Getting to yes: Reported Basel retooling may — or may not — have legs

Bloomberg News

WASHINGTON — While it's clear bank regulators plan to make substantive changes to a bank capital overhaul requiring institutions to put up more unborrowed funds to lend to consumers, banking experts vary on how this might be accomplished, and whether even a revised proposal will be enough to preclude legal challenges from the banking industry.

The Basel proposal was hotly contested when it was first proposed last July on a number of grounds, including the top-line capital raise for the largest banks, the risk weight treatment of mortgages, clean energy assets and small business loans. Bloomberg reported last week that regulators are shopping a draft set of revisions to the proposal aimed at quelling those concerns.

Lawyer Gregory Lyons of Debevoise and Plimpton said he isn't confident of the timeline just yet, given regulators still appear to be hashing things out internally.

"I think there's different proposals circling around how to amend it, but honestly, I'm not sure they know," said Lyons. "We're pretty close to what's going on and I just do think there's a lot of internal — good faith — but internal debates about how this is all going to play out."

Corporate lawyer Chen Xu, also with Debevoise, says he thinks the heads of the agencies involved in the rulemaking — which is a joint effort between the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. — would like to strike a compromise with their capital skeptic colleagues, some of which are within the same agency. 

"Some of the agency principals hope if they make enough concessions, they can get it through by August so this doesn't get tied up with the election," he said. "We've been hearing that view is gaining traction, but we've also heard that there are a number of folks inside the agencies who would rather have a reproposal, and right now it's hard to see who's winning."

But whether those adjustments can be incorporated into a final proposal or must be included in a new proposal — or some mix of both — remains unclear. Under the Administrative Procedure Act, changes made to final rules must be a "logical outgrowth" of what was in the original proposed rule. Many in and around the banking sector argue that the changes needed for the Basel III endgame proposal exceed this standard, and therefore an entirely new rule should be put through its own notice and comment period.

Jaret Seiberg, financial policy analyst at TD Cowen says he expects regulators will at least partially withdraw and re-propose the rule — often dubbed Basel III endgame — given statements from one of the most influential players shaping the pending regulation: Federal Reserve chair Jerome Powell.

"Powell has effectively made this commitment to Congress," commented Seiberg. "It doesn't mean there is zero probability for the rule to be finalized, but a re-proposal seems likely." 

Regulators invited banks to present data about how they would be affected by the proposal in January. Seiberg says the findings of the study — which he predicts should come this summer — should provide more clarity about whether or how quickly a re-proposal could happen.

While the Fed is the most politically independent of the financial regulators, it is facing pressure from both the financial industry — which wants a re-proposed rule — while some Democrats and consumer advocates want the rule finished largely as is. A new proposal would significantly extend the timeline for finalization. Banking policy expert Ian Katz of Capital Alpha Partners says the Fed could devise a way to allow public comment on certain rule revisions without restarting the process.

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"The Fed may put out something that basically looks like a reproposal but is called something else and allows the public to comment without starting the process from scratch," said Katz. "If the Fed were to do that in the fall — before the elections — it could finalize the Basel endgame rule next year, probably in the first half."

Banks and their trade group representatives have been vocal in their opposition to the Basel proposal and have availed themselves of novel tactics in elevating the issue with voters and lawmakers. From launching advertising campaigns on Sunday night football to identifying procedural weaknesses they could challenge in court, the industry has made it clear that it will oppose the rule on as many fronts as possible. Bank trade group the Bank Policy Institute, whose members would all be impacted by the rule, has retained corporate litigator Eugene Scalia — son of former Supreme Court Justice Antonin Scalia — to advise a potential legal challenge to the rule.

While the agency trio has yet to formally announce planned revisions to the rule, industry allies within the regulatory state have begun to provide cover for the kinds of changes banks are demanding.

Fed Governor Michelle Bowman — who has previously called for the rule to be reproposed —  Wednesday floated a number of changes she believes are required to garner broad consensus among the Fed's deliberative body, the Board of Governors. She argues the rule does little to address the underlying causes of the most recent U.S. bank failures in March 2023.

"I think we addressed the challenges that we faced during the earlier financial crisis through the implementation of Dodd Frank, I think those have proven to be successful," she said. "What led to SVB failing was not the same thing that led to the real estate crisis back then, earlier, a decade ago."

Powell has repeatedly stressed the need for this consensus. Bowman called for the agencies' to pare back what she called redundancies in the capital framework — between the new market and operational risk requirements in the rule and the stress capital buffer which she says burdens banks with redundant costs. She also called to recalibrate the market risk aspect of the rule to mitigate substantial increases in risk-weighted assets, and treat non-interest and fee-based income more reasonably to encourage revenue diversification. She made clear again this week she believes any rule that can proceed — let alone approach finalization — will need broad changes and input from interested parties in the industry and general public. 

"​​While these steps would be a reasonable starting place, they are not a replacement for a data-driven analysis and a careful review of the comments submitted," she said during a fireside chat following her remarks. "This would result in a better proposal that includes changes to address not only these concerns, but also many other concerns raised by the public."

Lyons says two of the major issues banks have identified with the rule are the scope of banks — largely those with over $100 billion in assets — roped into the rule's remit, as well as the market and operational risk portions flagged by Bowman, which he says is one of the key concerns for big banks.

"I think there are issues of relevance both to the larger banks, given the operational and market risk issues," he said. "And to the smaller banks, in the $100 billion asset class, regarding how much of this will apply to them."

Regardless of what path regulators take, the banking industry and its allies have questioned the need for capital reforms in the first place, given their view that firms are well-capitalized. But rather than fight tooth-and-nail to prevent any new capital requirements, some think they may accept a slimmed-down version of the proposal in order to achieve regulatory certainty.

"We believe banks would prefer to accept a reasonable final rule than to extend this battle for what could be another five years," Seiberg remarked. "The timing for finalizing the rule is after the inauguration. It is why there is election risk, though we believe the bulk of the final rule is likely to have bipartisan support at the Federal Reserve."

Given ongoing talks at the agencies about how to proceed, the industry will likely be eyeing its allies on the inside, who can help shape the rule to their liking. Bowman's comments on Wednesday suggest the industry may get their way in many regards. 

"As Chair Powell has said, that he expects broad and material change to this proposal, and I would hope that a number of the things that I've identified in a number of speeches throughout the last year or since the proposal was introduced would be included in some of those changes," she said. "If the proposal is [put] forward, it has to be voted on by the board and the other regulatory agencies — so we'll just have to see what happens."

Lyons noted a Supreme Court decision Friday upending the Chevron doctrine — which generally stated judges should defer to agency judgment on rulemakings — increases the pressure on regulators to ensure their final rule is something banks can live with. With the repeal of Chevron, regulators now have to convince courts of the merits of individual regulations.

"[Chevron] raises the question of how much the courts have to defer to the agencies in rulemakings and so forth," he said. "I think it heightens the stakes — or risks, depending on your point of view — banking agencies or their trade groups may push back in court against rules they perceive to be problematic."

Kyle Campbell contributed to this article.