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Fed finalizes rule on banks' loss-absorbing capacity

The Federal Reserve finalized its rule regarding long-term debt holdings and total loss-absorbing capacity, or TLAC, at the largest banks.

The rule, originally proposed in October 2015, will require global systemically important banks, or G-SIBs, to meet minimum thresholds for debt and loss-absorbing capital to enhance banks' resiliency and resolvability in the event of failure. The Fed made a number of revisions to the proposal that, based on an impact analysis, would reduce the total shortfall for long-term debt and TLAC requirements from $120 billion to about $70 billion.

On long-term debt, the draft final rule retained its requirement that banks hold long-term debt in an amount equal to or greater than 6% of risk-weighted assets plus the firm's surcharge under the G-SIB surcharge rule. Long-term debt holdings would also need to make up at least 4.5% of total leverage exposure. But the Federal Reserve said it had received comments expressing concern over the proposal's definition of unsecured "plain vanilla" long-term debt, which would exclude, for example, structured notes or derivative-linked debt. Fed staff, citing public comments, said they have now made an exception to allow long-term debt with non-vanilla impermissible acceleration clauses to be grandfathered into long-term debt count as long as it is issued before Dec. 31, 2016. The Fed acknowledged that "nearly all" outstanding long-term debt contains such acceleration clauses.

For the TLAC component of the rule, the Fed reduced its requirement on how much TLAC must be held relative to total leverage exposure. The proposal originally had the leverage-based requirement at 9.5%, but the final rule reduced the percentage to 7.5%. The final rule compensates for the reduction with a 2% buffer added to the minimum leverage component, which acts like the capital buffer brought forward by Governor Daniel Tarullo in September.

The final rule maintains the proposal's requirement that TLAC also make up 18% of risk-weighted assets, although the Fed modified its implementation timeline for the new rules. Originally, the rule had a transition provision requiring covered companies to meet a 16% ratio by 2019 and reach the 18% mark by 2022. But the final rule scraps the 2019 checkpoint and requires all covered companies to comply with the rules by Jan. 1, 2019. The Fed says because the final draft rule now grandfathers most outstanding external LTD, the companies should face less burden meeting the Fed's requirements.

In the meeting, Chair Janet Yellen asked Fed staff working on the rule to compare the TLAC requirements to those in other countries. Staff said that while the Financial Stability Board's proposal is "aligned" with the U.S. requirements, the U.S. is unique in its focus on long-term debt instead of broadly asking companies to watch the debt and equity composure of their loss-absorbing capacity.

The Federal Reserve Board approved the final rule in a vote Dec. 15.