Fed proposal puts $168b debt burden on big US banks

New rule aimed at avoiding chaotic bank failures, reducing threat to financial system

WASHINGTON • The largest United States banks would face a US$120 billion (S$168 billion) total shortfall of long-term debt under a Federal Reserve proposal aimed at ensuring their failure would not hurt the broader financial system.

Banks, such as Wells Fargo and JPMorgan Chase, 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 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 US 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.

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.

It is 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.

Mr Jaret Seiberg, an analyst at Guggenheim Securities, 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 per cent of risk-weighted assets starting in 2019 and 18 per cent by 2022, people with knowledge of the rule have said. That would broadly match the Fed's proposal.

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 Mr 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".

The banks subject to the proposal are Wells Fargo, JPMorgan, Citigroup, Bank of America, Goldman Sachs Group, Morgan Stanley, State Street and Bank of New York Mellon.

The proposal is open to comments from the public until Feb 1.

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A version of this article appeared in the print edition of The Sunday Times on November 01, 2015, with the headline 'Fed proposal puts $168b debt burden on big US banks'. Print Edition | Subscribe