TLAC – Yet Another Pricey Requirement

Federal Reserve Gov. Daniel K. Tarullo indicated last week that the Federal Reserve intends to introduce a proposed capital requirement that would be more stringent than requirements contemplated by the Basel III agreement. Tarullo indicated that the proposed requirement, Total Loss Absorbing Capital (TLAC), will “probably be a little bit more rigorous with respect to some of the qualifying instruments.”

The goal is to diminish the probability of future taxpayer bailouts. TLAC would require that banks maintain minimum amounts of long-term debt that could absorb losses and/or be converted into equity, if required, to keep the bank subsidiary solvent during the period that regulators are winding down the holding company. This appears to be an extension of the Federal Reserve viewpoint that Basel III is a floor and not a ceiling on capital requirements for internationally active financial institutions. Although Tarullo said that “in general what we will be doing is paralleling each of these major international frameworks with our own domestic implementation,” he further suggested that the Fed’s proposal to go above the Basel III guidelines “serves as a bit of an opportunity for other countries to think about what they will do.” Additionally he indicated that U.S. regulators intend to impose tougher rules on capital surcharges for the big banks that have been designated as systemically important financial institutions.

I find this worrisome on a couple of levels, even though I appreciate Gov. Tarullo’s goal of diminishing or eliminating the probability of future taxpayer bailouts. First, why do we want to issue rules on our largest banks that make them less competitive in the world marketplace? The Federal Reserve certainly had a seat at the table when the Basel III rules were agreed to. Those rules were intended to level the global playing field, so that all banks in the world would be equal relative to capital requirements. Why, then, is the Federal Reserve now proposing that the United States be more restrictive?

Second, while this requirement is pointed at the largest banks, history shows that what is imposed on the largest banks eventually filters down to all U.S. banks. A recent example was the stress testing, implemented less than five years ago, that was to apply only to the 19 largest U.S. banks. Now elements of stress testing are being imposed on even the smallest of community banks, to the extent that the Indiana Bankers Association has hosted educational seminars on stress testing. How long, then, before the TLAC capital requirements, intended exclusively for systemically important financial institutions, will be imposed on all banks?

As I have often voiced, it seems that there is an effort coming from Washington, D.C., to destroy the bifurcated financial services system that is unique to the United States. Our system of international banks, national banks, regional banks and local community banks is the envy of the world. It has made us the most powerful economic engine ever on earth. Should we not be preserving and promoting this successful system?

While Tarullo’s goal may be worthy, the proposal comes at the price of making our biggest banks noncompetitive on a worldwide basis and of potentially adding yet another log to the fire that is burning up so many community banks. That price, I fear, is far too high to pay.

– S. Joe DeHaven

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