Banks Face 25% Loss-Absorbency Rule in FSB Too-Big-to-Fail Plan

Oct. 6 (Bloomberg) — The largest global banks face rules forcing them to issue capital instruments and loss-absorbing debt equivalent to as much as a quarter of their risk-weighted assets.

The Financial Stability Board is developing minimum standards that will limit the double-counting of capital banks use to meet existing international rules, according to an FSB working document sent for comment to Group of 20 governments and obtained by Bloomberg News.

The restriction means that, while the basic requirement will be set at 16 percent to 20 percent of risk-weighted assets, the final number will be higher because the banks must separately meet “other regulatory capital buffers,” according to the document, dated Sept. 21. The FSB in Basel, Switzerland, declined to comment on the document.

The FSB, which consists of regulators and central bankers from around the world, plans to present the draft rules to a G-20 summit in Brisbane, Australia, next month. The plans, which will be published for comment and completed next year, are part of a package of measures designed to make sure taxpayers are no longer on the hook when banks fail.

The FSB plan would force the world’s most systemically important banks to issue junior debt and other securities that could be written down in a straightforward manner and cover costs associated with winding down or restructuring. The rule would fully apply in 2019 at the earliest.

Bank of England Governor Mark Carney, the FSB’s chairman, has said that the measure is essential to prevent taxpayer- funded bailouts of banks.

Capital Buffers

“It is essential that systemically important institutions can be resolved in the event of failure without the need for taxpayer support, while at the same time avoiding disruption to the wider financial system,” Carney said in a letter to the G-20 last month.

The FSB proposals include criteria that debt and other securities have to meet to count toward a bank’s minimum required “total loss absorbency capacity,” or TLAC. Under the TLAC standard, lenders wouldn’t be able to count the equity they use to satisfy two existing international capital buffers.

The first of these, set in 2010 by the Basel Committee on Banking Supervision, requires banks to have core capital equivalent to 2.5 percent of risk-weighted assets beyond the minimum Basel requirement to absorb losses. Failure to meet this standard can result in curbs on the bank’s ability to pay bonuses and dividends.

The second buffer, set by the FSB for the world’s biggest banks, can also rise to 2.5 percent of risk-weighted assets, and provides an extra safeguard in case of crisis. Both requirements must be met with the highest-quality capital, such as ordinary shares and retained earnings.

Credit Booms

Thus the basic requirement of 16 percent to 20 percent of risk-weighted assets can swell to 21 percent to 25 percent, and could go even higher if a bank had to comply with a so-called countercyclical buffer set by its local regulator to tame credit booms.

While the FSB plan doesn’t specify which instruments can count toward TLAC, it spells out which liabilities don’t qualify, such as those “which are preferred to normal senior unsecured creditors under the relevant insolvency law,” or which arise from derivatives.

Debt issued by the bank would also need to “have a minimum remaining maturity” of at least a year to count.

The FSB maintains a list of globally systemic banks that it updates each November. The latest list included 29 banks and identified HSBC Holdings Plc and JPMorgan Chase & Co. as the banks whose failure would do the most damage to the global economy.

–With assistance from Ben Moshinsky in London.

To contact the reporter on this story: Jim Brunsden in Brussels at [e-mail] To contact the editors responsible for this story: Patrick Henry at [e-mail] Simone Meier