The Federal Reserve announced Wednesday that it would meet next week to consider finalizing a major rule aimed at ensuring that big banks can fail without requiring bailouts or threatening the financial system, one of the major pieces of the post-crisis rules yet to be finished.
The agency will meet Dec. 15 to consider the rule, which would require banks to issue certain amounts of long-term debt that could be converted to equity in the case of a bank failure, effectively forcing creditors to “bail in” the bank rather than taxpayers bailing it out.
The finalization would come just a month before President-elect Trump takes office, despite congressional Republicans’ warnings to financial regulators not to rush rules out the door before President Obama’s term ends.
The rule in question was proposed in October 2015 and would apply to the eight U.S. banks that have been identified as potential threats to the financial system if they were to fail.
Those banks would be required to issue debt of maturity greater than one year at the bank holding company level — the highest level of corporate organization. The banks would have to maintain a minimum of capital and that long-term debt equal to 18 percent of their assets, or 18 percent “loss-absorbing capacity,” as regulators call it.
The idea is that, in the case of a failure, the banks’ shareholders would see their ownership stake wiped out, and the long-term debtholders would become the new owners. By stating in advancing that the holders of the long-term debt would be the first to see their debt written down, the rule would, in effect, spell out how the bank would be restructured in advance, a foresight that the Fed hopes would reduce the odds of a panic.
Issuing long-term debt would be cheaper than being required to maintain equivalently high levels of capital, from the perspective of the bank’s owners.
The long-term debt rule is just one of the post-crisis rules applying to big banks, including new liquidity rules and higher capital requirements that are more stringent for the biggest banks.
Some regulators have expressed skepticism of the long-term debt scheme. Federal Deposit Insurance Corporation Vice Chairman Thomas Hoenig, for example, has said that it is “paradoxical” for regulators to try to make the system safer by requiring banks to issue more debt, when over-indebtedness led to the last crisis.
Federal Reserve Bank of Minneapolis President Neel Kashkari, who last month announces a financial reform plan that hinges on far higher capital requirements, also has criticized the idea. Kashkari, who served as the Treasury official responsible for carrying out the 2008 TARP bailout of banks, has said that it is implausible that, during the chaos of a panic, a bank would be able to smoothly carry out a bail-in.
