WASHINGTON — Formally designating domestic systemically important banks could improve transparency and oversight over such firms but may also introduce additional complexity to an already intricate regulatory system, industry experts say.
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"Doing so could provide helpful transparency and rigor for those banks that need it," he said. "As it would clarify the stakes involved in weakly supervising and regulating such institutions."
Section 165 of the Dodd-Frank Act created a tiered regulatory framework that requires the Federal Reserve to apply stricter regulations to larger bank holding companies based on their asset size. The larger a bank holding company is, the more stringent the oversight and regulatory requirements become — including provisions for stress testing, resolution plans and higher capital requirements.
However, Section 165 specifically applies to banks' parent entities and not directly to how other regulators — namely the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. — oversee the subsidiary banks of these holding companies.
Despite this legal ambiguity, both the OCC and the FDIC have adopted similar tiering approaches based on a bank's asset size, applying more stringent regulations to larger banks even though they are not technically required to do so under Section 165.
Jeremy Kress, a professor at the University of Michigan Ross School of Business, says the idea of establishing a DSIB designation framework would involve the agencies themselves developing a mechanism for identifying and regulating riskier domestic banks, which would be similar to designation authorities that exist for global systemically important banks and nonbanks.
"You might imagine an approach like the Fed's GSIB methodology, with appropriate adjustments given the domestic nature of the firms' operations — e.g., no cross-jurisdictional activity metric," he said. "I presume that Hsu must have in mind some other approach to designating DSIBs that is based on other metrics beyond just asset size."
The Basel Committee on Banking Supervision has provided guidelines for determining DSIBs, with a focus on factors such as a bank's size, complexity, substitutability and interconnectedness. However, unlike many other countries, the U.S. does not formally designate a category of domestic systemically important banks, though Section 165 provides heightened oversight of large domestic non-GSIB banks that are required to undergo stress testing and submit resolution plans under Dodd-Frank.
Banking scholar Art Wilmarth said it is unlikely the OCC would designate the largest non-GSIB firms — those with between $100 billion and $250 billion of assets known category IV banks — as DSIBs since these banks already fall into an existing regulatory tier with a distinct set of regulatory requirements. Further designating them as DSIBs could add unnecessary complexity to the regulatory system without significant benefits.
"I am not sure what a new designation for DSIBs would achieve given the existing category II and category III classifications for non-GSIBs," Wilmarth said. "If the OCC's proposed classification of DSIBs would be different from category II and/or category III, it would likely introduce additional complexity into an already complex system of supervision and regulation."
Todd Baker, managing principal at Broadmoor Consulting and a senior fellow at Columbia University, said designating DSIBs could make U.S. oversight of certain large firms more consistent with global standards, but large domestic banks that are required to do stress testing and submit resolution plans under Dodd-Frank are already subject to heightened regulation.
"This group [of] more than 20 banks … are effectively treated as U.S. DSIBs," Baker said. "What Comptroller Hsu seems to be suggesting is that regulators should take a more proactive approach in identifying institutions with true systemic importance [and] clarify the supervisory expectations for these institutions."
TD Cowen analyst Jaret Seiberg said in a note he sees domestic designation as a real possibility for regional banks with at least $50 billion in assets, though it could take years to be proposed and implemented.
Wilmarth suggested that any process to designate domestic systemically important banks as DSIBs is unlikely to raise capital levels for these firms. Given the current pushback from the banking industry over other capital increases, such as those tied to
"Given the ongoing retreat by the federal bank regulators from their original Basel III endgame proposal, it doesn't seem likely that the regulators would be prepared to propose a new category of DSIBs that would receive more stringent supervisory and regulatory treatment than the forthcoming, watered-down Basel III endgame rules for category II and category III institutions," he said.
While Hsu did not explicitly call for a capital surcharge for these banks, Seiberg said it is not certain that the designation of domestic firms would completely preclude the possibility of additional capital implications for designated firms.
"The expectation after Congress enacted Dodd-Frank is that banks would face a capital surcharge starting at $50 billion of assets to reflect the enhanced risk they represented if they failed," he said. "We believe a surcharge would be inevitable as the goal will be to reduce the risk of their failure by having them hold more capital."
Baker said designated firms would be more likely to face softer checks on their riskiness in the form of supervision, rather than capital requirements.
"[Additional capital requirements are] unlikely," he said. "What is more likely is an enhanced supervision regime and the imposition of risk limits of some kind associated with particularly systemically sensitive business models."
