Systemically important banks now hold more capital and less risk than they did in 2008 but their resolution is still a challenge, the Financial Stability Board said in an assessment of too-big-to-fail reforms launched in the aftermath of the global financial crisis.

The key goal was to determine whether too-big-to-fail reforms have achieved their objective of making banks more resilient and resolvable without the use of taxpayer money, Claudia Buch, vice president of the German central bank, said June 26. The evaluation also aimed to find whether the reforms have resulted in any material side effects, said Buch, who chaired the group that produced the report.

The exercise was completed before the onset of the COVID-19 pandemic, so it does not provide policy recommendations in that regard, Buch noted. Despite that, the FSB decided to release the report as originally scheduled as it deems its findings important in the current environment, she said.

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The FSB found the too-big-to-fail reforms have been effective in reducing systemic risks and moral hazards in the financial sector, Buch said, adding that systemically important banks are now better capitalized and have build up significant loss-absorbing capacity, thanks to the post-2008 bank resolution and recovery rules.

Improved resilience

The FSB data shows that global systemically important banks, or G-SIBs, have seen a material increase across all four regulatory measures — risk-based capital ratios, leverage ratios, liquidity coverage ratios and net stable funding ratios — between 2012 and 2019. "This suggests that G-SIBs' ability to absorb solvency and liquidity shocks as a going concern has markedly increased," according to the report.

The risk-weighted capital ratios of the G-SIBs monitored by the FSB have increased to around or above 14% on average in 2019 from a range of 6% to 9% in 2012, the FSB data shows.

G-SIBs have also managed to increase their total-loss absorbing capacity, or TLAC, which is the main tool for recapitalizing banks deemed failing or likely to fail under the post-2008 recovery and resolution regimes. Since Jan. 1, 2019, G-SIBs are required to hold 16% of their risk-weighted assets and 6% of their leverage exposure in TLAC-eligible instruments on a transitional basis.

The final requirement, to come into force Jan. 1, 2022, will call for a TLAC minimum of 18% of RWAs and 6.75% of leverage exposure.

The FSB found that all 26 G-SIBs in advanced economies it evaluated had TLAC-to-RWA ratios above the 2019 transitional minimum, and 21 of them were already above the final 2022 minimum as well.

More work on resolution rules

Nevertheless, bail-in regimes were the area where the FSB saw a need for future improvement. "Resolution of banks is a complex process and some obstacles to resolvability remain," Buch told journalists.

According to the report, more work needs to be done on the distribution of TLAC resources across the G-SIB franchises to ensure that sufficient TLAC buffers are held at material subsidiaries or subgroups based in jurisdictions different than the home country of the G-SIB. These buffers, known as internal TLAC, have to then be balanced against the remaining TLAC resources in the group to ensure there will be enough bail-in-able instruments to go around if the bank runs into trouble.

Funding of banks in resolution also remains problematic as the FSB analysis of resolvability assessment processes shows the evaluation of funding needs and identification of funding sources for banks in resolution is still underdeveloped. Many jurisdictions are also still at an early stage of ensuring continued access to financial markets of banks in resolution, according to the report.

Timely disclosure of key data in the resolution process is also essential to completing the work on the too-big-to-fail reforms. Disclosure of TLAC resources and holdings has been uneven, preventing investors from accurately assessing the resolvability of individual banks, according to the report.

The data available to regulators and standard setters is also patchy, "which reduces their ability to monitor and evaluate," the FSB said. For example, there is insufficient information about the holders of TLAC instruments issued by G-SIBs, which could prevent the accurate assessment of the potential impact of a bail-in on the financial system and the economy, it said.

Lack of timely disclosure of assets and liabilities data by banks is still a barrier to the valuation of banks in resolution, the FSB said.

Side effects

The FSB evaluation found no evidence of "relevant negative side effects" such as greater unintended financial market fragmentation or a drop in lending to the real economy as large banks reduced their activities, bowing to tighter post-2008 rules, Buch said. Where big banks have withdrawn from lending, other market participants have stepped in, she added.

However, the FSB has warned of potential risks related to the shift of market share to nonbank financial institutions, or the so-called shadow banking sector. This shift may boost financial stability to some extent as it may increase the diversification of funding sources, but it could also cause instability as it transfers risks outside of the stringently regulated banking system.

The FSB said its current evaluation "has not examined the implications for nonbank financial intermediaries, but the findings on the banking sector reinforce the importance of continuing work by the FSB and standard-setting bodies to assess vulnerabilities and develop policy recommendations designed to address related financial stability risks."