U.S. Regulators to Bank Boards: “Debt is Good”

Just before Labor Day, the federal banking regulators – The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Fed), and the Federal Deposit Insurance Corporation (FDIC) – labored to issue a proposed rule for comment that would require require certain financial institutions to issue and maintain outstanding a minimum amount of long-term debt (LTD). Impacted organizations include certain large depository institution holding companies, U.S. intermediate holding companies of foreign banking organizations, and certain insured depository institutions.

The regulators feel that this proposed LTD rule would:

1. Improve the resolvability of these banking organizations in case of failure,
2. Potentially reduce costs to the Deposit Insurance Fund, and
3. Mitigate financial stability and contagion risks by reducing the risk of loss to uninsured depositors.

What Level of Debt Is Being Proposed?

Under the proposal, a covered entity would be required to maintain outstanding eligible LTD in an amount that is the greatest of:

• 6.0 percent of the covered entity’s total risk-weighted assets,
• 3.5 percent of its average total consolidated assets, and
• 2.5 percent of its total leverage exposure if the covered entity is subject to the supplementary leverage ratio rule.

A covered entity would be prohibited from redeeming or repurchasing eligible LTD prior to its stated maturity date without obtaining prior approval from the Board where the redemption or repurchase would cause the covered entity’s eligible LTD to fall below its LTD requirement.

The proposed eligible LTD requirement was calibrated primarily on the basis of what the proposed regulation refers to as a “capital refill” framework. Under that framework, the LTD requirement’s objective is to ensure that each covered entity has a minimum amount of eligible LTD. In essence, if the covered entity’s going-concern capital is fully depleted and the covered entity fails and enters resolution, the eligible LTD would be sufficient to fully recapitalize the covered entity.

This proposed LTD would replenish an entity’s going-concern capital to at least the:

1. Amount required to meet minimum leverage capital requirements and
2. Common equity Tier 1 risk-based capital requirements, plus
3. The capital conservation buffer applicable to covered entities.

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In terms of risk-weighted assets, a covered entity’s common equity Tier 1 Capital level is subject to a minimum requirement of 4.5 percent of risk-weighted assets plus a capital conservation buffer equal to at least 2.5 percent. Therefore, a covered entity would be subject to an external LTD requirement equal to 7 percent of risk-weighted assets minus a 1 percentage point allowance for balance sheet depletion.

This proposed rule would result in an LTD requirement equal to 6 percent of risk-weighted assets shown above.

The Potential Upsides of This LTD Proposal

The 1 percentage point allowance for balance sheet depletion is appropriate under the capital refill theory because the losses that the covered entity incurs leading to its failure would deplete its risk-weighted assets as well as its capital. Accordingly, the pre-failure losses would result in a smaller balance sheet for the covered entity at the point of failure, meaning that a smaller dollar amount of capital would be required to restore the covered entity’s pre-stress common equity Tier 1 Capital level. Although the specific amount of eligible external LTD necessary to restore a covered entity to its minimum required common equity Tier 1 Capital level plus minimum buffer in light of the diminished size of its post-failure balance sheet will vary, applying a uniform 1 percentage point allowance for balance sheet depletion avoids undue regulatory complexity.

The application of the capital refill framework to the leverage-based capital component of the LTD requirement is analogous.

• Currently: A covered entity’s Tier 1 leverage ratio minimum is 4 percent of average total consolidated assets and, if the covered entity is subject to the supplementary leverage ratio, its supplementary leverage ratio minimum is 3 percent of total leverage exposure.
• Under The LTD Proposal: A covered entity would be subject to an LTD requirement equal to 3.5 percent of average total consolidated assets and 2.5 percent of total leverage exposure, if applicable.

These requirements, with a balance sheet depletion allowance of 0.5 percentage points, are appropriate to ensure that a covered entity has a sufficient amount of eligible LTD to refill its leverage ratio minimums in the event it depletes all or substantially all of its Tier 1 Capital prior to failing.

RELATED CONTENT: Regulatory Risk and Compliance in Financial Services

Share Your Thoughts With OCC Regulators by November 30, 2023

You may submit comments to the OCC by any of the methods set forth below. Comments must be received on or before November 30, 2023.

Please use the title “Long-term Debt Requirements for Large Bank Holding Companies, Certain Intermediate Holding Companies of Foreign Banking Organizations, and Large Insured Depository Institutions” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods:

• Federal eRulemaking Portal—“regulations.gov”: Go to www.regulations.gov. Enter “Docket ID OCC-2023-0011” in the Search Box and click “Search.” Click on “Comment Now” to submit public comments. Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov, including instructions for submitting public comments.
• E-mail: regs.comments@occ.treas.gov.
• Mail: Chief Counsel’s Office, Attention: Comment Processing, Office of the Comptroller of the Currency, 400 7th Street, SW, suite 3E-218, Washington, DC 20219.
• Hand Delivery/Courier: 400 7th Street, SW, suite 3E-218, Washington, DC 20219

The full proposed 200+ page regulation is available here: Long-Term Debt (FR) (fdic.gov).

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