Federal Reserve Adopts Bailout-Prevention Rule Without Major Changes -- 3rd Update

WASHINGTON -- The Federal Reserve on Thursday adopted a bailout-prevention rule that will force big banks to issue substantial amounts of new long-term debt -- one of the finishing touches to its new regulatory regime for big firms.

The Fed board voted 5-0 for the rule, without making major changes to a draft proposed last year. The total-loss absorbing capacity rule, known as TLAC, will force the eight U.S. banks considered globally "systemically important," as well as large foreign-owned U.S. banks, to fund themselves with a minimum amount of debt. The debt could be converted to equity in a crisis -- a "bail-in" in which the debtholders become shareholders, instead of a "bailout" where taxpayer money is used to inject equity into the bank.

The Fed estimated four of the eight large U.S.-based banks subject to the rule would have to issue new debt or equity to comply with it, totaling about $70 billion. Banks can also cut the size of their balance sheets to comply with the rule. The estimate was down from one of $120 billion about a year ago because banks have already started preparing for the rule to take effect, Fed officials told reporters.

In all, the U.S. banks' funding costs would increase by a total of between $680 million and $2 billion annually, the Fed said. That is up from the upper estimate of $1.5 billion in the October 2015 proposal.

The new rule represents "one of the last critical safeguards that make up the core of our post-financial crisis reform efforts," Fed Chairwoman Janet Yellen said in a statement.

The rule is emblematic of the bailout-prevention efforts of Ms. Yellen and other regulators appointed by President Barack Obama. Instead of breaking up big banks, they have essentially set up a system that acts as a sort of tax on their size. The banks judged to pose the most risk face the strictest rules, in the form of restrictions on their funding and a host of new "stress tests" and other compliance exercises.

The enforcement of those rules will, starting next year, be handed over to regulators appointed by President-elect Donald Trump, whose team has talked tough about Wall Street but also criticized the existing set of rules as overly complex and distorting financial markets. It isn't clear how Mr. Trump's team will handle rules like TLAC.

Fed governor Daniel Tarullo, one of the central architects of the new regime, said the new rule would help impose "market discipline" on big banks. "Investors holding this debt will be motivated to monitor the bank more closely precisely because they would be converted into equity holders if the firm failed," he said in a statement.

"The TLAC requirement is the culmination of a legal and balance sheet revolution that has effectively ended 'too big to fail,' " said Greg Baer, president of the Clearing House Association, a trade group of large U.S. banks.

The rule adopted by the Fed included some changes from its 2015 proposal. The most important shift would allow certain debt securities issued prior to Dec. 31, 2016, to count toward banks' compliance with the rule, easing the burden on banks whose existing debt doesn't meet the requirements.

U.S. banks owned by foreign firms that are considered globally "systemically important" also would benefit from changes that appear to reduce their debt requirement and give them more flexibility in issuing debt.

Sally Miller, chief executive of the Institute of International Bankers, issued a statement saying the trade group appreciated the changes, but "we continue to question the need for" the rule.

She suggested the rule is unfair because foreign banks' U.S. footprints are, on average, smaller than those of a number of large U.S. banks that aren't subject to the rule.

The rule would still raise some banks' funding costs substantially, because long-term debt can be more expensive than other types of funding, such as deposits. Wells Fargo & Co. in particular has been a vocal critic of the rule. The bank relies more on deposit funding than its megabank peers.

The Fed also tightened the deadline for fully complying with the rule, moving it to Jan. 1, 2019, from January 2022, saying that banks' debt shortfalls have "declined substantially" and the changes to the rule should make the debt requirements easier to meet.

Write to Ryan Tracy at ryan.tracy@wsj.com