Fed proposes total loss-absorbing capacity (TLAC) rule

The Federal Reserve Board on Friday proposed a new rule that 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 proposed rule would apply to domestic firms identified by the Board as global systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs. These institutions would be required to meet a new long-term debt requirement and a new “total loss-absorbing capacity,” or TLAC, requirement. The requirements will bolster financial stability by improving the ability of banks covered by the rule to withstand financial stress and failure without imposing losses on taxpayers.

To reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function. Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms’ critical operations during resolution.

“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,” Chair Janet L. Yellen said. “This is an important step toward ending the market perception that any banking firm is ‘too big to fail.'”

For domestic GSIBs, 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 upon failure. The complementary 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. These requirements will improve the prospects for the orderly resolution of a failed domestic GSIB and will strengthen the resiliency of all GSIBs.

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.

“By increasing required loss-absorbing capacity by 60% 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,” Governor Daniel K. Tarullo said.

To further facilitate an orderly resolution, the proposal also would require the parent holding company of a domestic GSIB to avoid entering into certain financial arrangements that would create obstacles to an orderly resolution. These “clean holding company” requirements would include bans on issuance of short-term debt to external investors and on entering into derivatives and certain other types of financial contracts with external counterparties. These requirements will reduce the risk of destabilizing funding runs at the holding company, reduce holding company complexity, and enhance the resiliency of operating subsidiaries during an orderly resolution. The proposal also includes regulatory capital deductions for Board-regulated banking firms that hold unsecured debt of the parent holding companies of domestic GSIBs.

To mitigate the threats to U.S. financial stability from the failure of a large foreign bank, the proposal would also establish long-term debt and TLAC requirements for the U.S. operations of foreign GSIBs. However the long-term debt and TLAC would be required to be issued internally, from the U.S. operations to the foreign parent, rather than sold to external investors. This feature of the proposal would help ensure that the U.S. operations of a failed foreign GSIB could be recapitalized and kept operating in the event of resolution of the foreign bank by its home resolution authority.

The U.S. operations of foreign GSIBs generally would be required to hold at a minimum:

A long-term debt amount of the greater of 7 percent of risk-weighted assets and 3 percent of total leverage exposure and 4 percent of average total consolidated assets; and
A TLAC amount of the greater of 16 percent of risk-weighted assets and 6 percent of total leverage exposure and 8 percent of average total consolidated assets.

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