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Global banks ready for TLAC requirements

With the internationalisation of the renminbi, more Chinese banks are becoming considered 'globally systematically important'.
China Construction Bank: 'globally systematically important'
China Construction Bank: 'globally systematically important'

International regulators released an annual update to the list of systemically risky banks and the new debt requirements those institutions will have to meet, but some observers have questioned the new regime's efficacy in times of crisis.

The Financial Stability Board on Nov. 3 updated the list of global systemically important banks, or G-SIBs, that have to maintain more stringent capital ratios under Basel III. The list of G-SIBs is broken into various buckets based on systemic risk, with higher buckets requiring more capital. All eight U.S.-based banks on the list were in the same bucket as last year.

The only changes came from the addition of China Construction Bank Corp., the removal of Banco Bilbao Vizcaya Argentaria SA and moving Royal Bank of Scotland Group Plc down a bucket.

The inclusion of China Construction Bank was expected as the other three largest banks in China —Agricultural Bank of China Ltd., Bank of China Ltd. and Industrial & Commercial Bank of China Ltd. — are already on the G-SIB list, Steven Leung, executive director at UOB Kay Hian, told SNL.

"There is a lot of room for the Chinese banks to grow in the European and the U.S. markets, as the internationalization of the yuan makes banks become more important in the global market," Leung said.

With a financial system that continues to grow, future lists could include additional Chinese banks. The Financial Stability Board calculates G-SIB scores by comparing a bank's size, complexity and other factors against the aggregate figures of the 75 largest banks in the world. Of those 75 banks, 14 are based in China.

As Chinese banks get larger, their inclusion on G-SIB lists could be seen as a proxy for the nation's growing influence in global financial governance, said Samuel Chua, senior vice president at KGI Securities. "This is a consequence of China's further opening up its economy and its growing participation in the global business operations," Chua told SNL.

Regulators put China Construction Bank in the lowest 1.0% bucket along with the three other China-based banks. The 1.0% bucket denotes those banks will have to generally hold common equity Tier 1 ratios of 8% on a fully phased-in basis. Broken down, the banks have to hold a minimum ratio of 4.5%, a capital conservation buffer of 2.5% and then the additional 1.0% buffer for being a G-SIB. Regulators can also impose a discretionary counter-cyclical buffer of an additional 2.5%.

Most of the banks included on the G-SIB list, 19 out of 30, were placed in that 1.0% bucket. Royal Bank of Scotland was able to move down as part of its broader shift required by regulators to become a retail-focused bank after its investment banking operations triggered the need for a government bailout during the financial crisis. The bank has trimmed its total assets to £876.43 billion as of Sept. 30, from more than £2.4 trillion in 2008.

Another European bank, Spain's BBVA, dropped off the list entirely. The bank approved of the decision, saying in a statement that the move was "coherent with the nature of [its] business model," and that it was "predominantly a retail bank."

The FSB left the top bucket, which would require an additional buffer of 3.5%, empty. If a bank were systemically risky enough to be placed in the bucket, regulators would create a new bucket at 4.5% so that there is always a disincentive for banks to become more systemically important. Therefore, the top bucket in practice is, for now, the 2.5% one, in which just two banks sit: HSBC Holdings Plc and JPMorgan Chase & Co.

The Financial Stability Board also released details on total loss-absorbing capacity, or TLAC, requirements that all 30 G-SIBs will need to meet. The rule requires that a bank have sufficient amounts of debt that could be bailed in to recapitalize it in times of crisis. Essentially, in times of crisis, the new class of TLAC debt could be converted into equity to recapitalize a foundering bank.

While estimates suggest banks will need to issue a lot of this debt, some analysts remain skeptical that the plan will work in practice. International regulators estimate the rules could require G-SIBs to issue as much as €1.1 trillion in new debt. U.S.-based G-SIBs have to meet the Federal Reserve's requirements, which are more stringent. Swiss regulators also have passed tougher TLAC requirements for banks based there. Both the Fed and the FSB require total TLAC equivalent to 18% of risk-weighted assets by 2022, but the Fed set a higher minimum TLAC leverage ratio requirement at 9.5%, fully phased-in, compared to 6.75% at the international level. The Fed estimated U.S.-based G-SIBs would need up to $120 billion of new debt to meet the TLAC requirements.

China-based banks will be temporarily exempt from the rules and will need to meet fully phased-in TLAC requirements by 2028, unless corporate debt markets grow to a certain level, according to the FSB.

Although the amount of debt needed sounds large, it appears analysts expect G-SIBs will have little trouble meeting the requirement. After the Fed announced its more stringent TLAC requirements, some analyst notes suggested the eight U.S. banks on the G-SIB list would have little trouble meeting the minimum requirements.

Drexel Hamilton analyst David Hilder wrote that he expected all U.S. banks to be able to meet the Fed's rules as they are already wary of excessive leverage and have been working to reduce their total risk-weighted assets due to the G-SIB framework.

"In addition, we expect the banks to convert or replace some debt that does not qualify as TLAC under the Fed proposal into TLAC-qualified debt, and issue additional unsecured parent-company debt as necessary," Hilder wrote in a Nov. 2 note.

John McDonald, an analyst with Sanford C. Bernstein & Co., came to a similar conclusion, arguing that most banks were already in good shape to meet the TLAC requirements.

McDonald estimated in a Nov. 2 note that Bank of America Corp. would need to raise $34 billion of debt, Citigroup Inc. would need $11 billion, JPMorgan $22 billion and Wells Fargo & Co. would need to issue $39 billion of long-term debt to comply with the rule. Both Hilder and McDonald said the rule seemed more forgiving than initially feared.

Standard & Poor's Ratings Services called the TLAC framework "a key component of the regulatory jigsaw to address the 'too-big-to-fail' dilemma.'" The rating agency wrote in a Nov. 9 report that the TLAC framework could reduce the default risk of a bank's senior unsecured creditors. S&P recently placed U.S. G-SIBs on CreditWatch with negative implications due to possible removal of government intervention in times of crisis. At the same time, S&P noted that some work is left to do on TLAC. To get investors comfortable with the new class of debt, there needs to be more disclosure by banks and assurances from policymakers on the predictability of regulatory response, S&P said.

Other observers were more critical. The editorial board at Bloomberg rejected TLAC, arguing it could be "making things worse" by introducing complexity and uncertainty to banks' balance sheets. Further, the editorial board argued, it could increase leverage by causing banks to lower equity-to-asset ratios in order to issue the TLAC debt.

Simon Johnson, a professor at the Massachusetts Institute of Technology and a member of the FDIC's Systemic Resolution Advisory Committee, said regulators should be looking to reduce debt leverage at banks and require more tangible assets.

"The concept of a loss-absorbing debt is an oxymoron. Debt is not loss-absorbing in any way that can make you comfortable," Johnson told SNL.

Johnson said that during financial crises, debt will often take a hit first that will force holders of similar debt to face a repricing event. That could create leverage problems for the debt-holders and cause knock-on effects from counterparty risks. While TLAC debt is explicitly "bail-in-able," Johnson said financial players have a history of forgetting the original terms of an instrument and that it is likely the debt-holders will consider TLAC debt more akin to debt than equity.

"I think TLAC is one of the most dangerous ideas to come out of the international community of regulators," Johnson said. "I think Basel III as a whole is going in the right direction, but TLAC itself is very dangerous."

Jason Webb contributed to this article.

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