The Fed’s Loss-Absorbing Capacity Threatens Big Banks

In October 2015 the Fed governors unanimously voted to pursue a “loss-absorbing capacity” measure requiring the largest eight banks, including “JP Morgan, Chase, Citigroup and Bank of America,” to issue hundreds of billions in new equity and debt to insulate the economy from the crippling effects of future financial shocks. The key focus of this proposal is to transfer the risk of failure back to the financial sector, specifically investors, by ensuring an adequate supply of high-quality assets are easily accessible to convert to stock for capital injection purposes instead of relying on tax-payer bailouts.

Oliver Ireland, former associate general counsel at the Fed, offered this analogy to best describe the justification for such action: “The previously adopted capital and liquidity rules are the ‘belt’ designed to reduce the likelihood of big banks failing, while the new proposal for transferring potential losses to investors is the ‘suspenders’ in case banks do fail.” If adopted the regulations governing the new equity and long-term debt issues would mandate the formation of a holding company which, in the case of a bank’s failure, the assets “would be seized but subsidiaries would be allowed to continue to operate.”

Consequently it is reasonable to assume the largest eight “too big to fail” banks will offer investors greater interest rates to compensate for such added risk. Unfortunately it is not clear how current stakeholders will be rewarded should they hold on to their portfolio if and when the loss-absorbing capacity rule becomes effective. Presently the word on the street is “if formally adopted, most of the requirements wouldn’t take effect until 2019, and the remainder not until 2022.” Thus, between now and sometime in the not too distant future it is likely the market will witness a potentially volatile disruption in the market caps of these eight banks.


Edmund Burden

I help business owners grow their businesses through effective use of financial technology tools. Personal finance is a passion of mine so I try to stay on top of all the trends and write about where I see the market going.

Other Articles by Edmund Burden

U.S. Economy: The Game of Political Smoke & Mirrors Continues

On February 5, 2016 President Obama addressed the nation to announce national unemployment “dipped to 4.9 percent in January” noting “151,000” jobs were created during the month. Obama used this opportunity not only to quell public anxieties over rumors of a looming recession in 2016, but also scolded GOP presidential candidates for stoking the flames. However, given job rates tend to increase around the holiday season – hence the term...

Is U.S. Housing Investment Under Threat of an Impending Slowdown?

It's no secret 2016 started off in precarious fashion as several U.S. stock indices tumbled on news of China’s slowing economy, weakening international crude oil prices, and quietly transmitted rumors of a looming recession. Upon these revelations and other market performance indicators, the FOMC announced last week “to maintain the target range for the federal funds rate at ¼ to ½ percent” in accordance with “its objective of maximum employment...

U.S. Trade Imbalance Trending Behavior

Since the early 1990’s the United States has and continues to suffer trade imbalances, or trade deficits, of substantial and growing proportions with several foreign nations. For those unfamiliar with the term balance of trade (BOT), it is simply the difference between a country’s imports versus its exports. For nearly 2.5 decades U.S. leadership has apparently permitted (to the extent supported) this economic disparity to manifest into an extremely lopsided...