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From Banking and Finance Law Daily, March 20, 2015

Senate banking considers whether $50 billion threshold is one-size-fits-all

By Colleen M. Svelnis, J.D.

The Senate Banking Committee has held a hearing examining the impact of the existing regulatory framework on regional banks. Under 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 was titled “Examining the Regulatory Regime for Regional Banks,” and had testimony from agency heads on their supervisory and regulatory practices.

Opening statements. Richard Shelby (R-Ala), Chairman of the committee, said that regional banks “have been placed in a regulatory framework designed for large institutions because of an arbitrary asset threshold established by the Dodd-Frank Wall Street Reform and Consumer Protection Act.” Shelby expressed concern about the “arbitrary” $50 billion threshold. “I would like to hear from the witnesses today whether the $50 billion threshold is the appropriate and most accurate way to determine systemic risk in our banking sector.”

“I have always been a proponent of prudent regulation and strong capital requirements. We must, however, consider the economic impact of subjecting banks that are not truly systemically risky, to enhanced prudential regulation. We must also ask whether the existing regulatory framework is the best use of regulators’ resources.”

Shelby referred to an Office of Financial Research report that he says shows that regional banks generally pose a small fraction of the risk to the financial system compared to the largest banks.

Sherrod Brown (D-Ohio), Ranking Member of the committee, also spoke to open the meeting and stressed the importance of ensuring that prudential regulations for regional banks are crafted appropriately. He said that enhanced prudential standards are important not just to respond to the last crisis, but also to prevent the next crisis. “I agree we should not over-regulate, and so did the authors of Dodd-Frank.” He said the Dodd-Frank Act called for heightened rules for large bank holding companies, but that it also directed regulators not to take a one-size-fits-all approach.

Brown stated that the rules were not meant to cover just the “Too Big to Fail” banks, or the “systemically important” ones. He highlighted that the failure of a single large institution can create systemic risk, but so can multiple failures of similar small or mid-sized institutions.

Asset size a “starting point”. Thomas J. Curry, the Comptroller of the Currency, testified at the hearing regarding his agency’s experience with section 165 of the Dodd-Frank Act, and the OCC’s approach to tailoring its regulatory and supervisory expectations. Curry noted that the OCC’s role in section 165 is limited and said its only direct rulemaking authority is with respect to the company-run stress test requirements under section 165(i)(2). But Curry also stated that the provisions of section 165 have a significant effect on national banks and the OCC’s supervisory oversight of those institutions.

According to Curry, the OCC has tailored its supervisory programs into three distinct portfolios: community banks, midsize banks, and large banks. Additionally, Curry said the agency seeks to tailor the application of its supervisory standards and expectations to the size and complexity of each individual bank. “We believe our risk-based supervisory approach is consistent with the tailored application that Congress provided for in section 165,” said Curry.

Curry said that while “a bank’s asset size is often a starting point in our assessment of appropriate standards, it is rarely, if ever, the sole determinant.” He said the OCC’s supervisory programs are structured to allow adjustments to the supervisory oversight as a bank’s risk profile changes.

Criteria beyond asset size. In his testimony, Martin J. Gruenberg, Chairman of the Federal Deposit Insurance Corporation, said that the companies that meet the $50 billion threshold for enhanced prudential standards represent a significant portion of the U.S. banking industry. According to Gruenberg, as of Dec. 31, 2014, 37 companies with combined assets of $15.7 trillion reported total assets greater than $50 billion. They owned a total of 72 FDIC-insured subsidiary banks and savings institutions, with combined assets of $11.3 trillion, which is 73 percent of total FDIC-insured institution assets.

The FDIC has developed criteria to identify community banks that included more than a strict asset size threshold according to Gruenberg. These criteria include the following:

  • a ratio of loans-to-assets of at least 33 percent;

  • a ratio of core deposits-to-assets of at least 50 percent; and

  • a maximum of 75 offices operating in no more than two large metropolitan statistical areas and in no more than three states.

Based on the criteria, 93 percent of all FDIC-insured institutions with 13 percent of FDIC-insured institution assets currently meet the criteria of a community bank. Gurenberg said this covers 6,037 institutions, 5,676 of which have assets under $1 billion. The average community bank holds $342 million in assets, has a total of six offices, and operates in one state and one large metropolitan area.

However, Gruenberg said The FDIC does not have a similar set of criteria to identify regional banks. He described regional banks as “institutions that are much larger in asset size than a typical community bank and that tend to focus on more traditional activities and lending products.”

Gruenberg also described how the FDIC and the Fed used statutory discretion to develop a joint resolution planning rule that recognizes the differences among institutions and scales the regulatory requirements and potential burdens to the size and complexity of the institutions subject to that rule.

According to Gruenberg, regulatory agencies “should be cautious about making changes to the statutory framework of heightened prudential standards that would result in a lowering of expectations for the risk management of large banks.” He also said that it is appropriate to take into account differences in the size and complexity of banking organizations when formulating regulatory standards.

Compliance burden remains. Fed member Daniel K. Tarullo testified that the Fed was pursuing a tiered approach to prudential oversight in its supervisory and regulatory practices. Tarullo said the Fed has tailored its supervision of banking organizations by reference to size, business model, and systemic importance. He asked whether there is a threshold that is appropriate for mandatory application of a particular regulatory requirement, taking into account whatever discretion is given to the implementing regulatory agencies.

Tarullo did say that there are some statutory thresholds that might bear reexamination, and specified two:

  1. The Dodd-Frank Act provisions related to community banks. Even with tailored applications by the regulatory agencies, there still remains a level of compliance necessary at community banks.

  2. The 50 billion threshold under section 165. Tarullo cited difficulty in customizing stress testing, which he said can be a challenge for banks that just hit the threshold. Additionally, Tarullo said the supervisory benefits are “relatively modest” for these financial institutions.

Chart accuracy questioned. Better Markets, a nonprofit public interest organization released a statement following the hearing in response to Tarullo’s questioning of the accuracy of a Better Market’s Factsheet chart entitled “Tailored Key Elements of Enhanced Prudential Regulation.” The statement asserts the accuracy of the chart and says, “The $700 billion figure he questioned comes directly from the Federal Reserve own rules that were adopted on April 8, 2014, which placed an ‘enhanced supplementary leverage ratio’ on bank holding companies with consolidated assets ‘in excess of $700 billion.’”

The statement said the “counterparty risk” item Tarullo was seeking was covered by the “Capital” item in the chart. “More importantly, the Fact Sheet identifies the chart as a list of ‘key elements’ not ‘all elements’ and provides other important context. As Comptroller Curry stated at the hearing, the chart is accurate.”

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