Large regional banks could become the country’s next too big to fail firms, acting Comptroller Michael Hsu said, and the agency is looking at ways of incorporating resolvability into its bank merger review process.
Bank merger policy has become a hot-button financial regulation issue after it sparked the power struggle on the board of the Federal Deposit Insurance Corp. late last year. While Hsu has supported moving forward on bank merger issues in his capacity on the FDIC board, he’s been more quiet than fellow Democrats Martin Gruenberg, who now leads the FDIC, and Rohit Chopra, director of the Consumer Financial Protection Bureau. The OCC plays a critical role in overseeing mergers among larger banks.
Hsu’s remarks, given at the Wharton Financial Regulation Conference on Friday, outline his concerns on bank mergers largely in the context of what he says could be a threat to financial stability. His comments signal a tougher time for banks going through the merger review process, said Bao Nguyen, a partner at Skadden's Financial Institutions Regulation and Enforcement Group.
“Larger transactions involving regional banks are going to be more costly for organizations both as a transaction cost matter and on an ongoing basis,” he said.
The four largest non-systemically important banks have consolidated assets more than $500 billion, Hsu noted.
“If one were to fail, how would it be resolved?” Hsu said.
Currently, the solution would be for regulators to sell that bank to one of the country's global systemically important banks, or GSIBs, making that bank even larger and more systemically important. That might work to a certain extent, Hsu said, in that markets would continue to chug along and a bank run would be avoided.
“But from a broader financial stability perspective, a GSIB would be forced through a shotgun marriage to be made significantly more systemic, with minimal due diligence and limited identification of integration challenges, which for firms of this size are significant,” he said. “In addition, with the resulting increase in the concentration of banking — of making one of the biggest firms even bigger and more systemic — trust in the resolution process and in the government’s ability to proactively manage such situations would likely erode, just as it did over the course of 2007 when a series of such shotgun marriages were carried out.”
Reforming bank merger policy could be a way to address these issues, Hsu said. While the OCC would need the cooperation of the FDIC and Federal Reserve to enact changes “on a permanent basis,” there are moves the agency could make in the short term, he said.
But trying to regulate systemic risk by addressing mergers is a double-edged sword: Being too restrictive could make banks less competitive and being too lenient could concentrate risk in a few institutions. Hsu suggested the solution isn’t to stop them entirely, he said, because more GSIBs means more large banks competing with each other. He said the goal should be that new large banks should demonstrate their resolvability as part of the merger process.
“Prohibiting such mergers could shield the GSIBs from competition, potentially helping to solidify their dominance in various markets,” Hsu said.
The OCC is considering hinging approval for large bank mergers on requirements that the merged bank is more easily resolvable, and that it holds a minimum amount of long-term debt as a buffer, Hsu said, as a potential remedy to this problem.
To avoid a Lehman-like chaotic situation in the event of a wind-down, banks would have to show they have a “single point of entry” strategy. In this approach, only one parent holding company is supposed to file for bankruptcy rather than forcing each of the holding company's component parts to declare bankruptcy individually.
The merged firm would also have to hold a minimum amount of debt that could be converted to equity in a crisis, Hsu said, in a total loss-absorbing capital, or TLAC requirement. This would make private inventors absorb a failing firm’s losses, instead of that firm needing a bailout.
Another part of this approach would be to ensure that merged firms could identify lines of business or portfolios that could be sold quickly, “ideally over a weekend.”
“In other words, the firm must be able to be broken up,” Hsu said. “In most large financial groups, this is not a given. Business lines or portfolios that seem naturally separable are often structured and operated in ways that make it quite difficult to sell them quickly for value.”
