It only makes sense that if you’re “too big to fail”, then you need to have extra financial reserves to see you through a worst case scenario. The U.S. Federal Reserve proposed a new rule on Friday, October 30th, that will require the six “global systemically important banks” (GSIBs) to up their debt/equity reserves by a total of around $120 billion.Industry analysts note that megabanks will almost certainly meet this new requirement by issuing long-term debt, given current ultra-low interest rates.

The new proposed rule is basically in line with what banks had been expecting expectations, and, as it should be, the rule is focused on the total loss-absorbing capacity of each GSIB.

Too Big To Fail

New Fed rule bolsters cushion for “too big to fail” banks

The proposed rule is really just the latest of a series of new rules aimed designed to contain risk in the banking system by making too big to fail banks use a reasonable amount of debt and equity to fund themselves.

The Federal Reserve governors approved a draft of the proposal in a vote this week, and it will now be submitted for a public comment process.

One staffer who worked on the rule commented in a public meeting that the banks should have little problem complying with the new rule, because the requirement overlapped with current rules. Moreover, the majority of the debt requirements can be fulfilled by refinancing existing debt, the staffer noted.

The proposed rule would require domestic GSIBs to hold at least:

  • A long-term debt the greater of 6% plus its GSIB surcharge of risk-weighted assets and 4.5% of total leverage exposure; and
  • A total loss-absorbing capacity (TLAC) the greater of 18% of risk-weighted assets and 9.5% of total leverage exposure.

Of note, a few of the new requirements must be met by Jan. 1, 2019, but some of the more-stringent requirements do noy have to be fully complied with January 1, 2022.

Keep in mind that the most stringent requirements are applied to JPMorgan, followed by Citigroup. Then comes Bank of America, Goldman Sachs and Morgan Stanley, all of which have the same requirement. Wells Fargo requirement is next, followed by State Street Corp and finally Bank of New York Mellon.

Apparently, two two banks already comply with the long-term debt requirements under Friday’s proposal, but Fed officials would not provide further details.

Statement from Fed Chair Yellen

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