What is TLAC, how does bail-in work mechanically, and why was it designed for G-SIBs?

Question

AcadiFi · Accepted Answer

**Total Loss-Absorbing Capacity (TLAC)** is the minimum amount of equity and eligible long-term debt that a Global Systemically Important Bank (G-SIB) must maintain so that it can be resolved (restructured or wound down) without taxpayer support by absorbing losses through **bail-in** — converting debt to equity or writing it down.

**TLAC Requirements**

| Metric | Minimum |
|---|---|
| TLAC / RWA | >= 18% (plus buffers) |
| TLAC / Leverage Exposure | >= 6.75% |

**Eligible TLAC Instruments**

| Instrument | Qualifies? | Why |
|---|---|---|
| CET1 (common equity) | Yes | First loss absorption |
| AT1 (contingent convertibles, CoCos) | Yes | Converts at trigger events |
| Tier 2 subordinated debt | Yes | Written down or converted |
| Senior unsecured bonds (TLAC-eligible) | Yes, if subordinated to operating liabilities | Loss absorption in resolution |
| Deposits | **No** | Protected by deposit insurance |
| Secured debt (covered bonds) | **No** | Collateralized, exempt from bail-in |
| Derivatives liabilities | **No** | Too complex to bail-in reliably |

**Bail-In Mechanics**

```mermaid
flowchart TD
    A["G-SIB Enters Resolution"] --> B["Step 1: Write down CET1 to zero"]
    B --> C["Step 2: Write down AT1 or convert to equity"]
    C --> D["Step 3: Write down Tier 2 or convert to equity"]
    D --> E["Step 4: Bail-in senior unsecured TLAC debt"]
    E --> F["Convert to new equity shares"]
    F --> G["Recapitalized bank continues operating"]
    G --> H["Old shareholders wiped out"]
    G --> I["Old TLAC debt holders become new shareholders"]
```

**Worked Example**

Grandview Global Bank (G-SIB) has:
- Total assets: $1.8 trillion
- RWA: $720 billion
- Losses requiring resolution: $85 billion

| Layer | Amount | Action | Remaining Loss |
|---|---|---|---|
| CET1 | $52B | Written down to zero | $33B |
| AT1 (CoCos) | $12B | Converted to equity at par | $21B |
| Tier 2 | $18B | Written down | $3B |
| Senior TLAC bonds | $65B | $3B written down; $62B converted to new equity | $0 |

Result: Grandview is recapitalized with new equity from former TLAC debt holders. Depositors, derivatives counterparties, and secured creditors are unaffected. No taxpayer money is used.

**Why TLAC Exists**

Before TLAC, when G-SIBs failed (Lehman Brothers, Bear Stearns, AIG), governments faced a choice between taxpayer bailout or disorderly collapse. TLAC creates a third option: **orderly resolution** funded by investors who priced the bail-in risk into the yield they demanded.

**Investor Implications:**
- TLAC bonds trade at wider spreads than equivalent non-bail-inable senior debt (50-150 bps premium)
- Investors must understand the creditor hierarchy and the "point of non-viability" trigger
- Rating agencies assign lower ratings to TLAC-eligible instruments reflecting bail-in risk

For more on resolution frameworks, check our FRM Part II question bank.

What is TLAC, how does bail-in work mechanically, and why was it designed for G-SIBs?

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