The largest U.S. banks would face a $120 billion total shortfall of long-term debt under a Federal Reserve proposal aimed at ensuring their failure wouldn’t hurt the broader financial system.
Banks such as Wells Fargo & Co. and JPMorgan Chase & Co. will be required to hold enough debt that could be converted into equity if they were to falter, according to the Fed rule that’s set to be approved Friday. The Fed’s proposal, which applies to eight of the biggest U.S. banks, requires debt and a capital cushion equal to at least 16 percent of risk-weighted assets by 2019 and 18 percent by 2022.
The proposal, along with other measures regulators have taken to avoid chaotic bank failures, “would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms,” Fed Chair Janet Yellen said in a statement. The plan “is another important step in addressing the ‘too big to fail’ problem,” she said.
The rule on Total Loss-Absorbing Capacity, or TLAC, is a key part of regulators’ efforts to avoid another financial crisis. If U.S. banks were to fail, investors in their stock would lose everything, but the debt would be converted into equity in a new, reconstituted bank under the plan. It’s an element of the so-called living wills banks must submit to the Fed and Federal Deposit Insurance Corp. each year to map out their hypothetical demise.
The reason for the provision: When a bank fails, regulators want it to have a war chest to fund a new, healthy version of the company -- hopefully without a dime from taxpayers.
The Financial Stability Board, a group of global regulators that makes recommendations to the Group of 20 nations, plans to phase in a TLAC rule requiring long-term debt of at least 16 percent of risk-weighted assets starting in 2019 and 18 percent by 2022, people with knowledge of the rule have said. That would broadly match the Fed’s proposal.
The Fed is also set to approve mandatory levels of minimum long-term debt, which vary depending on how large and complex the banks are. Fed officials said Friday that the types of debt that qualify are tougher than proposed last year by the FSB.
Since the financial crisis, the Fed has consistently written rules that have been more stringent than global regulatory accords on capital and liquidity.