Fed Feels Heat to Tailor Capital Rules for Nonbank Firms

WASHINGTON — Lawmakers are increasing pressure on the Federal Reserve Board to apply different capital rules to nonbank financial firms, like insurance companies, thought to be risky to the financial system.

A bipartisan group of senators introduced a bill this week that would clarify a provision of the Dodd-Frank Act to say that the central bank does not have to apply bank-like capital requirements to systemically important nonbank firms.

The issue has been brewing for months, with the industry insisting that the Fed has the power to tailor the rules for nonbank firms and Fed officials arguing that Dodd-Frank mostly tied their hands. Observers said such firms will ultimately be treated differently, but it's not clear when or how it will happen.

"When we get to the end of this story, I think that nonbank SIFI insurers will have different capital rules than banks, but the path to getting there is murky at best right now," said Isaac Boltansky, an analyst with Compass Point.

It is one of the biggest unanswered questions of the post-financial regulatory system nearly four years after the passage of Dodd-Frank, and has been raised frequently at hearings on Capitol Hill.

At issue is how the Fed will interpret a provision of the financial reform law authored by Sen. Susan Collins, R-Maine, that said there must be universal minimum capital requirements for all systemically important institutions. The central bank has signaled that it is willing to tailor capital rules as best as possible for insurers and other nonbank firms, but has said it is limited by the statute in what it can do.

"I think it's important to note that we do operate under a constraint here," said Fed Gov. Daniel Tarullo at a Senate Banking Committee hearing on July 11. "It, that is to say that the Collins amendment does require that generally applicable capital requirements be applied to all of the holding companies that we supervise."

The Collins amendment was intended to apply bank-like capital requirements to larger firms under the Fed's purview, including bank holding companies. But lawmakers, even some who supported Dodd-Frank, are claiming the capital floors were not meant for other types of firms.

Sens. Sherrod Brown, D-Ohio, Susan Collins, R-Maine, and Mike Johanns, R-Neb., introduced legislation last week that would attempt to address the issue, following a hearing last month by the Senate Banking financial institutions subcommittee, which Brown chairs. The bill would clarify the Fed's authority to distinguish its application of stringent capital rules between banks and insurance companies.

Both lawmakers and the insurance industry have pointed to the fact that insurers, unlike banks, rely on funding from customer premiums, transact long-term investments and insure against natural disasters.

"Traditional banking operations — while faced with a different set of challenges — conduct business distinctly different than that of an insurer," Brown said in rolling out the bill with his co-authors. "That is why the Federal Reserve must recognize the differences between the industries and ensure that institutions engaging in insurance are not held to the same capital requirements as traditional banks."

Under the reform law, the Financial Stability Oversight Council has the power to name nonbank firms as systemically risky, but it is up to the Fed to decide how to supervise those institutions. To date, FSOC's designations have included two insurance powerhouses — American International Group and Prudential Financial — and others are said to be under consideration.

The American Insurance Association also already endorsed the bipartisan legislation, saying it reflects the consensus of Congress and the Fed in recognizing differences between banks and insurance companies.

"The bill clarifies the Federal Reserve Board's ability to tailor appropriate insurance-based capital standards for the insurance companies under its supervision," said Leigh Ann Pusey, president and CEO of AIA.

But political analysts are skeptical of how quickly a final bill can pass, while noting that its existence helps put the issue into the political spotlight. (A nearly identical bipartisan bill is being touted in the House.)

"We continue to question how quickly Congress will act as this measure does provide lawmakers with fundraising opportunities and this is something that could be done in the fall or during the lame duck session in the winter," Jaret Seiberg, an analyst with Guggenheim Securities wrote in an analyst note.

Brown hoped to use the hearing last month to build support for the Fed to exercise its own flexibility in adapting how capital regulations should apply to insurance companies.

Collins, who testified at the hearing, argued that her provision was not meant to impose bank-like standards on firms like insurance companies, but more recently noted that the bipartisan bill would eliminate any uncertainty surrounding the issue.

"Our bill removes any doubt about the Federal Reserve's authority to draw this distinction and addresses the legitimate concerns raised by insurers," said Collins.

But analysts suggest the likelihood that Congress would be receptive to re-opening the 2010 Dodd-Frank Act is slim given Senate Banking Committee Tim Johnson's reluctance to do so.

"Senator Johnson wants his legacy as chair to be that he put a moat around the Dodd-Frank Act and that the law wasn't materially altered under his watch," said Boltansky. "So I doubt that this insurance bill is going to get a clear runaway to passage in 2014."

That could all change next year. Brown is in position to have more power on the committee once Johnson retires. If Democrats keep the Senate, he is a leading candidate to chair the panel. If Republicans take control, Brown could serve as its ranking member.

Still, some believe that the Fed will likely use the legal arguments offered by Collins, Brown and the industry to find its own solution.

"Even if Congress fails to act, we continue to believe the Federal Reserve will follow the logics detailed in numerous industry memos to conclude that the Collins Amendment does not require nonbank SIFIs to follow the same capital rules as existed for banks," said Seiberg.