WASHINGTON — Banks are pushing the Federal Reserve and other regulators to advance their regulatory relief efforts even further than proposed, while public interest groups and even one Fed regional bank say the agencies' plans to ease the post-crisis supervisory framework already go too far.
The comment period for a pair of proposals released in October expired earlier this month, and one of the most fundamental points of contention was whether asset size alone should determine whether a bank is subject to enhanced prudential standards.
The proposals — part of a broader recalibration of the post-crisis regime — raise certain asset thresholds to narrow their scope to fewer institutions while in other areas incorporate factors other than size to determine applicability. But both regulatory hawks and reg relief advocates believe the agencies' proposed adjustment needs improvement.
The American Bankers Association "strongly supports the consideration of risk factors beyond simple measurements such as asset size" but "such factors should be as precise and aligned to actual risk exposure as we can reasonably realize,” said Hugh Carney, the ABA's vice president for capital policy. (Most commenters submitted a single letter for both proposals.)
On the other side, the Americans for Financial Reform said the proposal issued by the Fed could enable banks to more readily game the system. The group said asset size is a good determinant of regulatory class while adding secondary considerations like overseas assets and nonbanking activity creates opportunity to eschew regulatory controls.
“We are concerned that such changes will make it easier for banks to arbitrage their exposure to different prudential rules, and make the application of such rules less transparent to the public,” according to the letter by AFR's Education Fund, submitted to the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency. “We believe that size is the single best indicator of the economic importance of a bank and that the complexity metrics used in the proposed rule risk unjustifiably lowering prudential standards for extremely large banks.”
In an unusual move, the Federal Reserve Bank of Minneapolis also submitted a letter opposing the Fed proposal, which would implement sections of last May's regulatory relief law enacted by Congress.
Regional Fed banks are not involved in the development of regulatory policy, which is vested solely with the Federal Reserve Board. Nonetheless, the Minneapolis Fed argued that the board's plan is “alarming” and runs the risk of lowering capital retention in the banking system, thus creating the conditions for another financial crisis. The bank's president, Neel Kashkari, has supported tougher measures for the largest institutions.
“Recent evidence — some of which economists from the Board of Governors itself has produced — finds that equity funding requirements for the largest banks are too low, not too high,” the Minneapolis Fed said. “Even measures of the credit cycle and financial stability risk indicate that it is likely prudent for banks to continue to build capital,” the bank said.
When President Trump signed the Senate’s regulatory relief bill last year, banks with less than $100 billion were automatically exempted from the enhanced prudential standards mandated in the 2010 Dodd-Frank Act. But the new law required the Fed to decide which of its post-crisis rules to apply to banks with between $100 billion and $250 billion. (Dodd-Frank previously subjected all banks above $50 billion to the full array of standards.)
On Oct. 31, the agencies issued two proposals, one exclusive to the Fed's authority under the new law that addresses regulatory changes such as reforms to the central bank's stress test regime. The other issued jointly by the three agencies dealt with risk-based categories for determining a bank's compliance with pre-existing capital and liquidity rules.
Under the proposals, banks above $100 billion would fall into a four-tier regulatory structure. Category I would be comprised of the eight U.S. "global systemically important banks," or G-SIBs; Category II banks would have either more than $700 billion of U.S. assets or more than $75 billion of cross-jurisdictional assets; Category III banks would have more than $250 billion of assets and exceed certain other risk metrics; Category IV banks would have assets of $100 billion to $250 billion.
Category I and Category II banks would receive virtually no change in their regulatory burden. Banks in Category III and IV, meanwhile, would have their obligations under the Liquidity Coverage Ratio and Net Stable Funding Ratio reduced or eliminated. The banks would also face less frequent stress testing, be able to opt out of requirements that they account for "accumulated other comprehensive income," and enjoy other forms of relief.
In practice, only Northern Trust would fall into Category II, while only U.S. Bancorp, PNC Financial, Capital One and Charles Schwab would be included in Category III as a result of the proposals.
The consumer advocacy organization Public Citizen argued in its comments that the idea of breaking banks into different categories according to their risk profile is sensible; however, the regulators do not explain how they determined those categories or the level of regulatory burden in each class, the group said.
“We do not object to these categories, although agencies have provided no clear explanation of why these break points are relevant, or why there should be four categories instead of five, or ten,” Public Citizen said in its comments. “We ask the agencies to provide such a justification before finalizing the rule.”
Bankers that would still face a tough regulatory regime also argued that the new proposed thresholds seem arbitrary, but for different reasons.
Michael O’Grady, president and chief executive of Northern Trust, argued in the bank’s comments that the $75 billion overseas asset threshold for Category II was inappropriately static and failed to account for both overseas assets and liabilities. As a custody bank, Northern Trust relies on stable overseas deposits as well as exposures. Having a mix of both assets and liabilities mitigates any risk on the balance sheet, O'Grady said.
“At a minimum, the final tailoring rules should allow cross-jurisdictional claims consisting of central bank deposits and other high-quality liquid assets to be netted against cross-jurisdictional liabilities in the same jurisdiction when calculating cross-jurisdictional activity, thus focusing the risk-based indicator on the activities that actually give rise to the risks it is designed to capture,” O’Grady said.
A joint letter from PNC, U.S. Bancorp and Capital One welcomed the Fed’s tiered approach and the regulatory changes that would differentiate them from the G-SIBs. But they argued that additional changes would better capture the lower risk profile that their institutions pose. Specifically, the banks suggested that the Fed include Category III banks in a more extensive rollback of the liquidity coverage ratio, or LCR.
Under the modified LCR, the calculation of total net outflows used to determine banks’ liquidity requirement is based on the difference between a peak outflow and the 30-day average net outflow. The modified LCR was meant to reduce the maturity mismatch of liabilities, the banks said, and that rationale is applicable to banks in Category III as currently defined.
“The Federal Reserve has previously determined that the modified LCR and proposed modified [net stable funding ratio] are appropriate for banking organizations that are ‘smaller in size, less complex in structure, and less reliant on riskier forms of market funding’ than banking organizations subject to the agencies’ full LCR rules,” the banks’ letter said. “Qualifying Category III banks exhibit the same attributes as those banking organizations for which the Federal Reserve developed the modified LCR.”
