Bank regulators have sparked debate among policy specialists about what
Last week, the Federal Reserve and the Federal Deposit Insurance Corp. issued an
"They're truly going into this with an open mind and looking for feedback on what the best approach would be for these firms," said Jeremy Kress, a business law professor in the University of Michigan. "I didn't take much substantively out of reading the ANPR, other than, 'Here are a bunch of questions, everything's on the table.' The only thing we can say with certainty is that the agencies all agree that this is a problem that ought to be addressed."
Yet, while the agencies have not taken a firm stance on how they might change their policies toward Category II and Category III banks — also known as large regional banks or domestic systemically important banks, or DSIBs — others have read between the lines.
Dennis Kelleher, head of the nonprofit advocacy group Better Markets, praised the agencies' recognition of the financial stability risk posed by these banks. But he said he is concerned about the questions focused on long-term unsecured debt requirements. Kelleher said this was tied too closely to the "grossly inadequate and unworkable idea of total loss-absorbing capacity."
"TLAC is a fraud on the public because it has the appearance of helping financial stability when it will likely be destabilizing in a crisis and increase the likelihood of taxpayer bailouts," Kelleher said.
Stephen Miller, a senior research fellow at the Mercatus Center, also sees the agencies preparing to "lower the threshold at which TLAC applies," thus extending the too-big-to-fail framework of the global systemically important banks (GSIBs) to more banks. Because banks are already well capitalized and have little exposure to high-risk assets, he said such a shift would not be particularly burdensome, but he questioned its efficacy in protecting customers, taxpayers or financial stability.
"They're not the most costly changes if they are implemented, but they may not be the most effective." Miller said. "That is not something that really concerns me, but it's kind of like making a change just to make the change. It's like window dressing."
Since the Dodd-Frank Act of 2010, eight U.S.-based GSIBs have been required to submit resolution plans to the Fed every two years. In addition to being subject to TLAC requirements, these banks also face "clean holding company" rules — prohibiting certain risky activities at the holding company level — and are subject to supervisory guidance from the Federal Reserve Board of Governors. Category II and III banks submit resolution plans every three years, alternating between full and targeted plans, but face none of the other requirements as the GSIBs.
How closely the resolution framework for large regional banks should resemble that of the GSIBs is at the heart of the agencies' preliminary round of questions.
Regulators and policy advocates have been alarmed about large regional banks and their resolvability for years. Martin Gruenberg, acting director of the Federal Deposit Insurance Corp., gave a speech about the subject at the Brookings Institution in October 2019. Then a member of the FDIC board of directors, Gruenberg said the yearslong focus on ensuring the GSIBs were positioned to withstand a failure or bankruptcy had "obscured the risks associated with the failure of a large regional bank and permitted an unjustified sense of confidence to develop that the failure of such an institution would not be challenging."
From December 2019 to December 2021, the average Category III bank — those between $250 billion and $700 billion of assets — grew from $413 billion of consolidated assets to $554 billion, according to the memo released by the Fed and FDIC last Friday. Many of these banks are also more heavily reliant on uninsured deposits and engaged in more complex lines of business than in years past.
"The [Insured Depository Institutions] have gotten so big that the traditional approach the FDIC has to deal with them is, at best, creaky and more likely not viable under stress," said Karen Petrou, founder and managing partner of Federal Financial Analytics.
The resolution plan requirements currently imposed on large banks have made them more resilient than pre-Dodd-Frank, Petrou said. She also noted that bank holding companies in these categories tend to meet the standard of "clean" already, and their underlying depository institutions are all insured, so additional regulatory requirements have not been necessary.
Yet, one element of the large-bank resolution that warrants revisiting is the "least-cost test," Petrou said. A provision of the 1991 FDIC Improvement Act requires the FDIC, when overseeing the resolution of a failed bank, to liquidate the institution's assets at the lowest cost possible to the public.
Petrou said updating the least-cost standard, or at least clarifying its applicability under the current regulatory framework, should be a key goal for the FDIC as it revisits its resolvability practices.
For smaller banks, those with under $10 billion of assets, the FDIC generally orchestrates a purchase and assumption agreement, in which another bank buys the failed institution and takes on its insured deposits. If such a transaction cannot be facilitated, the FDIC pays out insurance on its insured deposits and takes the remaining assets into receivership.
Given the cost of taking a large bank into receivership, Petrou said, the least-cost doctrine has incentivized the FDIC to find a single buyer for a failed institution, even if it means subsidizing the sale. This is, in part, because large banks, unlike GSIBs, are not required to have plans for divvying up subsidiaries, portfolios and lines of business in the case of a failure.
"In a very big regional bank, the least-cost test remains an obstacle to doing things like breaking up the bank and selling pieces off," she said. "Planning ahead, that might be possible. In an emergency, it isn't [possible]."
This nearly happened when Washington Mutual failed in 2008. In his 2019 speech, Gruenberg said that, had JPMorgan Chase not been able to purchase the failed thrift company for $1.9 billion, taking WaMu into receivership would have wiped out the FDIC's Deposit Insurance Fund and forced uninsured depositors to suffer losses.
"Given the stressed economic and financial environment in September 2008 when Washington Mutual failed, imposing a loss on $45 billion of uninsured deposits could have had a significantly destabilizing effect," he said.
The FDIC board of directors is set to discuss the advance notice of proposed rulemaking at its October meeting on Tuesday.
