WHEN big banks fail, taxpayers usually foot the bill

English: Mark Carney, Canadian banker
English: Mark Carney, Canadian banker (Photo credit: Wikipedia)

WHEN big banks fail, taxpayers usually foot the bill. For instance, since the most recent financial crisis, British taxpayers alone have provided around £1.2 trillion ($1.9 trillion) worth of support to banks. Governments and their citizens around the world are understandably keen that this does not happen again. In response to this pressure, on November 10th the Financial Stability Board (FSB), an international group of regulators, announced proposals that Mark Carney, the governor of the Bank of England, says will end the risk to the public purse from bank failures.
Under the proposals­—named “Total Loss-Absorbing Capacity” (TLAC)—big banks will have to fund themselves with loss-absorbing capital equal to 16-20% of their risk-weighted assets. This capital includes both shareholders’ equity and some convertible securities (capital that is raised as debt, but converts into shares when a bank enters financial difficulties). In reality, when TLAC comes into force by 2019, banks will need slightly more capital than the new rules prescribe due to the extra “buffers” demanded by the Basel Committee on Banking Supervision, another international regulator.
Mr Carney emphasises that the new TLAC rules will not prevent future bank failures. Rather, they will mean that a bank’s shareholders can be wiped out without its liabilities becoming a burden on the state. Instead, some creditors­—such as the holders of convertible bonds—will automatically become the new owners. As a result, the bank will avoid defaulting on its conventional debt to other financial institutions. This is the nightmare scenario, in which “contagion” spreads around the financial system, that bailouts try to avoid. Were a bank to suffer losses exceeding the TLAC buffers­—such that the convertible debt was wiped out ­too—it would fail more completely. Only at that point might taxpayers be on the hook.
Regulators hope that the requirements will be stringent enough that such a complete failure is rendered almost impossible. If they are right, the “too-big-to-fail” subsidy­—the reduction in the interest rate banks pay on their debt due to an implicit taxpayer guarantee­—will be all but eliminated.
There are 30 banks around the world considered large enough to be “globally systemically important” and hence potentially subject to the TLAC rules. However, those headquartered in emerging markets will initially be exempt due to the “different market conditions” they face. In particular, this will benefit three banks based in China. The FSB’s impact assessment will consider the extent to which this could create an uneven playing field.
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