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The House Financial Services Committee narrowly passed an amendment yesterday 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 enable a council of regulators to break up large, complex banks and another to let the Federal Deposit Insurance Corp. (FDIC) set up a liquidity facility to help solvent companies, according to American Banker, a Collections & Credit Risk sister publication.
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."
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.
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.
