remarks at Columbia Law School in October, he noted that capital, by its very definition, gets absorbed in a crisis situation, and so it is necessary to have a plan in place for when the capital runs out.
"That's why you need an identifiable set of instruments which will, by definition, not have been eroded in the run-up to the stress period, which will then be available to the FDIC to convert into equity, thereby recapitalizing the firm," Tarullo said.