Tougher rules that could cut into U.S. big banks’ profits are coming soon following the announcement this week of an international agreement on how to ensure that big banks can fail without involving taxpayer bailouts.
Financial regulators from a group of advanced countries unveiled an agreement this week on a set of rules requiring that big banks hold a certain amount of liabilities that can be written off in the case of a failure, allowing the company to continue through a restructuring without taxpayer help.
U.S. regulators will discuss the proposed rules with their counterparts from G-20 nations at this weekend’s meeting in Brisbane, Australia, and then return to the U.S. and quickly begin the process of making them official regulations for U.S. banks.
Bank of England Governor Mark Carney, the head of the Financial Stability Board of regulators created in 2009 by the G-20 nations, said while introducing the proposal that it was a “watershed in ending ‘too big to fail’ for banks.”
The purpose of the agreement is to make banks issue enough stock and unsecured debt that the costs of keeping the firm’s business operating after a failure could be borne by those stockholders and creditors, rather than by taxpayers. Those creditors could be wiped out or made the new stockholders in the company after regulators effectively put it through bankruptcy, a process known as a bail-in.
“The goal here is to have enough bail-in debt that there aren’t any more bailouts,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc., a firm that advises financial services firms on regulatory matters.
Considered with existing capital requirements, the proposal would require big banks to be able to absorb losses of 25 percent of their total risk-weighted assets.
Not only would it prevent taxpayer bailouts, the Financial Stability Board said, but it would raise the cost of financing for big banks, cutting into the implicit subsidies they are thought to receive from the expectation that the government would bail them out if they became insolvent.
The eight U.S. banks that would be affected if the U.S. implements the rule would be Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo. The banks declined to comment on the potential impact of the rule. A representative for Goldman Sachs said the bank was “analyzing its impact.”
Daniel Tarullo, the Federal Reserve governor who represents the U.S. on the Financial Stability Board, and other regulators have signaled that they will move to implement a “a particularly stringent version” of the rule for U.S. banks, Petrou said. But the question to be answered in the months following the G-20 meeting is “how much of what is a very tough proposal is actually implemented,” she added.
“The philosophy is great, but actually getting it to be implemented to really mean something — we’re a long way from there,” said Mayra Rodriguez Valladares, managing principal at MRV Associates, a financial regulatory consultant.
U.S. banking regulators will move to propose and finalize rules based on the Financial Stability Board’s recommendation within the next six months or so, Valladares said. The responsible agencies will be the Fed, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, which insures banks’ deposits and was tasked by the 2010 Dodd-Frank law with finding a way to resolve failing big banks without sparking a run on other financial firms or using taxpayer funds.
One criticism of the loss-absorbing capacity requirement is sure to be that it is measured as a percent of risk-weighted assets, which are determined in an opaque manner and can be gamed by banks, Valladares said. Nevertheless, she added, this week’s announcement is “a strong signal of agreement in a day and age when it’s so hard for anyone to agree on anything.”
She added that regulators at this weekend’s G-20 meeting also will discuss the ethics and culture of banking, the specifics of winding down failed banks, and the role of shadow banking, or financial intermediation that takes place outside the regulatory system.
