In challenging markets, this column exposes itself to dangerous levels of cant, piffle, and rot emanating from the corporate world. Contagion is always a risk. So perhaps a quarter of the writing might be set aside to absorb doublespeak. This buffer would protect readers of the remainder from the risk of cognitive loss.
Not convinced? Hopefully the idea works better with the world’s major banks. The Financial Stability Board – a concatenation of national regulators – thinks that loss-absorbing liabilities (whether equity or debt) should be the equivalent of a quarter of banks’ risk-weighted assets. These liabilities would be consumed when banks went under and needed funding to be resolved. This Total Loss-Absorbing Capacity (TLAC) would, in theory, stop taxpayer money being eaten up instead.
If this pert little abbreviation removes the implicit subsidy from the price of banks’ equity and debt, good. The problem is that capital structures and creditor hierarchies are more complicated than newspaper columns.
On Monday, the FSB said a third or more of a bank’s TLAC ought to comprise debt. This would, notably, include senior bonds, which are still sometimes treated as protected. That makes sense. Senior bonds are where observers usually look first for the signs of an implicit guarantee, so that is the place to reset expectations. Banks might in theory also prefer to fill their TLACs with senior debt paying lower rates to investors for a more senior claim than to issue more Tier 2 subordinated bonds with steeper interest costs. As Société Générale has noted, European banks sell only €40bn of Tier 2 paper each year. If volumes went up by multiples, prices of existing Tier 2 bonds would wobble.
But banks will have to issue the right kind of senior debt. Within operating subsidiaries, senior debt usually ranks alongside the sorts of liability the FSB wants to protect in resolution, such as deposits, and equal status is legally tricky to separate once joined. The TLAC terms instead encourage senior bonds issued by banks’ holding companies, which do not have deposits.
Holdco senior debt is, however, more common at US, UK or Swiss banks than at their decentralised peers in Europe, such as Santander. The European market for it may be shallow. Happily, TLAC rules will not apply for another half-decade. Banks’ structures may look very different by then anyway.
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