Big Banks $70 Billion Short in Fed Push to Prevent Bailouts

LONDON (Capital Markets in Africa) – Wall Street banks are about $70 billion short in building up funds the Federal Reserve says they’ll need to tap following a collapse, down by almost half from the central bank’s earlier estimates.

The eight biggest U.S. financial firms are required to build cushions of long-term debt that can be transformed into equity in a new company if the old one fails, according to a rule the Fed governors approved Thursday. Stockpiles of capital will also be used to meet the new standard known as total loss-absorbing capacity, or TLAC, which is a vital component of the plan to make giant banks easier to unwind without taxpayer bailouts. In October 2015, the Fed estimated banks had a total shortfall of $120 billion.

“This requirement means taxpayers will be better protected because the largest banks will be required to pre-fund the costs of their own failure,” Fed Chair Janet Yellen said about the rule, which aims to prevent a repeat of 2008’s financial-sector disaster by making sure the biggest firms can absorb more losses — even after failing. She called it “one of the last critical safeguards” put in place since the crisis.

The Fed estimates four banks, without identifying them, need about $70 billion more in qualifying unsecured debt and capital by the Jan. 1, 2019 deadline, while the other four banks already satisfy the standard. New debt issued in the last year by the banks helped to cut the shortfall. Investors buying the debt will know in advance that they could be subjected to losses if the issuer fails.

Wells Shortfall
The rule still faces some uncertainty, however, especially following the election of Donald Trump. The president-elect has criticized regulations that squeeze financial firms’ ability to lend to people, and Republican lawmakers have warned federal agencies not to issue 11th-hour rules before Trump takes office. If Congress takes issue with the new debt requirement for banks, it has the power to roll it back, and regulatory officials appointed by Trump could also blunt the measure in the future.

When the Fed proposed the idea more than a year ago, a chief industry concern was the rule’s apparent disregard of certain kinds of long-term debt already in wide use, but the agency made concessions to allow for existing debt with certain “acceleration clauses” to be used in the final version. Like the proposal, Thursday’s final rule includes a tally of capital and long-term debt that ranges from 21.5 percent to 23 percent of risk-weighted assets for the eight U.S.-based firms affected, the Fed estimated.

Meeting the demand by 2019 isn’t difficult for banks such as Goldman Sachs Group Inc. and Morgan Stanley that are accustomed to issuing that kind of debt. The rule will be more of a burden for banks like Wells Fargo & Co., which has historically relied more on traditional funding from deposits. The lender’s chief executive officer, Timothy Sloan, said earlier this month at an investors conference in New York he was “scratching his head” over the rule, since it calls for his bank to get deeper into debt. He estimated the bank’s shortfall could be more than $36 billion.

The impact of the Fed rule only adds to recent headwinds for beleaguered Wells Fargo, which this week was the only major bank to have its so-called living willrejected by regulators. It’s still reeling from a scandal this year over fake accounts that were opened without customers’ knowledge.

Global Effort
The other U.S. banks covered by the rule are JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs, Morgan Stanley, Bank of New York Mellon Corp. and State Street Corp., and a similar version applies to U.S. units of foreign banks, though the Fed reduced the burden slightly for those companies.

The final requirement should end the idea some banks are “too big to fail,” said Greg Baer, president of the Clearing House Association, an industry group. He said in a statement that the rule ensures that losses in bank failures “are borne by creditors and shareholders, and not the taxpayer.”

The new standard is based on a global effort to make sure the world’s largest financial institutions can fail without dragging the rest of them down. In an agreement among officials at the Financial Stability Board, regulators from the U.S. and other countries agreed to phase in a TLAC requirement starting in 2019. In the accord, the level of debt eventually had to be equal to at least 18 percent of each firm’s assets weighted by how risky they are — meaning the total goes up if the assets are more volatile.