Regulators unveil plans to force regional banks to borrow in case of failure

Martin Gruenberg, Chairman of the Federal Deposit Insurance Corporation (FDIC), testifies about recent bank failures during a hearing of the US Senate Committee on Banking, House and City Affairs May 18, 2023 on Capitol Hill in Washington, DC.

Saul Loeb | AFP | Getty Images

US banking regulators on Tuesday unveiled plans to force regional banks to issue debt to protect depositors in the event of further bankruptcies.

All American banks with at least $100 billion in assets would be subject to the new requirement, requiring them to hold a layer of long-term debt to absorb losses in the event of a government seizure, a joint Treasury Department statement said of the Currency Competent Authority, the Federal Reserve and the Federal Deposit Insurance Corporation.

FDIC Chairman Marty Gruenberg conveyed his intentions in a telegram last month speech at the Brookings Institution.

Broadly speaking, the proposal includes measures that apply to the largest institutions – known in the industry as global systemically important banks (GSIBs) – up to banks with at least $100 billion in assets. The moves were widely anticipated after the sudden collapse of Silicon Valley Bank in March shook customers, regulators and executives, alerting them to emerging risks in the banking system.

These include steps to increase long-term debt held by banks, removing a loophole that allowed middle-market banks to avoid recognizing declines in bond holdings, and requiring banks to provide more robust living wills, or resolution plans, that would take effect in the event of failure .

Regulators would also consider updating their own guidance on monitoring risks, including high concentrations of uninsured deposits, and changing deposit insurance prices to discourage risky behavior, Gruenberg said in his Aug. 14 speech. The three banks seized by authorities this year all had large amounts of uninsured deposits, which were a major factor in their failures.

Analysts have focused on debt requirements as it represents the most influential change for bank shareholders. The point of increasing leverage, according to Gruenberg, is that if regulators need to seize a midsize bank, there will be a layer of capital willing to absorb losses before uninsured depositors are threatened.

The move by regulators will force some lenders to either issue more corporate bonds or replace existing sources of funding with more expensive forms of long-term debt, Morgan Stanley analysts led by Manan Gosalia wrote in an Aug. 28 research note.

As a result, the margins for medium-sized banks, which are already under pressure due to rising financing costs, will fall even further. According to Gosalia, the group could see an annual profit decline of up to 3.5%.

According to the analysts, there are five banks in particular that may need to raise around $12 billion in new debt in total: regions, M&T bank, citizen finance, northern trust, And Fifth Third Bancorp.

Holding long-term debt should reassure depositors during tough times and would reduce the cost of the FDIC's deposit insurance fund, Gruenberg said in his speech. It would also increase the chances that a bank's weekend auction could be conducted in a way that minimizes costs to the FDIC and gives it more options in this scenario, such as B. the change of ownership or the dissolution of banks in order to sell them in parts.

“While many regional banks have some outstanding long-term debt, the new proposal will likely require new debt issuance,” Grünberg said. “Because this debt is long-term, it will not trigger liquidity pressures if problems materialize. Unlike uninsured depositors, investors in this debt know they will not be able to call in the event of problems.”

Investors in long-term bank debt will have “greater incentive” to monitor risk at lenders and can pressure them to manage risk, and publicly traded debt will “serve as a signal of how the market views these banks' risk ‘ he said.

This story evolves. Please check again for updates.

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