WASHINGTON — The Dodd-Frank Act included a provision to lock some of the biggest firms into the law's enhanced supervisory regime even if they tried to leave. But that grasp may not be as strong as it used to be.

Zions Bancorp.'s recent decision to focus just on its bank subsidiary already cast doubt on the need to own a bank holding company. But the calculus could also change for larger companies — specifically investment bank giants like Goldman Sachs and Morgan Stanley — due in part to the changing nature of regulatory policy roughly a decade after the financial crisis.

“A larger, more complex bank holding company … might consider debanking,” said David Portilla, partner at Debevoise & Plimpton.

Goldman Sachs signage is displayed at the company's booth on the floor of the New York Stock Exchange.
Dodd-Frank's so-called "Hotel California" provision, drafted with Goldman Sachs and Morgan Stanley in mind, sought to ensure that once they became bank holding companies, they could not just shed that status to escape regulation. Bloomberg News

At issue is Dodd-Frank's so-called Hotel California provision, which was drafted with Goldman and Morgan in mind and ensured that once they became BHCs, they could not just shed that status to escape regulation.

The section's nickname comes from the lyrics of the famous Eagles song: "You can check out anytime you like, but you can never leave." It stipulated that shedding a BHC meant still being regulated as a nonbank "systemically important financial institution." The idea was that that alternative might be unappealing enough so that the bank kept its holding company.

But observers say policymakers could alter nonbank supervision to make that alternative more appealing.

"Theoretically there is room for a large broker-dealer to be a nonbank SIFI and be subject to a different set of rules than a bank holding company that has a large broker-dealer business," said Portilla. "There’s certainly flexibility.”

Under Dodd-Frank, nonbank SIFIs are still supervised by the Fed, but the law allows firms removing their holding company to appeal their SIFI designation to the Financial Stability Oversight Council. Zions, which is above $50 billion in assets, has indicated that it will pursue that course to shed its SIFI status once its restructuring is complete.

Still, Sandy Brown, a partner at Alston & Bird, said the particular path that Zions has chosen — to shed its holding company and become a pure bank — is something that smaller bank holding companies might consider, but probably not any of the larger banks. For the larger banks — particularly those that only became bank holding companies during the financial crisis — there may be some appeal in going the other way and shedding the bank altogether.

“Zions is really about the only one in the big-bank range where that currently makes a lot of sense,” Brown said. “For the companies that were not bank holding companies pre-crisis, I think they all should be evaluating in their executive suites and boardrooms what’s best for their company.”

Prior to the financial crisis, both Goldman Sachs and Morgan Stanley were investment banks — that is, they largely did not take insured deposits and were not subject to Fed supervision, but rather were overseen by the Securities and Exchange Commission. During the crisis, both fell into distress and sought liquidity relief and became bank holding companies in order to gain access to the Fed’s discount window and Troubled Asset Relief Program.

Dodd-Frank's “Hotel California” provision sought to prevent the two firms from simply turning around and debanking once the crisis subsided.

Neither Morgan Stanley nor Goldman Sachs commented for this story; Morgan Stanley did not return a request for comment and Goldman declined. The Federal Reserve also declined to comment.

But Goldman chairman and chief executive Lloyd Blankfein said in an interview with CNBC earlier this year that the bank didn’t really see an advantage in changing its business model, including debanking, unless more significant changes to the regulatory structure were to arise.

“The only practicality of debanking would be for us to lose the benefits of being a bank but not necessarily the regulatory burdens of being a bank,” Blankfein said. “So we would have to redo the regulatory scheme for us to think realistically of doing what it would take to forgo our status as a bank.”

Karen Shaw Petrou, managing partner at Federal Financial Analytics, said that if there were no Hotel California provision, it is possible that investment banks would have availed themselves of this option — becoming a bank holding company short-term and then switching back once they no longer needed the benefits — years ago.

But nearly 10 years on and after untold millions spent to accommodate the post-crisis regulatory regime, the costs of shedding their bank holding companies is probably more trouble than it is worth, Petrou said.

“In 2011, yes, I think we would have seen BHCs … forced into conversions immediately try to check out of Hotel California,” Petrou said. “In 2017, with seven years of significant change to their business model and investment in insured deposit gathering, lending and other more traditional functions that need to be in a bank, the decision is a lot less clear. In Goldman and Morgan Stanley’s case in particular, to debank is a significant structural transformation.”

