PriyaPatelTLDR:
- The banking agencies’ long-term debt (LTD) requirements for large bank holding companies are misguided and fundamentally flawed.
- The proposal implicitly acknowledges that current capital requirements are not high enough to prevent large bank failures.
- Retail investors are likely to face large losses in the event of a bank failure, as they are the most likely holders of LTD.
- Contagion risk and financial stability could be endangered due to uncertainty and actual losses on LTD issued by failing banks.
- LTD issuance would increase debt-service payments and make large banks more highly leveraged, increasing the likelihood of failure.
The banking agencies’ proposed long-term debt (LTD) requirements for large bank holding companies have been criticized by Better Markets, a non-profit, non-partisan organization focused on promoting the public interest in financial markets. The organization argues that the proposal is misguided, fundamentally flawed, and endangers retail investors.
At the core of Better Markets’ critique is the belief that the proposal implicitly acknowledges that capital requirements are not high enough to prevent large bank failures. As a result, the focus should be on strengthening capital requirements and stress testing programs to enhance the financial resilience of large banks before they fail.
Another key flaw identified by Better Markets is the potential for retail investors to face significant losses in the event of a bank failure. Retail investors are likely to hold LTD either directly or indirectly through brokerage accounts, mutual funds, and pension funds. Better Markets asserts that the experience of Credit Suisse and other large bank failures in Europe provides evidence that imposing losses on debtholders who are retail investors could lead to a political backlash.
Better Markets also raises concerns about the potential for contagion risk and financial instability resulting from uncertainty and actual losses on LTD issued by failing banks. The organization argues that the proposal places excessive faith in the ability of LTD to facilitate a smooth and orderly process in the event of a large bank failure. Market forces, especially during periods of stress, can be unpredictable and may lead to panic selling, fire sales, and contagion similar to what occurred in 2008.
Finally, Better Markets highlights the risk of increasing debt-service payments and leverage for large banks through LTD issuance. Higher leverage directly increases the likelihood of potential failure. The organization emphasizes that there is no substitute for capital and higher capital requirements to reduce the likelihood of failure in the first place.
Overall, Better Markets believes that the banking agencies’ LTD requirements are misguided, fundamentally flawed, and could ultimately pose a danger to retail investors and financial stability. They argue that the proposal should be withdrawn and the focus should be on strengthening capital requirements and stress testing programs instead.
