Home' Trinidad and Tobago Guardian : November 19th 2015 Contents NOVEMBER 19 • 2015 www.guardian.co.tt BUSINESS GUARDIAN
INTERNATIONAL | BG21
Fixing the banking system to
prevent another crisis on the
scale of 2007-2008 is a com-
plicated and time-consuming
task. It is not the kind of
thing that generates tabloid
headlines and public approbation. However,
another important stage in the process was
reached on November 9, when the Financial
Stability Board (FSB), a global regulators
forum, issued new guidelines on bank bal-
The underlying problem is as ancient as
banking itself: Banks lend out more money
than they have capital to absorb losses. If
their loans go sour---or if the banks own
creditors, including depositors, lose confi-
dence---institutions can rapidly go bust.
Then, because of the importance of the
banking system to the economy, govern-
ments feel obliged to ride to the rescue at
potentially vast cost.
To avoid this danger, the FSB wants private
investors to bear the cost of bank failure.
As well as their equity capital, it argues,
banks should issue a new type of debt with
terms that make it explicit that the lenders
will be among the first to take a hit if the
bank gets into trouble.
This has two advantages. First, severe
bank losses will be absorbed by these bondholders
and not by depositors. This reduces the risk of a
public panic and thus the need for a government
rescue. Second, the threat of a potential loss will
encourage bondholders to keep a close eye on bank
management and to intervene if they feel that exec-
utives are taking too much risk.
Asking banks to raise a great deal of new debt
immediately is not ideal. One of two things might
happen. The banks could flood the market with new
bonds, causing the cost of borrowing to rise, or they
could improve their capital ratios by lending less,
cutting off funds to business and hurting the economy.
Thus the reform has to be phased in.
All these changes sound eminently sensible. This
is finance, however, so the regulators proposals
inevitably come cloaked in impenetrable jargon dotted
with obscure acronyms. The relevant measure of
capital---equity plus at-risk debt---is called "total loss-
absorbing capacity" or TLAC.
The ratio will apply only to the most important
institutions, dubbed global systemically important
banks, aka G-SIBs. It is hard to see the public marching
behind Mark Carney, who heads both the FSB and
the Bank of England, shouting: "What do we want?
Higher TLAC for G-SIBs! When do we want it?
Phased in between 2019 and 2022, except for emerg-
ing-market banks, which will have till 2025 to 2028
Those familiar with the minutiae may complain
that the FSB has not been as demanding as it might
have been. It is asking banks to have TLAC of 16 per
cent of their risk-weighted assets by 2019, rising to
18 per cent by 2022. This is at the lower end of the
expected range. The FSB estimates that banks will
have to raise as much as US$1.2 trillion in new TLAC-
compatible debt. Not all of this will be additional
borrowing, however: Banks can simply issue TLAC
bonds to replace existing debt as the latter matures.
That helps explain why the estimated costs of the
reform are so low. Doubtless investors will demand
a higher yield on bonds that will be counted as TLAC.
This higher cost is likely to be passed on to bank
customers in the form of higher lending rates, which
may crimp economic growth. However, the FSB esti-
mates that the effect, in both cases, will be a small
fraction of a percentage point---far less than the cost
of another bank blow-up.
None of this will prevent a future banking crisis.
Instead the aim is to limit the damage that such a
crisis can create by making clear where the losses
will fall---something that was not obvious in 2008.
The biggest economic impact occurs when depositors,
having assumed that their money was safe, take
fright---that is when you see lines around the block.
Back in the 1930s America introduced deposit insur-
ance to reduce this problem. The new reforms give
depositors an even more secure status.
Bank losses have to be borne by somebody, though.
In that sense bank runs are rational: If you think a
bank will run out of cash or capital, it makes sense
to withdraw deposits, or to dump investments in the
bank, before the rest of the herd. That will be true
of TLAC bonds too.
Alas, you can t get rid of risk altogether. Because
TLAC bonds will take the hit during the crisis, they
will provide early warning of trouble. Corporate-
bond markets are pretty illiquid, however, and even
liquid government bonds have seen sudden lurches
in price. It is quite possible that TLAC bonds could
give false indications of a looming crisis---smoke
without fire, in other words.
Even sensible reforms have their flaws.
@2015 The Economist Newspaper Ltd. Distrib-
uted by the New York Times Syndicate
Bonds designed to fail
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