Fed’s New Rule Would Ease Strain From Dying Banks

31 Oct 2015 | Author: | No comments yet »

In A Financial Fire, Big Banks Will Have An Extra Extinguisher.

Washington: The largest US banks would face a $120 billion (Dh441 billion) total shortfall of long-term debt under a Federal Reserve proposal aimed at ensuring their failure wouldn’t hurt the broader financial system. Two days after the Federal Reserve released what was allegedly its most hawkish statement in months came a reminder that the path toward a rate hike won’t be an easy one.Hillary Rodham Clinton said this week that, if it came to it, she would let a big bank fail — and it would not be surprising if other presidential candidates adopted her anti-bailout stance.

The rules would force some major banks to issue long-term bonds that — in an emergency — could provide a cushion of capital to cover losses, rather than leaving it to taxpayers. 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 a Fed rule that was approved by a unanimous vote on Friday. One of the main economic factors for Fed officials when it comes to assessing the right time to start hiking rates is wage growth, tied with the consumer spending that is supposed to follow. The Fed is determined to “substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms,” Yellen said. The Fed’s proposal, which applies to eight of the biggest US banks, requires debt and a capital cushion equal to at least 16 per cent of risk- weighted assets by 2019 and 18 per cent by 2022.

The country has eight “systemically important” banks: Bank of America, Citigroup, Goldman Sachs, JPMorgan, Mellon, Morgan Stanley, State Street and Wells Fargo. The big releases of the day were on personal income, which increased just 0.1 percent in September, missing even the meager consensus estimate of 0.2 percent, and the University of Michigan consumer confidence survey, which, at 90, whiffed as well with its second-lowest reading of the year. The new regulation seeks to inflict the costs of a failure on investors who have lent to an ailing bank and on its shareholders, rather than on taxpayers.

Below the Wall Street radar, though, came another report that doesn’t garner the headlines but is believed to be one watched closely by Fed Chair Janet Yellen and her fellow monetary policymakers: The employment cost index. The hope is that the rule would work without greatly disrupting the wider market and economy. “The proposal is another important step in addressing the ‘too big to fail’ problem,” said Janet L. The quarterly release from the Bureau of Labor Statistics showed that compensation costs for nongovernment workers rose just 0.6 percent in the three-month period — about what economists had expected but not much to move the inflation needle. Yellen, the Fed chairwoman, referring to the notion that the government has to bail out big banks because letting them fail would cause severe collateral damage in the economy. If another financial crisis hit the banks, then those other six might need infusions of cash to maintain critical functions until being absorbed by stronger banks.

On an annualized basis, compensation costs rose just 2 percent, which actually is a decline from the 2.2 percent increase realized for the same period a year ago. 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.

And if large banks have to consistently pay more for their financing, they may decide to shrink to make their businesses more profitable. “The proposal should also improve market discipline,” Daniel K. 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 banking industry, perhaps wanting to avoid harsher measures, has mostly embraced the system of winding down large banks that was set up under the Dodd-Frank Act, which Congress passed in 2010 to overhaul the United States’ shaky financial system. With the slow wage growth, core inflation as measured through Yellen’s preferred indicator, the personal consumption expenditures index, is tracking at just 1.25 percent, according to Steve Blitz, chief economist at ITG. “The FOMC, if true they are tied to trends, can only be disappointed by the trend in consumption and wage growth coming out of the third quarter,” Blitz said in a note. “Because [if] they really, really, really want to move 25 basis points in December they have to be, by their own rules, now focused on whether the individual data points for the economy in the next six weeks indicate a change in trends to the upside. In other words, the next two payroll numbers mean everything.” Economists currently expect next Friday’s nonfarm payrolls report to show a gain of 180,000 for October, which despite being below trend would indicate an improvement from September’s 142,000 gain. Since the financial crisis, the Fed has consistently written rules that have been more stringent than global regulatory accords on capital and liquidity. TLAC is “the final piece of the puzzle in ensuring that the largest banks will be resolvable at no taxpayer cost,” according to Greg Baer, president of the Clearing House Association, which represents the largest banks.

But he said in an email the Fed plan “seems to go significantly beyond the types and amounts of loss absorbency required for this purpose, and once again significantly beyond what has been proposed as an international standard.” Banks will find the requirements more challenging after the Fed raises interest rates, Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics, said in an emailed statement. “Big banks have issued a lot of debt under current rates that, when reissued to comply with TLAC and meet market demands, will cost considerably more,” Petrou said. A bank’s borrowings are not usually seen as a stable form of capital because the money has to be repaid, and thus may not be around to absorb losses if the bank’s creditors flee.

By making it clear upfront who will bear a failing bank’s losses, the Fed hopes to dispel much of the chaos and panic that can occur when a large financial firm is foundering. Analysts added that it was hard to identify which banks already complied because it was not clear how much of a bank’s current long-term debt would qualify for inclusion in the buffer. Also on Friday, the Fed joined other federal regulators in approving a rule that aims to strengthen the market for swaps, a type of financial contract that is traded heavily on Wall Street.

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