G-Sib regulation: Sensible answer to the wrong question

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The Financial Stability Board’s proposals to identify global systemically important banks (G-Sibs) and demand they hold extra risk weighted capital at subsidiaries deemed 'material' is going to be costly for the 30 G-Sibs that have been picked out.

Canary Wharf 3-160x186
Canary Wharf
So costly, in fact, that many analysts expect the current wave of divestments of business lines and markets apparent at some G-Sibs to extend beyond the peripheral sources of revenue and into disposals of what were, until recently, considered core businesses.

Let’s, for now, set aside questions about what constitutes a material subsidiary or problems in even creating a universal definition of RWA. Let’s also ignore, for now, whether local debt capital markets around the world can absorb the proposed issuance of billions of dollars’ worth of loss-absorbing instruments needed to satisfy  total loss absorbing capacity capital requirements to ring-fence these subsidiaries. The real question is: is TLAC the solution to the wrong problem?

The drive from the regulators is clear. The Financial Stability Board has stated that in the case of another failure of a large, global foreign institution there is a need to be able to recapitalize that firm and promote market confidence (in other words avoid system risk from contagion) during and after resolution.

Global retrenchment

The regulators are determined to avoid local taxpayers having to step in and restore G-Sibs in their markets if the HQ country is unable or unwilling to do so. This aim is both laudable and understandable. However, as a PwC briefing note points out, this has led to the FSB setting TLAC levels based on current G-Sib profiles that don’t seem to take into account recovery plans that these institutions have in place, which would trigger asset sales and recapitalization efforts well in advance of resolution.

Also, the TLAC levels focus on creating levels of loss absorbing capital that would preserve a G-Sib’s consolidated business – and not just the core, critical functions that would need to be saved. Would a G-Sib facing resolution really wish to preserve its business in entirety? As such, do the proposed TLAC levels look like a sensibly-calibrated extra layer of capital to facilitate resolution? Or an additional penalty for scale?

The questions are hugely important – and not only for the G-Sibs concerned – because the proposals will almost certainly lead to a big global retrenchment by the G-Sibs. This will have a (mixed) impact on the G-Sibs themselves but will probably be more keenly felt by banks operating in the markets that see the withdrawal of the international banks.

While it will be positive for those locals (and their shareholders) – and is likely to lead to a simpler banking system for the national regulators to oversee – it will not be such good news for the businesses and individuals seeking credit in those markets. Nor will it be good news for multinational businesses looking for global partners to provide global and local treasury services and corporate and investment banking products.