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Business News/ News / Bank Debt Proposal Poses a Test for Regulators

Bank Debt Proposal Poses a Test for Regulators

Forcing large regional lenders to issue long-term bonds will give them sturdier funding. But will it really help in a crisis?

Bank Debt Proposal Poses a Test for RegulatorsPremium
Bank Debt Proposal Poses a Test for Regulators

(Bloomberg Opinion) -- Banks borrow to finance most of their business. But when those loans can be pulled almost instantly – as was the case with Silicon Valley Bank’s deposits in March – executives and regulators have few options to stem the panic. A new proposal aims to address that problem by requiring banks to lock in more of their funding for at least one year. It’s a worthwhile idea, with an important caveat.

The US already has a similar requirement for the country’s biggest lenders, the so-called globally systemically important banks. Now regulators want to mandate that federally insured lenders with $100 billion or more in assets issue long-term debt to finance a specified minimum percentage of the total. They’ll allow three years to comply, a sensible timeline, and estimate the effect on net interest margin to be between 0.03 to 0.12 percentage points, a manageable cost for most lenders. One result is that if a bank fails and its equity is wiped out, bondholders would absorb additional losses, making it less likely that uninsured depositors would be at risk.

In theory, that would have several benefits. Debtholders would be motivated to monitor banks’ financial health closely, so a sudden drop in bond prices would signal emerging concerns. Depositors would be less likely to flee in a crunch, providing regulators with crucial time to act. Any failures that did occur would also be less costly. As one example: Authorities were able to unwind Washington Mutual in 2008 at no cost to the FDIC’s insurance fund because it held sufficient long-term debt to cover its losses.

That said, the proposal has an important weakness. Imposing losses on bondholders, even those who have been warned and compensated for the risk that they might not get all their money back, can create added stress on markets. After authorities in Switzerland wrote down the value of some of Credit Suisse Group Inc.’s debt in March, the price of similar securities at other institutions immediately fell. Likewise, just days after Washington Mutual’s successful resolution, regulators had to invoke emergency measures to protect debtholders at (similarly teetering) Wachovia Corp. because they feared that imposing any losses would create unmanageable risks to the broader system.So while a new long-term debt mandate would make the system safer, it shouldn’t induce complacency. Regulators should know by now that equity capital is the only type of funding that can reliably absorb losses — and they should require more of it. Otherwise, when the next crisis comes, they may face the same set of unfortunate choices.

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Published: 17 Apr 2024, 01:21 AM IST
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