Tuesday, January 13, 2015

TLAC for G-SIBs tackle TBTF. – “Resolution is not resurrection. But nor is it insolvency.”

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.


The FSB press release and the consultative TLAC document, both dated November 10, 2014, are available here.