Fed Will Differentiate Barely 'Systemic' from Truly TBTF

CHICAGO — Midsize banks that technically meet the Dodd-Frank law's definition of systemically important — holding $50 billion or more of assets — will not be treated the same as the largest institutions, Federal Reserve Board Chairman Ben Bernanke said Thursday.

In a speech to a conference hosted by the Federal Reserve Bank of Chicago, Bernanke said the central bank intends on using a graduated approach in how it will require banks of all sizes to implement higher capital and liquidity requirements. The Fed chief said the agency will be judicious in how it treats banks that just cross the $50 billion threshold, but which are not on par with the most systemically important institutions.

"They will be graded on a scale, so to speak," Bernanke said. "We're going to be very careful not to have a discrete drop, a discrete change, a discrete difference between $49 billion and $51 billion banks."

Many banking industry representatives objected when Congress set a hard and fast limit in the regulatory reform law, arguing that size alone should not dictate which institutions are considered systemically important.

Bernanke's comments make it clear that despite that target, the largest banks will hold more capital and face tougher prudential regulation than those closest to the $50 billion watermark.

Bernanke said the Basel Committee on Banking Supervision is also looking at a similar approach as it drafts a list of which institutions fall into the category of the most globally significant banks.

"It will not be the case that community banks, or medium-sized regional banks, or international giants will face the same changes in regulation," Bernanke said.

Federal Deposit Insurance Corp. Chairman Sheila Bair, who spoke at the conference, told reporters she shared Bernanke's concern, but urged a slightly different, more expansive approach, at least initially. "I do worry about cliff effects. I am sensitive to that," she said.

The Financial Stability Oversight Council needs to develop hard metrics to determine which institutions are systemically risky, Bair said. Such institutions would have to provide a plan to the Fed and FDIC on how they could be resolved by the government.

In the early going, Bair said, she would rather have more institutions comply with such requirements than fewer, so the FDIC is not left flat-footed in the event such an institution fails. "We would like to get additional information on resolvability and that may well lead to the vast majority not being designated, but we do think that kind of information would be helpful," she said. "That's why we need a fairly flexible or expansive metric … to at least require them to give us a type of indication of how resolvable they are in event of a bankruptcy situation. We are very concerned about being gamed and everyone wanting to try to avoid this because it's going to mean higher capital and stronger regulation."

Industry representatives sided with Bernanke's approach, noting the diversity of the banking system in the U.S. "Is there anybody in here that thinks one regulatory system would be adequate to cover that kind of diversity? How about two? Three?" said Wayne Abernathy, executive director for financial institutions policy and regulatory affairs for the American Bankers Association.

He welcomed the Fed's intention to make distinctions. "More and more regulators are coming to this conclusion that we need a scalable, graduated, adaptable … regulatory system that can address the broad range of different types of institutions," Abernathy said.

Mark Van Der Weide, senior associate director for the Fed, acknowledged that until this point regulators have not delved deeply into how they will make designations. The FSOC has released two proposals, neither of which provided much detail on how regulators will determine which institutions are systemically important. "There have been some proposed rules that have been high level I have to admit. They mostly just reiterate the regulatory framework, statutory requirements," Van Der Weide said. "We are exploring the extent to which we can provide additional information in that regard. In an ideal world, we would provide maximum clarity on this issue, but at the same time at the end of the day deciding whether a particular firm or holding company is systemically important or not is a very complicated, judgmental, qualitative decision."

Making "that regulatory framework proportional to the systemic footprint for firms above $50 billion is not an easy task," Van Der Weide said, and the central bank spends a lot of energy trying to figure out a way to measure how systemically important the banks are and figuring out the right approach on the gradation.

Several sources have said the Fed and FDIC disagree on the issue, with the FDIC pushing for more institutions to qualify as systemically important, while the Fed wants fewer companies in that bucket. During her speech, Bair hinted as much, warning regulators they must prove to the financial system that "too big to fail" is a thing of the past. "Unless reversed, we can expect to see more concentration of market power in the hands of the largest institutions, more complexity in financial structures and relationships, more risk-taking at the expense of the public, and, in due time, another financial crisis," Bair said.