Should regulators really be happy with banks issuing more debt?

The move by regulators and rating agencies to push banks to increase debt burdens will not make any material difference in terms of who bears the cost of a crisis in the future; investors and those saving for their pension – says Kames fixed income manager Gregory Turnbull-Schwartz.
Turnbull-Schwartz adds that the huge sums banks are being forced to raise will, in fact increase the cost, and risks, banks face today.
“The FT recently quoted a figure of up to €1.1trn which banks will need to raise to meet a requirement to raise their levels of Total Loss Absorbing Capital (TLAC) yet further,” he says. Meanwhile rating agencies have accommodated this concept into their methodologies, rewarding banks for issuing more subordinated debt.
“We agree that holding more capital is in general a sound objective. The problem is that debt, regardless of how many bells and whistles it has, is still debt, not capital.” A consequence of the mandate to increase so-called capital is that the debt really does have increasing complexity and that is across jurisdictions, e.g. France relative to Germany, and institutions. Because the implementation of regulation is via legislation, and each country addresses that in its own fashion, there are an increasing number of types of bank bonds in the market. At a time when many appear concerned about market liquidity, anything that further fragments the market is a potential risk factor.  So while there isn’t real capital being raised, there is real market liquidity being eroded.
Turnbull-Schwartz said as portions of banks’ earnings are siphoned off to spend on this higher-cost debt, retained earnings at banks grow less rapidly, preventing them from generating more capital with which to support lending, or to protect themselves in the event of a downturn.
“We would ask then whether this new debt will actually succeed in making banks more robust.  Will banks with more subordinated debt manage to avoid a crisis more successfully than banks with less of it? It is unclear, and even if one were to agree with the unproven view that it would work, it still leaves the burning question of who actually holds this new debt and therefore takes the loss,” he says.
“More than likely it will be bought by investment funds in which we all have collectively invested our pension and savings, and it will be those funds which suffer in the event of any future losses.”
“It seems like an awful lot of fuss and certainly cost – and a further headwind for banks which will prevent them increasing real lending to the economy – for something with highly uncertain benefits to taxpayers, aka investors.”