Big U.S. banks would need to significantly overhaul their ownership structures to avoid a crisis or bailouts, the Federal Reserve mandated Friday.
The bank regulatory agency voted to propose rules that would require the eight biggest banks to have enough equity and long-term debt that its owners and the holders of that long-term debt would be able to absorb any losses the bank might suffer, reducing the risk of taxpayers having to step in with a bailout.
The new rule “is another important step in addressing the ‘too-big-to-fail’ problem,” said Fed Chairwoman Janet Yellen, speaking at a meeting of the Fed’s Board of Governors.
Under the new rules, which would come into effect in 2019, the eight banks face a $120 billion shortfall in the kinds of ownership shares and long-term debt they would need, according to a Fed memo.
To meet the requirements, the board estimated, the banks would face added funding costs of $680 million to $1.5 billion annually. Those costs, however, would be outweighed by the benefits to the financial system and taxpayers, in the Fed’s assessment.
The U.S. banks that would be affected are: JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, State Street and Wells Fargo.
The premise behind the rule is that if a large, complicated bank-holding company composed of many smaller banking units suffered large losses and failed, the situation could be resolved simply and safely by having the bank share necessary losses could between its parent company’s owners and the holders of its long-term debt. The shareholders would lose their stake in the bank-holding company and the debt holders would become the new owners. The rule is meant to ensure that the companies issue enough unsecured long-term debt that they and the owners can absorb any foreseeable losses, ruling out the possibility of a disorderly failure that could bring down the financial system or force a taxpayer bailout.
While other rules implemented in the wake of the financial crisis have been meant to make banks safer, Fed governor Daniel Tarullo said, this rule is meant “to make the failure of systemically important banks possible without either causing disorder in financial markets or requiring injections of government capital.”
The rule would require that the bank-holding companies have capital and long-term debt, what the Fed refers to as “total loss-absorbing capital,” equal to 18 percent of their assets, adjusted for riskiness.
The industry has until February to comment on the rule.
