Eight of the country’s largest banks would be required to raise $120 billion to comply with a new rule proposed Friday by the Federal Reserve Board, with the money designated to recapitalize the bank should it fail, lessening the likelihood of a a government bailout.
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The Fed’s rule stems from an worldwide effort to expand financial buffers at giant banks to help protect them against losses.
By making it clear upfront who will bear a failing bank’s losses, the Fed hopes to dispel much of the chaos and panic that can occur when a large financial firm is foundering.
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.
But Fed staff did release an estimate that with the Fed’s debt requirement, the effective minimum loss-absorbing capacity-a combination of capital and debt-would rise to as high as 23.5% for J.P. Morgan Chase & Co., the top US bank by assets. Wells Fargo’s requirement is the next highest, followed by State Street and finally Bank of New York Mellon.
The rule would allow the bank’s investors to suffer losses, while the critical operations of the firm continue to function. The shareholders would lose their stake in the bank-holding company and the debt holders would become the new owners. Wells Fargo, for instance, had feared a TLAC minimum as large as 20%. The Fed sees a mandate for loss-absorbing capacity as a key to enabling that process. While the European Central Bank (ECB) signalled its readiness to introduce more stimulus after its policy meeting last week, People’s Bank of China (PBoC) not only cut interest rates for the sixth time in less than a year but also reduced the amount of cash its banks should hold as reserves. Those costs, however, would be outweighed by the benefits to the financial system and taxpayers, in the Fed’s assessment.
The complementary TLAC requirement would set a minimum level of total loss-absorbing capacity, which can be met with both regulatory capital and long-term debt.
The officials declined to say which two banks already meet the long term debt requirements under Friday’s proposal.
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Under the new rules, which would come into effect in 2019, the eight banks face a $120 billion shortfall in the kinds of ownership shares and long-term debt they would need, according to a Fed memo. The industry had wanted those notes to count without any limitations.
