The FSB proposal on total loss-absorbing capacity, or TLAC, would apply to the FSB's list of 30 global systemically important banks, with HSBC and JPMorgan Chase & Co. identified as the most significant. Standard & Poor's estimates that these banks "would potentially need to issue in excess of $500 billion in TLAC instruments in the next four to five years," based on the lower end of the FSB's proposed requirement of 16 percent to 20 percent of risk-weighted assets.

In their joint response to the FSB's public consultation on TLAC, the Institute of International Finance and the Global Financial Markets Association said that "the volume of instruments in the market that will be subject" to the rule is about $4 trillion.

"Where's the appetite for this stuff?" Flint said in Brussels last November. "There is a perception that there is enough appetite in the world to fund the TLAC that's going to be required," he said. "So where is that capacity?"

That's a problem for the banks, which will have to find buyers ready to step in as they refinance debt that's as safe as deposits with bonds that can be written down. It's also a problem for investors, who need to invest to meet liabilities years into the future, even as pressure on yields from the European Central Bank's (ECB's) bond-buying program boosts demand for investment-grade company debt.

Investor Base

Banks already issue dated subordinated debt with mandatory coupons that banks can count toward some existing loss-absorbency requirements. Those notes, which have an established investor base, potentially could also be used to meet TLAC. That would be expensive: Average yields on Tier 2 debt are 1.53 percent, more than double the 0.70 percent yield on banks' senior bonds in euros, according to Bank of America Merrill Lynch index data.

Using the IIF-GFMA $4 trillion estimate for refinanced issuance and new debt to be raised, the annual interest bill would be more than $62 billion. That figure would soar if yields reverted toward their five-year average of 4.62 percent, the data show.

"The TLAC equation for investors is based not only on how much demand for it there may be, but also on how the requirement itself changes the business model for issuing" banks, said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc.

"If TLAC is too much, as it may well be to absorb all but catastrophic risk ahead of taxpayers, then banks will have to reduce deposits and other liabilities to absorb TLAC costs as well as change their asset mix," she said. "Sharp reductions in short-term assets—lower risk from an interest-rate perspective—are also possible."

For continental European banks, this issue is particularly acute because of the way many of them are structured. Lenders such as BNP Paribas SA and Deutsche Bank AG sell bonds from their operating companies and lack parent companies they could use to issue securities that meet the TLAC requirements.

The FSB wants to count primarily securities that are clearly subordinated and so immune to legal challenges or compensation claims when bailed in, according to a term sheet published on Nov. 10. Such subordination can be harder to achieve with bonds issued by operating companies.

Funding Costs

The FSB's plan "clearly discriminates" against banking groups with an operating company at the top, associations of Nordic and Baltic banks said on Feb. 2. "Such banking groups would have to issue large quantities of new types of highly subordinated debt, which would most likely increase significantly the funding costs for those banks."

In tandem with the push for TLAC, European Union banks face the bloc's rules on minimum required eligible liabilities, another measure of how far losses can be be imposed on a failing lender's investors and creditors. The standards are being rolled out as part of a law adopted last year and will apply to all banks in the 28-nation bloc.

Michael Huenseler, who helps oversee about $16 billion at Assenagon Asset Management SA in Munich, said "a lot of details" in the TLAC proposal still aren't clear, such as the extent to which senior debt could count.

"Bailing in is the new reality," he said. "State support is disappearing. That also goes without TLAC though. It is really hard to explain to taxpayers why they should guarantee a bank."

Insurance funds now have to reckon with their own regulatory capital needs under an EU law called Solvency II.

"We used to be able to hold a lot more financials," said Wee Mien Cheung, who oversees about 3 billion euros of debt issued by financial companies at Delta Lloyd Asset Management in Amsterdam. "Solvency II penalizes us in terms of ratings. The lower you go down the rating scale, the more capital you have to hold. At a certain point, it's not efficient anymore."

The average rating of the senior debt in Bank of America's Euro Senior Banking index, now A2, was three levels higher at Aa2 a decade ago.

For pension funds, inclusion of bank debt in benchmark indexes is likely to be a major consideration, said Neil Davies, an associate at U.K. pension fund advisers Barnett Waddingham.

"Without that, we might see some demand but it wouldn't be everyone sticking their hands in the air and saying, 'It's for me,'" he said. "It's in the nature of pension fund trustees that they're very cautious. I'd struggle to see them diving in head-first."

–With assistance from Jim Brunsden in Brussels.

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