Bowman, Waller voice concerns about Fed's long-term debt proposal

Bloomberg

Two Federal Reserve Board governors expressed concerns about a set of proposals aimed at improving the resolvability of large banks.

Fed Govs. Michelle Bowman and Christopher Waller both raised issues with a potential rule change that would require all banks with at least $100 billion of assets to hold long-term debt. Bowman also opposed proposing new guidance for enhanced resolution plan requirements for certain large banks. 

Bowman and Waller — who both voted against proposed changes to the risk capital framework last month — argued that the changes introduced Tuesday could be too onerous for certain banks. They also noted that the proposals risk undermining the tailoring principles regulators use to ensure the highest level of regulatory scrutiny is reserved for the biggest banks that are deemed the largest risks to the system.

"I am concerned that collapsing Categories II, III and IV into a single prudential category may call into question whether the Federal Reserve is complying with the statutory requirements to tailor prudential requirements for large firms," Bowman said, referring to the Fed's numerical regulatory categories. "Flattening these standards could result in the need for large firms to grow through acquisition to achieve the necessary economies of scale to comply with increased regulatory requirements."

The comments come after the Fed joined the Federal Deposit Insurance Corp. in proposing new standards for banks that are large but fall below the threshold to be considered global systemically important banks, or GSIBs. 

Currently, only GSIBs are required to maintain long-term debt as part of a requirement that they maintain total loss-absorbing capacity. Under the proposal, the calibration of the requirement for non-GSIBs is less onerous than the one applied to their systemically important peers, but would still be large enough to "fully recapitalize failed banking organizations."

Both Bowman and Waller voted in favor of publishing the proposal to gather public comments, but noted significant concerns that, if left unaddressed, could impact their willingness to support the final rule.

"I support putting the proposal out for comment. Having long-term debt can make it easier to resolve a failing bank and may mitigate risks to financial stability," Waller said in a statement. "But, I do have concerns about its calibration. More importantly, I am concerned that our regulatory framework for large banks is moving in a direction that does not tailor requirements in a manner consistent with the spirit of the Dodd-Frank Act, as amended by Congress in 2018."

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In the proposals, the Fed notes that by maintaining certain levels of long-term debt, banks will become more resilient during periods of acute distress because they will have an additional tool for absorbing losses. The central bank also states that such debt would "reduce the speed and severity of bank runs, and limit the risk of contagion when a bank is under stress." 

The proposal notes that banks affected by the rule change would be able to use existing debt to cover much of their new requirements, but estimates that an additional $70 billion of long-term debt will have to be issued collectively.

In her remarks, Bowman questioned the proposal's assertion that long-term debt could have mitigated the bank failures that occurred earlier this year. She also expressed skepticism at the conclusion that the change would have only a "moderate" cost impact on banks, noting that the economic analysis does not factor in the potential impacts of the Basel III endgame rules that were proposed last month. 

"Changes to both risk-based capital requirements and long-term debt requirements could significantly alter how banks are funded, the activities in which they engage, the products they offer, and the markets they serve, yet the proposal does not address these potential indirect costs," Bowman said. "I am concerned that it will be challenging for commenters to understand and meaningfully comment on the proposal, specifically regarding the unintended costs associated with this proposal and the effects those costs could have on banks, their customers and the economy."

Bowman voted against seeking public input on new guidelines for resolution plans for non-systemically important domestic and foreign banks with more than $250 billion of assets. 

The proposal calls for creating a set of criteria for living wills that cater more specifically to the risks associated with banks of this size, also known as Category II and III banks, or triennial filers — because they file resolution plans every three years. 

Bowman noted that the proposal raised questions, such as whether the requirement for banks to compile a "least-cost resolution analysis" will be coupled with transparency around how such reports will be evaluated. She also argued that issuing some guidelines on top of the final Basel III capital requirements would be too burdensome on banks.

"Since each of these rulemaking proposals may impact firms' resolution strategies, it might be more effective to delay publication of the resolution-planning guidance until the pending proposals are finalized," she said.

The proposals have been posted to the Federal Register and will be open to public comment until Nov. 30.