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From Banking and Finance Law Daily, April 2, 2019

Agencies propose rule to limit the impact of large bank failures

By Nicole D. Prysby, J.D.

The Fed, FDIC, and OCC have issued a proposed rule that would limit the interconnectedness of large banking organizations and reduce the impact from the failure of the largest banking organizations. The proposal would discourage specified large banking organizations from purchasing large amounts of "total loss-absorbing capacity" debt by requiring them to hold additional capital against substantial holdings of TLAC debt.

On April 2, 2019, three federal agencies announced a proposed rule to limit the impact of large bank failures. The Federal Reserve Board, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency jointly proposed a rule to complement earlier rules implemented to limit interconnectedness among large banking organizations. According to the joint press release, it would discourage certain firms (generally, those with $250 billion or more in assets or $10 billion in foreign exposure) from purchasing large amounts of total loss-absorbing capacity (TLAC) debt by requiring the organizations to hold additional capital against substantial holdings of TLAC debt.

Currently, minimum capital requirements for banking organizations include minimum risk-based and leverage capital ratios. The capital ratios measure different definitions of regulatory capital relative to risk; the numerators of those ratios include adjustments and deductions to generally accepted accounting principles-based capital components. These deductions include a bank’s investments in its own regulatory capital instruments (or those held reciprocally) or those issued by specified unconsolidated financial institutions. The intent of the rule is to reduce interconnectedness and contagion risk among banks. In 2015, the Fed added onto those requirements with TLAC and long-term debt instrument (LTD) rules. The TLAC and LTD rules require banking organizations to have sufficient loss-absorbing capacity on both a going-concern and a gone-concern basis. The TLAC and LTD rules apply to global systemically important bank holding companies (covered BHC) or intermediate holding company subsidiary of a globally systemically important foreign banking organization (foreign GSIB) with $50 billion or more in U.S. non-branch assets (covered IHC).

At the time the TLAC and LTD rules were issued, the Fed proposed limitations on investments by Fed-regulated banking organizations in LTD issued by covered BHCs, but did not finalize those limitations because it needed additional time to work with the OCC and FDIC towards an interagency approach. This proposed rule is the result of that additional research, and incorporates public comments from the 2015 proposal. The rule would recognize the systemic risks posed by banking organizations’ investments in covered debt instruments and would create an incentive for advanced approaches banking organizations to limit their exposure to GSIBs. Under the proposal, an investment in a covered debt instrument by an advanced approaches banking organization would be treated as an investment in a tier 2 capital instrument and would therefore be subject to deduction from the advanced approaches banking organization’s own tier 2 capital. A covered debt instrument would include unsecured debt instruments issued by a covered BHC or a covered IHC, and thus potentially subject to deduction if they are eligible debt securities or eligible covered IHC debt securities under the TLAC Rule, or if they are on equal footing or subordinated to any eligible debt security or eligible covered IHC debt security.

Comments sought. The agencies have requested comment on the proposal and specifically asked for the following:

  • comments on all aspects of the proposed deduction approach for investments in covered debt instruments by advance approaches banking organizations;
  • information on the extent to which non-advanced approaches banking organizations have material holdings of covered debt instruments issued by covered BHCs, covered IHCs, and foreign GSIBs;
  • feedback and potential alternatives to the proposed definition of "covered debt instrument;"
  • whether the proposed definition of covered debt instrument captures non-capital debt instruments issued by covered BHCs and covered IHCs;
  • whether the proposed definition of covered debt instrument captures debt instruments issued by foreign GSIBs or their subsidiaries;
  • possible alternatives to the definition of "excluded covered debt instrument;" and
  • whether the proposed exclusions from deduction for certain investments in covered debt instruments of an unconsolidated financial institution appropriately align with the treatment set forth in the TLAC holdings standard.

The agencies believe the proposed rules will have a relatively small effect on advanced approached banking organizations, although there may be some regulatory costs to those entities associated with changes to internal systems and processes. Comments on the rule will be due 60 days after publication in the Federal Register.

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