It may look like the Fed is holding back of late in introducing changes that would affect the U.S. economy, but nothing could be further from the truth.
Along with its decision to possibly initiate an interest rate hike at its next policy meeting in December, the FOMC committee came down hard on major U.S. banks by releasing new guidelines for the amount of money big banks must keep on hand in order to avoid a possible bailout. This latest move would not only reduce the chances of future taxpayer bailouts, it would put the burden on the eight biggest U.S. banks which would now have to store up funds against future losses, thus moving the onus of debt from the banks to investors.
“Loss-absorbing Capacity”
At the meeting Friday, the Fed governors led by Chair Janet Yellen voted 5-0 to put into place what was referred to as “loss-absorbing capacity” requirements for the banks which, in essence, were part of a plan proposed by international regulators back in November 2014.
the Fed has undertaken to dismantle large banking concerns and financial firms that could collapse and place the broader system in jeopardy…
Since that time, the Fed has undertaken to dismantle large banking concerns and financial firms that could collapse and place the broader system in jeopardy and it has taken on the responsibility of enabling the process of reducing big banks’ loss-absorbing capacity which it sees as a key to banking stability. The new requirements would put long-term debt into a bank's holding company that could be converted to stock should an injection of capital be needed. If a bank fails under the regulators' scenario, the holding company will be seized but its subsidiaries would be allowed to continue to operate.
The 8 banks, which include JPMorgan Chase, Citigroup and Bank of America, would have to add $120 billion in total to their long-term debt.
Friday’s Fed move follows rules it had adopted last July which stipulated that the eight banks were required to fortify their financial bases with about $200 billion in additional capital, over and above the amount of capital required up until now. July’s rules were in addition to those introduced in 2014.
Investors’ Funds at Risk
With the new formula, it will be clear to investors that if a bank fails, the ball will be in their court and they will most probably not recover the full amount they put in. Higher interest rates paid by banks on the debt they issued beforehand would make up for the investors' risk.
In addition to the additional bank funding requirements, the Fed members at the Friday meeting introduced new levels of collateral needed by banks to cover possible losses resulting from trades in derivatives made outside clearinghouses which were blamed for bringing about the financial crisis in 2008. The $600 trillion global derivatives market was unregulated before the crisis and was seen as the main catalyst for the financial meltdown.
If formally adopted, most of the requirements announced at the Friday Fed meeting wouldn't take effect until 2019, and the remainder not until 2022.