Fed Set to Propose New Bank Debt Requirement to Reduce Bailout Risks

The Federal Reserve proposed a new bank bailout-prevention rule as part of a global regime and final post-crisis steps to preserve the stability of financial system, especially the problems of lenders who are “too big to fail”. The plan primarily requires banks to increase their costs and restrict the way of running their businesses. It sets a new minimum level of “total loss absorbing capacity” (TLAC) for eight of the biggest US banks to hold enough resources in their accounts in time of crisis. The “total loss absorbing capacity” demand each bank to carry a minimum amount of capital and liabilities equaling to 18% of risk-weighted assets. However, the 18% figure is expected to be higher for banks considered to have greater outsize risks due to their size, coverage, and the nature of their operations. The Fed gave the deadline of 2022 for firms to fully comply with its new plan.

The Fed’s new rule is considered stricter than the one proposed by global regulators last year. The Fed’s rule requires each firm’s loss-absorbing capacity must include the minimum amount of debt, whereas, the international rule allowed more options for firms to combine equity and debt to meet their target.

Following the Fed’s rule, the eight US bank would have to release the total of $120 billion in new long-term debt to prepare for their possible insolvency. The Fed estimated that this would increase the overall annual funding cost of firms by somewhere in between $680 million and $1.5 billion. For the eight major banks, the Fed projected a minimum required loss-absorbing capacity of at least 23.5% of assets for J.P. Morgan Chase, 21.5% for Citigroup Inc., 20.5% Bank of America Corp., Goldman Sachs, and Morgan Stanley, 18.5% for Wells Fargo & Co., 18% for State Street Corp. and Bank of New York Corp. Wells Fargo is expected to have a tougher time meeting the rule than other firms because it relies more on deposits and less on debt than its competitors.

By: Kay (Kyoeun) Lee

Wall Street Journal

Financial Times

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