“The Relative Role of Debt in Bank Resiliency and Resolvability”- Remarks by FDIC Vice
Chairman Thomas M. Hoenig. Presented to the Peterson Institute for International Economics,
Washington, DC.
January 20, 2016
Introduction
In the bankruptcy reorganization of a failed commercial business, the conversion of debt into
equity or some revised debt instrument is often the protocol. This has long proven useful in
transitioning a failed business back into a productive enterprise. However, mandating increased
levels of debt as part of a broad, prescribed resolution strategy has potential effects that,
paradoxically, may undermine the very financial stability being sought.
This may be the case with TLAC. Total Loss-Absorbing Capacity, as set out by the Financial
Stability Board, requires large, interconnected banking firms to hold certain levels of long-term
debt.1 Its intention is laudable: to improve the resolvability of banking firms to assure that,
should they fail, they can be resolved without turning to the taxpayer for help. The proposed U.S.
version of TLAC would require global systemically important banks (GSIBs) to maintain TLAC-
related debt at the holding company with restrictions on ownership.2 However, in many
instances, to meet the proposal’s goals, firms would have to not only maintain current levels of
debt, but also would have to add debt to their balance sheets.
In my remarks today, I will highlight TLAC’s effects and suggest that it be used in a more
limited and discretionary manner. I will suggest that its use depend on a bank's business model
and Title I resolution plan. Such an approach would acknowledge that not all business models
1 http://www.fsb.org/wp-content/uploads/20151106-TLAC-Press-Release.pdf
2 http://www.federalreserve.gov/newsevents/press/bcreg/20151030a.htm
Chairman Thomas M. Hoenig. Presented to the Peterson Institute for International Economics,
Washington, DC.
January 20, 2016
Introduction
In the bankruptcy reorganization of a failed commercial business, the conversion of debt into
equity or some revised debt instrument is often the protocol. This has long proven useful in
transitioning a failed business back into a productive enterprise. However, mandating increased
levels of debt as part of a broad, prescribed resolution strategy has potential effects that,
paradoxically, may undermine the very financial stability being sought.
This may be the case with TLAC. Total Loss-Absorbing Capacity, as set out by the Financial
Stability Board, requires large, interconnected banking firms to hold certain levels of long-term
debt.1 Its intention is laudable: to improve the resolvability of banking firms to assure that,
should they fail, they can be resolved without turning to the taxpayer for help. The proposed U.S.
version of TLAC would require global systemically important banks (GSIBs) to maintain TLAC-
related debt at the holding company with restrictions on ownership.2 However, in many
instances, to meet the proposal’s goals, firms would have to not only maintain current levels of
debt, but also would have to add debt to their balance sheets.
In my remarks today, I will highlight TLAC’s effects and suggest that it be used in a more
limited and discretionary manner. I will suggest that its use depend on a bank's business model
and Title I resolution plan. Such an approach would acknowledge that not all business models
1 http://www.fsb.org/wp-content/uploads/20151106-TLAC-Press-Release.pdf
2 http://www.federalreserve.gov/newsevents/press/bcreg/20151030a.htm
are the same and that different resolution strategies might work better for different financial
firms -- and for financial stability.
Resolution Planning and SPOE
TLAC is a necessary component of the single point of entry (SPOE) resolution strategy that has
been proposed but not yet adopted in the United States.3 It therefore is difficult to discuss TLAC
without first describing SPOE.
The FDIC initially proposed SPOE to facilitate an orderly resolution of a failed financial
institution under Title II of the Dodd-Frank Act. Under SPOE, only the top-tier bank holding
company of the failed firm would be put into receivership. In theory, the parent firm would have
enough long-term debt to both absorb any remaining losses after equity is depleted and to
recapitalize subsidiaries so that they could remain well-capitalized and continue operations under
a new holding company. The presumption is that this would all be accomplished without
causing overwhelming panic and necessitating additional government intervention.
