TLAC: Off to a Good Start but Still Lacking
While higher capital requirements can reduce the likelihood of banking crises, bank subsidiary capital requirements may be more effective than holding company capital requirements, and the benefit-cost analysis used to analyze the rule could be improved by adding other dimensions to the analysis. Throughout much of US history, populist politicians and small banking interests colluded to pass state laws and regulations restricting branching and interstate banking to limit competition from large city banks. The unintended consequences of these laws and regulations include frequent banking crises, the formation of bank holding companies to get around the branching restrictions, and the development of a mortgage-backed securities (MBS) market to help banks diversify their risks nationally, since they could not diversify directly.
To demonstrate the merits of TLAC and LTD and widen the scope of the findings, the cost side of the analysis might offer better insight if it included other forms of capital. Alternative questions to consider include: What if capital requirements were applied at the bank subsidiary instead of the holding company? What if capital were defined as equity only, or long-term bonds only? What if institutions determine their own composition of capital? What if only the flat leverage ratio were used instead of risk-based capital requirements?
Overall, the proposed rule’s emphasis on higher capital, using debt and equity, is a step in the right direction for mitigating future crises, but the holding company is not necessarily the correct entity to rely on to mitigate future crises. Also unclear is whether the continued use of risk-based capital could create problems in the future.