|Yesterday, the Senate Banking Committee released summaries of a bill that paves the way for reduced regulation of 26 regional banks representing $3.7 trillion worth of consolidated assets in one fell swoop. The bill encompasses issues ranging from consumer protection to basic mortgage guidelines to systemic risks posed by the biggest financial institutions in the country.
It’s a comprehensive bill that has been negotiated for about two weeks. It will take a good deal longer for it to be introduced, marked-up, debated (probably in that order), and for the House and White House to perfect it. Help for big banks could be in the midterm mix for candidates and voters in ‘18.
What’s in the bill and what systemic risk problem does it seek to solve? See below.
The Senate Banking compromise would provide regulatory relief for banks in the $1 billion to $10 billion asset range. But Section 401 raises the threshold for applying enhanced prudential standards from the current level of $50 billion to $250 billion. Firms holding $50 billion to $100 billion would be relieved immediately. Those with $100-250 billion are set loose after 18 months.
As Senators evaluate this proposal, they will consider the main requirements and practices that fall under Dodd-Frank’s “enhanced prudential standards.” What are these requirements? What do they matter the to big beneficiary banks? Is the status quo better and worth defending?”
For several months if not years, members of Senate Banking have dismissed ways to provide relief to small financial institutions. In a move that came as a surprise to most observers, a handful of Senate Democrat negotiated with Committee Chair Crapo to cut regulations on 26 regional banks that together hold $3.7 trillion — over one sixth of industry assets.
Democrats and independents supporting the legislation include Senators:
• Joe Donnelly (Indiana) *
• Heidi Heitkamp (North Dakota) *
• Tim Kaine (Virginia)
• Angus King (I-Maine)
• Jon Tester (Montana) *
• Mark Warner (Virginia)
• Joe Manchin (West Virginia)
• Claire McCaskill (Missouri) *
• Gary Peters (Michigan)
* up for re-election next year
The proposal has divided Democrats already. One key point of departure: regulating the in-between big and small financial institutions, a diverse set of firms any of which could someday be the next IndyMac or Lehman Brothers — firms that aren’t among the biggest but are canaries in the mineshaft, early warning signs of systemic instability and collapse a la 2008.
What do Big Banks Really Want?
Section 401 of the bill is at the top of the legislative agenda in this Congress with trade and lobbying groups the American Banking Association. What does it provide?
• Stress Tests
Comprehensive Capital Analysis and Review (CCAR) for banks over $50 billion quantitatively and qualitatively evaluates a firm’s capital adequacy and planned capital distributions. The purpose is to determine whether firms are sufficiently capitalized to operate and lend to creditworthy households and businesses during times of financial stress. The Fed may or may not object to a firm’s capital plan after the review.
Today, the U.S. economy benefits from a careful process of weighing every regional bank’s ability to withstand stress. The policy was designed to ready firms for financial crisis. Over the last seven years, regional banks have become healthier: this year, every firm subject to CCAR earned approval of its capital plans. This demonstrates a track record of success. Our economy is safer with CCAR applied to banks between $50 billion and $250 billion each year.
Under the bill, 31 regional banks would no longer be subject to Fed oversight via CCAR requirements. Additionally, they would no longer be required to maintain a greater than 4.5 percent post-stress common equity Tier 1 capital ratio. Regional banks would lose a regulatory structure that is geared toward incentivizing preparation for crisis.
It is hard to imagine President Trump’s appointees recreating a similar architecture. So these firms would enjoy millions of dollars in savings as a result of no longer having to invest in systems to meet the Fed’s expectations.
• Liquidity Coverage Ratio
The Modified Liquidity Coverage Ratio (LCR) is explicitly meant as a less stringent version of the LCR affecting banks over $250 billion in size that are internationally active. The modified rule requires the firms with $50 billion or more in total assets to hold a certain amount of High Quality Liquid Assets. The purpose of the ratio is to reduce liquidity risk.
The “High-Quality Liquid Asset” category includes only those with a high potential to be converted easily and quickly into cash. There are three categories of high-quality liquidity assets with decreasing levels of quality: level 1, level 2A and level 2B assets.
• Living Wills
Aka Resolution Plans, the requirement that banks with $50 billion or more in assets submit worst-case scenario resolution plans annually to the Fed and FDIC. Regional banks must submit plans outlining the strategy for quick and ordered resolution in the event of failure or material financial distress. The banking industry is more stabile because this process helps regulators and firms think about mapping an exit strategy that minimizes systemic consequences of firm failure.
Under the bill, 31 regional banks would no longer be required to make such preparations. When a number of firms of this medium-range size slip under a sectoral slide at once, the entire national economy faces risks, as we well know.
For Small Banks
The nine Democrats who have signaled support for the bill may be attracted by provisions designed to give regulatory relief to small banks in their constituencies.
• Basel III Capital Regime Relief — The bill would significantly simplify Basel III requirements for banks that hold less than $10 billion in assets. Banks this size that meet a leverage ratio of between ten and twelve percent would be considered in compliance with capital and leverage requirements. Notably, most small banks already hold the capital required to be compliant.
• Volcker Rule — The deal would further benefit banks with less than $10 billion in assets by exempting them from the Volcker Rule, provided the bank’s trading assets and liabilities are not more than 5 percent of total assets.
• Reciprocal Deposits — The bill would change the treatment of reciprocal deposits brokered by the Federal Deposit Insurance Corporation. While banks would still have to go through the FDIC, they would no longer have to request a waiver for deposits that fall from “well capitalized” to “adequately capitalized.” Banks complain that, under the current law, obtaining a waiver takes far too long.
• Call Reports and Examination Cycles — Small banks with less than $5 billion in assets would be able to file short-term call reports. In addition, the bill would extend the examination cycle for banks under $3 billion in assets to 18 months (the current threshold is $1 billion).
• Mortgage Providers — Banks and credit unions that manage less than $10 billion in assets would get relief from several mortgage regulations. Mortgages held by these institutions would not be considered “qualified mortgages” under Dodd-Frank, expanding the type of mortgages banks and credit unions can offer.
It is not surprising to see a number of provisions designed help small banking institutions in the Crapo deal. Broad bipartisan support of small and community banking relief is well documented. However, this point does little to explain the motivation behind agreeing to raise the critical asset threshold. A bill solely focused on small banks would have passed the Senate with 80 votes, so why attach it to something that will substantially increase systemic risk in the American financial sector?
Those who support hiking the $50 billion asset trigger by five times (you could say reducing protections by five times) and deregulation the vast majority of the nation’a 50 biggest financial firms, despite conflicting evidence the Section 401 relief would boost bank profits much more, let alone usher in a golden age of lending. A bank with $50-250 billion in assets cannot guarantee it won’t trigger a crisis. The bank does so next time might be an IndyMac — itself not even $50 billion in size when its failure greatly aggravated other threats our financial system