U.S. banking regulators have revealed their plans to mandate regional banks to issue debt in order to safeguard depositors in the event of bank failures. This new requirement will apply to American banks with assets of at least $100 billion. The regulators, including the Treasury Department, Office of the Comptroller of the Currency, Federal Reserve, and the Federal Deposit Insurance Corporation, stated that these banks must hold a certain amount of long-term debt to absorb losses in case of a government seizure. The amount of debt required will be either 3.5% of average total assets or 6% of risk-weighted assets, whichever is higher. Additionally, banks will be discouraged from holding the debt of other lenders to minimize contagion risk.
It is acknowledged that the debt requirements will result in slightly higher funding costs for regional banks. However, banks will have a three-year grace period to comply with the new rule, and many of them already possess an acceptable amount of debt. According to estimates, regional banks already hold approximately 75% of the necessary debt.
The intention to implement these measures was signaled by FDIC Chairman Martin Gruenberg in a speech at the Brookings Institution. The proposal extends regulations that were previously applicable to global systemically important banks (GSIBs) to banks with assets of at least $100 billion. This move was prompted by the unexpected collapse of Silicon Valley Bank in March, which raised awareness regarding emerging risks in the banking system. The proposal also includes the requirement for banks to increase their levels of long-term debt, close the loophole that allowed midsized banks to avoid recognizing declines in bond holdings, and develop more robust living wills or resolution plans to address potential failures.
Regarding the impact on regional banks, analysts have primarily focused on the debt requirements. The purpose behind raising debt levels is to ensure that there is sufficient capital to absorb losses before uninsured depositors are put at risk. Morgan Stanley analysts led by Manan Gosalia anticipate that the new regulations will force some lenders to issue more corporate bonds or replace existing funding sources with more expensive forms of long-term debt. This will further reduce margins for midsized banks, which are already facing challenges due to rising funding costs. As a result, these banks could experience a potential annual earnings hit of up to 3.5%.
According to analysts, there are five banks in particular, namely Regions, M&T Bank, Citizens Financial, Northern Trust, and Fifth Third Bancorp, that may need to raise approximately $12 billion in fresh debt. The presence of long-term debt will reassure depositors during times of financial distress and decrease costs to the FDIC’s Deposit Insurance Fund. Gruenberg believes that it also improves the possibility of conducting a weekend auction of a bank without resorting to extraordinary powers reserved for systemic risks. Having options like replacing ownership or breaking up banks into smaller pieces for sale enables regulators to have more flexibility in such scenarios.
Gruenberg stresses that while some regional banks already have outstanding long-term debt, the new proposal will likely require the issuance of additional debt. However, since this debt is long-term, it does not exert liquidity pressure when problems surface. Investors in this debt are aware that they cannot withdraw their investments when problems arise, unlike uninsured depositors. According to Gruenberg, investors in long-term bank debt will have a greater incentive to monitor risk at lenders, and these publicly traded instruments will serve as indicators of the market’s assessment of risk in these banks.
Please note that this story is currently developing, and updates will be provided.
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