In comments reported today by Bloomberg, FedFin managing partner Karen Petrou lays out challenges created by TLAC identified in the firm’s analysis not only of the FSB consultation, but also of how this latest post-crisis reform fits into the broader regulatory framework.   Here, we summarize the results of work to date.

As Bloomberg notes, Karen believes TLAC must be analyzed not only in its own right to assess its feasibility and cost, but also in the broader array of liquidity and capital rules redefining asset-liability management and, thus, the role larger banks can henceforth play as financial intermediaries.

In addition to our analysis of the FSB’s TLAC consultation, FedFin has reviewed analyses of its market impact. S&P in its FSB comment estimated that an additional $500 billion in eligible debt would need to be issued, but we note that this figure is premised on FSB’s lowest-possible threshold. Estimates of up to $1.6 trillion are credible, with the cost of this debt even more formidable under normalized interest-rate conditions.

In our view, banks at the very least would need to substitute TLAC for deposits, sharply reducing their capacity to fund short-term assets and increasing interest-rate risk. Reduced deposit reliance would also adversely alter retail-branch economics, further eroding this channel of consumer finance and increasing use of non-bank, uninsured liabilities across the financial system.

It is of course possible that funding would simply shift to smaller banks, where TLAC would not apply; it is, however, wholly uncertain that these institutions could replace larger banks in credit markets, especially for more complex, larger-dollar products.

In addition to considering TLAC’s strategic impact, it is critical to assess its effectiveness as the bulwark   it is intended to provide against taxpayer bail-out. In the absence of a transparent single-point-of-entry framework that is clearly credible across borders and for complex institutions, TLAC’s insulating capacity is in our view most unclear. An array of additional analytics is necessary to assess TLAC’s strategic and policy impact before final action.