Proposal would limit ‘interconnectedness’ of big banks by discouraging TLAC debt purchases

FDIC points out highlights of proposal in letter

“Interconnectedness” of large banking organizations would be limited under a proposal issued by the federal banking agencies Tuesday and aimed at reducing the impact of a failure of a large financial firm.

The Federal Deposit Insurance Corp. (FDIC), Federal Reserve and the Office of the Comptroller of the Currency (OCC) said that to discourage globally significant important bank holding organizations (GSIBs, the “largest and most complex banking organizations”) and “advanced approaches” banking organizations from purchasing large amounts of certain debt from other big banks, all of the large institutions would be required to hold additional capital against “substantial holdings” of the debt.

The three agencies released the proposal with a 60-day comment period.

The agencies noted that GSIBs are required to issue debt with certain features under the Federal Reserve’s “total loss-absorbing capacity” (TLAC) rule, which is intended to be used to recapitalize the holding company during bankruptcy or resolution if it were to fail.

The proposal, however, would discourage the purchase of such debt by the GSIBs and the “advanced approaches” financial firms (those have $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure) from buying large chunks of TLAC debt.

“This would reduce interconnectedness between large banking organizations and, if a GSIB were to fail, reduce the impact on the financial system from that failure,” the agencies said in a release.

The proposal also requires the holding companies of GSIBs to report publicly their TLAC debt outstanding, the agencies said.

In a financial institution letter (FIL) issued Tuesday, the FDIC said the proposal would:

  • Amend the capital rule such that an investment in a covered debt instrument by an advanced approaches banking organization generally would be treated as if it were an investment in a tier 2 capital instrument, and therefore, subject to the existing deduction approaches under the capital rule.
  • Require advanced approaches banking organizations to fully deduct from tier 2 capital any significant investment in or reciprocal cross-holding of covered debt instruments, and direct, indirect, or synthetic investment in the banking organization’s own covered debt instrument.
  • Generally require advanced approaches banking organizations to include investments in covered debt instruments in the calculation of non-significant investments in the capital of unconsolidated financial institutions.
  • Provide for separate, 5 percent common equity tier 1 thresholds for advanced approaches banking organizations that are GSIBs and advanced approaches banking organizations that are not GSIBs. The aggregate amount of certain investments in covered debt instruments that are below these thresholds would not be subject to deduction.
  • Provide that any covered debt instrument held for five or fewer business days in connection with bona fide underwriting activities would not be subject to deduction.

Agencies Propose Rule to Limit Impact of Large Bank Failures

FDIC FIL-18-2019: Regulatory Capital Rule: Regulatory Capital Treatment for Investments in Certain Unsecured Debt Instruments of Global Systemically Important U.S. Bank Holding Companies, Certain Intermediate Holding Companies, and Global Systemically Important Foreign Banking Organizations