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How the Proposed LTD Rule Could Redefine the Debt Landscape

How the Proposed LTD Rule Could Redefine the Debt Landscape 

The Federal Reserve, OCC, and FDIC’s long-term debt (LTD) rule, aimed at mitigating the burden on the FDIC’s Deposit Insurance Fund when large banks fail, emerged from lessons learned during last year’s regional bank failures—and specifically targets banks with assets exceeding $100 billion. Unlike the total loss-absorbing capacity (TLAC) rules that apply to global systemically important banks (GSIBs), this rule extends to include a broader spectrum of large financial institutions, including certain foreign entities and large insured depository institutions. 

Based on Peter Kapp’s comprehensive breakdown of the LTD rule in The RMA Journal, here are its key features and implications: 

  • Increase in Market Debt: The rule will increase the volume of bank debt in the financial markets—potentially leading to wider credit spreads and heightened costs for new issuances—and make debt issuances particularly pricey during periods of market stress. 
  • Debt Issuance Requirements: Affected banks are required to issue long-term, unsecured, and nonconvertible debt, with stringent criteria on the denominations and terms to enhance systemic stability and ensure adequate resources are available in case of bank failure. 
  • Strategic Adjustments: Banks will need to reassess their funding structures, likely resulting in an uptick in fixed-rate, longer-term funding. This adjustment will also require a recalibration of interest-rate risk management strategies, potentially increasing the reliance on derivatives. 
  • Regulatory Interactions: The LTD rule interacts with other regulatory frameworks, adding layers of complexity to compliance efforts. This includes potential overlaps with the forthcoming Basel III Endgame requirements, which could further influence LTD needs by adjusting risk-weighted asset calculations. 

This regulatory change compels banks to not only bolster their capital structures but also to innovate their risk management and funding strategies. As banks adapt to these new requirements, risk professionals should remain vigilant, ensuring that their institutions can navigate this challenging yet crucial transition effectively. 

Stay tuned for part two of this series, which will delve into optimization strategies for complying with the LTD rule.