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Loss Absorbing Capacity: Beyond G-SIBs

Here’s a summary of the paper “Loss-absorbing capacity requirements for resolution: beyond G-SIBs” (FSI Insights No. 69)

Summary of the Document

Purpose of the Paper

The paper examines how countries design loss-absorbing capacity (LAC) requirements for non-G-SIB banks—ie, banks that aren’t globally systemic but may still be domestically systemic. After the 2023 regional bank failures, global policy bodies have stressed the need to expand LAC beyond just G-SIBs.

1. Background & Rationale

After the 2007–2009 financial crisis, authorities developed resolution regimes to ensure that systemic banks can fail safely, without taxpayer bailouts.
Resolution depends heavily on LAC, which provides resources for:

  • Absorbing losses
  • Recapitalising the bank or successor entity
  • Supporting continuity of critical functions

For G-SIBs, the FSB introduced the TLAC Standard.
But no global standard exists for non-G-SIB systemic banks, even though many could still cause major systemic disruption in failure.

Countries therefore tailor their own LAC rules for such banks.

2. How LAC Works (core concepts)

LAC can come from:

  • Regulatory capital (CET1, AT1, Tier 2)
  • Additional long-term debt designed for bail-in
  • Industry-funded vehicles (deposit insurance, resolution funds)
  • Exceptional government support (undesirable)

TLAC Eligibility Criteria (mirrored by many non-G-SIB frameworks):

  • Fully paid-in
  • Long-term (maturity > 1 year)
  • Unsecured
  • Subordinated
  • No set-offs or derivatives complexity
  • Must be bail-in-able and enforceable under governing law

3. Jurisdictional Approaches

The paper reviews six jurisdictions:
Australia, Canada, Hong Kong, EU Banking Union, South Africa, United Kingdom.

Approaches vary along two dimensions:

A. Scope of Application

Countries use one of two models:

(1) Only designated systemic banks (D-SIBs/SIFIs)

  • Canada
  • South Africa

(2) Determined through resolution planning (broader scope)

  • EU Banking Union (SRB)
  • United Kingdom
  • Hong Kong
  • Australia (hybrid—currently D-SIBs only, but could extend case-by-case)

B. Calibration Approach

Two main models:

(1) Uniform Add-on to Capital Requirements

Simple, transparent, not tailored.

  • Australia: +4.5% RWA added to D-SIB capital requirements
  • Canada: TLAC ratios of ~25% RWA / 7.25% leverage

(2) Tailored Requirements Based on Resolution Strategy

Each bank’s LAC is customized based on:

  • Loss-absorption needs
  • Recapitalisation needs
  • Preferred resolution strategy (PRS)
  • Resolvability assessments

Used by:

  • EU Banking Union (MREL)
  • United Kingdom (MREL)
  • Hong Kong
  • South Africa (future calibration to be tailored)

4. Key Characteristics of LAC Instruments

Across jurisdictions, LAC instruments must be:

  • Long-dated
  • Unsecured
  • Subordinated (statutorily, contractually, or structurally)
  • Bail-in-able (with recognition clauses if foreign law applies)

Some jurisdictions impose additional constraints:

  • Minimum debt ratios (HK and South Africa require ≥1/3 of LAC in debt)
  • Retail investor restrictions (HK, EU in some countries, SA)
  • Foreign-law enforceability requirements

The EU and UK allow the widest range of instruments (eg, certain uninsured deposits).

5. Implementation Experience & Challenges

Authorities report that:

  • Banks generally have not struggled to meet LAC requirements.
  • Smaller banks face higher issuance costs and weaker investor familiarity.
  • Market capacity considerations are important—authorities often phase in requirements over several years.
  • Supervisors actively engage with banks to develop issuance plans and ensure market understanding.

Notable support measures include:

  • HKMA engagement with investors and rating agencies
  • SRB flexibility in issuance timelines
  • UK’s multi-year glidepath for growing banks nearing MREL requirements

6. Policy Observations & Trade-offs

The paper highlights several policy tensions:

A. Tailoring vs. Simplicity

  • Highly tailored calibration is more accurate but complex and less predictable.
  • Simpler frameworks promote transparency but may need conservative buffers.

B. Scope vs. Instrument Feasibility

  • Broader scope → more banks required to issue debt
  • Smaller banks may have trouble issuing market-priced instruments
  • Heavy reliance on CET1 is risky because CET1 may be depleted before failure

C. Internal vs. External Sources of Resolution Funding

Local decisions reflect:

  • Strength of deposit insurance funds
  • Industry-funded resolution funds
  • Political tolerance for bail-in of retail investors
  • Market depth for long-term bank debt

7. Key Takeaways

  • LAC is essential for ensuring that non-G-SIB systemic banks can fail without destabilizing the financial system.
  • Countries are extending LAC rules beyond G-SIBs, but no global consensus exists on how.
  • Two main approaches dominate: uniform capital add-ons vs. tailored MREL-style calibration.
  • Instrument eligibility rules broadly mirror the FSB TLAC standard.
  • Authorities must balance credibility, feasibility, and simplicity when designing national frameworks.