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From Banking and Finance Law Daily, September 9, 2016

Dodd-Frank bank activities report recommends statutory repeals and regulatory changes

By John M. Pachkowski, J.D.

The three federal bank regulatory agencies—the Office of the Comptroller of the Currency, Federal Reserve Board, and Federal Deposit Insurance Corporation—have released a report to Congress and the Financial Stability Oversight Council on the activities and investments that banking entities may engage in under applicable law. The report was required by section 620 of the Dodd-Frank Act.

For purposes of the report, a banking entity is considered to be a depository institution and any company that controls an insured depository institution or is treated as a bank holding company under the International Banking Act of 1978. The report also covers any affiliate or subsidiary of such companies.

Study. Prior to the report, section 620 of the Dodd-Frank Act required the agencies to conduct a study of the activities and investments that banking entities may engage in under state and federal law. In carrying out the study, the agencies were required to review and consider:

  • the type of permissible activities and investments of banking entities;
  • the risks, including financial, operational, managerial, or reputational, associated with or presented as a result of such activities or investments; and
  • the risk mitigation activities undertaken by banking entities with regard to such risks.

Report contents. The agencies’ report is comprised of three sections in which each agency discusses permissible activities, risk mitigation, legal limitations, and specific recommendations as required by the Dodd-Frank Act. The Fed’s portion of the report discussed activities of state member banks, depository institution holding companies, Edge Act and agreement corporations, and the U.S. operations of foreign banking organizations; the FDIC’s portion of the report discussed activities of state nonmember banks and state savings associations; and the OCC’s portion covered activities of national banks, federal savings associations, and federal branches and agencies of foreign banks.

Recommendations. As for recommendations by the agencies, section 620 required them to: assess whether the activities or investments have or could have a negative effect on the safety and soundness of the banking entities or the U.S. financial system; the appropriateness of the conduct of the activities or types of investment by banking entities; and additional restrictions as may be necessary to address risks to safety and soundness arising from the permissible activities or types of investments of banking entities.

Statutory repeals. The Fed recommended that statutory changes should be made by Congress that eliminate special exemptions that permit certain firms to operate free of activities restrictions and/or outside of the prudential framework applicable to other banking entities. Specifically, the Fed called for the repeal of:

  • the authority of financial holding companies (FHCs) to engage in merchant banking activities;
  • the grandfather authority for certain FHCs to engage in commodities activities under section 4(o) of the Bank Holding Company Act;
  • repeal the exemption that permits corporate owners of industrial loan companies to operate outside of the regulatory and supervisory framework applicable to other corporate owners of insured depository institutions; and
  • the exemption for grandfathered unitary savings and loan holding companies from the activities restrictions applicable to all other savings and loan holding companies.

The Fed believes that taking these actions "would create a more level playing field among regulated financial institutions and owners of insured depository institutions."

It should be noted that the Fed issued an advance notice of proposed rulemaking in early 2014, seeking comments on issues related to physical commodity activities conducted by FHCs (see Banking and Finance Law DailyJan. 14, 2014).

Enhancements and clarification. After examining its handling of applications filed by banks under the section 24 of the Federal Deposit Insurance Act and the agency’s regulation codified at 12 CFR Part 362, which implementing section 24, the FDIC identified several areas of its policy and procedures that could be enhanced or clarified. Specifically, the FDIC plans to:

  • Review activities related to investments in other financial institutions and other equity investments to evaluate the interaction of existing FDIC regulations and supervisory approvals and conditions under Part 362, with other more recent regulatory and statutory rules governing such investments, in order to determine whether changes to Part 362 or related procedures with regard to such investments are needed.
  • Determine whether the prudential conditions and standards under which the FDIC will evaluate Part 362 filings with respect to mineral rights, commodities, or other non-traditional activities need to be clarified and, if so, consider issuing a statement of policy pursuant to such review.

Prudential regulatory enhancements. Finally in its portion of the report, the OCC determined that activities involving derivatives, physical commodities, securities, and structured products "warranted special focus."

The OCC did not recommend any legislative action, but did identify "potential enhancements to the prudential regulatory scheme and certain precedents that merit reconsideration or clarification."

Specifically, the OCC plans to:

  • issue a proposed rule that restricts national banks from holding Type III securities asset-backed securities, which may be backed by bank-impermissible assets, and to issue an analogous proposed rule for federal savings associations;
  • address concentrations of mark-to-model assets and liabilities with a rulemaking or guidance;
  • clarify minimum prudential standards for certain national bank swap dealing activities;
  • consider providing guidance on clearinghouse memberships;
  • clarify regulatory limits on physical hedging;
  • address national banks’ authority to hold and trade copper; and
  • incorporate the Volcker Rule into the agency’s investment securities rules.

Welcome news. Following the release of the report, Sen. Sherrod Brown (D-Ohio), the Ranking Member of the Senate Banking Committee, applauded U.S. banking agencies for urging Congress to limit Wall Street’s investments in merchant banking and physical commodities. He stated, "Today’s recommendations are welcome news for consumers, taxpayers, and manufacturers, and for the safety and soundness of our financial system. This report reflects diligent work by the nation’s banking agencies and Congress has an obligation to give their recommendations serious attention. The Federal Reserve should act without further delay to finish its proposal to address banks’ involvement in commodities markets."

No evidence. On the other hand a group of trade associations, that included the Securities Industry and Financial Markets Association, The Clearing House, American Bankers Association, Financial Services Roundtable, and Financial Services Forum, called the recommended repeal of the merchant banking and related authorities "unfortunate and ill-considered." They noted, "For the last 15 years bank holding companies have successfully used the merchant banking authority granted to them by law to finance start-ups and growing companies" and "have done so without any threat whatsoever to the safety and soundness of their affiliated banks or to the financial system at large."

The associations added, "The regulators have made these recommendations without pointing to any evidence that these activities have ever posed any problem, and have made no attempt to assess the costs to businesses and jobs. They have not provided a cost-benefit analysis or a robust justification for such sweeping changes to laws which were heavily negotiated over a very long period of time and by several administrations. While the regulators did not believe that the costs of regulation were worth considering here, we believe Congress should and will consider such costs."

Companies: American Bankers Association; Financial Services Forum; Financial Services Roundtable; Securities Industry and Financial Markets Association; The Clearing House

MainStory: TopStory BankHolding BankingOperations DoddFrankAct Loans PrudentialRegulation SecuritiesDerivatives StateBankingLaws VolckerRule

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