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From Banking and Finance Law Daily, July 23, 2013

BANK HOLDING COMPANIES—Senate subcommittee hears views on bank activities in physical commodities and energy markets

By Amanda Maine, J.D.

The Senate Banking Committee’s subcommittee on Financial Institutions and Consumer Protection Affairs held a hearing to hear opinions about bank holding companies’ activities in physical commodities and energy markets. In his opening remarks, subcommittee Chairman Sherrod Brown (D-Ohio) voiced his concern that banks are becoming increasingly involved in activities not related to banking, leading to their control over power plants, warehouses, and oil refineries. According to Brown, this trend is troubling because bank’s commodities business are not adequately reported and are often buried in arcane regulatory filings. He also warned that there is a lack of transparency in these activities, noting that taxpayers should have a right know what is going on in case they have to rescue banks yet again.

Separation of banking and commerce. Saule Omarova of the University of North Carolina School of Law shared Brown’s concerns about the significant expansion of large banking institutions into physical commodities. One of the core principles underlying and shaping U.S. bank regulation is the principle of separation of banking and commerce, she said. More bank control over commodities raises several issues including those related to systemic risk, market integrity, lack of competition, regulatory capacity, and the safety and soundness of insured depository institutions.

Randall D. Guynn, the head of Financial Institutions Group, was also a witness at the hearing. He explained that although there is a commonly held view that banking should be separate from commerce, there have are ancient roots between banking and commodities. Although he has heard of possible dangers with bank involvement in commodities, detractors have not provided any evidence that the potential dangers are likely to occur, he said.

Risk of crisis. Joshua Rosner of Graham Fisher & Company told the subcommittee that allowing bank holding companies to have control over commerce could result in another financial crisis should any “small tragedy” occur, such as the destruction of a bank-controlled pipeline. Banks seeking to control non-financial infrastructure should not be “coddled” by the Federal Reserve, which can use its judgment to grant exemptions to banks from laws that are aimed at preventing such occurrences. He called on Congress to restrict the Fed’s power to allow banks to be in businesses that do not directly support the resilience of the payments system or the stability of FDIC insured deposits.

Bank-controlled warehouses. Timothy Weiner, global risk manager of commodities and metals at MillerCoors LLC, spoke of his company’s issues in obtaining aluminum used in cans and kegs. According to Weiner, it can take up to 18 months to get aluminum stored in London Metal Exchange (LME) warehouses controlled and owned by U.S. bank holding companies following the purchase of the aluminum. Bank holding companies that are members of the LME set its rules and end up charging rent and other premiums for MillerCoors to access aluminum that it has purchased, resulting in unnecessary overpayment and higher prices, Weiner said.

Effect of catastrophes on infrastructure. Sen. Elizabeth Warren (D-Mass.) also expressed concern that asset managers at huge Wall Street banks are exercising power over key parts of America’s infrastructure. She posed the question of how Wall Street control over infrastructure such as seaports could affect systemic risk. Rosner said that if some kind of catastrophe were to affect an infrastructure business, it could have a large impact, including counterparty exposure, loss of liquidity, and possibly even more government bailouts. He pondered what would happen if the Exxon Valdez had been owned by a bank at the time of the oil spill.

Brown remarked that bank examiners who are overworked and underfunded might not fully appreciate and understand the potential environmental impact of events such as the Exxon Valdez oil spill. Omarova concurred, warning that even if an examiner has a PhD in economics or finance, that person might have difficulty figuring out the dynamics of markets such as oil and electricity.

Managing risks. Guynn acknowledged that there are risks involved in allowing bank holding companies to control infrastructure and commodities, but banks take risks every day when they hold and lend money. Banks try to manage these risks with tools like volume limits and liquidity requirements, he said, so they should also be able to manage other risks. Omarova agreed that risks cannot be eliminated entirely, but the current regulatory scheme is built on the assumptions that banks are engaged in bank activities. A bank acting outside of that regulatory scheme is when it becomes an issue, she said.

Need for deliberation. Warren also inquired about the impact of financial institutions taking consumer deposits and using them to control an electric plant or similar businesses. Omarova said that without limitations, in the future consumer might face a situation where they buy a house with money borrowed from a bank, that was built by a bank, and which is supplied with heat and water by a bank. It is not necessarily a bad thing, Omarova said, but it does require public deliberation.

LegislativeActivity: BankHolding BankingOperations FederalReserveSystem

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