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Regulators lay out plan to end ‘Too-Big-To-Fail’

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An end to Too Big To Fail? Photograph by Mandel Ngan — AFP/Getty Images

The world’s banking regulators unveiled at the weekend their last great plan for ending the phenomenon of banks that are ‘too-big-to-fail’, proposing that the most important institutions should carry at least as much as capital as other banks to ensure that taxpayers don’t ever have to rescue them again.

The Financial Stability Board, which coordinates the global regulatory response to the 2008 financial crisis on behalf of the Group of 20 major economies, said that Global Systemically Important Banks, or G-SIBs, should in future have to hold loss-absorbing capital equivalent to between 16%-20% of their total assets, adjusted for risk.

That’s more than double the 8% ratio that was prescribed in the so-called “Basel III” accords in 2011, which are being phased in around the world by 2018. The actual ratio required may even be higher than the basic range of 16%-20% range, as the plan allows national regulators to add on further capital charges if they deem it necessary.

The scale of the new requirements reflects, in part, the fact that regulators have largely failed to crack the legal and political problems of resolving a global bank (such as Lehman Brothers was), if its collapse leaves a trail of creditors in numerous jurisdictions, all with competing claims on its assets.

The new requirements would hit 30 banks that the FSB considers G-SIBs. They include JP Morgan Chase Inc. (JPM), Citigroup (C), Goldman Sachs , Morgan Stanley (MS), State Street (STT) and Wells Fargo Inc. (WFC), as well as all of the largest European and Japanese banks, plus two Chinese lenders.

Mark Carney, chairman of the FSB and governor of the Bank of England, told the BBC Monday that the pre-crisis system, which forced governments to carry out multi-billion dollar bail-outs to avert financial disaster, had been “totally unfair.”

“The banks and their shareholders and their creditors got the benefit when things went well,” Carney said. “But when they went wrong the…public and subsequent generations picked up the bill–and that’s going to end.”

Banks have complained ever since the Basel III accords that stringent new capital requirements would make it difficult for them to turn a profit, but such claims have lost credence as bank profits–especially in the U.S.–have rebounded with the economic upturn.

The new rules wouldn’t necessarily mean that banks will have to issue floods of new shares that would dilute their existing shareholder base. More likely is that banks–which typically depend to a far greater extent on bonds than equity to finance themselves–will have to rely less on “senior” debt, and switch more of it for “subordinated” debt that regulators can write down to zero if a bank’s losses exceed its equity base.

The FSB said it expects that banks will be able to use such ‘bail-in-able’ debt securities to meet at least one-third of the requirement.

Under the FSB’s proposals, banks would have until 2019 to meet the requirements. If they fail to do so, then regulators could restrict or ban bonus payments or dividends until a bank met them.

The final terms of the requirement will be fine-tuned after feedback from the banks themselves, and from a ‘Quantitative Impact Study’ in early 2015.