For more than a year, a once ambitious bank regulatory reform agenda has
Now that the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency are in apparent agreement on
The coming months will tell if there is enough political will — or time — for those agencies to resurrect their push to put more safeguards around the nation's large regional banks, and whether they can do so without
"We are now in a world where Chevron deference is gone, and so therefore everything is more amenable to challenge than it was before," said David Sewell, former attorney at the Federal Reserve Bank of New York and partner at Freshfields. "Every new regulation that comes out — you have to assume somebody is going to challenge [it]."
For regulators, the most difficult balancing act may be next on the agenda. Fed Vice Chair for Supervision Michael Barr — who outlined the various changes coming to the Basel III endgame proposal in a
The proposal would require banks to maintain certain amounts of subordinated debts that can be used to "bail-in" the institution in cases of distress or failure, with the aim of lowering the public costs of bank resolutions. Currently, only global systemically important banks, or GSIBs, are obligated to maintain this type of funding.
The Fed, the FDIC and the OCC have been eyeing a long-term debt expansion since 2022, when they issued what is known as an advanced notice of proposed rulemaking — a precursor to a formal rulemaking process — before issuing an official proposal last September. But finalizing that rule while risk-based capital changes are still pending could have significant unintended consequences, said Karen Petrou, managing partner of Federal Financial Analytics.
The proposal would set long-term debt requirements at each impacted bank at the greater of 6% of total risk-weighted assets, 3.5% of average total consolidated assets or 2.5% of total leverage exposure if the bank is subject to the supplementary leverage ratio. Because the Basel III endgame proposal would realign the risk-weighting calculus, Petrou said neither banks nor regulators can know the impact of the long-term debt requirement until the capital rules are established.
"The long-term debt rule can make no sense until it's understood in the capital context when it applies. To do long-term debt first and capital rules second is a mistake," she said, adding that doing so "opens [regulators] up to substantive challenge," if not a procedural one.
Petrou said the calibration of capital rules could bring similar complications to other pending and prospective changes, including policies relating to
Still, the long-term debt proposal would do something that the capital proposal has largely moved away from: addressing systemic risks presented by large regional banks.
In his speech, Barr said the capital rules would no longer apply to banks with between $100 billion and $250 billion of assets, also known as category IV banks within the Fed's regulatory tailoring regime. These 20 or so institutions would still see their regulatory capital increase as the result of having to include paper gains and losses in their securities portfolios in their capital calculations.
Barr said the decision to exclude category IV banks was made after regulators realized that revised calibration of the proposal would not actually result in higher capital for those banks, other than those related to unrealized gains and losses, also known as accumulated other comprehensive income, or AOCI.
"When we looked at that, we said, do we really need them to go through all of the process of creating systems to comply with the new capital rule when there's no capital impact on how safe they are," Barr said during a question-and-answer session following his speech. "That didn't seem like a tradeoff worth making."
Still, the decision to remove category IV banks from the capital proposal has frustrated academics, consumer advocates and some consultants who feel that class of banks represents a weak point in the regulatory framework.
Mayra Rodriguez Valladares, a bank and capital markets risk consultant, said the decision contradicts a point Barr made repeatedly after the failures of Silicon Valley Bank, Signature Bank and First Republic Bank last year, that banks can pose risks to financial stability without being systemically large.
"No, they're not Citibank, no, they're not JPMorgan, but look at the havoc that SVB, on its own, wreaked," Rodriguez Valladares said. "What happens is depositors immediately, when they hear those problems at a big bank like that, they immediately start to think, 'Wait a minute, what's the spillover to other banks?'"
Jeremy Kress, a law professor and former Fed lawyer, was also disappointed in the regulators' decision to narrow the scope of their capital proposal, calling it a capitulation to industry demands. In light of this, he said, it is crucial for regulators to adequately address category IV bank risks through other reforms.
"The retreat on capital makes it all the more important that the regulators finalize strong liquidity rules and strong long-term debt rules," Kress said. "It's not going to make up for inadequate capital, but it can help offset the softening of the endgame capital rules."
Others, particularly those aligned with large banks, say last year's banking stress — particularly the issues at play for Silicon Valley Bank — were idiosyncratic and should not be used as the basis for broad changes.
"There were many unique factors impacting the SVB resolution, so that shouldn't be the textbook case or a universal problem that we're trying to resolve," said Tabitha Edgens, co-head of regulatory affairs for the Bank Policy Institute. "We need to go back to principles and look at the resolution plans that banks have been developing for the past decade and consider if these changes are designed correctly in light of all of those plans and the work banks have done previously."
In his remarks last week, Barr said the banking stress of 2023 influenced the joint capital proposal — which had been in the works on and off since 2017 — by encouraging the agencies to be more "conservative" in their calibrations. After reviewing more than 400 public comments about the proposal — many of them critical — Barr said regulators realized they had been too conservative and failed to take into account the residual implications of their reforms.
Whether the same pattern plays out for other reforms initiated in the wake of the failures remains to be seen. Rodriguez Valladares said the trajectory of reforms will largely be shaped by the results of this fall's elections.
"There's a lot of political influence," she said. "The tone at the top is so important, and we've seen that time and again."
