New law causes $120 billion shortfall by U.S. banks

A BNY Mellon sign is seen on their headquarters in New York's financial district, January 19, 2011. REUTERS/Brendan McDermid

On Friday the Federal Reserve proposed a new rule for the biggest U.S. banks . The new rule will require six big U.S. banks to raise an additional $120 billion which could be used as long-term debt.

The new rule is to insure that the banks will be able to survive another crisis without using a government bailout or burdening taxpayers. The goal is for the banks to hold enough debt that can be converted into equity without disrupting the markets. The new requirement will affect banks such as Wells Fargo & Co., JPMorgan Chase & Co., and Goldman Sachs Group Inc.

Issuing debt is more cost-effective than issuing equity and this is how the banks are expected to raise the $120 billion shortfall. The proposed rule concerns banks’ total loss-absorbing capacity.

A draft was approved by the Federal Reserve governors through a vote. This means the proposal will be submitted to the public for comment.

The new proposal is one of many rules that are aiming to reduce the risk of the banking systems. The new rule would put the fall more on the investors instead of the taxpayers. Janet Yellen, Fed Chair, made a statement on how the proposal “would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms.”

This proposal is to help guide the banks if they were to collapse into another recession. “By making the failure of even the largest banks more manageable, the proposed regulation will be another important step in solving the too-big-to-fail problem,” said Fed Governor Daniel Tarullo in a statement on Friday. One way of doing this is to refinance already existing debt.

The requirements are more stringent for some banks. The orders in which they fall are JP Morgan followed by Citigroup. Then there is Bank of America, Goldman Sachs and Morgan Stanley, which have the same requirements in common. The next highest requirement is Well Fargo & Co., followed by State Street and then finally Bank of New York Mellon. JP Morgan has more than $2 trillion in total assets, making it the largest U.S. bank by that measure.

Since the new rule overlaps with some of the other regulations already in place, there are no concerns at the moment that the banks will have trouble meeting this requirement. Some rules are required to be met by January 2019 and the more stringent ones are to be met by January 2022.

There are two banks that have already met the long-term debt requirement, but officials have declined to say which two banks have met these needs.

The new proposed rules also apply to U.S. operations of foreign globally systemically important banks, establishing roughly parallel requirements as those for U.S. banks, Federal Reserve officials said.

Also on Friday, there was an announcement made about a draft final rule that would establish minimum margin requirements for swaps that are not cleared through an exchange. This rule is said to be exactly the same as another rule proposed by other regulators.

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