By Charles H. Green
During the aftermath of the financial crisis, the regulatory community largely stood together and at times endured a withering degree of criticism that they had not done their job, given the extent of the systematic breakdown following the housing crash. When there were differences, they always seemed to be when FDIC Chair Sheila Bair offered a harder line of bank criticism than the others, expressing many of the failures of the system and some of its institutions.
Another such difference bubbled to the surface in the supervisory community recently
photo courtesy of Bloomberg.com
after the Federal Reserve reported that capital at the eight largest American banks averaged 12.9 percent of assets at the end of 2014, according to their measurement, well above required regulatory minimums.
But in contrast, in a recent speech by FDIC Vice Chair Thomas Hoenig, he calculated that capital at those same banks averaged only 4.97 percent at the end of 2014. This discrepancy is due to differing views at the FDIC of the risks posed by the banks’ vast holdings of derivative contracts used for hedging and speculation, which is more closely aligned with international accounting standards.
The Fed assumes that gains and losses on derivatives generally net out, in keeping with American accounting rules and the central bank’s accords, and as a result, most derivatives do not appear as assets on banks’ balance sheets, an omission that bolsters the ratio of capital to assets. The FDIC takes exception to this generous view.
Since passage of the landmark Dodd-Frank Act in 2010, fully named, the Wall Street Reform and Consumer Protection Act, delaying, confusing and rolling back the new law has been a constant pursuit of many of the nation’s largest banking institutions. As fast as the resulting new regulations were announced or implemented, an onslaught of proposals were aired for regulatory reform by the financial industry, intended to dilute or delay any and all effects on the pre-crisis leeway the major banking houses had to the banking system that previously crashed.
Maybe the day for reform has finally arrived, as Hoenig announced a bold new proposal to scale back the regulations on a majority–more than 90 percent, in fact–of the nation’s banks, who would be largely exempted from many of the onerous reporting requirements, tangled compliance mandates and restrictive capital tabulations of Dodd-Frank.
The catch, of course, is that while the suggested relief of regulatory burdens will affect the vast majority of institutions that pose no danger of systematic risk, due to their business activities, the relative scale of risky operations or capitalization.
Hoenig has proposed some smart ways to give regulatory relief to the banks that deserve it: low-risk, traditional banks that did not cause the financial crisis. Those institutions that did contribute to the 2008 mess get no relief under the plan.
Hoenig’s proposal is based on the size, complexity and business activities of any institution to determine whether it’s eligible for the possible relief. He and his deputy Karl Reitz examined bank failure rates and looked at the institutional characteristics of banks that were able to withstand downturns.
From this exercise, Hoenig devised a criteria list for banks he felt would be safe to exempt from some regulations without posing risks to the financial system and ultimately, the taxpayers. The winners would be banks that:
- Hold no trading assets or liabilities;
- Have no derivative positions other than plain-vanilla interest-rate swaps and foreign exchange derivatives;
- Hold a notional value of all derivatives exposures totals less than $3 billion;
- Have a capital level of at least ten percent.
As for the latter, such a simple, straightforward capital ratio cannot be gamed as more complex, risk-weighted ratios can. Obviously, many smaller community banks already have capital ratios at or above this minimum level, and for most that don’t, it would be difficult to get there
What kinds of regulations could banks avoid if they met these qualifications? Hoenig offered his ideas that 1) they might be given longer periods between examinations by their regulators, such as every 18 months instead of every 12; 2) exempting a bank from having to complete some sections of the quarterly call report; 3) banks could avoid having to adhere to capital standards and calculations required under the rules of the Basel Committee on Banking Supervision, the international standard-setter.
“From our point of view, a bank that meets the 10 percent threshold of equity to assets and that doesn’t have trading or off-balance-sheet items, that’s a well-capitalized bank,” Mr. Hoenig said.
In addition, Hoenig suggested that qualifying banks could also escape having to conduct stress tests under the Dodd-Frank Act. “If you meet the 10 percent capital requirement and you’re traditional, we would do the stress test ourselves,” Mr. Hoenig said.
Banks meeting the criteria Hoenig propose would not be exempt from the Volcker Rule, which was intended to separate banks’ risk-taking trading desks from their federally insured units. That’s because these banks aren’t engaging in these kinds of practices. “The reality is that the vast majority of community banks have virtually no compliance burden associated with implementing the Volcker Rule,” Mr. Hoenig said.
Congressional support is required to make some of these changes. Politicians are well aware of the rules, since the clamor for regulatory relief from the large, politically connected financial institutions has been a constant ever since Dodd-Frank was enacted. After working to water down the rules as they were being written, today they are simply pushing for repeal.
How Hoenig’s proposal will be received remains to be seen, but the choices are quite clear as the regulatory community agrees with relief if they are permitted to differentiate between institutions that truly deserve a lighter burden and those that do not.
“For the vast majority of commercial banks that stick to traditional banking activities and conduct their activities in a safe and sound manner with sufficient capital reserves, the regulatory burden should be eased,” Mr. Hoenig said. “For the small handful of firms that have elected to expand their activities beyond commercial banking, supported with the subsidies that arise from the bank’s access to the safety net, the additional regulatory burden is theirs to bear.”
What do you think? Comment on this page or write me at Director@SBFI.org.