Lighter reg touch could be mixed blessing for regionals
WASHINGTON — Regional banks are definite winners in the Federal Reserve Board's plan to shake up its post-crisis regulatory framework, escaping a stringent set of requirements that would be reserved for the biggest banks.
But not everyone is cheering.
Some analysts are suggesting that the relief is a double-edged sword. On one hand, many banks with more than $100 billion of assets will enjoy reduced compliance costs, less frequent stress tests and an easing of liquidity requirements. But on the other, some in the market may view these banks as less attractive investments because their risk of failure might go up.
“What we’re looking at is what affords creditors' protection, and two of the key elements are capital and liquidity,” Rita Sahu, vice president and senior credit officer at Moody’s Investors Service, said in an interview. “These regulatory requirements … are kind of guardrails to ensure the safety and soundness of the institution, as well as the whole system. And so without the guardrails, it’s kind of up to management on how they want to manage their business and their balance sheet.”
The pair of proposals that the Fed unveiled Oct. 31 encompassed a broad array of supervisory changes for banks with between $100 billion and $250 billion of assets, as required by the regulatory relief bill enacted by Congress in May. Those banks would transition from an annual to biannual stress test cycle, avoid both short-term and long-term liquidity requirements that have been part of the Fed regime, and enjoy a streamlining of the models they use to determine capital levels.
Larger banks with assets of more than $250 billion — including the super-regionals PNC, Capital One, Charles Schwab and U.S. Bank — would also gain some relief, including less stringent requirements for meeting short-term and long-term liquidity benchmarks under, respectively, the Liquidity Coverage Ratio and the Net Stable Funding Ratio.
But after the release of the proposal, Sahu and two other Moody's colleagues released a report saying the changes "would be credit negative." They noted that the changes for regional banks "are likely to reduce their capital and liquidity buffers" and that the proposed changes for super-regionals go beyond the intent of Congress in the reg relief bill.
They added that a secondary effect of freeing firms from annual stress testing could be to diminish the value of the stress tests for all participating banks.
"The reduced frequency of capital and liquidity stress testing could lead to more relaxed oversight and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since fewer firms will participate in the public supervisory stress test," the report said.
Other reactions to the proposals were more predictable. Champions of the banking industry thought the Fed’s proposed changes were necessary, if perhaps not as comprehensive as they had hoped. Regulatory hawks, meanwhile, derided the proposals as unwarranted giveaways to Wall Street.
But just like the Dodd-Frank Act and ensuing rules led to concerns about regulatory costs, some observers said the new changes could concern investors that have grown accustomed to the post-crisis regime.
Karen Shaw Petrou, managing partner of Federal Financial Analytics, said that when many of the post-crisis rules were proposed, there was concern that they could create new market disruptions, but the Fed seems equally unconcerned about disruptions that could arise from dismantling those rules now.
“The U.S. is dismantling not only aspects of the rules … that do little good for all their cost, but also the liquidity, risk-management, and ... the post-crisis resolution-planning requirements,” Petrou said in a research note. “Are we just dismantling the post-crisis framework as heedless of interactions and market forces as we were when it was put into place?”
Fed Gov. Lael Brainard — the only member of the Fed board not appointed by President Trump — was the lone dissenting voice at the central bank opposing the proposals. She warned that the changes would create more risk in the banking system with little added benefit, particularly concerning those banks with more than $250 billion in assets.
“The proposed change in liquidity buffers would lead to a very small positive effect on net interest margins at these banks, at the expense of an economically meaningful increase in the probability of stress at the affected institutions,” Brainard said. “It is worth highlighting that a distressed acquisition of a large banking institution by one of the largest domestic banking institutions is a less likely option today than previously. The alternative is the use of taxpayer resources — precisely the outcome that the core resiliency reforms seek to avoid.”
But some other analysts say the proposed changes just aren’t dramatic enough to pose a significantly greater risk to markets or the taxpayer.
Isaac Boltansky, an analyst at Compass Point Research & Trading, said that the easing of the LCR for smaller regional banks — much less easing the NSFR, which has not yet been finalized — probably won’t do much for those institutions one way or the other.
“We're talking about a tiny change to the liquidity rule,” Boltansky said. “It doesn't alter the capital requirements, it doesn't change the annual capital planning, it doesn't change the stress tests, which will be every other year. I don't think that in five years, we'll come back and say, 'This was the moment.’ ”
Sahu said that another concern is whether regional banks would respond to lighter liquidity requirements by reducing their amount of assets that could be sold quickly in a stressed situation.
“For the largest banks, their rules are unchanged, but these banks will have more leeway to reduce their buffers if they choose to,” she said.
The LCR rule requires banks to hold enough "hiqh-quality liquid assets" — such as cash, Treasury bonds and other safe stores of value — to maintain operations for 30 days. But those assets also tend to generate less revenue, which is why banks have bristled at the LCR in the past.
The elimination of the LCR would certainly free regional banks’ hands to make riskier but more profitable investments, Sahu said. But investors may decide that less liquid capital puts regional banks at a competitive disadvantage — at least under stress conditions — to the largest banks, which still have the LCR in place.
"If they encounter stress, they’ll have less flexibility to manage that,” she said.
Boltansky added that whatever effects the changes may yield would have to wait for the regulatory process to play out, which could take months. And as for the LCR changes, it also isn’t readily apparent what kinds of higher-yielding investments banks will want to make given rising interest rates and an uneasy stock market.
“We've got another year for this, and how quickly will inherently cautious bankers shift their cash and Treasuries into loans, especially when we're in the ninth inning of a cycle?” Boltansky said. “I think that's a really fair question.”