WASHINGTON The fight over the Dodd-Frank Act's $50 billion threshold will determine whether some banks get a respite from tougher rules, but it may also shape how the industry and lawmakers think about threats to the financial system more broadly.
Regional banks are pushing to raise or remove the reform law's hardline threshold for enhanced prudential standards, including stress tests, living wills and higher capital requirements, arguing that they're not "systemically important" like the Wall Street megabanks. The debate raises fresh questions about the meaning of systemic importance and how that intersects with increased demands for oversight.
"What's happened over the last five years is that the term SIFI has become interchangeable with being subject to the Federal Reserve prudential standards, whether you're a bank or not," said Aaron Klein, director of the Bipartisan Policy Center's financial regulatory reform initiative.
The issue of how to apply the term "systemic importance" cropped at a recent Banking Committee hearing with financial regulators, when Daniel Tarullo, a governor at the Federal Reserve, observed that the term may have several meanings in different contexts.
"There are two ways you can think about it. One is systemic importance in the sense that this high-stress or failure on that particular firm might itself lead to a financial crisis so that's the systemic risk, too-big-to-fail concern that we're thinking about from six, seven years ago," he told lawmakers at the March 19 hearing.
Tarullo added: "The second form of systemic importance is if you just reverse the syntax importance to the financial system. And this is where just the sheer size of an institution, the fact that it has a big footprint across the country, the fact that its credit intermediation is important for American businesses and households gives it an importance that, for example, doesn't attach to a community bank."
Advocates for a change to the regulatory regime argue that regional banks don't score on international evaluations of systemic significance, such as in a recent study by the Office of Financial Research looking at capital surcharges for the largest global banks and thus they shouldn't be required to submit to the same rules as financial behemoths that could tank the economy.
In fact, many argue, any hardline number is insufficient for determining risk, suggesting the need for a more qualitative approach based on complexity, interconnectedness and other factors, like that used by the Financial Stability Oversight Council for nonbanks and by international regulators.
"Right now, you have a threshold as a blunt instrument, so the idea is to give regulators a toolbox full of tools they can use as they see fit," said Edward Mills, a policy analyst at FBR Capital Markets. "That's where the sell for this is not a rollback of Wall Street reforms, but a removal of an arbitrary threshold that's allowing an unfair advantage to the large-cap institutions."
For those that think lawmakers set the bar too low at $50 billion, the concern is that the regional banks are being overregulated given their level of potential risk to the system.
"The enhanced prudential standards are there because of the systemic nature of some banks," Klein said, adding that use of the SIFI term to describe all banks over the Dodd-Frank line "is illustrative it's symbolic, perhaps, of the fact that there's been an overreliance on one-size-fits-all regulation and not enough tailoring of the standards."
But regulators across the board say they've already taken measures to tailor the rules for many of the financial institutions subject to the new standards, particularly those on the smaller end of the scale that remain focused on traditional banking.
Those opposed to raising the $50 billion line argue that the prudential standards weren't intended to suggest systemic importance in the same way as the nonbank designations, which are discussed in the same section of Dodd-Frank. Marcus Stanley, policy director at Americans for Financial Reform, calls this a "conflation of different meanings of systemic significance."
The Dodd-Frank standards "are supposed to scale up by bank size, and there is no requirement in Dodd-Frank to determine that an individual bank is 'systemically significant' for those stronger standards to apply," he said, arguing that the effort is "is very different from the systemic significance standard for designating non-banks, or the 'global systemically significant' standard that international regulators are applying."
Moreover, critics say, a failing regional bank could pose a threat to particular geographic area and the damage could be more widespread if several failed together. Such concerns potentially create a gray area for thinking about how to draw any line on prudential standards.
"When we're talking about the risks that the $50 billion banks pose to the economy, we need to consider that not just one bank could go south at a time, but that two or three or four could be following similar business practices and get caught short at the same time, which would pose a much bigger risk to the economy," said Sen. Elizabeth Warren, D-Mass., at a March 24 hearing on the issue.
Sen. Sherrod Brown, D-Ohio, the banking panel's top Democrat, has also pointed to the distinction raised by Tarullo, though he has not yet indicated how he might vote on a bill to change the threshold.
"We heard from Governor Tarullo that systemic importance is about the failure of one institution creating a crisis, but it is also about the importance of an institution to homeowners and small businesses in the economic footprint where that bank operates," he said at the March 24 hearing.
Still, there's significant support to move the line, particularly among GOP lawmakers, and Sen. Richard Shelby, R-Ala., chairman of the banking panel, has said he's interested in pursuing legislation. But for now, the question of where to draw the line instead or whether to scrap it altogether remains unanswered, in part because of this question about how to determine real threats to the financial system.
"The biggest hurdle to this fight is that there's an agreement that where the line is drawn now is inappropriately low, but there's disagreement over how high to make without unfairly including or excluding someone from the list," said Mills.
In the meantime, the slippery question of defining systemic importance is one that's bound to continue.
"Systemic importance is not a static concept," said Klein, noting that a bank's failure can vary in systemic importance depending on whether it's due to an isolated issue or part of a larger panic.
"It will always be a moving target, and hopefully over time there will be a greater consensus about what the target range is and how it moves," he added. "But there's not a natural constant of SIFI-ness that research can find."