Fed tells mega-banks to build new cushions against losses to cut risk of taxpayer bailouts

“These banks must bear the costs their failure would impose on the financial system and the economy,” Federal Reserve chief Janet Yellen said.

“These banks must bear the costs their failure would impose on the financial system and the economy,” Federal Reserve chief Janet Yellen said.

(Cliff Owen / Associated Press)

The eight biggest U.S. banks will be required to build new cushions against losses that would shift the burden to investors. The action by the Federal Reserve was the latest bid by regulators to reduce the chances of future taxpayer bailouts.

The Fed governors led by Chair Janet Yellen voted 5-0 Thursday to lay down the new requirements. The mega-banks must bulk up their capacity to absorb financial shocks by issuing equity or long-term debt equal to certain portions of total bank assets. The idea is that the cost of a huge bank’s failure would fall on investors in the bank, not on taxpayers.

The Fed action comes as Washington braces for changes to the 2010 law that reined in Wall Street after the financial crisis and the Great Recession. President-elect Donald Trump urged during his campaign that the Dodd-Frank law be dismantled, and his transition team has set that as a goal. Republicans, who overwhelmingly opposed Dodd-Frank, will control the White House and Congress in January and see an opening to go after key parts of the law, such as the Consumer Financial Protection Bureau.


“Today we are putting into place one of the last critical safeguards that make up the core of our reform efforts” after the financial crisis, Yellen said at the start of the meeting. “These banks must bear the costs their failure would impose on the financial system and the economy.”

The Fed governors imposed the “loss-absorbing capacity” requirements on the eight banks: JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street Bank.

They would have to issue a total of about $70 billion in new equity and long-term debt to meet the requirements, the Fed staff estimates. Four of the eight banks are estimated to have shortfalls. Those four were not named.

Still, most of the requirements won’t take effect until 2019, and the remainder not until 2022.

“We’re going to start looking at rolling back [rules] before we’ve started implementing,” said Oliver Ireland, an attorney specializing in banking law at Morrison & Foerster who was an associate general counsel at the Fed.

With the new loss-absorbing requirements, Ireland said, investors will know that if a bank fails, they’ll be on the hook and probably won’t recover the full amount they put in. Higher interest rates paid by banks on the debt they issued beforehand would compensate for the investors’ risk.

The new cushions come atop rules previously adopted by the Fed for the eight banks to shore up their financial bases with about $200 billion in additional capital — over and above capital requirements for the industry. And they’re in addition to 2014 rules directing all large U.S. banks to keep enough high-quality assets on hand to survive during a severe downturn.

Stricter capital requirements for banks were mandated by Congress after the financial crisis, which struck in 2008 and set off the worst economic downturn since the Great Depression. Hundreds of U.S. banks received taxpayer bailouts totaling hundreds of billions of dollars during the crisis, including the eight Wall Street mega-banks that became known as “too big to fail” in Washington.

In its action, the Fed put in place its piece of a plan proposed by international regulators in November 2014 for loss-absorbing capacity for the world’s 30 largest banks. Including the eight U.S. banks, they are considered so big and interconnected that if any one collapsed, it could threaten the global financial system.

U.S. regulators won the power under the Dodd-Frank law to seize and dismantle big banks and financial firms that could topple and jeopardize the broader system. The Fed sees a mandate for loss-absorbing capacity as a key to enabling that process. It would put long-term debt into a bank’s holding company that could be converted to stock as an injection of capital — instead of taxpayer funds. If a bank failed under the regulators’ scenario, the holding company would be seized but subsidiaries would be allowed to keep operating.