Seven years after the collapse of Lehman Brothers jolted theglobal economy, the world's biggest banks may need to raise as muchas US$1.2 trillion to meet new rules laid down by financialregulators.

After years of work, the Financial Stability Board (FSB),created by the Group of 20 nations in the aftermath of the crisis,published its plan for making sure giant lenders can be wounddown and recapitalized in an orderly way, without taxpayerbailouts.

Under the rule for total loss-absorbing capacity, or TLAC,most systemically important banks must have liabilities andinstruments “readily available for bail in” equivalent to at least16 percent of risk-weighted assets in 2019, rising to 18 percent in2022, the FSB said on Monday. A leverage ratio requirement willalso be imposed, rising from 6 percent initially to 6.75 percent.The banks' shortfall under the 18 percent measure ranges from 457billion euros to 1.1 trillion euros ($1.2 trillion), depending onthe instruments considered, according to the FSB.

“TLAC is one of the last bricks in the wall of the post-crisisreform agenda,” said Richard Barfield, a financial-services riskand regulation director at PricewaterhouseCoopers LLP. Many bigbanks “will now resume the debt issuance that has been put on holdwhile waiting for today's details,” he said. The FSB's impactanalysis shows that most of them “should be able to meet therequirements.”

The push to make sure banks are no longer too big to fail isalso advancing on a second front, as Wall Street expands a revisionof financial contracts worth trillions of dollars. The changes areexpected to allow certain securities and funding contracts toremain intact for as long as 48 hours after a bank fails, saidthree people with knowledge of the matter.

The extra time is intended to give a faltering bank's homegovernment time to jump in and set up a healthy version of thedoomed institution, something that's difficult to do whencounterparties have terminated contracts and fled.

Bank of England Governor Mark Carney, who heads the FSB, said onMonday that the TLAC rules make a major failure less likely becausebanks' creditors know they'll face losses in a collapse.

Previously, the “lenders, the unsecured creditors, to a bankwere implicitly and ultimately explicitly relying on the state toback them up, and therefore didn't pay that much attention to whatthe institutions were actually doing,” Carney told reporters inBasel on Monday. “Now they actually have skin in the game, so tospeak, and they will exert greater pressure, consistent with theirfiduciary duties, and that in and of itself will make failure lesslikely.”

The FSB rules separate the liabilities needed to keep a bankrunning from purely financial debts such as notes issued forfunding. By “bailing in” the bonds—writing them down or convertingthem to equity—regulators aim to ensure that a lender in difficultyhas the resources to be recapitalized without using publicmoney, and to allow the resolved firm to continue to operate. In adeparture from previous practice, senior debt issued by banks isexplicitly exposed to loss.

The hundreds of billions of dollars governments globally pouredinto banks reeling from the 2008 financial crisis were used as muchto rescue lenders' senior bondholders, whose claims sat alongsideand were equal to those of depositors, as to bail out thebanks themselves. The situation confronted governments with thechoice of risking bankruptcy by rescuing the lenders or allowingthe disorderly collapse of the financial system.

Why TLAC Is Crucial

Carney said in an interview last week that it would take“several years” for banks to “reorganize their capital structureand also their business models” to comply with TLAC, and only thenwould regulators be in a position to resolve a major globalbank.

Analysis done by the Basel Committee on Banking Supervisionshowed that two-thirds of the banks on the FSB's list are short oftheir targets for 2019. Those in developed markets had 14.1 percentTLAC at the end of 2014 and need to boost that level by 498 billioneuros in the next three years. Including the emerging-market banks,the shortfall amounts to 767 billion euros.

To put the shortfalls into perspective, across 29 global bankstotal outstanding debt security issuance was 4.5 trillion euros atthe end of 2014, the FSB said. Average issuance is 156 billioneuros, of which 81 percent matures in the next five years. Theregulator said issuance to meet TLAC should largely involve“substitution of one bond for another with differentcharacteristics, and not net new issuance of the full shortfallamount.”

Banks from the U.S., European Union, Japan, and Switzerlandaccount for the lion's share of the FSB's list of systemicinstitutions. The Federal Reserve moved on Oct. 30 to apply theTLAC standard to eight of the biggest U.S. banks, estimating theirtotal shortfall of long-term debt at $120 billion.

“TLAC is crucial,” Nathan Sheets, U.S. Treasury undersecretaryfor international affairs, said before the announcement. “It's avery important step forward toward addressing concerns about 'toobig to fail,' giving large financial institutions additionalbuffers that can be drawn on in extremis to protect the taxpayerfrom having to bail out these institutions.”

Emerging-market banks in the FSB list have until 2025 to meetthe 16 percent loss-absorbing capacity target, rising to 18 percentin 2028. This schedule could be accelerated if, “in the next fiveyears, corporate debt markets in these economies reach 55 percentof the emerging market economy's” gross domestic product, accordingto the FSB.

Cross-Border Lenders

Authorities in some G-20 nations still lack the power needed tobe able to resolve a major lender without turning to taxpayers, theFSB said. Along with bail-in, these powers include the ability toprevent counterparties demanding early settling of trades, thepower to establish a bridge bank and to impose changes in companystructure and management.

The regulator gives the U.S., EU, Japan, and Switzerland alargely clean bill of health in its review of the G-20's progressin implementing measures needed to resolve large cross-borderlenders in an orderly manner. Yet China lacks the majority of thepowers it would need should one of them fail, according to theFSB.

The extent to which taxpayers can be shielded when major banksfail will depend on how bail-in works in practice.

“Let's hope that it takes longer than in the past beforegovernments have to get involved, because that's one way ofthinking about the bail-in process and how it's supposed to work,”said Stefan Ingves, chairman of the Basel committee. “We justdon't know how it will work.”

–With assistance from Silla Brush and Jesse Hamilton inWashington.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.