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Taxpayers Will Not Bear Banks' Losses With New Rules

During the recent financial crisis, taxpayers around the globe invested billions of dollars saving ailing banks. New global rules put forward by the Financial Stability Board would force creditors to bear banks' losses.

The Financial Stability Board (FSB), an international body monitoring and making recommendations about the global financial system, is composed of national authorities responsible for financial stability in 24 countries. The board was established in 2009 in the wake of the financial crisis that forced governments to bail out numerous financial institutions with public money. The G20 leaders consequently called on the FSB to assess and develop proposals on how global systemically important banks (so- called G-SIBs) should build up their ability to cope with large losses without burdening the taxpayers in the case of failure. The FSB's consultation paper on G-SIBs' total loss absorbing capacity (TLAC) was then presented at the G20 Brisbane Summit last November. There are currently 30 banks considered as G-SIBs, including Credit Suisse, which will have to comply with the tougher standard put forward.

Yet Another Capital Frontier for G-SIBs

The proposal sets out the amount of easily available financial resources that G-SIBs will have to hold to ensure that they can fail in an orderly manner – without using taxpayers' money or without causing major disruption on the financial markets or the real economy. Under the new so-called bail-in rules, the 30 banks will have to hold a TLAC (securities such as equity or debt that will become loss bearing) totaling a minimum of 16 to 20 percent of their risk-weighted assets (RWA) or at least twice the amount of capital needed to fulfill the Basel III framework's Tier 1 capital leverage ratio. (See box below for an explanation of the terms in bold) This additional TLAC requirement comes on top of the capital buffers already set out in the Basel III framework such as the capital conservation buffer, counter-cyclical buffer and the G-SIB surcharge. "This means that total TLAC needs (of the G-SIBs) easily could reach 20 to 25 percent of RWA," said Christine Schmid, Head Global Equity and Credit Research at Credit Suisse Private Banking and Wealth Management. (See adjacent figure) "These new tougher capital rules might require banks to create or issue TLAC liabilities that need to be easily recognizable to investors," she added. The FSB also requires internal TLAC for each of the affected banks, to be pre-positioned at material legal entities within them such as a wealth management or investment banking division, within a 75 to 90 percent range of the hypothetical standalone requirement (as if the legal entity was completely independent from the group and its other members).

Simpler, Fairer and Safer Financial System

Prior to the financial crisis, risks were hidden and financing chains extremely complex, as the sub-prime mortgage crises showed when it broke out in 2007. Additionally, many of the world's largest banks were undercapitalized prior to the financial crisis, and levered 40 to 50 times. The aim of the announced reforms is not only to make the global financial system simpler and safer, but also fairer. Numerous governments had to bail out banks with billions of dollars of taxpayers' money during the financial crisis. "In Brisbane we reached a watershed in ending too big to fail, with agreements to take forward proposals on TLAC for globally systemic banks… As banking systems around the globe implement fully the new framework, a system that was built precariously on sand will stand more firmly on rock," said the Chair of the FSB and the Governor of the Bank of England, Mark Carney, in a speech. Final rules are likely to be adopted at November's G20 summit with full implementation likely as of January 2019.

Setting Up of TLAC Comes With Material Costs

The TLAC setup does however come with material costs for the affected banks. Why? Because TLAC is intertwined with how a bank's failure is carried out. A resolution process can be executed in two ways: Under the single point of entry (SPE) approach, one regulator takes care of the entire resolution process if a bank fails and all losses are absorbed by the top parent or holding level of the bank. Under the multiple point of entry (MPE) approach, various regulators are involved and losses are taken at decentralized legal entities. The latter case has huge consequences as banks operating under a MPE approach may have to comply with the TLAC requirements at each subsidiary and not only at the top holding level. Most of the eurozone's G-SIBs are not organized as holding companies, with HSBC and Santander being good examples. They both plan to implement a MPE resolution approach given their international presence in retail and corporate banking. This type of organizational structure will lead to high regulatory costs, ultimately weighing on their profitability. The new TLAC rules clearly favor G-SIBs from the US, UK and Switzerland, operating under a holding company structure with a SPE mechanism applied for resolution. "Setting up a holding company from scratch is an expensive and time consuming exercise," explained Michael Kruse, a senior credit analyst covering banks at Credit Suisse. "Investor acceptance of TLAC debt will only be sustained in the long run if regulators can harmonize global rules and ensure uniform, comparable resolution procedures," Kruse concluded.