WASHINGTON Global regulators are set to unveil a key piece of their plan Monday to allow them to close failed behemoths without wrecking the greater financial system.
The Financial Stability Board's highly anticipated "loss absorbency" plan seeks to impose the costs of a big bank collapse on the failed firm itself, rather than on taxpayers. Under the proposal, which the FSB says it will finalize next year, big banks already subject to international capital rules must strengthen balance sheets further and raise large amounts of new unsecured debt. In a failure, the new instruments would be converted to equity to recapitalize a successor firm.
A minimum loss absorbency requirement for global systemically important banks "will improve global financial stability as it will ensure that each G-SIB has a minimum amount of loss absorbing capacity available, so will help authorities, if required, to resolve financial institutions in an orderly manner without taxpayer support," the FSB said in its "total loss-absorbing capacity" proposal, which was made available to news organizations before its official release.
"The requirement should improve market confidence that each G-SIB can be resolved in an orderly manner, thereby improving the provision of credit globally."
The centerpiece of the plan which was drafted for the G-20 summit in Australia later this month is a proposed minimum range of regulatory capital and convertible debt that together make up 16% to 20% of a firm's risk-weighted assets.
That level of "TLAC" is designed to be at least twice the Basel III total risk-based capital ratio of 8%. However, a bank's minimum TLAC would also have to incorporate the Basel regime's additional capital buffers, likely raising the loss absorbency requirement for the biggest banks to as high as 25%. Banks would also have to comply with a separate non-risk weighted TLAC requirements, which would be double the current Basel III international leverage ratio of 3%.
Under the proposal, which the public can comment on until Feb. 2, the convertible debt instruments would have to comprise at least 33% of the minimum TLAC requirement. FSB member nations can also act to impose further "Pillar 2" TLAC requirement for individual firms on top of the international minimum.
The plan also outlines criteria for which types of debt qualify, limiting TLAC instruments to those with at least a one-year maturity and excluding things like insured deposits. Meanwhile, the FSB also outlined guidelines for establishing minimum TLAC levels in a firm's overseas subsidiaries.
Loss absorbency is seen as a crucial element of a proposed resolution method favored by several nations including the U.S. known as "single point of entry", in which a failed bank's parent would be closed and replaced by a bridge firm to hold the subsidiaries. The idea is that if capital is exhausted, the remaining TLAC made up of "bail-inable" debt could restore the successor firm's capital position without relying on government liquidity. The old creditors would become the new investors, with the objective of making the new firm well-capitalized.
"Resolution is not resurrection. But nor is it insolvency: the institution or successor institution has to meet at least the minimum conditions for authorization in order that supervisors may allow it to continue performing authorized activities, in particular critical functions," the proposal said.
Yet the FSB plan would only establish an international framework seen as acceptable to member nations, with home countries able to implement separate versions that can go beyond the minimum standard. In the U.S., Federal Reserve Board Gov. Daniel Tarullo has already voiced plans for the U.S. version of TLAC to be more stringent.
"Once implemented, [TLAC] will play important roles in enabling globally systemic banks to be resolved without recourse to public subsidy and without disruption to the wider financial system," FSB Chairman Mark Carney, governor of the Bank of England, said in a press release accompanying the proposal.
After the FSB's proposal is presented at the G-20 summit, the board plans to conduct a study next year on the rule's potential impact on the economy. As part of the process, the FSB with the participation of the Basel Committee will conduct a market survey to assess the availability of TLAC-eligible instruments and how debt holders would be affected by the new standard. The board said it plans to revise the standard by the 2015 G-20 summit planned for Turkey. Banks are expected to be in compliance by 2019.