The Fed and FDIC must stop pretending that capital substitutes like TLAC will work in resolving large banks when they have fundamental flaws

WASHINGTON, DC Dennis M. Kelleher, President and CEO of Better Markets, issued the following statement regarding the submission of Better Markets’ comment letter to the Federal Reserve and Federal Deposit Insurance Corporation regarding their advance notice of proposed rulemaking regarding processing-related resource requirements for large banking organizations:

“Effective resolution planning, which includes ample capital available, is essential to avoid future bank failures, contagions and financial crashes. This is particularly true for so-called global systemically important banks (‘GSIBs’) and those very large banks that are only slightly smaller, so-called domestic systemically important banks (‘DSIBs’), which are the focus of a proposed rule by the Federal Reserve and Federal Deposit Insurance Corporation. Unfortunately, the proposal is fundamentally flawed and will not work as agencies once again rely on the misconception that convertible long-term debt (TLAC) limits contagion and allows for a smooth settlement process. That will not happen.

“As evidence continues to be shown, such debt is likely to increase the financial burden and risk profile of large banks and – as seen in several examples in Europe – just shifting losses from the banks to pensioners and other borrowers, which the government almost certainly will.” bail will get out anyway. Put another way, the government would still have to absorb the same losses as if the convertible long-term debt weren’t there at all. To pretend otherwise is to deceive the public into believing that there are valid layers of protection at the banks when this is the case nothing but a mirage.

“This again proves the obvious: there is no substitute for capital and capital requirements for large banks must be higher. Since one of the objectives of the long-term debt requirements is to capitalize the subsidiaries in liquidation, there must be capital requirements for significant subsidiaries in addition to the overall capital requirements. In this way, the banks’ losses would actually be absorbed by the banks, which would bear the cost of their profitable operations, rather than shifting the burden back onto the public. Regulators must end the privatization of profits and the socialization of losses, but this proposal does the opposite and increases moral hazard again.

“Beyond long-term debt and capital, there are several improvements that should also be made to the resolution process to more effectively limit contagion, losses to the deposit insurance fund and losses to taxpayers. The agencies are right in bringing all major banking organizations up to a standard that will actually protect the American public from the catastrophic consequences of their failure, but they must do so in a way that is effective. Pretending otherwise may fool some people until the next financial crisis, when there will be another crisis of confidence in banking supervision, which will have failed again.”

Read our full commentary here.

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Better Markets is a nonprofit, nonpartisan, and independent organization formed in the wake of the 2008 financial crisis to advance public interest in financial markets, support Wall Street financial reform, and make our financial system workable for all Americans to do again. Better Markets works with allies – including many in the financial community – to promote pro-market, pro-business, and pro-growth policies that help build a stronger, more secure financial system that protects and nurtures Americans’ jobs, savings, retirements and more. To learn more, visit www.bettermarkets.org