The push to make sure banks are no longer too big to fail is also advancing on a second front, as Wall Street expands a revision of financial contracts worth trillions of dollars. The changes are expected to allow certain securities and funding contracts to remain intact for as long as 48 hours after a bank fails, said three people with knowledge of the matter.

The extra time is intended to give a faltering bank's home government time to jump in and set up a healthy version of the doomed institution, something that's difficult to do when counterparties have terminated contracts and fled.

Bank of England Governor Mark Carney, who heads the FSB, said on Monday that the TLAC rules make a major failure less likely because banks' creditors know they'll face losses in a collapse.

Previously, the “lenders, the unsecured creditors, to a bank were implicitly and ultimately explicitly relying on the state to back them up, and therefore didn't pay that much attention to what the institutions were actually doing,” Carney told reporters in Basel on Monday. “Now they actually have skin in the game, so to speak, and they will exert greater pressure, consistent with their fiduciary duties, and that in and of itself will make failure less likely.”

The FSB rules separate the liabilities needed to keep a bank running from purely financial debts such as notes issued for funding. By “bailing in” the bonds—writing them down or converting them to equity—regulators aim to ensure that a lender in difficulty has the resources to be recapitalized without using public money, and to allow the resolved firm to continue to operate. In a departure from previous practice, senior debt issued by banks is explicitly exposed to loss.

The hundreds of billions of dollars governments globally poured into banks reeling from the 2008 financial crisis were used as much to rescue lenders' senior bondholders, whose claims sat alongside and were equal to those of depositors, as to bail out the banks themselves. The situation confronted governments with the choice of risking bankruptcy by rescuing the lenders or allowing the disorderly collapse of the financial system.

Why TLAC Is Crucial

Carney said in an interview last week that it would take “several years” for banks to “reorganize their capital structure and also their business models” to comply with TLAC, and only then would regulators be in a position to resolve a major global bank.

Analysis done by the Basel Committee on Banking Supervision showed that two-thirds of the banks on the FSB's list are short of their targets for 2019. Those in developed markets had 14.1 percent TLAC at the end of 2014 and need to boost that level by 498 billion euros in the next three years. Including the emerging-market banks, the shortfall amounts to 767 billion euros.

To put the shortfalls into perspective, across 29 global banks total outstanding debt security issuance was 4.5 trillion euros at the end of 2014, the FSB said. Average issuance is 156 billion euros, of which 81 percent matures in the next five years. The regulator said issuance to meet TLAC should largely involve “substitution of one bond for another with different characteristics, and not net new issuance of the full shortfall amount.”

Banks from the U.S., European Union, Japan, and Switzerland account for the lion's share of the FSB's list of systemic institutions. The Federal Reserve moved on Oct. 30 to apply the TLAC standard to eight of the biggest U.S. banks, estimating their total shortfall of long-term debt at $120 billion.

“TLAC is crucial,” Nathan Sheets, U.S. Treasury undersecretary for international affairs, said before the announcement. “It's a very important step forward toward addressing concerns about 'too big to fail,' giving large financial institutions additional buffers that can be drawn on in extremis to protect the taxpayer from having to bail out these institutions.”

Emerging-market banks in the FSB list have until 2025 to meet the 16 percent loss-absorbing capacity target, rising to 18 percent in 2028. This schedule could be accelerated if, “in the next five years, corporate debt markets in these economies reach 55 percent of the emerging market economy's” gross domestic product, according to the FSB.

Cross-Border Lenders

Authorities in some G-20 nations still lack the power needed to be able to resolve a major lender without turning to taxpayers, the FSB said. Along with bail-in, these powers include the ability to prevent counterparties demanding early settling of trades, the power to establish a bridge bank and to impose changes in company structure and management.

The regulator gives the U.S., EU, Japan, and Switzerland a largely clean bill of health in its review of the G-20's progress in implementing measures needed to resolve large cross-border lenders in an orderly manner. Yet China lacks the majority of the powers it would need should one of them fail, according to the FSB.

The extent to which taxpayers can be shielded when major banks fail will depend on how bail-in works in practice.

“Let's hope that it takes longer than in the past before governments have to get involved, because that's one way of thinking about the bail-in process and how it's supposed to work,” said Stefan Ingves, chairman of the Basel committee. “We just don't know how it will work.”

–With assistance from Silla Brush and Jesse Hamilton in Washington.

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