|With S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, set to hit the floor tomorrow, attention is now turning to the least discussed and most abstract — and systemically most consequential — part of the bill.
Title IV of S. 2155 is not like the first three titles. Those three involve benefits provided to a diverse range of stakeholders, with tradeoffs for competing stakeholders. Not so Title IV: chiefly its Section 401 provisions, benefiting 30 out of the nation’s top 40 financial institutions exclusively and very generously. One of those provisions was the ABA’s chief legislative goal for 2017.
Below, we review Section 401 of the Act and its impact on safety and soundness rules as they apply to the biggest financial firms in the country.
Raising the Standards Threshold Fivefold
Section 401 of S. 2155 provides for a five-fold increase in the size threshold for firms to be subject enhanced prudential standards. These standards themselves are then deregulated further in the rest of the Section.
The ABA-prize centerpiece of the legislation increases the asset threshold for the automatic application of post-crisis safeguards, known as enhanced prudential standards, from $50 billion to $250 billion.
This change would deregulate 25 of the country’s largest 34 banking institutions in the country. These 25 together hold $3.5 trillion in assets and collected a total of $47 billion in TARP funds after the financial crisis. Raising the asset threshold from $50 billion to $250 billion would amount to the largest rollback of Dodd-Frank attempted to date.
Section 401 does give the Fed discretion to re-apply enhanced prudential standards to financial institutions with total assets between $100 billion and $250 billion, should they pose substantial systemic risk. Given the choice, the Trump appointees who would be responsible for reapplying standards are likely to err on the side of under-regulation. Fed Governor Randal Quarles, a known opponent of the enhanced prudential regulatory regime under the Dodd-Frank Act, is unlikely to retain many of these standards for institutions with assets under $250 billion.
Worse, it is possible that the Fed will lose discretionary powers to administer enhanced prudential standards to even the largest firms as a result of the legislation. S. 2155 will amend Section 165 of Dodd-Frank by changing the word “may” (with regard to the Fed’s ability to tailor the application of enhanced prudential standards, based on “risk-related factors”) to “shall.” The wording change puts greater pressure on the Fed to weaken its enhanced prudential requirements even for the very largest SIFIs, and would encourage financial institutions to file lawsuits if the Fed decides to put them on the list.
Stress Tests: Deregulation as Data Deprivation
A mandatory system of regular and consistent stress tests is one of the most important policy innovations of the post-crisis era. Stress testing allows for more accurate projections of losses that banks would suffer under adverse financial conditions, which enables bank managers and regulators to determine whether a given bank would remain solvent under severe financial stress. Post-stress capital levels have increased substantially since the crisis, demonstrating the positive overall impact of mandatory stress testing on the health of the financial system. Last year, 33 of the nation’s largest 34 banks passed CCAR stress tests — an indicator that these institutions are better able to withstand crisis conditions.
The bill would make the current system of stress testing more complicated, fragmented, and potentially much less effective. Broken down by asset holdings we can see these potential effects as follows:
- $50 billion to $100 billion in assets: Banking institutions in this asset class would no longer be subject to Fed-run stress testing.
- $100 billion to $250 billion in assets: 18 months after the enactment of this legislation, banking institutions in this asset class would no longer be subject to annual Fed-run stress tests. A substitute test would simulate performance only under an adverse economic scenario, meaning these banks would no longer undergo stress testing that measures baseline and extremely adverse economic scenarios, and would likely be tested less frequently. As with other enhanced prudential standards, S. 2155 grants the Fed additional authority to exempt banks in this asset class from stress testings before the 18 month review period.
- Banks with at least $250 billion in assets: 18 months after the enactment of this legislation, banking institutions with at least $250 billion in asset size will no longer be subject to Fed-run stress testing that measures adverse economic conditions. These banks will only undergo stress testing that measures performance under baseline and extremely adverse economic conditions.
Liquidity Coverage Ratio
The Liquidity Coverage Ratio (LCR) directs financial institutions to hold a certain amount of High Quality Liquid Assets (HQLA), relative to their net outflows. This ensures that SIFIs are able to cover losses in the event of a market shock without defaulting or contributing to a crash. As with all “enhanced prudential standards,” this bill would allow the Fed to relieve banks with less than $250 billion in total assets from the constraints of the LCR — a uniquely excessive deregulatory measure.
The Fed has already “tailored” the LCR for banks between $50 and $250 billion in asset size by adopting what is known as the modified LCR (mLCR). This means that the Fed has already decided that these institutions should have different regulations and apply them appropriately. The Fed is also currently considering changing the mLCR for these institutions on a sliding scale with new ratios. Codifying that they “shall” consider each institution individually and quintupling the asset threshold will either be irrelevant or, given the current and incoming crop of regulators, extremely dangerous.
Living Wills: Unwarranted, Unwanted Relief
As with the other enhanced prudential standards, S. 2155 would mean that:
- Banks with total assets between $50 and $100 billion would be immediately exempt from the requirement to submit annual living wills.
- Banks between $100 and $250 billion would be subject to the Fed’s discretionary oversight, pending an 18-month review period. The extent to which the Fed would require these firms to continue resolution plan submissions is unclear. Chairman Powell has been broadly supportive of living wills and the other pillars of Dodd-Frank, but others at the Fed, including the new Vice Chair for Supervision Randal Quarles, have been less supportive in the past.
In his remarks before the Senate Banking Committee on Thursday, Chairman Powell remarked that the financial system is much healthier now than it was in 2007-08, and specifically cited living wills as having contributed to this stability.
Industry is generally supportive of the provision. In December, JPMorgan Chase Chairman and CEO Jamie Dimon expressed his belief that living wills were “good for industry.” It is widely acknowledged that the very process of preparing these submissions, under an explicit mandate of the law, actually helps banking institutions’ management to gain a better enterprise-wide view of their businesses.
There is also begrudging Republican acceptance for living wills. Resolution planning prepares firms for potential liquidation, and makes it less likely that they will have to go through the FDIC’s Orderly Liquidation Authority (OLA). Many Republicans claim this special resolution alternative distorts the market by circumventing the bankruptcy process, and this mistrust of OLA tempers their distaste for living wills. Despite this broad acceptance of the importance of resolution planning, S. 2155 would mean that many the nation’s largest banks would no longer be required to submit these plans.
Missing the Forest for the Trees
Just a decade after the largest financial crisis in nearly a century, S. 2155 seeks to deregulate some of the most systemically important banking institutions in the country. The bill’s creators set out to bring regulatory relief to community banks which they claim are overburdened by onerous compliance costs. While the bill does bring some modest relief to these small banks, the most impactful section of the bill is focused on reducing burdens on much larger banks that have registered record profits in recent years.
A cloture vote on S. 2155 is scheduled in the Senate tomorrow. That procedural measure is expected to pass easily. And then comes the floor debate and possibly amendments, but possibly with an agreement among the bill’s supporters to lock arms as was done in a Senate Banking markup that saw no amendments adopted. The floor speeches may be more interesting.
*DB USA Corporation and Santander USA INC are Intermediate Holding Companies of foreign-based banking institutions.