Luigi De Genghi, a partner at Davis Polk, said the shift toward adopting BHC status has gone from being artificially imposed by regulators, or born of necessity because of the liquidity crunch experienced during the crisis, to a more practical and secular one borne of a desire for the secure liquidity streams that insured deposits and access to the Fed’s discount window can provide.

“If you look at the landscape now, there are only a couple of significant standalone U.S. investment banks, not owned by a bank holding company,” De Ghenghi said. “You could say, that was a reaction to the crisis, and people may be more relaxed about that now. But it depends on how comfortable you are about liquidity and access to the Fed’s discount window and it depends how much you like having access to deposits.”

But De Ghenghi noted that regulatory frameworks change over time, especially in relation to each other across international jurisdictions.

Under the current law, even if a former BHC changed its structure, its prudential regulatory standards would still be set by the Fed so long as it were a SIFI. But if, for example, the U.S. framework for investment banks were changed such that the SEC applied similar prudential regulations to investment banks as to deposit-taking institutions — and the law were changed so as to make the Fed less of a default prudential regulator — it might entice some BHCs to change their structures.

“I suspect that right now it’s just more convenient to preserve the bank holding company structure to engage in nonbanking activities," De Ghengi said. "You would probably have to see something like the United States adopting more of a European model of [applying] a lot of the same requirements to investment firms and banking firms indistinctly before you see a move toward U.S. regulators being comfortable with large nonbanking firms being regulated by the SEC as the primary regulator as opposed to the Fed.”

It is also unclear how willing the Fed would be to have a larger and more complex BHC shuttle out of its oversight. Brown said that, except the $65 billion-asset Zions, the firms that have made the move to date — Bank of the Ozarks and BancorpSouth — hold less than $20 billion in assets, and the Fed has let them go without protest.

“The Federal Reserve with the three that have already done it … the Fed has been kind of" complacent, Brown said. “If one of the really big guys does it, I don’t know if the response will be so laissez-faire.”

Another question is whether the FSOC would permit or encourage any of those larger banks to restructure, or if they did, what kind of regulation the council and Fed might decide to impose on a former BHC that would, under these circumstances, now be a nonbank SIFI.

Portilla said the law gives the Fed sole discretion to decide how to regulate a nonbank SIFI, though the oversight council has an advisory role. That discretion is fairly broad, he said, and certainly broad enough that the Fed could issue a set of rules for a nonbank SIFI broker-dealer that is not a carbon copy of its rules for BHCs.

“The nonbank SIFI rule set is not defined in the same way today as the bank holding company rule set,” Portilla said.

Brown said that Congress might actually push the oversight council and the Fed to make such accommodations because one fewer BHC means one fewer large institution with access to the federal backstop provisions that a formal bank charter provides.

“If the Republican Congress would not accept that as a free-market theory, then they’re not true Republicans,” Brown said. “If you’ve eliminated the backstop, then the government has less claim over an interest in your business. So the Republican Congress ought to look at that and say, ‘Sure.’ ”

Petrou said this idea of having the bank backstop separated more formally from the nonbank functions of BHCs is in some ways at the heart of what Treasury Secretary Steven Mnuchin and others in the administration have described as a “21st Century Glass-Steagall,” where risks inherent in nonbanking activities are compelled to float on their own and robust protections are put in place for banking institutions.

“Glass-Steagall was all about separating commercial from investment banking, but gradual erosion merged the two activities to virtual extinction,” Petrou said. “Hotel California was a new way to force large investment companies with banks into a BHC under the Fed with what at the time seemed a ‘no exit’ sign. The new-style financial holding company under consideration by the Trump administration would separate traditional banking far more effectively than is done under current law, making the BHC far less important.”

The FSOC and the White House have been generally suspicious of nonbank SIFI designations, with President Trump having issued an executive order in April calling for a review of the nonbank SIFI designation process.

The Treasury issued its report, prompted by the presidential order, last month. It outlined broad changes to the process for nonbanks to be designated as SIFIs and highlighted industry concerns about the effectiveness of nonbank SIFI designation.

But Portilla said it is still too soon to know whether Treasury's position will result in changes to how BHCs are automatically designated as SIFIs.

“I don’t think we know,” Portilla said. “These are all open questions.”

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