Why Banks See Threat from Global Bank Cleanup Plan

WASHINGTON — U.S. regulators have yet even to propose loss absorbency metrics for big-bank resolutions, but a pending international standard for how a failed institution would be recapitalized in a cleanup is already giving the industry plenty of heartburn.

The Financial Stability Board's proposed standard for "total loss-absorbing capacity" would require global systemically important banks — or G-SIBs — to hold combined capital and long-term unsecured debt that in some cases exceed 20% of risk-weighted assets, ensuring enough remains are left over in a failure for authorities to close the firm and operate its subsidiaries without taxpayer help.

While many of the nearly 60 comment letters to the FSB praised a strong standard as aiding resolutions, bankers said the proposed TLAC threshold is far too high. Banks and industry groups also questioned restrictions on which types of debt count toward the total, a requirement that long-term debt make up a third of the TLAC amount and a provision allowing regulators to impose additional TLAC standards on individual firms. They also called for changes in the calculation for a non-risk-weighted TLAC requirement.

"Requiring TLAC in excess of what is necessary to support the orderly resolution of G-SIBs, or structuring or defining TLAC in an unnecessarily restrictive way, would constrain G-SIBs in managing their balance sheets, with the consequence not only being economic inefficiency but possibly even the impairment, instead of the promotion, of the safety and soundness of these institutions," four U.S. trade groups — the Clearing House, the American Bankers Association, the Securities Industry and Financial Markets Association and the Financial Services Roundtable — said in a joint letter.

Others took a different tone, focusing on TLAC's advantages for helping governments unwind failed banks while saying that the final loss absorbency rules implemented by member nations should be even tougher.

"We remind the FSB that the" proposal, "when finalized, should be a floor and not a ceiling for the TLAC requirements that national regulatory authorities around the world ultimately set for their own countries," Sheila Bair, former chairman of the Federal Deposit Insurance Corp. who now chairs the Systemic Risk Council, wrote in a Feb. 2 letter.

The FSB's November plan calls on countries to institute a baseline TLAC standard of between 16% and 20% of risk-weighted assets, which is about double the international Basel III capital norms. Yet that would not include Basel's additional capital buffers for the biggest firms, meaning some could effectively see TLAC minimums stretch as high as 25%. Large banks would have to meet a separate TLAC standard for non-risk-weighted assets.

A workable loss absorbency standard is seen as vital to the success of new government regimes to resolve financial giants, like that managed in the U.S. by the FDIC. The idea is that a failing firm's remaining capital and convertible debt could recapitalize a new firm, thereby avoiding a bailout. Domestically, the Federal Reserve Board will be the agency implementing TLAC. The central bank has already signaled its plan will be tougher than that of the FSB.

"By removing the implicit subsidy that systemic banks have long enjoyed, it will re-establish market discipline," Bank of England Gov. Mark Carney, who chairs the FSB, said of the proposal in an October speech.

But bankers' main complaint is that the board's minimum standard would go beyond what is necessary to recapitalize a firm in a resolution.

The joint U.S. trade group letter said the FSB's main TLAC requirement should not exceed 16%. The groups suggested that the board had not yet done a sufficient analysis to justify the minimum level outlined in the proposal. (The FSB has said it intends to carry out a study on the plan's economic impact this year.)

"It is exceedingly important that the final TLAC framework be grounded in sound quantitative analyses," the groups' letter said.

Wells Fargo, which filed its own comment letter on Feb. 2, said the TLAC level proposed by the FSB would be "too high," is not supported by historical data and will cost institutions.

"While these additional costs could be justified if grounded in empirical analysis and linked to a specific quantifiable risk, the proposal does not provide information on the methodology employed to establish the 16-20% range and does not set forth an empirical analysis suggesting that the range bears any relationship to historical or hypothetical stress scenarios," the bank said.

Many commenters also criticized a clause in the proposal that gives home country regulators the authority to tack on an additional TLAC capital on a case-by-case basis.

The joint letter from the four U.S. trade groups said that that so-called "pillar 2" discretionary requirement is redundant, and should be scrapped altogether.

"A Pillar 2 component would have the effect of imposing two tailored G-SIB components, one established under a transparent international standard and the other entirely subjective and, by its terms, unreviewable," they said.

But not all banks apparently agree. Wells said the principal TLAC should be supplemented "with a Pillar 2 requirement that captures the specific risks posed to the financial system by different G-SIBs."

Meanwhile, some also called for the FSB to expand the types of liabilities that can satisfy the debt portion of a bank's TLAC. Under the proposal, eligible debt instruments are limited to those with at least a one-year maturity. Things like structured notes and insured deposits are excluded.

"Structured notes should not be arbitrarily excluded from TLAC, as long as they satisfy the key requirements of the final TLAC term sheet," wrote the heads of the Institute of International Finance and the Global Financial Markets Association in a Feb. 2 letter. "Structured note obligations do not differ conceptually from vanilla instruments that are hedged. Both are unsecured claims on the balance sheet that can be converted into equity in resolution."

Yet industry concerns about the burdens created by the proposal are separate from whether the plan better enables national authorities to close failed institutions without resorting to bailouts.

Bernard de Longevialle, managing director at Standard & Poor's Rating Services and chair of S&P's Global Financial Institutions Regulatory Task Force, said the company "believes" the proposal "will likely increase the credibility of bail-in strategies in the recovery and resolution of failing institutions.

"Combined with other regulatory initiatives underway in a number of jurisdictions, it may represent a credible alternative to government support, although the resolution through bail-in of a global complex bank and the possible related contagion risks are still largely untested," he said.

Some suggested the final loss absorbency rules imposed on banks should be tougher.

The Systemic Risk Council said TLAC rule should emphasize a bank's non-risk-weighted assets rather than risk-weighted assets. The proposal does include a requirement that banks' TLAC be twice the leverage ratio set out by Basel III, but Bair said the board should "base the TLAC requirement primarily on a substantial leverage ratio based on non-risk-weighted total assets.

"Risk weightings are complex, rife with exceptions and carve-outs, retrospective, tainted by various biases, and subject to the inherent difficulty of economic forecasting," she said. "By contrast, simpler leverage ratios based on total assets are more easily understood, comparable among financial institutions, market-oriented, and more difficult to 'game.'"

But U.S. banks worry home country regulators could go too far in requiring TLAC based on total assets.

Basel III set the minimum international leverage ratio at 3%, meaning a 6% TLAC level for non-risk-weighted assets. Yet banks in this country worry the Fed could set a much higher bar since U.S. regulators had increased the Basel leverage ratio for their domestic banks to 5%, for holding companies, and to 6%, for subsidiaries.

"We … recommend the removal of the leverage floor in the final TLAC standard, or alternatively confirmation that the reference to a leverage requirement of at least twice the relevant 'Tier 1 leverage ratio', specifically means a threshold set at two times the Basel III leverage ratio, or 6%," wrote Stefan Gavell, executive vice president at State Street, in a Feb. 2 letter.