A 27 per cent risk ratio beckons for banks: FSB
On Monday last week, the Financial Stability Board released to the G20 its final standard on Total Loss-Absorbing Capacity for the 30 global systemically important banks, the G-SIBs. The requirements of the standard had been well flagged.By 1 January 2018, G-SIBs will be required to have TLAC of at least the greater of 16 per cent of risk weighted assets or six per cent of the Basel III leverage ratio assets. By 1 January 2022, this steps up to the greater of 18 per cent of risk weighted assets and 6.75 per cent of Basel III leverage ratio assets.The FSB said "the TLAC standard has been designed so that failing G-SIBs will have sufficient loss-absorbing and recapitalisation capacity available in resolution for authorities to implement an orderly resolution that minimises impacts on financial stability, maintains the continuity of critical functions, and avoids exposing public funds to loss."The purpose of TLAC is to aim for the improbable: notionally to ensure that public funds are never again required, as they were during the GFC, to support banks too big to fail (TBTF).If it works, TLAC will not allow these banks to fail. Shareholders and various levels of subordinated creditors may be wiped-out or become shareholders in the new bank but the systemically important operations of the bank will continue on unaffected. There remains however, the critical question of whether it will work. Nobody knows; it has yet to be tested.As part of the work to develop the TLAC standard, the FSB undertook a historical analysis of losses and public recapitalisation costs for 13 systemically important institutions that failed or received official support during the GFC or the Japanese banking crisis of the 1990s. The findings of this analysis are sobering and leave doubt as to whether the TLAC standard is sufficient to ensure that a failing G-SIB could be resolved without the use of public funds. Losses and recapitalisation costs for the banks ranged from five per cent to 15 per cent of risk weighted assets for nine of the banks and up to 25 per cent in the case of Fortis. Dexia and Merrill Lynch came in at around 18 per cent and 17 per cent, respectively.Moreover, FSB presents the results of other historical studies. The UK's Independent Commission on Banking in 2011 published a study that considered a broad set of banks, focusing mostly on the GFC period. It found that cumulative peak losses were up to 16 per cent of risk weighted assets, with Anglo Irish Bank an outlier at 39 per cent. With TLAC set at 16 per cent initially and rising to 18 per cent it may be sufficient to cover losses and recapitalisations cost but then again, it might not. In fact, a quick look at the numbers from the FSB study shows that, to be 95 per cent confident that TLAC will be sufficient to resolve a failing G-SIB, TLAC needs to be set at 22 per cent of risk weighted assets.To be 99 per