Basel Committee Consults on TLAC

It ain’t over till it’s over: the Basel Committee on Banking Supervision churns out new regulatory initiatives like there’s no tomorrow. Last week, the Committee issued a consultation on TLAC.

The good thing is that the BCBS does consult. And the Basel TLAC consultation deserves support: it proposes to deduct TLAC holdings from regulatory capital. This should curb double gearing and contagion in case banks become non-viable.

The not so good thing about TLAC is the sheer amount of capital involved. See the graph below from the TLAC Quantitative Impact Study (QIS) Report: tlac compositionIdeally, debt will convert into equity, so Case 4 looks kind of good: TLAC liabilities cover all equity – an insurance  policy that prevents the bank from going bust.

So far so good.

But, there is the risk that holders may start complaining about the haircuts they suffer for when things go off the rails. In that case, the insurance policy resembles your bog standard holiday insurance policy. Yes, the one promises pay-outs only (but never delivers).

This may have serious consequences for TLAC holders. Will pension funds and insurance companies sit still when they face a hair-cut? If they do, prepare for lengthy legal battles. If they don’t, they may become new owners, which introduces the same double gearing issues that the TLAC proposal tries to prevent.

In addition, with a solid insurance policy, moral hazard may become a problem. For example, can we prevent bank executives from holding TLAC instruments that convert into equity?

Unfortunately, BCBS steers clear from such deeper questions. Instead, it offers pragmatic solutions that stay within its remit. Please do not let this put you off from responding.

Open for consultation until Friday 12 February 2016.