WASHINGTON — Bailed out, sometimes repeatedly, by the government and now confirmed as "too big to fail," many of the largest banks are viewed as having benefited from the financial crisis.
But under legislation expected to be approved by the House Financial Services Committee today, the largest firms would pay in myriad ways that could impede their growth, reduce their liquidity and drive up their costs, according to observers.
The bill would require large firms to hold more capital; pay more in deposit insurance premiums; hold new, potentially expensive convertible debt instruments; pay assessments to a new systemic-risk insurance fund; and face restrictions on interaffiliate activities. The legislation also would make it easier for the government to fail them or break them up based on their size or interconnectivity.
The bill comes on top of other measures due for consideration this month by the full House that would require bigger institutions to fund the creation of a separate consumer protection agency, make it harder for national banks to operate across state lines and require all standardized derivatives trades to be centrally cleared or go through exchanges.
If the bills were enacted, "I think you would see most of the very large banking organizations pull themselves apart," said Karen Shaw Petrou, the managing partner of Federal Financial Analytics. The legislation really would "force strategic reassessment for the largest bank holding companies."
When the Obama administration first proposed designating certain large institutions as Tier 1 financial holding companies, much of the initial criticism was that such a label would confirm to investors they were "too big to fail" and perversely reward them with a funding advantage.
Since then, the House Financial Services Committee bill has undergone several changes, leading many observers to argue that the legislation would severely restrict large banks.
Other measures, such as those to create a proposed Consumer Financial Protection Agency and regulate derivatives, have also targeted large banks as a result of continued public outrage over last year's bailouts.
Representatives of the large banks have said the systemic-risk bill and the broader reform effort are overkill, and go too far in taxing the banks for being big, including allowing regulators to break apart a healthy institution if they determine its collapse would pose too great a risk to the economy.
The Financial Services Roundtable urged lawmakers to oppose the bill in a five-page letter sent to all committee members this week that lays out several problems the trade group has with the legislation. "The cost to large institutions will amount to hundreds of millions per institution, and that ultimately could weaken those firms," said Scott Talbott, the Roundtable's top lobbyist. "You could see that the collective effect of these regulations could cause some firms to go under. There would be incentives to reduce yourself or not become big. The other end of the scale would be companies that were doing well competitively in the market and growing would have to put the brakes on and limit their productivity."
Although large banks are lobbying heavily against the bill, many observers said the legislation is doing what it needs to do: reduce the incentives for banks to grow extraordinarily large and reduce their threat to the system.
William Longbrake, executive in residence at the Robert H. Smith School of Business at the University of Maryland, said that while certain provisions raise concerns, such as one that would force secured creditors to take a 20% haircut, overall the legislation is appropriate. "It's balanced," Longbrake said. "My sense is my sense is that overall, while the bill is not perfect in all respects, it is going in the right direction of trying to deal with longer-range issues, such as redressing imbalances in the regulatory system."
The number of banks that would be affected by the various aspects of the reform bills varies according to each provision. For example, an interagency council could break up and check the activities only of institutions considered so large they pose a threat to the system — a figure likely to be under a dozen.
Those firms must also hold contingent capital, a new form of debt that converts to equity in the event of a crisis, which some critics said could be prohibitively expensive. They would also face higher debt costs because of to the 20% secured-creditor haircut and would lose access to the Federal Home Loan banks, which are unlikely to give advances if there is a chance they could take a loss on them.
But a wider pool of institutions would be covered by other measures.
Institutions with more than $50 billion in assets — of which there were 37 through Sept. 30 — would have to pay additional assessments into a new systemic-risk fund. Banks with assets of more than $10 billion — of which there were 109 — would also pay for the funding of the new consumer protection agency, and be subject to its enforcement authority (smaller institutions would be regulated by their current bank regulators).
Some smaller banks would potentially be captured by provisions that would require the Federal Deposit Insurance Corp. to base premiums off of assets, rather than domestic deposits. Such a calculation tends to hurt larger banks, however, because they rely more heavily on alternative funding sources to deposits.
A bill to regulate derivatives would require many to be exchange-traded and go through a clearing house, a process likely to cut deeply into the profits of large banks. Small banks that are end users of derivatives, however, would largely be exempted from such requirements.
All national banks, too, regardless of size, would face questions about whether they have to comply with state consumer protection laws. Under the bill to create the CFPA, the Office of the Comptroller of the Currency could preempt state laws only on a case-by-case basis, and could not universally preempt them as it does now.
Petrou pointed to other provisions that she said are technical and often overlooked, but would still have a big impact, including restrictions on interaffiliate transactions, a requirement that banks create living wills detailing how they should be taken apart in a crisis, and proposed limits on counterparty risk.
"Interaffiliate restrictions would limit the use of bank deposits on nonbanking activities," Petrou said. "That's why you own a bank. You don't own a bank because you like branches, you own a bank because you want cheap core funding. … That really strikes directly at the heart of a diversified banking organization."
To be sure, many predict a final reform bill could lose some of the tougher provisions.
"The scariest things will either be dropped from the legislation or not be used in practice," said Douglas Elliott, a fellow at the Brookings Institution. "The scariest things are proposals to break up the big banks. There is real danger of overshooting there."