Last Friday at the meeting of the G20 in Cannes, the Financial Stability Board (FSB) revealed a list of 29 global systemically important financial institutions (known as the G-Sifis). These institutions are deemed to be so important to the interconnected global financial system that the unexpected and disorderly failure of any one of them could seriously threaten the world’s financial markets. Of the batch, seven US banks made the list: Bank of America Corp. (NYSE: BAC), Bank of New York Mellon (NYSE: BK), Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), JP Morgan Chase & Co. (NYSE: JPM), State Street Corp. (NYSE: STT), and Wells Fargo & Co. (NYSE: WFC). Now things start to get interesting.

These 29 banks have been awarded an implicit guarantee that they are, indeed, ‘too big to fail.’ That’s the good news. The not-so-good news — at least from the institutional point of view — is that capital requirements for the banks will increase and each bank must create a plan by the end of 2012 describing how they would wind themselves down if necessary.

Boosting capital reserves presents little or no problem for any of the banks. The US banks can manage that easily by increasing their retained earnings. They’ll squawk some, but that will be mostly for show.

The requirement that each bank create what amounts to a ‘living will’ represents the real teeth in the G-Sifi designation. The rule is intended to shine a light on a bank’s lending and trading practices, and that transparency is expected to restrict moral hazard. This is far from being a guarantee that if one of these banks fails that world governments will ride to the rescue. The G-Sifi banks will have to disclose where the money is, how it’s being lent and borrowed, and how much risk the bank is really taking. Presumably, the ‘borrow short, lend long’ practices that crushed Lehman Brothers and nearly killed AIG would at least be open to inspection and criticism, if not regulatory prohibition.

For example, recent reports provide very different estimates of US banks’ total exposure to the debt of Portugal, Ireland, Italy, Greece, and Spain (the PIIGS or, more genteelly, the GIIPS). The total direct exposure of five US banks to Greek debt is about $8.6 billion. Not much in the great scheme of things. Here’s a chart from Citigroup published at the Financial Times Alphaville blog:

However, when derivatives and other financial instruments are included, these banks’ direct exposure to the PIIGS debt was estimated at $175 billion, and the Bank of International Settlements set the total at around $725 billion. This figure is disputed by the US banks, which prefer to net out their exposure over their entire portfolio. They come up with a figure of about $50 billion.

The 29 G-Sifi banks won’t be able to account for their derivatives in a way that best suits the individual bank. The FSB will force the banks to follow a single set of rules that should provide figures that can be examined and compared.

For investors and regulators, transparency is a wonderful thing. For banks, it is less so. In the coming months, look for at least some of the G-Sifi banks to try to get out from under the designation. These banks will have figured out that being TBTF is a curse, not a blessing.

Paul Ausick

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