The US financial regulators have announced new rules that aim to reduce the cost of bank failures and protect depositors’ money. The rules require banks with at least $100 billion in assets to issue long-term debt that can absorb losses if they are at risk of becoming insolvent. The rules also limit the use of the Federal Deposit Insurance Corporation’s (FDIC) fund, which is used to back up depositors’ money at failed banks.
New rules to prepare banks for failure
The new rules were approved by the FDIC, the Federal Reserve and the Office of Comptroller of the Currency (OCC) on Tuesday, after a five-year investigation. The rules are intended to prevent banks from tapping into the FDIC’s Deposit Insurance Fund (DIF), which covers up to $250,000 per depositor for each account ownership category. The DIF had $116.1 billion as of April, but it was depleted by $31.5 billion due to three bank failures earlier this year.
The rules require banks with at least $100 billion in assets to issue around $70 billion in long-term debt that can be converted into equity or written off if the bank is at risk of failure. This would shift the risk of bank failure from depositors to bondholders, who would likely demand higher interest rates to invest in such debt. The rules also impose stricter capital and liquidity requirements on banks, as well as more frequent stress tests and resolution plans.
The rules do not apply to the largest US banks that are considered systemically important, such as JPMorgan Chase, Bank of America and Citigroup, since they already comply with similar requirements. The rules mainly target mid-sized and regional banks that have grown significantly in recent years and pose a potential threat to financial stability.
Benefits and costs of the new rules
The regulators said that the new rules would benefit the economy and the public by reducing the likelihood and impact of bank failures. The rules would also enhance market discipline and transparency, as well as align the incentives of bank managers and shareholders with those of depositors and taxpayers.
However, the new rules also bear costs for banks and their customers. The rules would increase the funding costs for banks, as they would have to pay higher interest rates on long-term debt. This would reduce their profitability and returns for shareholders. The rules could also affect the availability and pricing of credit for consumers and businesses, as banks may pass on some of their costs to their customers.
The regulators acknowledged these trade-offs and said that they tried to balance them by providing a three-year transition period for banks to comply with the new rules, as well as exemptions and adjustments for certain types of banks and activities. They also said that they would monitor the effects of the new rules on bank behavior and market conditions, and make changes if necessary.
Reaction from the banking industry
The banking industry expressed mixed reactions to the new rules. Some industry groups welcomed the rules as a positive step towards ensuring financial stability and protecting depositors’ money. They also praised the regulators for providing flexibility and clarity for banks to implement the new rules.
However, some industry groups criticized the rules as unnecessary and burdensome, especially for smaller banks that do not pose a systemic risk. They argued that the rules would hamper their ability to serve their customers and communities, as well as compete with larger banks and non-bank lenders. They also questioned the effectiveness of the rules in preventing bank failures, given the complexity and uncertainty of financial crises.