It is becoming increasingly unrealistic for international banks to satisfy ever-larger capital requirements to meet politicians’ demands to protect taxpayers from economic failure. By rethinking their recovery and resolution plans, banks could significantly reduce the prospects of needing a bailout and, in the process, demonstrate that they can function effectively on lower capital levels.
“Too big to fail” has prompted banking regulation designed to increase capital, tighten up governance and operating practices and mitigate any further need for government bank bail-outs of Globally Systemically Important Banks or "G-SIBs."
The latest of these initiatives, introduced by the FSB, relates to a bank’s Total Loss-Absorbing Capacity (TLAC). It imposes stringent bank capital requirements on the largest global banks. In the event of a crash, TLAC increases the chance of stabilising a bank and restoring solvency, thereby buying time for an orderly restructuring and/or a solvent wind-down.
But do the regulations allow the banks to continue to support the wider economy while still maintaining a safety net? The paradox is that a new banking regulation aimed to strengthen G-SIBs could make it more difficult for them to get the capital the new regulation is requiring. On the other hand, the regulations could drive banks to radically rethink their approach to recovery and resolution, to prevent the prospect of capital shortfalls.
Europe has established its own separate capital buffer regulations, Minimum Requirement for Own Funds and Eligible Liabilities (MREL), imposed by the Single Resolution Board (SRB), a new European authority set up to address the issue of failing banks. With discernable differences between MREL and TLAC, European-based G-SIBs will now have to comply with both MREL and TLAC.
International banks must now search for ways to establish recovery and resolution plans that simultaneously satisfy different requirements. Larger, multinational banks typically operate complex inter-company asset transfers and payments, which already creates considerable complexity.
The two broad resolution strategies:
Arguably the most critical question is: how can economies ensure that their banks avoid taking excessive risks, yet remain engines of growth capable of lending to businesses? Each increase in required capital levels could also limit the ability to provide much-needed credit to national and global economies.
A lack of affordable capital, especially for higher-risk investors, could possibly stall growth, creating a form of economic sclerosis that could cause serious systemic harm. Furthermore, capital requirements alone cannot remove all risk from the marketplace since banks are also coping with other risks such as exposure to new, unproven technology and clearing systems.
TLAC and MREL should both accelerate banks’ creation of sound, well-drafted resolution plans. They could also lead to simpler bank structures, where, in the event of insolvency, assets are less likely to generate competition for ownership and instead be divided properly, in accordance with legal entities’ rights.
Governments and regulators must, however, consider the wider market need for liquidity and try to avoid over-restrictive capital requirements that dampen the market. The lack of a coherent, cross-authority approach to regulation also adds unnecessary layers of complexity and uncertainty to the process of capital adequacy. Greater collaboration can add efficiency and enable banks to create appropriate capital levels that protect them, without holding back lending power.
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