Largest US banks face $120 billion shortfall under new rule

31 Oct 2015 | Author: | No comments yet »

Fed’s New Rule Would Ease Strain From Dying Banks.

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 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.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.

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 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 country has eight “systemically important” banks: Bank of America, Citigroup, Goldman Sachs, JPMorgan, Mellon, Morgan Stanley, State Street and Wells Fargo. 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. The broad strokes of the proposal, including the lengthy phase-in period and the 18 percent target instead of what some bankers thought could be as high as 20 percent, are easier than many in the industry expected. 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.

Yellen, the Federal Reserve 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.

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. 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 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. 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 e-mail 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 e-mailed statement. “Big banks have issued a lot of debt under current rates that, when re-issued 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. Under certain assumptions, which could change if the banks shrink or grow, JPMorgan’s buffer, for example, could reach 23.5 percent of its assets, according to figures released on Friday by the Fed. But the Fed noted that losses might have been higher in the last crisis had the government not shored up the system — and there may be less assistance in the next bust. 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.

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