The Federal Reserve has adopted a final rule [1] requiring the country’s largest bank holding companies to hold more long-term debt in order to reduce the systemic impact of bankruptcy on the U.S. financial system and therefore protect taxpayers.
The final rule will apply to those bank holding companies the Fed has termed as “globally systemic important banks” or GSIBs—JPMorgan Chase, Bank of America, Citigroup, State Street, Bank of New York Mellon, Morgan Stanley, Wells Fargo, and Goldman Sachs.
Under the new final rule, investors and not taxpayers would bear the losses if a bank should fail, according to the Fed. The long-term debt can be converted in to equity, a source of private capital, should one of the banks fail.
“The rule is guided by common sense principles: bank shareholders and debt investors should place their own money at risk so depositors and taxpayers are well protected, and the biggest banks must bear the costs that come with their size,” Fed Chair Janet L. Yellen said.
In addition to the new long-term debt requirement, the new rule implements a new “total loss-absorbing capacity,” or TLAC requirement, for the banks. The rule sets minimum levels for the GSIBs for both long-term debt and TLAC; the long-term debt can be used to recapitalize a company’s critical operations, and both regulatory capital and long-term debt can be used to satisfy the TLAC requirement, according to the Fed.
“While equity is far and away the best form of capital to ensure the resilience of a firm, the whole point of resolution planning is to prepare for the eventuality, no matter how unlikely, that the firm might become insolvent in some circumstances,” Fed Governor Daniel K. Tarullo said. “By definition, at that point equity capital will either be totally lost, or at least below the level markets have historically required for a financial intermediary to be credible. The long-term debt required by this proposal would survive the disappearance of a bank's equity and resultant failure, and would be available for conversion into new equity.”
According to the Fed, the new long-term debt and TLAC requirements will strengthen the resiliency of the covered institutions and “improve the prospects of an orderly resolution of a failed GSIB.”
These same eight GSIBs were required to submit “living wills” (plans to show how the companies would enter bankruptcy without disrupting the U.S. financial system) to the Fed and FDIC last year. In April, the plans of five of the bank holding companies (Bank of America, BNY Mellon, JPMorgan Chase, State Street, and Wells Fargo) were determined by either the Fed or FDIC (or both) to be not credible or they would not facilitate an orderly resolution under the U.S. Bankruptcy Code. While four of those companies have since submitted revised living wills deemed acceptable by the two federal agencies, Wells Fargo made headlines recently when their plan was rejected for the second time [2],
Click here [3] to view the final rule as published in the Federal Register.