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GSIBs hike bail-in buffers but resolution of 'too big to fail' remains uncertain

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GSIBs hike bail-in buffers but resolution of 'too big to fail' remains uncertain

Global-systemically important banks have increased their total loss-absorbing capacity to the level required under new rules, but the higher bail-in buffers do not necessarily guarantee smooth resolution of too-big-to-fail banks, according to analysts.

The total-loss-absorbing-capacity, TLAC, standard is one of the main pillars of the global post-crisis regulatory reforms and is designed to ensure GSIBs do not use state aid in case they run into trouble, but instead have sufficient resources to shore up their own business in times of crisis.

The first phase of the global TLAC framework came into force at the beginning of 2019, and GSIBs are required to hold at least 16% of their risk-weighted assets and at least 6% of their leverage exposure in bail-in-able debt and equity instruments. From 2022, the percentages for minimum TLAC will increase to 18% of RWAs and 6.75% of leverage exposure. GSIBs based in emerging markets will have more time to meet TLAC minimum requirements, and will have to reach 16% of RWAs and 6% of leverage exposure by 2025 and the next level by 2028.

Overall, GSIBs have made good progress in building up their TLAC reserves in recent years and had reached a level that met or exceeded the currently required 16% of RWAs and 6% of leverage exposure, the Financial Stability Board, said in its latest review of the standard in July.

Although the TLAC reserves are in line with the regulatory requirements, there is still uncertainty about the way these reserves would be used in case of resolution, credit analysts said.

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Execution risks

All regions hosting GSIBs except China implemented the FSB's TLAC regime by the Jan. 1 deadline, Fitch Ratings said in a report reviewing the current state of resolution rules across major global jurisdictions.

Nevertheless, resolution regimes "remain largely untested across the G20, and execution of bail-in may yet raise legal and operational challenges," the credit analysts said. Emerging market economies such as Brazil, India, Indonesia, Saudi Arabia and Turkey "have rarely applied losses beyond equity to banks outside liquidation," Fitch Ratings said. In developed markets, there has never been a resolution case where the senior debt of a cross-border banking group has had to be bailed-in.

Furthermore, the sum-of-parts loss-absorbing capacity requirements for cross-border groups can in itself become a barrier to resolution. U.S. and EU authorities have worked out rules for calibrating loss-absorbing capacity buffers to be held at group and subsidiary-level. However, "excessive siloing can prevent cross-border fungibility and may limit cooperation between authorities, so constraining the ability of groups to transfer funds to meet shocks," Fitch said.

Global regulators have identified cross-border bank resolution as a key issue to be tackled in the future and have called for more cooperation between global and national authorities. In a cross-border resolution case, "local law may permit resolution authorities to more readily ring-fence assets to satisfy local creditors where debt is issued directly into local markets," Fitch said.

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Limited disclosure

Furthermore, the existing requirements do not provide for a detailed disclosure of bank resolution plans, according to Moody's. The Basel regime only requires the disclosure of volumes and distortion of TLAC liabilities across banking groups but there are no rules obliging banks to disclose minimum TLAC requirements for the whole group, for individual large subsidiaries within the group, or for internal TLAC, which is the buffer held by the group for the bail-in of its subsidiaries across jurisdictions.

The Basel disclosure rules also do not require "details as to the proposed resolution approach for individual groups, leading to uncertainty as to whether and how losses will emerge," Moody's said.

The resolution approach for GSIBs is expected to be a Single Point of Entry bail-in and recapitalization, Moody's said. The SPE approach means that resolution will be executed by the relevant authorities at the global banking group's home jurisdiction. The TLAC liabilities will be written down and the single parent company recapitalized.

This approach will not necessarily apply to all entities within the GSIB groups and given the complex structure of the credit institutions, individual resolution cases would likely be different from each other, Moody's said. Without detailed resolution plans at each of the GSIBs, creditors will remain largely in the dark about the allocation of losses if the group they have invested in collapses, according to credit analysts.

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Late adoption

While most GSIBs, especially in the U.S., have released some details about their resolution planning, the disclosures lag their implementation of TLAC requirements, Moody's said. The FSB has found the public disclosures of TLAC resources made by the various GSIBs widely differ from each other. The main inconsistencies are in the disclosures of the maturity and composition of external and internal TLAC buffers, Moody's said.

That can partly be attributed to the late adoption of the Basel Pillar III disclosure rules, the rating agency said. The Pillar III requirements, which call for public disclosure of risks, capital adequacy, and policies for managing risk at financial institutions, are expected to come into force for all relevant banks by the middle of 2020, a year and a half after the first implementation of TLAC requirements.

"Once disclosure rules come into effect, it is likely that not all home jurisdictions will require full Basel III disclosure on internal TLAC," Moody's said. "In our view, however, even full Basel III disclosure remains inadequate for a full understanding of how these large banks will be resolved, which is credit negative for investors."