WASHINGTON — The House Financial Services Committee narrowly passed an amendment Wednesday that would raise the cost of funding for the largest financial institutions and cut them off from Federal Home Loan Bank advances.

The amendment was among many the panel voted on including one that would allow a council of regulators to break up large, complex banks and another to let the Federal Deposit Insurance Corp. set up a liquidity facility to help solvent companies.

But it was the amendment from Reps. Brad Miller and Dennis Moore, which was approved on a 34-to-32 vote, that could have the broadest impact. The measure would let the FDIC impose on all secured creditors, including the 12 Home Loan banks, a 20% haircut when resolving systemically important institutions that fail.

Industry observers warned that it would raise the cost of funding for the largest banks, since it would introduce uncertainty to the marketplace and ensure secured creditors no longer are guaranteed a full return.

"There is a significant issue for all secured lenders," said Lawrence Kaplan, a partner at Paul, Hastings, Janofsky & Walker LLP. "The cost of borrowing by banks will go up if secured lenders have insecurities as to whether they will ultimately be repaid. The ripple effect is the banks' costs to borrowers will rise. … The net effect is an increase in the cost of credit."

The measure would include qualified financial contracts such as repurchase agreements, industry representatives said.

"It changes the whole process of secured borrowing in general," said John von Seggern, the president of the Council of Federal Home Loan Banks. "That's very serious and bad policy to go down this path."

The amendment would also effectively prevent the largest institutions from borrowing from the Federal Home Loan banks.

"This amendment would preclude advances to certain members," said Alfred DelliBovi, the president of the Federal Home Loan Bank of New York. "If we are only going to get 80% back from a certain borrower, then we will just not lend to them. That's an easy decision."

While exactly which institutions would be considered systemically important remains undefined, some of the largest banks that would undoubtedly be part of that group borrow heavily from the Home Loan banks.

Bank of America Corp., for example, had $69 billion of outstanding advances at June 30, while Citigroup Inc. had $57 billion. None of the Home Loan banks could absorb a 20% loss on such large advances, which currently are fully secured in the event a bank fails. By statute, the Home Loan banks are also required to lend only on a fully secured basis.

"If we're not secured, we are not going to lend," said DelliBovi. "I would tell my salespeople, 'Just say no.'"

The amendment appears to be part of a long-running feud between the Home Loan banks and the FDIC, which has long sought to end the Home Loan banks' priority status in the event of a failure. In general, failed institutions that borrow heavily from the Home Loan banks end up costing more to resolve because the government-sponsored enterprises get first crack at some of the best assets in receivership.

Miller, a North Carolina Democrat, said he drafted the proposal at the behest of the FDIC and couched it as an effort to save taxpayers from bearing the cost of systemic failures.

"This is a suggestion of [Chairman] Sheila Bair's," Miller said during debate on the bill.

A FDIC spokesman said the agency supports the amendment, which he said would "help enforce market discipline and add another layer of protection between the failed firm and the government."

Rep. Randy Neugebauer, R-Texas, raised objections.

"If you are a secured creditor you aren't quite secure," he said.

Miller responded that "they should take a haircut, rather than taxpayers and the insurance fund."

But Home Loan bank officials and others argued that the FDIC, too, would be hurt if the amendment was enacted.

DelliBovi said that the Home Loan banks serve as an important source of liquidity to institutions, and that if they could not make advances, more failures might result.

"They would be cutting off liquidity to their own insured depositories," he said. "This sets up a situation very much like what we had before a Home Loan bank system and before a FDIC."

William Isaac, a former FDIC chairman, said the unintended consequences could be serious.

"I'm not sure we even know all the potential consequences," he said.

"It may well increase the cost of funding to banks and it may curtail the availability of funding."

Another amendment from Rep. Paul Kanjorski would let a proposed systemic-risk council take "extraordinary" action to force large, interconnected, systemically significant institutions to divest, avoid mergers, stay away from certain financial products, sell assets or branches or drop off-balance-sheet activities.

The amendment, which passed 38 to 29, would require the Treasury secretary to sign off when requiring the firm to sell, transfer or divest $10 billion or more in assets and would require the president's concurrence when that amount hit $100 billion.

"I don't want to kid anybody this is a contentious amendment. … I recognize this is extraordinary power," Kanjorski said. "Hopefully it will never have to be used."

Committee Chairman Barney Frank said the issue crystallized the divide between Republicans and Democrats.

"This shows the philosophical differences between members on the other side," the Massachusetts Democrat said. "You propose bankruptcy, but you do nothing to prevent risk. … It would be better to try to prevent this from happening. What we want to be able to say is let's prevent a future AIG from getting there."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.