U.S. Banks Have To Raise $120 Billion To Protect Themselves In Case Of Global Recession, Says Federal Reserve

Leading banks in America need to raise about $120 billion to comply with the Federal Reserve's proposed ruling that aims to ensure the banks remain financially buoyant in the event of a global economic crisis.

All the major U.S. banks could soon have to ensure they have $120 billion in long-term debt under a new Federal Reserve proposal that attempts to protect the financial system, even if the banks fail or collapse. The reforms will affect eight large, interconnected banks, such as JPMorgan Chase & Co, Goldman Sachs Group Inc., Wells Fargo & Co., Bank of America Corp., Morgan Stanley, Citigroup Inc., State Street Corp. and Bank of New York Mellon Corp.

The Federal Reserve's reforms have been formulated so that the banks could remain self-reliant in case the world faces a catastrophic economic event, which usually has a domino effect on the financial institutions around the globe. Under such rapidly crumbling conditions, American banks could partially protect themselves by converting a part of their debt, particularly if it was issued by their holding firms, into equity without having to roil stock markets or seek the government's aid for a bailout, reported Modern Readers.

Federal officials confirmed during a press conference held on Friday that banks are free to issue debt in order to meet the $120 billion shortfall. They recommended this strategy over relying on equity, as it is much more economically viable. Federal governors have already approved a draft of the proposed reforms. The ruling has been put for public scrutiny till February 1, 2016. The reforms are just a small part of a series of rules that will eventually mitigate risk America takes in financial institutions by carefully determining the quantum of debt and equity these financial institutions would need to finance themselves in case of an economic crisis, without asking for a bailout plan.

American Banks Have To Raise $120 Billion
(Photo by Saul Loeb / Getty Images)

The reforms, which cleared the voting process without facing any opposition, would mandate banks like Wells Fargo & Co. and JPMorgan Chase & Co. to hold enough debt that could be converted into equity if they were to falter, reported News Max. Speaking about the reforms, Fed Chair Janet Yellen said as follows.

"The proposal, along with other measures regulators have taken to avoid chaotic bank failures would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms. The plan is another important step in addressing the 'too big to fail' problem."
The banks are to meet the $120 billion shortfall because they are expected to possess a contingency fund. Akin to a war-chest, the $120 billion is expected to help them recapitalize without disrupting markets. Quite often, these banks encounter catastrophic economic meltdown and then seek a substantial government bailout. The bailout eventually transfers the burden of getting these enormous failures back on track, on the taxpayers.

The rule concerns banks' Total Loss-Absorbing Capacity, or TLAC. Needless to add, the proposal is a key part of the regulator's efforts to avoid another financial crisis by ensuring it is the banks that are more cautious. Till now, if the American banks failed, it was the investors in their stock that were the biggest losers and as a precursor, the largest risk-takers. However, the $120 billion that the banks would raise through debt would allow the financial institutions to form new reconstituted banks with the debt money that would be converted into equity in order to ensure they keep on functioning.

Interestingly, experts indicate that the banks won't have much trouble complying with the reforms, since many of them simply overlap with current safeguards in place. Moreover, the banks could raise any shortfall to $120 billion simply by refinancing existing debt.

American Banks Have To Raise $120 Billion
(Photo by Carl Court/Getty Images)

With more than $2 trillion in assets, JPMorgan Chase & Co has the most stringent of requirements as compared to other banks. Interestingly though, two banks, which the federal officers refused to reveal, have already managed to raise $120 billion, reported Business Insider.

[Photo by Mark Wilson / Getty Images, Saul Loeb / Getty Images, Carl Court/Getty Images]