Banks Face Uphill Battle to Soften Too-Big-to-Fail Rules

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Banks are running out of time as they try to convince regulators that rules designed to smooth the wind-down of failed global lenders could actually diminish their ability to manage a cross-border crisis.

The Financial Stability Board’s proposal on internal total loss-absorbing capacity, or TLAC, requires the world’s 30 most systemically important banks to ensure that their key subsidiaries can be stabilized and shut down in an orderly way, without a taxpayer bailout.

Banks say the requirement for allocating liabilities that can be written down in a crisis to subsidiaries is too high and would hamper their ability to tackle problems within a corporate group. The FSB says the rule will boost trust between national regulators and avert more onerous local measures. A final version of TLAC, of which the internal allocation rule is a part, has been promised for the Group of 20 summit in November.

The measure is “a powerful way to incentivize cross-border cooperation if it’s done right,” Credit Suisse Group AG’s Wilson Ervin said in an interview. “But if it’s not done right, it could compartmentalize a bank and make it more brittle.”

If national regulators impose their own loss-absorbency requirements on subsidiaries, “then capital may be stuck in the wrong countries and can’t go where it’s needed,” said Ervin, Credit Suisse’s vice chairman of the Group Executive Office. “A structure like that could have made 2008 worse; you could’ve lost more banks.”

‘Very Similar’

The FSB’s TLAC proposal, made last year, would require the biggest banks to issue ordinary shares, subordinated debt and other loss-absorbing securities equivalent to as much as a fifth of their assets weighted for risk. They are currently about $700 billion short of that goal, according to Credit Suisse.

The internal TLAC requirement sets minimum loss-absorbency rules for “material” overseas subsidiaries, to be fixed at between 75 to 90 percent of what the TLAC requirement would have been if the unit were a standalone bank. The standard way for a subsidiary to meet the rule would be selling subordinated debt or other eligible instruments to the parent bank.

Bank of England Governor Mark Carney, who heads the FSB, has ruled out sweeping changes to TLAC, saying in March that the final rules will be “very similar” to last year’s draft. The regulations would take effect at the earliest in 2019.

‘Good Case’

In their response to the FSB, the Institute of International Finance and the Global Financial Markets Association said an internal TLAC requirement of 65 percent to 75 percent “would be a better range within which to fix a requirement, with a presumption toward 65 percent.”

A higher level, “certainly at the 90 percent level, would seriously constrict the flexibility required to move resources to avoid difficulties that may arise in one market or another,” the groups said.

“There’s a good case to make that high pre-positioning requirements can be detrimental to stability,” Nicolas Veron, an economist at the Brussels-based Bruegel research group, said in an interview. “By freezing the structure of the allocation of capital, you arguably make it more difficult rather than easier to resolve financial stability issues in the bank.”

Regulators say the internal standard is needed to enhance trust among themselves and that without it local authorities might take tougher measures.

‘Rules of Engagement’

Having internal TLAC “in place is a comfort for regulators and at least makes clear the rules of engagement in an emergency,” Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said by e-mail. “I very much doubt if there is much of an appetite amongst regulators to unpick the proposals.”

The FSB’s next full meeting takes place in September, at which it will seek to push forward work on the final TLAC standard.

“Internal TLAC essentially serves as collateral from the home authority to the host authority, in exchange for accepting the leadership of the home authority in a resolution situation,” Emil Petrov, head of capital solutions, EMEA at Nomura Holdings Inc., said in an interview.

“The host authority needs to be happy with the amount of internal TLAC that’s prepositioned,” he said. “It is a political compromise.”