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From Banking and Finance Law Daily, March 25, 2015

Senate Banking Committee continues debate on raising $50B threshold

By Colleen M. Svelnis, J.D.

The Senate Committee on Banking, Housing, and Urban Affairs has continued discussion on the regulation of regional banks and whether to raise the threshold for enhanced prudential standards. Under Section 165 of the Dodd-Frank Act, all banks with assets of $50 billion or more are subject to “enhanced prudential standards,” which can include heightened capital requirements, leverage, liquidity, concentration limits, short-term debt limits, enhanced disclosures, risk management, and resolution planning. The hearing, “Examining the Regulatory Regime for Regional Banks,” was the second on this issue this month (see Banking and Finance Law Daily, March 20, 2015).

Rigid system. Committee Chair Richard Shelby (R-Ala) noted in his opening statement that “Five years after this threshold was fixed in statute, no legislator or regulator has properly explained where it came from, why it was deemed appropriate at the time, or what analysis supported it. I believe that five years is long enough to know if an arbitrary threshold is appropriate and whether it should be changed.”

Shelby expressed concern that the current system is too rigid and that it “imposes unwarranted costs without enhancing safety and soundness. These costs are then passed along to consumers and businesses by restricting credit and other financial services.” According to Shelby, a regulatory regime “should allow for the maximum level of economic growth while also ensuring the safety and soundness of our financial system.”

Questions remain. Sherrod Brown (D-Ohio), Ranking Member of the committee, spoke about the need to ensure that prudential regulations for regional banks are crafted appropriately. “We all agree that regional banks are not systemic in the same way that money center banks are. The failure of one regional bank, assuming it is following a traditional model, will not threaten the entire system.”

Brown said he hoped the hearing would answer the following questions.

  1. Are there specific standards that are inappropriate for regional banks and why?

  2. Do the concerns being raised stem from implementing regulations, which require no legislation to fix, or from the law itself?

  3. Which concerns can be addressed by using the flexibility that the law provides the Federal Reserve Board, with prompting by the Financial Stability Oversight Council to lift the thresholds for some of these standards?

Regional banks differences. Deron Smithy, Treasurer of the Regions Bank Group, a $120 billion bank based in Birmingham, Ala., said the hearing is addressing issues “of critical importance” to his bank. “Regional banks fund ourselves primarily through core deposits and we loan those deposits back into our communities, where we are important sources of credit to small and medium-sized firms and we compete against banks of all sizes in our markets,” he said. Smithy stressed that regional banks are not complex, saying they “don’t engage in significant trading or international activities, make markets in securities, or have meaningful interconnections with other financial firms,” in describing why regional banks should not be designated systemically important financial institutions (SIFIs).

Smithy talked about the tailoring that currently exists alongside the $50 billion threshold, saying “with an automatic threshold, the tailoring operates only as a one-way ratchet up. Because the threshold for more stringent rules exists as a floor, it separates regional banks from many of their peers and competitors, while occasionally adding new requirements for the most complex firms.”

Smithy listed differences between regional banks and the eight U.S. bank holding companies that are global SIFIs.

  1. Regional banks are more likely to engage in traditional lending.

  2. Regional banks have a loan-to-deposit ratio of 88 percent and net loans and leases represent 65 percent of assets compared to 61 percent and 25 percent for the global SIFIs.

  3. Regional banks are less complex. Their broker-dealer assets account for less than 1 percent of total firm assets compared to close to 20 percent for the global SIFIs.

  4. Regional banks are U.S. institutions. Less than 1 percent of their deposits and loans are outside the United States, while the corresponding numbers are 28 percent and 18 percent for the global SIFIs.

Increased number of compliance employees. Mike Rounds (R-SD), committee member, responded to news that Smithy’s bank employs more compliance employees than commercial lending employees with the following statement: “When a bank is forced to hire more compliance officers or retain more capital it makes fewer loans, this means that there is less money available for small business owners to start or expand their businesses.”

Tailored approach. In his testimony, Oliver Ireland, a financial services lawyer and former Associate General Counsel for the Fed, where he helped establish policies and write rules designed to reduce systemic risk in the financial system and for consumer protection, said that “Section 165 is clearly designed to apply to large, interconnected banking organizations whose failure could threaten the financial stability of the United States.” He stated that other provisions of Dodd-Frank, and other regulatory requirements, including the Volcker Rule and the requirement to use the advanced approaches method in capital calculations, “also provide for varying standards based on thresholds tied to the size of the institution or the size of the activity.”

Ireland said that globally, supervisors are increasingly focused on a broader, more nuanced array of systemic risk measurements rather than just an institution’s size. He gave the example of the Basel Committee on Banking Supervision, which has presented five principal factors for identifying global systemically important banking organizations. These factors include:

  • size (total exposures instead of total consolidated assets);

  • interconnectedness;

  • substitutability;

  • cross-jurisdictional activity; and

  • complexity.

Ireland said that the BCBS systemic risk factors could be tailored to the U.S. economy, and used to identify banking organizations that pose systemic risks to the United States.

Total exposure v. total assets. Simon Johnson, a professor at the MIT Sloan school of Management and co-founder of The Baseline Scenario, also testified for the committee. Johnson said that since 2010, the Fed has not applied one set of standards to all banks with assets over $50 billion, instead, differentiating substantially depending on size, business model, complexity, and opaqueness. He said the differentiation, seems “sensible and reasonably robust.” However, Johnson said the Fed failed to protect consumers in the run-up to the financial crisis, and said these failures were “not due to lack of resources or an unawareness of the changes happening within the financial system.” Johnson said there was a “deliberate strategy of noninterference, along with many instances of actually encouraging various forms of deregulation” and that this resulted in “increased levels of systemic risk.”

According to Johnson, a better measure of potential importance to the financial system as a whole is “total exposure” of a bank holding company, as defined in the Systemic Risk Report form. Johnson said this requires a bank to “report both its on-balance sheet and off-balance sheet activities, including derivatives exposures and credit card commitments, in a comparable way.” The Systemic Risk Reports suggest that at all size levels “it would be sensible to think of bank holding company size more in terms of total exposure (on-balance sheet plus off-balance sheet) as defined in that report, rather than the more narrow measure of total consolidated assets.”

Task force recommendations. Mark Olson, Co-Chair, Bipartisan Policy Center Financial Regulatory Reform, testified about his experience as the co-chair of the Bipartisan Policy Center (BPC) Financial Regulatory Reform Initiative’s Regulatory Architecture Task Force. According to Olson, his task force’s recommendations include raising the threshold from $50 billion to $250 billion, “while giving regulators more flexibility to determine whether or not an institution should be subject to more rigorous oversight.” Olson said his task force “found little support for the idea that the current asset threshold, set at $50 billion and not indexed for any future growth, was an ideal solution to the real issues it was meant to address.”

The task force recommendations, according to Olson include the following two elements.

  1. Raising the bank SIFI threshold to focus on bank holding companies that are more likely to be systemically important. The task force suggested raising the threshold from $50 billion to $250 billion.

  2. Moving from a binary, “solid-line” threshold to a presumptive, “dashed-line” threshold that allows regulators to have more discretion in applying requirements based on other appropriate risk factors.

Olson said the advantages of these recommendations include making the threshold level less arbitrary by making it presumptive. Additionally, he said the threshold would be less likely to capture institutions that pose little systemic risk, and that it would focus scarce regulatory resources where they are most needed.

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