WASHINGTON — The Federal Reserve Board will consider a proposal Friday requiring the largest and most systemically risky banks to hold additional capital and unsecured debt to absorb losses in a failure scenario.
The proposal would establish a standard for "total loss absorbing capacity." It would require global systemically important banks to hold enough TLAC that could be used to recapitalize a temporary or successor institution. A sufficient amount of TLAC is seen as crucial in the effectiveness of a new Federal Deposit Insurance Corp. facility for resolving failed behemoths.
In prepared remarks ahead of the proposal, Fed Gov. Daniel Tarullo said the TLAC requirement would prevent taxpayer bailouts by effectively requiring banks to have the means of bailing themselves out.
"The principal effect of the long-term debt requirement will be to increase the loss-absorbing capacity of a GSIB even after it has failed," Tarullo said. "By making the failure of even the largest banks more manageable, the proposed regulation will be another important step in solving the too-big-to-fail problem."
The proposal focuses on two separate but related components for achieving adequate TLAC: long-term debt and Tier I capital. For the debt requirement, "plain-vanilla" instruments would qualify, therefore excluding things like structured notes. The debt would also have to be issued by the bank holding company directly rather than by a subsidiary in order to be consistent with the FDIC's "single-point-of-entry" approach for resolving failed firms. The proposal notably does not include any restrictions on what kinds of entities would be eligible to buy that long-term debt.
For the capital requirement, banks would have to maintain 18% of total risk-weighted assets or 9.5% of total leverage exposure, whichever is larger. Common equity Tier 1 capital and Tier 1 capital issued by the bank holding company, as well as eligible external LTD, would qualify toward that total. But the GSIB surcharge would have to be applied on top of the capital requirement, not as part of it. The rule details that the Fed could take actions to restrict dividend payments or curb "discretionary bonus payments" if covered banks fail to meet the capital requirements.
The Fed's policy memo on the proposal said "any covered [bank holding company] that already meets the existing capital requirements and capital buffers would be able to come into compliance with the proposal solely by issuing additional long-term debt." The memo said that six of the eight covered GSIBs have external TLAC shortfalls. The aggregate increased funding cost of the proposal is between $680 million and $1.5 billion, the memo said.
The rule includes a phase-in period, with certain aspects taking effect on Jan. 1, 2019, and the full requirement taking effect on Jan. 1, 2022. The Fed will take comment on the proposal through Feb. 1, 2016.
The Fed's rule comes as the international Financial Stability Board issued a framework rule last November that laid out a minimum TLAC standard amounting to between 16% and 20% of a bank's total risk-weighted assets.
The TLAC concept works by requiring a bank to hold instruments that could quickly be converted into capital after its capital base is exhausted in a failure. The idea is for regulators such as the FDIC to be able to use the recapitalization as a means to finance a bridge entity holding operations of the failed bank. The new capital could also be used to jumpstart a successor company's balance sheet.