In the near future, powerful global banks will be required to establish new policies in order to prevent another total financial meltdown similar to what happened in 2008. But until these rules are put into place, the major banks are still vulnerable. Despite their power, they are still not “too big to fail”.
The Group of 20 Nations (G20) established the Financial Stability Board (FSB) after the financial crisis in order to prevent a similar event from occurring in the future. As a result of new policies, banks will soon be required to have total loss-absorbing capacities (TLAC) that are at least equal to 16% of risk-weighted assets. This requirement will go into effect by 2019, and it will increase to 18% by 2022. Additionally, the FSB is requiring banks to maintain a leverage ratio requirement that will start at 6% and quickly increase to 6.75%.
Some estimates show that the shortfall that banks are facing under the 18% measure is up to $1.2 trillion. However, if one cuts out three massive Chinese banks, the estimate is “only” as high as $834 billion.
Vice chairman of the Group Executive Office at Credit Suisse Group AG Wilson Ervin said, “The TLAC announcement is hugely important. It’s a milestone of the first order in bank reform and ending too big to fail. There are a lot of important details to consider and hopefully improve, but the big picture is, if you have a bank rescue fund with $4 trillion to $5 trillion of resources, you can break the back of this problem.”
With the new policies, a major bank failure is much less likely to occur. This is because the creditors, or lenders, of banks know that they’ll experience major losses in the collapse of a bank.
In the past, lenders to a bank were basically relying on state governments to back them up in the event of a failure. As a result, these essentially unsecured creditors paid little attention to what practices the banks were actually doing. This is exactly how banks got entangled in the housing crisis mess of 2008. But now that creditors have more at stake, they will undoubtedly put greater pressure on banks to not allow for failure.
The new rules from the FSB require that banks keep liabilities associated with running a bank from purely financial debts. Regulators are working to ensure that a lender will be able to be recapitalized without having to resort to public money from a bail-out.
Still, adjusting to the new mandate will take the banks several years. Their entire capital structures and business models must be reorganized. Only once the banks are compliant with the TLAC requirements will regulators be able resolve a major global bank without significant government assistance. For now, major banks are still vulnerable.
However, the prospect of getting all major banks compliant with TLAC policies by the targeted date of 2019 is looking very unlikely. At the present time, two-thirds of these banks are not expected to meet this goal. Still, financial experts say that meeting this requirement as soon as possible is critical.
The United States Treasury undersecretary for international affairs Nathan Sheets said, “TLAC is crucial. It’s a very important step forward toward addressing concerns about too big to fail, giving large financial institutions additional buffers that can be drawn on in extremis to protect the taxpayer from having to bail out these institutions.”
So while it looks like these mandates will be able to eventually prevent another financial collapse, major world banks are still in danger until they comply. Let’s just hope that another financial crisis doesn’t occur anytime soon.