Banking and Finance Law Daily TLAC proposal would address TBTF problem; guidance needed on capital deductions
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Thursday, January 28, 2016

TLAC proposal would address TBTF problem; guidance needed on capital deductions

By John M. Pachkowski, J.D.

The Independent Community Bankers of America has commented on a proposal issued by the Federal Reserve Board in November 2015 that would require a small number of bank holding companies (BHCs), considered to be global systemically important banking organizations (GSIBs) by the Fed, to take a number of steps to enhance their resolvability under the U.S. Bankruptcy Code (see Banking and Finance Law DailyNov. 2, 2015).

Specifically, the Fed’s proposal would:

  • require covered BHCs to establish an external long-term debt requirement (external LTD requirement), an external total loss-absorbing capacity requirement (external TLAC requirement), and a related external TLAC buffer;
  • impose restrictions on the operations of covered BHCs to be known as “clean holding company requirements”; and
  • impose regulatory deductions for investments in the unsecured debt of covered BHCs by requiring an institution with a non-significant investment in a covered BHC to deduct any investment in unsecured debt issued by the covered BHC in the same manner as if the unsecured debt were tier 2 capital using the “corresponding deduction approach.”

To meet the external TLAC requirement, covered BHCs would be required to maintain outstanding eligible external TLAC equal to the greater of: 18 percent of risk-weighted assets (RWAs) and 9.5 percent of total leverage exposure. The external LTD requirement would be met if a covered BHC maintains outstanding eligible external LTD equal to the greater of: 6 percent of RWAs, plus the applicable GSIB capital surcharge, and 4.5 percent of total leverage exposure. Finally, the external TLAC buffer would equal the sum of 2.5 percent, any applicable countercyclical capital buffer, and the GSIB surcharge applicable under method 1 of the Fed’s GSIB surcharge rule.

In its comment letter, the ICBA generally supports the proposal to impose an external TLAC requirement and an external LTD requirement on covered BHCs and agreed with the Fed that “there is a need for both requirements and that the LTD requirement will specifically help address the too-big-to-fail problem.”

TLAC and LTD requirements. As for the external TLAC and LTD requirements, the ICBA noted that the proposed TLAC capital measure closely reflects the “historical loss experience of major financial institutions during the recent financial crisis.” It added that the proposed LTD requirement was “vital if the single point of entry (SPOE) resolution process is to work.”

Capital deduction. Commenting on the proposed requirement that there be a regulatory capital deduction for investments in the unsecured debt of covered BHCs, the ICBA noted that the deduction was necessary to address the potential contagion stemming from the failure of a GSIB.

Although the ICBA agreed that the capital deduction was necessary, it raised concerns regarding the effects that “corresponding deduction approach” would have on community banks. It recommended that the banking agencies issue specific guidance to community banks on this issue prior to the TLAC rules becoming effective in 2019. The ICBA noted, “The guidance should explain how the ‘corresponding deduction’ rules work under Basel III and the consequences to an institution’s regulatory capital if covered BHC debt is purchased.”

Companies: Independent Community Bankers of America

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