WASHINGTON — A slate of proposed rules related to resolution planning and long-term debt issuance has received a somewhat muted response from the industry, especially compared with the outcry that met last month's Basel III capital proposal.
Peter Dugas, head of the Center of Regulatory Intelligence at Capco, said that after three midsize regional banks failed
"I think they are trying to be specific in which fight they pick with which regulators and what they want to focus their time on," said Dugas. "I think they do recognize the fact that, you know, there are emerging risks that banks need to control for, there are certain challenges with certain banks and their business models."
The rules,
The FDIC's chairman, Martin Gruenberg, said that the proposals were motivated by the lessons learned from the failures of Silicon Valley Bank, Signature Bank and First Republic Bank in the spring of 2023.
"While the FDIC resolved all three institutions in a manner that mitigated systemic risk, that outcome was by no means certain," Gruenberg said. "In particular, the resolution of Silicon Valley Bank and Signature Bank required the use of extraordinary authority by [regulators] to protect uninsured depositors at those institutions, setting aside the least cost requirement to the Deposit Insurance Fund."
Jaret Seiberg, an analyst at TD Cowen, said he expected banks' pushback, but the proposals were not even remotely surprising for the industry. Open confrontation would be ill-advised at a time when banks are fielding such a wide slate of new rules — and regulators aren't likely to bow to pressure anyway.
"We do not see this political pressure mattering to the regulators — they view the proposal as critical to limiting the impact from a regional bank failure to the FDIC insurance fund," he wrote in a note. "This can get finalized before the election, though it is close [and] any delay favors the banks as GOP regulators may revamp or drop the long-term debt requirement."
The two Republican members of the FDIC board — Vice Chair Travis Hill and Jonathan McKernan — as well as Trump-nominated Fed governors Michelle Bowman and Christopher Waller — ultimately voted for the proposal, even as they expressed reservations.
Randy Guynn, chair of the financial institutions practice at Davis Polk, said tonal discrepancy between the banking industry trade responses this week and their
"The going-concern capital — what has been talked about the last couple of weeks — is higher on people's minds than the so-called gone-concern capital that the long term-debt requirement addresses," he said. "This long-term debt or credit didn't really affect the GSIBs in any material way, so for them it's a non-event. It's a big event for the regional banks and the midsize banks, but they tend not to be quite as vocal."
While there was a great deal of consideration made in the immediate aftermath of this spring's bank failures about
Dugas said that since the FDIC can't increase the overall requirements of the Deposit Insurance Fund on their own — that requires Congress — making banks hold long-term debt is another solution that can provide an effective backstop to improve the likelihood of resolvability.
"The next-best option would be for them to be able to issue requirements for long-term debt and for the banks to effectively do that," he said, adding that the proposal allows regulators to wind down an institution in a more cost-effective manner by using the debt to cover losses, thereby preserving the DIF.
"It's more about tools in their toolbox than it is about the bank itself," Dugas added.
Guynn said the long-term debt creates a secondary layer of de facto deposit insurance, where the deposit insurance is being provided by the long-term debt holders, and gives the FDIC more options when a bank fails.
"It reduces the risk to the historic deposit insurance fund, so it does give the FDIC more flexibility," he said.
Alexandra Barrage, a former resolution planning official at the FDIC who's now a partner at Davis Wright Tremaine thinks the new rules are a good first crack at giving regulators more tools to improve bank resolvability so they aren't forced to sell failed banks to GSIBs — an outcome that regulators faced blowback after the sale of First Republic to JPMorgan Chase. Long-term debt limits the risk of loss to depositors and the DIF and ensures that sophisticated creditors, not taxpayers, bear the risk of loss.
She does think there are some other areas that need to be addressed, however, including the fact that regulators are compelling regionals to adhere to debt requirements that GSIBs face even as they historically utilize different resolution strategies. Most GSIBs employ a strategy in their living wills known as a single-point-of-entry, or SPOE, recapitalization strategy.
In a SPOE strategy, only the bank's holding company goes into bankruptcy, while the firm stays open and the parent company endures the losses. Regional large banking organizations tend to do a multiple-point-of-entry — often called a bridge bank strategy — where the bank itself goes into receivership and the FDIC sells off the firm's assets. While FDIC notes banks can choose their resolution strategy, Barrage and Guynn both agreed this week's rule could nudge regional banks toward SPOE for resolution planning.
"They're also potentially requiring long-term debt not just at the bank, but also at the holding company for these large IDIs," she said. "If you want it at the holding company — which is where the GSIBs have it, and all the GSIBs have SPOE plans — then really what they're saying effectively is we want you to have an SPOE plan."
Guynn said Tuesday's rule opens the door for SPOE in the future.
"They're not saying that the regional banks have to change their strategy from what's called a bridge bank strategy to a single-point-of-entry strategy, but they're saying they would like to have the option to be able to execute one and this will help them do it," he said, adding that the move "could well push the regional banks toward the single point of entry strategy."
Barrage thinks the new proposals will be useful to improve regulators' toolkit, but will only account for part of the cause of the failures this year. More work, she says, is needed to address the supervisory shortfalls that failed to address the glaring risks at the firms before they failed.
"[Management and supervisory failures] were the root causes of why these banks failed," she said. "That's not to say that long-term debt can't give regulators more options — I think it can. But if they aren't also thinking about the supervisory fixes that are needed, then they're only getting at part of the problem."
Guynn thinks the new costs could incentivize regional banks to get bigger.
"The proposed increased capital requirements and this new long-term debt — which regional banks never paid before — will definitely increase their cost of doing business in fairly significant ways," he said. "They're subject to the same sort of costs as the GSIBs but they have a much smaller scale, so those higher costs are going to create a big economic incentive for the regional banks to actually merge and become bigger so that they have a larger scale to be able to spread those large costs across."
Whether it actually stops bank runs is another question, according to Guynn.
"I think the most important thing to stop runs is the market having confidence that the assets that the bank has that are ready to be pledged to the discount window for emergency loans from the Federal Reserve are sufficient," he noted. "if [depositors] know they can get paid, they probably won't run."
Barrage also thinks that these reforms do not guarantee that runs will be any less likely, as depositors are not as attuned to the regulatory superstructures which undergird bank stability.
"I don't think depositors are that sophisticated," she said. "I think what we learned was they pulled out their money en masse because of tweets — not saying those tweets were right or wrong or well informed — but to me, that's a stretch. It's not clear to me that long-term debt means there isn't a run."
