The total loss-absorbing capacity (TLAC) of the largest US banks increased over the past 12 months, despite BNY Mellon, Citi and Wells Fargo bucking the trend.

Risk Quantum analysis of the eight systemic US banks saw the average ratio of TLAC-eligible debt and equity to risk-weighted assets (RWAs) across the group was 31.2% at end-September, up from 30.8% a year earlier.

The average minimum requirement over the period fell slightly, from 21.1% to 20.9%.

Three banks saw their TLAC buffer shrink from the third quarter of 2020. Wells Fargo posted the largest reduction, with a drop of 208 basis points to 23.7%. BNY Mellon followed suit with a 50bp reduction, to 27.3%, ahead of Citi’s 40bp drop, to 24.8%.

On the flip side, Goldman Sachs reported the highest increase, as its RWA-based TLAC ratio increased by 240bp to 42.2%.

Morgan Stanley continues to have the greatest amount of headroom above its minimum, with its TLAC ratio a whopping 31.6% above its 18% requirement.

Goldman Sachs has the second-largest buffer on top of its minimum requirement, at 20.7%.

In contrast, Citi and Wells Fargo have thin buffers on top of their requirements, just 230bp and 218bp, respectively.

What is it?

TLAC, a concept designed by the Financial Stability Board and finalised in November 2015, is intended to prevent taxpayer bailouts of imploding systemic banks by forcing them to maintain a fixed ratio of debt and capital to risk-weighted assets and exposures.

As of 2019, designated G-Sibs have been obliged to hold minimum TLAC worth at least 16% of RWAs and 6% of leverage exposure. In 2022, the minimums jump to 18% and 6.75%, respectively.

On top of this, systemic lenders must also hold enough to meet additional regulatory capital buffers, such as the G-Sib, capital conservation and countercyclical add-ons. European Union banks are also subject to additional bail-in bond requirements under the minimum requirements for eligible liabilities regime.

Why it matters

Regulators have tied the amount of capital a bank can give back to shareholders and in bonus payments to executives to a minimum TLAC requirement. Firms are incentivised to issue debt in order to stay above it. Failing to do so will restrict their ability to pay dividends, a position no dealer wants to find itself in.

Moreover, TLAC requirements ebb and flow to deter systemic banks from growing too big. If their size increases, so do their TLAC minimums. More debt is then needed to cover the gap, in an endless loop.

Some banks seem to have taken this more seriously than others. The fact Morgan Stanley has a headroom of almost 32% above its requirement is testament to the work management has done through the years to build a strong buffer.

For those dealers that saw their buffers shrink, there are only a handful of options on the table: issue more bail-in bonds to top up their ratios over the coming months, cut dividend payouts, or curb their balance sheets. 

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