FSB outlines new rules on ‘too big to fail’

January  2015  |  FEATURE  |  BANKING & FINANCE

Financier Worldwide Magazine

One of the fiercest criticisms of post financial crisis legislative reform has been reserved for a perceived failure to address the notion of banks being ‘too big to fail’. That may soon change. In mid-November 2014, the Financial Stability Board (FSB), a global monitoring body, announced it had drawn up a number of new rules designed to condemn ‘too big to fail’ to the history books.

Under the new FSB legislation, the world’s 30 biggest banks, deemed ‘globally systemically important’, would be required to have total loss-absorbing capacity equivalent to as much as a quarter of their assets weighted for risk. Furthermore, under the new provisions national regulators will also be able to impose tougher standards on their country’s banks. Once the new legislation comes into effect, a breach of the regulations, or being deemed a ‘likely’ candidate to breach, could see a bank’s ability to pay dividends and bonuses dramatically curtailed.

The measures have been designed to ensure that in the event a bank collapses, it would do so without the safety net of a taxpayer bailout. In the wake of the financial crisis and the subsequent economic downturn, governments around the world over-committed billions of dollars in bailouts to failing financial institutions, much of which took the form of direct subsidies from taxpayers. British taxpayers alone have paid out over $1.9 trillion to support the country’s banking system since the financial crisis.

Instead of relying on government bailouts, under the revised rulings the responsibility and cost of a big bank failure would be borne by the bank’s shareholders and bondholders. Accordingly, the world’s biggest banks would be required to have a buffer of bonds or equity equivalent to at least 16 to 20 percent of their risk-weighted assets, such as loans, from January 2019. That figure could rise to 25 percent or more, depending on the size of the lender and whether national regulators choose to impose a further layer of protection. Regardless of the stance taken by local regulators, the base level of 16 percent is still a far bigger buffer than has ever been mandated by banking regulations. As a result, a number of banks are likely to be required to take on tens of billions of dollars in additional capital by selling extra bonds and restructuring some senior debt. Issuing billions of dollars of new debt is likely to create rather strong headwinds against earnings for a number of banking institutions, particularly those in the US. Accordingly, the announcements have proven to be unpopular.

Mark Carney, governor of the Bank of England and chairman of the FSB, believes that the new rules represent a “watershed” moment for the wider financial sector. Though the new rules will not prevent future financial collapses per se, they will mean that banks can fail without becoming a burden on the state. Mr Carney and the FSB hope that these new regulations will finally, six years after the onset of the financial crisis, enable financial regulators to put to bed the idea of banks being ‘too big to fail’. In a statement, Mr Carney noted that “Once implemented, these agreements will play important roles in enabling globally systemic banks to be resolved – wound down – without recourse to public subsidy and without disruption to the wider financial system.”

The new regulations will have a significant impact on the financial sector, and wider national and regional economies, but their potential for success is up for debate. Realistically, although the proposed new regulations will reduce the chance that taxpayers will be called upon to bailout an ailing financial institution, that possibility is not eliminated entirely.

The proposals, which have received a mixed reaction, only provide regulators with a template on which to base their own specific, tailored rules. As the FSB’s guidelines aren’t legally binding for financial regulators, their adoption will likely be piecemeal in certain jurisdictions, including in the US. The FSB hopes that US regulators will coordinate their efforts with other watchdogs worldwide, but there is no formal compulsion to do so. US regulators are still implementing the Dodd-Frank Financial Reform Act, which passed into law in 2010, so ensuring that companies are compliant with the FSB’s guidelines may be less of a priority. Furthermore, the likelihood of the global banking industry, and the relevant governmental bodies, agreeing upon and enforcing a catch-all set of rules and regulations appears unlikely.

Regardless of the adoption rate of its new guidelines, the FSB should continue its push to reform international banking. The group has already reached a number of agreements on more stringent capital requirements and heightened scrutiny of banks by industry watchdogs.

© Financier Worldwide

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Richard Summerfield