Following its consultation a year ago and a quantitative impact assessment, the Financial Stability Board (FSB) has finalised its minimum requirements for Total Loss Absorbing Capacity (TLAC) for G-SIBs.
This represents a further element in the FSB’s ‘too big to fail’ agenda. The key requirement will be for G-SIBs to hold long-term debt that can be written down or converted into equity in the event that a G-SIB is put into liquidation, thereby providing a specific means of absorbing losses and recapitalising the G-SIB. The numbers are significant, with the best estimate for the G-SIBs TLAC shortfall being €1.1tn.
Most of the details of the TLAC requirements remain broadly unchanged from the earlier consultation (click to read our November 2014 alert), but the overall minimum requirement has been pitched in the middle of the range proposed a year ago (at 18% of RWAs) and a (long) timeframe has been specified for the rollout to emerging market G-SIBs.
The FSB’s standards had already been pre-empted by the proposed rules published by the Federal Reserve Bank at the end of October, which imposes a tougher standard on US headquartered G-SIBs and on the US operations of G-SIBs headquartered outside the US.
Funding will become more expensive: Some banks subject to these requirements will need to raise additional debt that qualifies for inclusion in TLAC, convert some existing long term debt into TLAC debt instruments, and issue TLAC debt through resolution entities. This may be expensive, depending on the coupons demanded by investors, who know what they will be among the first creditors to be bailed-in in the event that a G-SIB is put into resolution. This may not be fully offset by reduced costs of other debt and deposits that might otherwise have been subject to earlier bail-in without the TLAC buffer.
This will be particularly expensive for banks that are funded predominantly by retail and corporate customer deposits, who will have to replace some of these deposits with TLAC qualifying debt. Overall, these TLAC standards are likely to erode further the competitive advantages of G-SIBs.
The amounts are significant: The quantitative impact assessment published by the Basel Committee shows that 20 (out of 27 non-emerging market G-SIBs) G-SIBs currently have TLAC below 16% of RWAs, and 12 have TLAC below 6% of total leverage exposure. These G-SIBs would need to issue an additional €755 billion of TLAC to meet both the 18% of RWAs and 6.75% of total leverage exposure minimum TLAC ratios. The three emerging market G-SIBs (as on the November 2014 list of G-SIBs) have an additional shortfall of €355 billion.
Higher price and reduced volumes of bank lending: In addition to passing on the higher cost of funding to their customers, G-SIBs may respond to these new requirements by reducing the volume of lending, rather than just by issuing new debt to cover the TLAC requirement. This potential reduction in credit origination capacity will in turn have an adverse impact on the G20’s jobs and growth agenda; the political tensions here are obvious.
Localisation: Although the standards cover various types of group structure and resolution strategy, they will not remove entirely the pressures on host jurisdictions to impose local requirements for TLAC for bank subsidiaries in individual jurisdictions, just as they have set local requirements for capital, liquidity, funding and corporate governance.
G-SIBs will need to work effectively with their Crisis Management Group (CMG) of regulators if they are to manage additional local minimum TLAC requirements.
Continuing business model uncertainty: The RWA denominator remains subject to significant upward change as a result of the Basel Committee’s continuing work on revisions to the standardised approaches to credit, market and operational risk, on restrictions on the use of internal models, and on the specification of a capital floor.
Multiple requirements: Some countries have already announced requirements that may exceed the FSB minimum. In the European Union, the Bank Recovery and Resolution Directive requires banks to hold up to 10% of liabilities (not RWAs) in the equivalent of TLAC. In the US, the Fed has proposed that G-SIBs headquartered in the US should hold TLAC of at least 9.5% of total leverage exposure and that the US operations of non-US G-SIBs should hold internal TLAC (issued to the foreign parent) of the greater of 16% of RWAs, 6% of total leverage exposure and 8% of total consolidated assets.
Scope: National authorities are likely to extend some form of these TLAC requirements to D-SIBs and possibly – as in the EU – to other banks undertaking significant critical economic functions. Therefore it has the potential to hit many more banks than just G-SIBs.
The main features of the minimum standard are:
To discuss the detail or implications further, please contact Clive Briault, Andrew Davidson or Giles Williams.