Fed unveils overhaul of large-bank supervision

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WASHINGTON — The Federal Reserve Board published a pair of proposals Wednesday to create a tiered structure for holding companies with over $100 billion of assets.

In a memorandum released ahead of an open meeting Wednesday morning, the Fed outlined the details of how it plans to restructure several key aspects of its post-crisis regulatory framework, thereby reducing capital, liquidity and procedural requirements for many of the bank holding companies it supervises.

The two proposals — one drafted by the Fed alone and another issued jointly with the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. — would create four tiers of bank and thrift holding companies with more than $100 billion in assets.

That structure would distinguish between banks with assets of $100 billion to $250 billion; banks with more than $250 billion of assets that exceed certain risk thresholds; firms with more than $700 billion of assets or more than $75 billion of cross-border assets; and U.S. global systemically important banks, or G-SIBs.

Banks in the first, least risky, category would “no longer be subject to standardized liquidity requirements or" have to "conduct and publicly disclose the results of company-run capital stress tests,” the memo said. Firms in the next category, which includes banks with over $250 billion, would be subject to “enhanced standards that are tailored to the risk profile” of the firms.

The Fed said that it would “largely keep existing requirements in place” for riskier firms in the remaining two categories: G-SIBs and banks with more than $700 billion of assets or $75 billion of foreign assets. The regulations for G-SIBs would remain unchanged.

Federal Reserve Chairman Jerome Powell said in a prepared statement that the proposal is meant to tailor regulations to meet the risk profiles of the covered institutions, and that means both reducing stringency for banks with the least systemic risk and maintaining stringency for those whose failure could shake the financial system.

“The principle of tailoring regulatory requirements to a firm’s specific risks is a longstanding practice of the Board, and it works in both directions,” Powell said. “The proposals before us would prescribe materially less stringent requirements on firms with less risk, while maintaining the most stringent requirements for firms that pose the greatest risks to the financial system and our economy. And the proposals seek to maintain a middle ground for those firms that are clearly in the middle.”

Fed Vice Chairman for Supervision Randal Quarles said the purpose of the changes is not to reduce the capital or liquidity in the banking system, but rather to direct the capital that is already being retained in the system to the firms that pose the most risk.

“The total amount of capital maintained by large bank holding companies that are subject to stress testing requirements is currently about $1.3 trillion,” Quarles said. “The cumulative effect of the proposed changes we are considering today would result in a decrease of $8 billion of required capital, or a change of 0.6%.”

Fed Gov. Lael Brainard — a nominee of former President Barack Obama — was critical of the proposal, however, saying that the proposals “weaken the buffers that are core to the resilience of our system.”

“The proposed reduction in core resiliency comes at a time when large banks have comfortably achieved the required buffers and are providing ample credit to the economy and enjoying robust profitability,” Brainard said. “In short, I see little benefit to the institutions or the system from the proposed reduction in core resilience that could justify the increased risk to financial stability and the taxpayer.”

The proposals are divided into two. The first, which is exclusive to the Fed board, would modify the central bank's stress testing regime both for capital and liquidity, adjust supervisory standards for risk management and single-counterparty credit limits, and extend those standards for banks holding companies to certain savings and loan holding companies, namely Charles Schwab, Synchrony Financial and E-Trade Financial.

Not included in the proposals are foreign banking organizations or intermediate holding companies owned by foreign banks. Those entities would be addressed in another proposal “in the near future.” The proposal also does not address resolution planning, which the Fed memo said would be modified in a future proposal drafted jointly with the FDIC.

The proposals are the culmination of months of internal deliberation spurred by the passage of the Senate’s bipartisan Dodd-Frank Act revision bill in May. Among the changes to Dodd-Frank outlined in that law were a provision raising the minimum threshold for the application of enhanced prudential standards from $50 billion to $250 billion. However, the law gives the Fed discretion on how to apply enhanced prudential standards to banks between $100 and $250 billion.

Various factions have already offered their views on how the Fed ought to apply those standards.

A group of more than 30 House Republicans sent the Fed a letter in September urging the agency to effectively rescind all enhanced prudential standards on banks with less than $250 billion of assets, echoing a similar letter sent in August by Republicans in the Senate. Meanwhile, Senate Democrats — including Jon Tester of Montana and Mark Warner of Virginia — asked Powell during his July testimony before the Senate Banking Committee to retain at least some of those prudential standards depending on the systemic risk posed by the individual institutions.

“I think there may be appropriate regulatory relief for some regional banks, but I want to make sure ... that for those banks in that $100-250 [billion] range, you're going to have a thorough process and rule making process that stress tests are going to continue on a regular basis,” Warner said. “There may be some institutions that fall in that category that still need the enhanced … designation.”

Quarles offered a peek into the Fed’s thinking in July, saying that the agency was considering using additional factors besides asset size — including cross-border activity, nonbank assets and reliance on short-term wholesale funding — to determine which enhanced prudential standards would be appropriate for which institutions. He suggested in that speech that certain post-crisis innovations such as living wills might be eliminated for banks below $250 billion entirely, and stress testing for smaller banks might not have to occur each year as they do now.

But Quarles also suggested that risk-based and leverage capital requirements are unlikely to be changed dramatically, and that even if stress tests are held less frequently, they “should continue to play an important role in assessing potential losses.”

The proposed framework remained largely consistent with that vision. The framework would apply risk-based standards — considering size, cross-jurisdictional activity, short-term wholesale funding and nonbank assets — to determine whether banks with assets of more than $100 billion but less than $250 billion would fall within either Category IV or Category III, just as Quarles proposed. The proposal also would consider off-balance sheet exposures, including derivative exposures, securities borrowing and lending, and committed extensions of credit.

Not included in the proposal was any mention of the G-SIB surcharge, quashing hopes by some Republicans in Congress that the Fed might revisit that surcharge as part of its reconsideration of the post-crisis regulatory framework.

A senior Fed official said prior to the Fed's board meeting that the emphasis of the proposals was to reduce compliance burdens for smaller and less systemically risky banks rather than the overall capital and liquidity retention in the system.

The official noted that while the capital reduction amounts to roughly $8 billion across the banking system, based on how banks calculate their losses in another point in the cycle, the rules could require an increased retention of capital.

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Regulatory reform Regulatory relief SIFIs Regional banks Stress tests LCR Living wills GSIBs Randal Quarles Jerome Powell Federal Reserve OCC FDIC
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