Regulators trying to end the problem of "too big to fail" banks are moving closer to a landmark deal that will give large banks more flexibility about how to deal with losses when they go bust and cut the amount of fresh bonds they will need to issue.
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Global regulators, led by Bank of England governor Mark Carney, want to agree a set of rules that would force bondholders to cover the losses that arise when a major bank fails, to avoid a repeat of the last financial crisis when taxpayers were forced to foot the bill.
Different banking models and legal systems have complicated the talks and in order to try and secure a deal by the next meeting of the Group of 20 leading economies in Brisbane in November, regulators have agreed a more flexible approach, according to two sources familiar with the draft proposals.
Under the new plan, major banks including HSBC, Industrial and Commercial Bank of China, Mitsubishi UFJ and Citigroup, will be able to count their surplus capital, including shares, earnings and some types of bonds, towards new buffers which are meant to be tapped when a bank gets into trouble.
The measure will apply to the 29 banks on the Financial Stability Board's "too big to fail" list. These banks already have to hold more capital than smaller banks by 2019.
Initially, banks expected they would have to issue new "bail in" bonds for the whole of the buffers regardless of whether they had surplus capital.
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The new proposal means fewer bonds will now have to be issued by those banks among the 29 whose capital buffers are already well above the minimum requirement.
The new proposals will be seen as a rebuff to U.S. supervisors who wanted the buffer to include only subordinated debt and not to be mixed up with other bank safety cushions.
Instead, the proposals will also take into account different banking models such as the Japanese system, which is heavily deposit-funded.
"We have significant amounts of deposits and our lending portfolio is much smaller than the size of our deposits," said Masaaki Tanaka, the deputy president of Mitsubishi UFG. "We don’t need to issue more debt."
After the November summit there will be a public consultation based on a range for the buffer rather than a single figure. The proposed range is expected to cover either side of 10 percent or equivalent to the core capital buffer the banks typically have already.
Studies by regulators next year would whittle the range down to a single minimum figure, though some of the 29 banks could have to hold more, the sources said.
There was also progress on how the new buffer will be calculated, with banks being called on to use two methods and comply with the higher figure, the sources said.
The first method, as preferred in Europe, calculates the requirement as a percentage of risk-weighted assets.
The second approach, which U.S. supervisors champion, uses a percentage of a bank's total assets.
Core to securing a deal will be safeguards to restore trust between a bank's home and host or overseas supervisors.
Trust between them was lost during the financial crisis when host regulators put pressure on foreign banks to hold capital locally to shield taxpayers.
To avoid disputes there would be advance agreements between home and host supervisors on where the buffer is located and on when the trigger to convert it into equity is pulled, the sources said.
The plans of each lender would be reviewed by supervisors from outside the lender's home country to build confidence.
The date for full compliance with the new buffer, formally known as gone concern loss absorption capacity or GLAC, was unclear though 2019, the date when other capital requirements come fully into effect, is seen as probably unrealistic, the sources said.