WASHINGTON: The US Federal Reserve on Thursday adopted one of the final banking reform steps following the 2008 financial crisis which aims to prevent government bailouts of major banks.
The new rule requires US and foreign systemically-important banks -- those deemed "too big to fail" -- to issue a minimum amount of long-term debt which could be converted to equity to shore up the bank in the event of a bankruptcy.
In addition, the rule increases the required capital cushion known as total loss-absorbing capacity. The Fed estimates there is a combined shortfall of about $70 billion for this kind of debt and capital.
"Simply put, this requirement means taxpayers will be better protected because the largest banks will be required to pre-fund the costs of their own failure," Fed Chair Janet Yellen said in prepared remarks.
The new rule, which was proposed last year, comes just days after the central bank and the Federal Deposit Insurance Corporation imposed restrictions on Wells Fargo, the world's second-largest bank by market value, over continuing flaws in its bankruptcy plan. The bank is from opening new international branches until the deficiencies are addressed.
The Fed in April ordered the eight largest banks to raise their capital levels to address weaknesses revealed by the 2008 financial crisis, to prevent their failure from undermining the whole system.
The federal government had to bail out financial institutions exposed to the rampant trade in complex derivatives and poor quality mortgage-backed securities, which threatened to topple the global financial system and sparked the Great Recession.
"Scholars and policy analysts concerned with the too-big-to-fail problem have long called for a debt instrument of this sort," said Daniel Tarullo, the Fed governor who oversees banking regulation.
"Investors holding this debt will be motivated to monitor the bank more closely precisely because they would stand to be converted into equity holders if the firm failed," he said in a statement.