Fed Proposes New ‘Too Big to Fail’ Bailout Rule

The Federal Reserve recently proposed a new rule that will remove some of the pressure from the government and taxpayers concerning eight of the nation’s largest banking institutions.

The institutions, or those deemed as global systemically important banks (GSIBs) by the Board include Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo.

These banks could be required to collectively come up with $120 billion to meet a new long-term debt requirement and a new "total loss-absorbing capacity” (TLAC).

"This is an important step toward ending the market perception that any banking firm is ‘too big to fail.'" - Fed Chair Janet Yellen

The proposed debt requirement is an important part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in 2010 to “mitigate risks to the financial stability of the United States that could arise from the material financial distress or failure of large, interconnected financial companies, including by ending market perceptions that certain financial companies are ‘too big to fail’ and would therefore receive extraordinary government support to prevent their failure.”

According to the Fed, the proposed rule would “strengthen the ability of the largest domestic and foreign banks operating in the United States to be resolved without extraordinary government support or taxpayer assistance.”

"The long-term debt requirement we are proposing today, combined with our other work to improve the resolvability of systemic banking firms, would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms," said Fed Chair Janet L. Yellen. "This is an important step toward ending the market perception that any banking firm is ‘too big to fail.'"

If a GSIB should fail, the Fed stated that an “orderly resolution process” will be followed to reduce the “systemic impact” of the failure, which will cause its investors to suffer the losses.

The new rules also note that the proposed long-term debt requirement would set a minimum level of long-term debt that could be used to recapitalize these firms' critical operations if they were to fail. Meanwhile the TLAC requirement would set a new minimum level of total loss-absorbing capacity, which can be met with both regulatory capital and long-term debt.

Domestic GSIBs would be required to hold at a minimum:

• A long-term debt amount of the greater of 6 percent plus its GSIB surcharge of risk-weighted assets and 4.5 percent of total leverage exposure; and
• A TLAC amount of the greater of 18 percent of risk-weighted assets and 9.5 percent of total leverage exposure.

“These requirements will improve the prospects for the orderly resolution of a failed domestic GSIB and will strengthen the resiliency of all GSIBs,” the Fed explained.

Fed Governor Daniel K. Tarullo noted that “by increasing required loss-absorbing capacity by 60 percent or more, the long-term debt requirement will bring us closer to the goal of ensuring that even one of the nation's largest banks could fail without either endangering the financial system or prompting a government bailout.”

Additionally, the proposal will also require the parent holding company of a domestic GSIB to avoid entering into certain financial arrangements that would create obstacles to an orderly resolution.

"Today's rule puts in place the critical remaining plank to ensure that even the largest and most complex banking institutions in America can fail without posing unacceptable risks to financial stability, by requiring them to hold a cushion of long-term debt sufficient to fully recapitalize their important operating subsidiaries in the event of bankruptcy,” said Fed Governor Lael Brainard. “Today's rule moves us closer to our goal of a safer, more responsible, and more resilient financial system.”

The Fed will accept comments on the proposal through February 1, 2016.

Click here to view the Federal Register Notice.

Click here to view the Proposed Requirement for Banks.