10th November 2014

Financial Stability Board unveils global rules to end ‘Too Big to Fail’

Written by Adam Cull, the BBA’s Senior Director (Financial Policy and Operations)

This morning brings details of proposed new loss absorbing standards the largest global banks will be expected to meet by the Financial Stability Board (FSB). The proposals for total loss absorbing capacity (known as TLAC) are one of the key elements of the G20’s efforts to end the problem of ‘Too Big to Fail’.

The proposal attempts to set a common minimum level of resources to be held by each of the 30 Global Significantly Important Banks (or G-SIBs) to ensure that they can absorb losses should they fail and be recapitalised to maintain the critical economic functions they provide without calling on external support.

The FSB proposes that each G-SIB holds a minimum of 16-20% of its risk weighted assets (RWAs) in liabilities which meet new minimum standards of loss absorbency in resolution. Banks must already meet an 8% capital requirement under Basel III (implemented as CRD IV under EU law). The TLAC proposal is an additional requirement to these minimum standards. Therefore items that count towards the Basel minimum will also count towards the TLAC requirement.  The minimum requirement can be supplemented by a firm-specific requirement if considered necessary by the authorities.

The eligibility criteria for instruments to be included in TLAC have been the subject of much debate. The FSB has attempted to set principles which can apply equally across the differing legal regimes in which the G-SIBs are headquartered and operate. In summary, the principles seek to identify the instruments which can be most readily exposed to loss in resolution without impacting the ability of the restructured bank to continue to operate the crucial services it provides, such as deposit taking, small business lending or the operation of payment or settlement systems.

A key and controversial aspect of the proposal is the suggestion that G-SIBs be required to pre-position ‘internal TLAC’ resources with material subsidiaries of their groups located outside their home country. This seeks to address the concern that national authorities will ringfence the parts of a global group operating in their country if it gets into difficulty, hastening the failure of the group as a whole and complicating restructuring post failure. This is a big change to how some banks currently operate and could result in a more fragile structure if not calibrated appropriately. It is likely to lead to some interesting discussions between national authorities over which subsidiaries are considered material and which are not.

What happens next? The FSB has invited comments on its proposal by 2 February 2015. In early 2015, a comprehensive impact assessment study will get underway to inform the calibration of the minimum requirement and gauge the depth of the market for TLAC eligible instruments. If agreed by the 2015 G20 Summit the new rules will be implemented, but not before 1 January 2019.

Further background on loss absorbency and resolution is available here.

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