#PolicyBlog Perhaps banks should get less Tender, Love and Care (TLC) and have more Total Loss-Absorbing Capital (TLAC)?

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A new bank regulation to be implemented in 2019 will oblige 30 global banks* (such as Citigroup and HSBC) to hold bigger buffers. The Financial Stability Board (FSB) – a group of international regulators – convened on 10 November to discuss the ‘Too Big to Fail’ syndrome. They concluded that a total loss-absorbing capital (TLAC), amounting to 16-20% of banks’ assets, should be enforced. This will be much higher than the percentages the world witnessed before the 2008-9 financial crisis. The buffer would come in two forms: 1) banks should have more equity, i.e. the amount of money shareholders put into the business; and 2) if there are losses, bondholders, whose money banks use to lend out to their clients, need to bare some of cost once the shareholders have no more liquidity. The idea is that bonds will only be counted in the TLAC, if they bear the potential losses. This will not immediately apply to small banks, because their intention is not for banks to go bankrupt. Ultimately, the FSB would like the credit market to perform more like standard markets, where a bankruptcy will not harm the entire economy. Hopefully, this will also remove the implicit subsidy that the banks have been receiving through the indirect promise that their losses would be covered – wrongfully incentivising them to take on ever riskier loans. This makes banks very wary – it is estimated that capital reserves will need to increase by some 200 billion euros in European banks alone. Moreover, it could result in reduced lending – already much too low.   Scope, a credit rating company, said in preliminary estimates last month that BNP Paribas might face a shortfall of €25.45bn if it had to meet a 20 per cent TLAC hurdle, while Santander would face a €17.55bn shortfall (same source as above). However, emphasis on the riskiness of assets rather than their magnitude could ultimately reduce the bailout burden for taxpayers (see here and here for more information).

Finally, another mission up FSB’s sleeve is to incentivise banks to build simpler structures, so that it is easier for them to go bust. A concrete idea has not been thought of yet – perhaps you have one?

*according to the latest press release from the FSB

 

By Maria Dahl

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