Since SPOE was first discussed, the concept has migrated and become the principal bankruptcy
plan under Title I of the Dodd-Frank Act for all but two of eight U.S. GSIBs.4 The basic theory
of SPOE in a bankruptcy reorganization is the same as for SPOE in a FDIC Title II receivership.
In this instance, the financial institution would go through bankruptcy without the critical
operating subsidiaries themselves becoming insolvent or requiring government support. These
operating units could include subsidiary insured banks, broker-dealers, and asset managers.
Resolution Planning and TLAC
A successful SPOE resolution, under Title I or Title II, assumes sufficient internal long-term debt
that can convert to equity in order to effectively recapitalize operating subsidiaries of the holding
company following its failure. The Federal Reserve’s TLAC proposal further specifies that a
clean holding company, with this long-term debt, is required in order to remove obstacles “to the
orderly SPOE resolution” of a financial institution. In short, the TLAC proposal is designed to
require a firm to have sufficient long-term debt to facilitate a SPOE solution both through
conversion of current debt and, if need be, added debt.
According to the estimates in the proposal, the GSIBs would have a combined long-term debt
requirement of approximately $680 billion. Existing debt issuance would cover much of this
amount, but the proposal estimates that there is a shortfall of approximately $100 billion.
3 http://www.gpo.gov/fdsys/pkg/FR-2013-12-18/pdf/2013-30057.pdf. As of this date, the FDIC has not
adopted this strategy.
4 Public versions of the resolution plans are available at
http://www.federalreserve.gov/bankinforeg/resolution-plans.htm.
firms -- and for financial stability.
Resolution Planning and SPOE
TLAC is a necessary component of the single point of entry (SPOE) resolution strategy that has
been proposed but not yet adopted in the United States.3 It therefore is difficult to discuss TLAC
without first describing SPOE.
The FDIC initially proposed SPOE to facilitate an orderly resolution of a failed financial
institution under Title II of the Dodd-Frank Act. Under SPOE, only the top-tier bank holding
company of the failed firm would be put into receivership. In theory, the parent firm would have
enough long-term debt to both absorb any remaining losses after equity is depleted and to
recapitalize subsidiaries so that they could remain well-capitalized and continue operations under
a new holding company. The presumption is that this would all be accomplished without
causing overwhelming panic and necessitating additional government intervention.
Since SPOE was first discussed, the concept has migrated and become the principal bankruptcy
plan under Title I of the Dodd-Frank Act for all but two of eight U.S. GSIBs.4 The basic theory
of SPOE in a bankruptcy reorganization is the same as for SPOE in a FDIC Title II receivership.
In this instance, the financial institution would go through bankruptcy without the critical
operating subsidiaries themselves becoming insolvent or requiring government support. These
operating units could include subsidiary insured banks, broker-dealers, and asset managers.
Resolution Planning and TLAC
A successful SPOE resolution, under Title I or Title II, assumes sufficient internal long-term debt
that can convert to equity in order to effectively recapitalize operating subsidiaries of the holding
company following its failure. The Federal Reserve’s TLAC proposal further specifies that a
clean holding company, with this long-term debt, is required in order to remove obstacles “to the
orderly SPOE resolution” of a financial institution. In short, the TLAC proposal is designed to
require a firm to have sufficient long-term debt to facilitate a SPOE solution both through
conversion of current debt and, if need be, added debt.
According to the estimates in the proposal, the GSIBs would have a combined long-term debt
requirement of approximately $680 billion. Existing debt issuance would cover much of this
amount, but the proposal estimates that there is a shortfall of approximately $100 billion.
3 http://www.gpo.gov/fdsys/pkg/FR-2013-12-18/pdf/2013-30057.pdf. As of this date, the FDIC has not
adopted this strategy.
4 Public versions of the resolution plans are available at
http://www.federalreserve.gov/bankinforeg/resolution-plans.htm.