The
Financial Stability Board (FSB) wants to make banks safer. For this
monumental task, it puts every possible means on the table: TLAC,
G-SIB, TBTF, BSCB, RAP, BIS, RWA, CET1, BRRD, SPE, and QIS.
Frankly,
what is happening here? Let’s for a moment forget about all the
shortcuts and talk about the basics. The overarching principle is the
following: If a bank is in crisis, it should be, first, up to the
shareholders and, second, up to the unsecured and uninsured creditors
to bear any loss. This is to ensure that the bank can accomplish an
orderly resolution process, either to recapitalize or to disappear.
How
can we achieve this? The buzzword here is TLAC.
What
is TLAC?
TLAC
means total loss-absorbing capacity. It consists of liabilities that
mature in at least one year and can be transformed into equity. In
other words, people who have lent money to a bank will no more be
paid back. Instead, they receive shares of the bank that is about to
die. However, this will only apply to unsecured and uninsured
creditors. Obviously, if all creditors, including depositors, were
concerned, we could not avoid a bank run.
To
make banks safer, the FSB suggests imposing minimum TLAC levels:
- Pillar 1 Minimum TLAC: TLAC must represent at least 16 – 20 % of the bank’s risk-weighted assets (RWA) and, in addition, be at least twice the Basel III leverage requirement.
- Pillar 2 Minimum TLAC: Depending on the complexity of the bank, home resolution authorities can impose additional TLAC requirements.
Together,
Pillar 1 and Pillar 2 TLAC are called “external TLAC”.
Who
needs to meet TLAC requirements?
First,
a bank only needs to hold minimum TLAC, if it is a global
systemically important bank (G-SIB).
Second,
TLAC must, in principal, be issued by a resolution entity inside the
banking group. A resolution entity can be a parent company,
(intermediate) holding company, or, depending on the preferred
resolution strategy of the firm, a subsidiary operating company. If
not issued by a resolution entity, liabilities can still be
recognized as TLAC if they are qualified as Tier 1 or Tier 2 capital
instruments under applicable consolidated capital requirements.
Third,
inside a G-SIB, there might be some entities, which are, on their
own, big enough to trigger a bank run. This is why the FSB intends to
distinguish so-called material subsidiaries inside the group that
have to meet proper TLAC requirements. A subsidiary is material if it
- either represents more than 5 % of the consolidated risk-weighted assets of the G-SIB group;
- or represents more than 5 % of the consolidated revenues of the G-SIB group;
- or represents a leverage exposure that is larger than 5 % of the G-SIB group’s total leverage exposure;
- or exercises critical functions for the G-SIB group.
TLAC
held by a material subsidiary is called “internal TLAC”. I find
that a bit misleading as external and internal TLAC actually don’t
add up to form total TLAC. Rather, they are two different ways to
look at the same amount of liabilities.
The
amount of internal TLAC applicable to any material subsidiary is set
in proportion to the size and risk of the material subsidiary’s
exposure. It should amount to 75 – 90 % of the (external) TLAC that
would apply if the subsidiary were treated on a stand-alone basis.
When
does all this apply?
TLAC
requirements will not apply before January 1, 2019.
What
is the problem?
Please
go through the following FSB quotes and guess what the problem is:
If
we want to avoid our Governments bailing out banks in a financial
crisis, we need to avoid the risk of a bank run. As a matter of fact,
it is the lack of confidence in banks and the financial system that
triggers a bank run. In my view, the crucial question then is: Will
customers understand that G-SIBs hold TLAC to avoid TBTF? My answer
is no: I simply don’t think that you can build confidence with
bureaucratic complexity.
Resource:
The
FSB press release and the consultative TLAC document, both dated
November 10, 2014, are available here.
