The world's largest banks will have to build up theirloss-absorbing liability buffers to see them through a crisis, asregulators tackle too-big-to-fail lenders six years after thecollapse of Lehman Brothers Holdings Inc.

The Financial Stability Board (FSB), led by Bank of EnglandGovernor Mark Carney, said today that the biggest banks may berequired to have total loss-absorbing capacity equivalent to asmuch as a quarter of their assets weighted for risk, with nationalregulators able to impose still tougher standards. The FSB isseeking comment on the rule, known as TLAC, which would apply atthe earliest in 2019.

The plans are a “watershed” in regulators' mission to end thethreat posed by banks whose size and systemic importance mean theirfailure would be catastrophic for the global economy, Carney toldreporters today in Basel, Switzerland. “The outlines of how we aregoing to end too-big-to-fail are here.”

The rules are the latest step by the FSB in a five-year quest toboost banks' resilience in the face of financial shocks. Agreementhas already been reached on measures including tougher capitalrequirements and enhanced scrutiny by supervisors.

The TLAC rules would apply to the FSB's register of globalsystemically important banks. The latest list, published last week,contains 30 banks, with HSBC Holdings Plc and JPMorgan Chase &Co. identified as the most significant.

The draft requirements announced by the FSB would measure banks'ability to absorb losses in a crisis, shielding taxpayers frombailouts.

European banks set to have to issue the most new debt to meetthe rule may include BNP Paribas SA, Banco Santander SA, SocieteGenerale SA, Deutsche Bank AG, Banco Bilbao Vizcaya Argentaria SA,and UniCredit SpA, according to analysts at Citigroup Inc.

Spokespeople for Societe Generale, Deutsche Bank, and UniCreditdeclined to comment on the FSB release. A call seeking comment atBNP Paribas wasn't immediately returned. Today is a public holidayin Spain.

Satisfying the TLAC requirements could cost European banks asmuch as 3 percent of their estimated 2016 profits, London-basedCiti analysts Andrew Coombs, Kinner Lakhani, and Ronit Ghose saidin a research note. “Least impacted” are Swiss and U.K. banks,which would benefit from existing holding company structures fromwhich they can issue senior debt, they said.

Funding Costs

Once the rules are in force, banks that breach, or are deemed as“likely” to breach, their TLAC requirements would face restrictionsfrom regulators, including curbs on their ability to pay bonusesand dividends.

Banks hit by the rule “may pass on a share of their higherfunding costs to their clients, prompting a shift of bankingactivities to other banks without necessarily reducing the amountof activity,” the FSB said. Also, banks' “dividends and otherdistributions, such as employee remuneration, might fall.”

Other side effects could include a decline in funding costs forgovernments, the FSB said.

Instruments that banks will be allowed to count as TLAC includeequity resulting from their issuance of ordinary shares, retainedearnings, and other securities that can count toward regulatorycapital. The definition of TLAC also includes some otherliabilities, such as some unsecured debt, where losses could be beimposed on creditors without practical or legal impediments.

While the basic requirement will be set at 16 percent to 20percent of risk-weighted assets, the final number will be higherbecause the banks must separately meet other capital buffersalready set by global regulators, the FSB said.

The FSB will seek views on the plans and carry out detailedimpact studies next year, before completing the rule in time forthe 2015 G-20 summit. This further work will allow the FSB toidentify a “single specific minimum” requirement.

Eligible Debt

Carney, who last week was reappointed for a second three-yearterm as FSB chairman, said that there was scope within the rulesfor some senior unsecured debt to count toward a bank's TLAC.

For debt to count toward TLAC, it would have to have a remainingmaturity of more than a year, Carney said. “The second thing is ithas to be subordinate to other creditors, to creditors who if theywere bailed in would contribute to a disorderly resolution,” suchas derivatives counterparties, he said.

Senior debt could, for example, count toward a bank operatingcompany's TLAC if it was issued by the holding company, and the“debt of the holding company is effectively subordinated to thedebt at the operating company,” Carney said.

Another way way senior debt could be eligible for TLAC is if it“could be subordinated in statutory terms so it could be made clearvia statute that senior unsecured creditors could be bailed inbefore other senior creditors—the most obvious ones aredepositors,” he said.

Some senior debt “currently in issuance” from globally systemicbanks “would need to be restructured in order to be eligible asTLAC”—for example, to “subordinate it to excluded liabilities,” theFSB said.

In addition to the rule measured against risk-weighted assets,banks will also need to have TLAC equivalent to 6 percent of theirtotal assets. This number could still rise as it linked to aparallel set of international talks on bank capital rules.

Banks “headquartered in emerging markets will not, initially, besubject” to the standards, the FSB said. The group addedAgricultural Bank of China Ltd to its latest list of systemicallyimportant lenders, taking the number of Chinese banks to three.

At least one-third of each bank's buffer should be made up ofdebt, the FSB said, to ensure that a failed lender has “sufficientoutstanding long-term debt for absorbing losses and/or effecting arecapitalization in resolution.”

Banks would also face curbs on their ability to count debt theysell to each other toward the TLAC requirement to “reduce the riskof contagion” if one firm collapses.

These curbs would work by targeting banks whose purchases ofshares and TLAC-eligible debt from another globally systemic lenderexceed certain levels. In such instances, the purchasing bank wouldbe forced to write down the size of its own buffer of TLAC-eligiblesecurities.

The FSB consists of regulators and central bankers from aroundthe world. Carney, appointed to a second three-year term aschairman last week, had committed the group to delivering the TLACplan by the Nov. 15-16 G-20 summit in Brisbane, Australia.

Banks will have until Feb. 2, 2015 to submit their views on theTLAC plan.

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