Market braces for FSB’s ‘scary’ TLAC number

By:
Louise Bowman
Published on:

The November G20 meeting could see the capital requirements of systemically important banks doubled.

Recent TLAC coverage

"Make no mistake – this is a really scary number." This was a stark warning given by the head of the capital solutions group at a leading European bank last month.

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The scary number he was referring to was the Financial Stability Board’s (FSB) proposed requirement for total loss-absorbing capital (TLAC) to be held by systemically important banks, which is due to be revealed at the G20 summit in Brisbane in November. "It could double the amount of capital that everybody needs," he said.

Shortly after this conversation, news began circling in the market that a provisional deal had been reached whereby TLAC required will be between 16% and 20% of risk-weighted assets, due to be phased in by 2019.

Under the present Basel III rules, banks are required to meet a minimum total capital ratio of 10.5% by 2019, so the banker’s scary prediction that bank capital needs could double is not far from the truth.

"I reckon that there is a 50/50 chance that this will go through," he told Euromoney. "If it does, banks will be required to raise further billions of capital."

The FSB’s proposals are targeted at 29 global banks that it deems to be too big to fail. The proposals will limit the extent to which unsecured senior debt can count towards TLAC, and might also include a regulatory deduction on holdings of other bank debt as part of this buffer – to minimize contagion in the event of a bank failure.

While these proposals have the strong support of regulators in the US and UK, they will likely prove hugely unpopular in Europe if passed as envisaged.

Drawing a line

The US regulator has imposed a tougher supplementary leverage ratio of up to 6% on US banks compared with the Basel III leverage ratio of 3% and last month Fed governor Daniel Tarullo revealed plans to increase the capital conservation buffer from 1% to 2% to up to 4.5% and add an additional buffer of 1% to 2% to banks that are deemed reliant on short-term funding.

In Europe, October’s stress-tests results are supposed to be drawing a line under bank capital needs, but if the FSB proposal goes through it will be a short-lived reprieve. Due to be published after October 17, the asset-quality review or comprehensive assessment has tested 128 banks in the eurozone for common equity tier 1 (CET1) and will grant banks between six to nine months to remedy any shortfalls. The stress-testing process forced the situation at Banco Espírito Santo into the open and there is likely to be much discussion of any shortfall numbers when they are published.

It should be remembered, however, the results will show the situation at year-end 2013 and do not take into account the substantial volumes of bank capital that eurozone banks have raised so far this year. Monte dei Paschi di Siena alone has raised €5 billion.

So while the European Central Bank, which takes over as eurozone bank regulator on November 4 under the single supervisory mechanism, will need to react to the final numbers, it is likely a large part of this problem will have been dealt with.

However, the FSB proposals for TLAC present a different problem. Despite a couple of recent wobbles in the AT1 market, bankers are confident there is sufficient appetite from both debt and equity to meet the remaining requirement for fully loaded CET1 capital under Basel III. However, if the FSB now doubles that requirement – all bets are off.