Photographer: John Taggart/Bloomberg

Big Banks $70 Billion Short in Fed Push to Prevent Bailouts

  • Final measure requires U.S. lenders to build up long-term debt
  • Rule comes as President-elect Trump vows to undo regulations

Wall Street banks are about $70 billion short in building up funds the Federal Reserve says they’ll need to tap following a collapse, down by almost half from the central bank’s earlier estimates.

The eight biggest U.S. financial firms are required to build cushions of long-term debt that can be transformed into equity in a new company if the old one fails, according to a rule the Fed governors approved Thursday. Stockpiles of capital will also be used to meet the new standard known as total loss-absorbing capacity, or TLAC, which is a vital component of the plan to make giant banks easier to unwind without taxpayer bailouts. In October 2015, the Fed estimated banks had a total shortfall of $120 billion.

“This requirement means taxpayers will be better protected because the largest banks will be required to pre-fund the costs of their own failure,” Fed Chair Janet Yellen said about the rule, which aims to prevent a repeat of 2008’s financial-sector disaster by making sure the biggest firms can absorb more losses -- even after failing. She called it “one of the last critical safeguards” put in place since the crisis.

The Fed estimates four banks -- which it didn’t identify by name -- need about $70 billion more in qualifying unsecured debt and capital by the deadline of Jan. 1, 2019, while the other four already meet the standard. New debt issued in the last year by the banks helped to cut the shortfall. Investors buying the debt will know in advance that they could be subjected to losses if the issuer fails.

Wells Shortfall

The rule still faces some uncertainty, however, especially following the election of Donald Trump. The president-elect has criticized regulations that squeeze banks’ ability to lend, and Republican lawmakers have warned federal agencies not to issue 11th-hour rules before Trump takes office. If Congress takes issue with the new debt requirement, it has the power to roll it back, and regulators appointed by Trump also could also blunt the measure.

When the Fed proposed the idea more than a year ago, a chief industry concern was the rule’s apparent disregard of certain kinds of long-term debt already in wide use, but the central bank made concessions in the final version to allow existing debt with certain “acceleration clauses” to be used. Like the proposal, the final rule adopted Thursday includes a tally of capital and long-term debt that ranges from 21.5 percent to 23 percent of risk-weighted assets for the eight U.S.-based firms affected, the Fed estimated.

Meeting the demand by 2019 isn’t difficult for banks such as Goldman Sachs Group Inc. and Morgan Stanley that are accustomed to issuing that kind of debt. The rule will be more of a burden for banks like Wells Fargo & Co., which historically has relied more on traditional funding from deposits. The lender’s chief executive officer, Timothy Sloan, said earlier this month at an investors conference in New York that he was “scratching his head” over the rule, since it calls for his bank to get deeper into debt. He estimated the bank’s shortfall could be more than $36 billion.

The impact of the Fed rule only adds to recent headwinds for Wells Fargo, which this week was the only major bank to have its so-called living will rejected by regulators. It’s still reeling from a scandal this year over fake accounts that were opened without customers’ knowledge.

Global Effort

The other U.S. banks covered by the rule are Goldman Sachs, Morgan Stanley, JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Bank of New York Mellon Corp. and State Street Corp.

The final requirement should end the idea some banks are “too big to fail,” said Greg Baer, president of the Clearing House Association, an industry group. He said in a statement that the rule ensures that losses in bank failures “are borne by creditors and shareholders, and not the taxpayer.”

While the Fed eased some of the language of its original pitch, it tightened the deadline for meeting the requirements. The 2019 drop-dead date originally had been the start of a phase-in period through 2022, but the Fed decided that because it will let banks use some of their existing securities, it’s now easier for them to get up to speed.

Eight foreign banks doing business in the U.S. must also meet the demand, including Deutsche Bank AG, Barclays Plc and Credit Suisse Group AG. The requirement for their U.S. holding companies is a little different from their domestic rivals and was eased a bit since last year’s proposal, now calling for a similar pile of long-term debt for each but combined totals of capital and debt smaller than the U.S. firms. Depending on how the bank plans to wind itself down in a failure, their total targets can be either 16 percent or 18 percent of their risk-weighted assets.

The new U.S. standard is based on a global effort to make sure the world’s largest financial institutions can fail without dragging others down with them. In an agreement among officials at the Financial Stability Board, regulators from the U.S. and other countries agreed to phase in a TLAC requirement starting in 2019. In the accord, the level of debt eventually had to be equal to at least 18 percent of each company’s assets weighted by how risky they are -- meaning the total goes up if the assets are more volatile.

— With assistance by Silla Brush

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