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From Banking and Finance Law Daily, June 16, 2016

Banking system ‘more resilient’ today, after reforms: FDIC’s Gruenberg

By Colleen M. Svelnis, J.D.

Federal Deposit Insurance Corporation Chairman Martin J. Gruenberg, speaking about the effects of the prudential safety and soundness reforms that have been implemented since the financial crisis, concluded that the U.S. banking system is "significantly more resilient today" as a result of these reforms. In his remarks before the Exchequer Club, Gruenberg stated that the reforms have strengthened the ability of banking organizations to serve the U.S. economy. As an example, Gruenberg noted that large banking organizations had twice as much tier 1 capital and liquid assets at the end of 2015 in proportion to their size as they did before the financial crisis.

According to Gruenberg, the federal banking agencies have:

  • strengthened the quality of regulatory capital and increased the level of risk-based capital requirements for all banks, and established enhanced leverage ratio requirements for the largest, most complex banking organizations;
  • finalized requirements for increased liquid asset holdings of large banking organizations, proposed liquidity rules addressing the need for longer-term stable sources of funding, and worked with other agencies to establish margin requirements for non-cleared derivatives and limit the use of the federal banking safety net to support proprietary trading; and
  • The stress testing process has increased the focus on rigorous management of the risks at large banking organizations.

Gruenberg focused his remarks on how these prudential reforms have affected banks’ ability to support U.S. economic growth and market functioning in the following four areas: credit availability, bank profitability, market liquidity, and the distribution of financial activity between banks and nonbanks.

Credit availability. Gruenberg stated that there has been strong loan growth at U.S. banks, and that loan growth at insured banks has been even stronger at the beginning of 2016 than in 2015. According to Gruenberg, the most important driver of bank lending is the business cycle and the credit needs of businesses and households.

Bank profitability. Bank earnings have improved during the post-crisis period, said Gruenberg, with almost two-thirds of all institutions reporting higher earnings in 2015 than in 2014. Additionally, only eight institutions failed in 2015, the lowest number since 2007. Banks have achieved this even with reductions in net interest margins, working off high levels of non-current loans coming out of the crisis, and, for the largest banking organizations, litigation expenses, Gruenberg stated.

Market Liquidity. Gruenberg discussed whether the post-crisis reforms have caused a pullback from market-making activity by bank-affiliated broker-dealers, and whether this in turn has hurt market liquidity. A second set of issues that frequently arises in discussions of market liquidity relates to changes in broker-dealer balance sheets and what is driving those changes. Regarding the effect of changes in broker-dealer balance sheets on the market liquidity of bonds, Gruenberg concluded that the research seems to indicate that post-crisis market liquidity for bonds has not declined, and in fact describes improvement in a number of standard measures of liquidity.

Migration to nonbanks. Gruenberg reflected on whether post-crisis reforms are changing the distribution of financial activity between banks and nonbanks, and by doing so making banks less important financial players.

Gruenberg described how, in the years before the financial crisis, the financial asset holdings of U.S. insured banks decreased steadily relative to the holdings of nonbanks. "If the post-crisis reforms were diminishing the role of banks in financing the credit needs of the U.S. economy, one would expect the pre-crisis migration of lending and assets to nonbanks to have continued or accelerated." Instead, according to Gruenberg, the data shows that trend "coming to a stop or reversing during the post-crisis period." He stated that banks’ steady share of financial assets since 2010 means that their overall asset holdings have expanded during this time at the same rate as the asset holdings of the U.S. financial sector. Gruenberg concluded that banks’ role as ultimate holders of the credit risk of loans has become more important in the post-crisis period

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