A Federal Reserve proposal on Friday would give large banks another buffer, designed to reduce the “too big to fail” perception of big institutions.
Banks will need a debt and a capital cushion equal to 16 percent of risk-weighted assets by 2019 and 18 percent by 2022. The Fed’s rule includes four different minimum ratios for firms to meet, leaving unclear the impact on the balance sheet of specific firms.
Six of eight key U.S. banks would need to raise an additional $120 billion to meet the requirements, according to Fed officials. Rules aim to reduce the risk of the companies— including Bank of America (NYSE: BAC), Bank of New York Mellon (NYSE: BK), Citigroup (NYSE: C), Goldman Sachs (NYSE: GS), JPMorgan Chase (NYSE: JPM), Morgan Stanley (NYSE: MS), State Street (NYSE: STT) and Wells Fargo (NYSE: WFC) — derailing markets or needing taxpayer money.
The Fed would expect some large banks to add long-term debt to comply. Similar rules would also apply to U.S. subsidiaries of big foreign banks.
While other rules implemented in the wake of the financial crisis have been meant to make banks safer, Fed governor Daniel Tarullo said, this rule is meant “to make the failure of systemically important banks possible without either causing disorder in financial markets or requiring injections of government capital”.
In its action Friday, the Fed was putting forward its piece of a plan proposed by global regulators in November 2014 for “loss-absorbing capacity” for the world’s 30 largest banks.
It is among a series of rules that are aimed at cutting risk in the banking system by finding out how much debt and equity banks must use to fund themselves.
“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,” said Fed Gov. Daniel Tarullo in a statement Friday.
Six of eight banks assessed would not meet requirements, though officials did not specify which. The Fed’s board was expected to vote on the proposal Friday, and it would then be open to public comment.
largest USA banks would be subject to the new rule, namely Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo.
TLAC is supposed to add another layer of protection. A bank’s borrowings are not usually seen as a stable form of capital because the money has to be repaid, and thus may not be around to absorb losses if the bank’s creditors flee. And, crucially, the debt would be turned into new equity that would provide the financial foundation for the new bank that emerges from receivership.
The requirements are most stringent for JPMorgan, followed by Citigroup. Wells Fargo, for instance, had feared a TLAC minimum as large as 20%. The official name for the buffer is total loss-absorbing capacity. It was expected to have a tougher time meeting the rule than other firms because it relies less on debt and more on deposits.
The proposed rule also required large foreign banks to meet certain long-term debt and TLAC requirements. After that come Bank of America Corp, Goldman Sachs and Morgan Stanley, all of which have the same requirement. Those costs, however, would be outweighed by the benefits to the financial system and taxpayers, in the Fed’s assessment. The costs would go up because the debt could be more expensive than existing sources of funding. While speaking at a background press briefing on Friday, Federal Reserve officials said that it is likely that the banks will meet the $120 billion loss by issuing debt, which is normally more cost-effective as compared to issuing equity.
Under the rule, the proposed long-term debt requirement would set a minimum level of long-term debt that could be used to recapitalize these firms’ critical operations upon failure. The industry had wanted those notes to count without any limitations.
It is among several rules that would aim to cut risk in the banking system.