Market Wrap-up for Nov. 11 - New Rules for "Too Big to Fail"

Market Wrap-up for Nov. 11 – New Rules for “Too Big to Fail”

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Equity markets have continued higher in recent days, with the Dow and S&P 500 logging in four consecutive record high closes. This season’s strong third-quarter corporate earnings and upbeat U.S. economic data have pushed the two indexes higher, following a rather volatile month of October.

On the global front, however, one industry is bracing itself for some tougher times ahead. On Monday, global financial regulators announced that there has been significant progress made in ending “too big to fail” - a label that has been a point of contention since the financial crisis of 2008.

Big Banks Brace for Stricter Capital Rules

The proposal from the Financial Stability Board (a group of global regulators) will force 30 of the largest global banks to significantly increase capital in an effort to better position the industry for market downturns. The hope is that when such a large institution fails, the costs and failure will be borne by its investors, rather than taxpayers.

The proposal will require these banks to beef up their loss-absorbing capacity by issuing equity or long-term debt worth 16% to 20% of their risk-weighted assets, which could mean tens of billions of dollars in additional capital for some banks. The proposed total loss-absorbing capital (TLAC) requirements would be at least twice the Basel leverage requirement.

Analysts have estimated that U.S. mega banks will have to add the following in new capital:

  • Wells Fargo (WFC) may need to raise as much as $33 billion.
  • J.P. Morgan Chase (JPM) may need to add $33.4 billion.
  • Citigroup (C) may need to raise $28 billion.
  • Bank of America (BAC) may need to add $3 billion.

Non-U.S. banks, including BNP Paribas, Deutsche Bank (DB), and Barclays (BCS), are estimated to be required to raise more than $33.63 billion in loss-absorbing capital.

According to regulators, this new proposal is poised to be a watershed in ending “too big to fail.”

Looking at the Long-Term

In the short-run, global financial institutions will likely incur higher borrowing costs due to the higher loss-absorbing capital regulations. While this may seem to be a bad thing, borrowing and lending are the bread-and-butter of banking, so the long-term benefits far outweigh the near-term negative effects.

The financial system is essentially the backbone of the economy – it’s where money flows in and out, where businesses go to expand operations, where you and I turn to when tapping our own equity, and so on. If another 2008-like crisis occurs, where banks took a significant hit, these new requirements will hopefully better position these key institutions for market downturns, and will avoid the possibility of taxpayers bearing the burden of any failures via more bailouts.

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