Loyola University Chicago School of Law, JD 2020
Background on Banking Regulation
In 2010, the Dodd-Frank financial-regulatory law drew a line at $50 billion in total assets to separate the big banks from the small. Any bank above the line faced mandatory strict scrutiny through stress tests and other regulations. The $50 billion boundary applied regardless of a bank’s complexity of nature of its business which caused banks with $65 billion in assets to be subject to the same rules as ones with $2.5 trillion. However, under the Trump administration, Congress and regulators have been considering alternative ways to categorize banks. In May 2018, Congress gave banks with assets between $50 billion to $100 billion relief from the mandatory rules of Dodd-Frank and instructed the Fed to decide which banks above $100 billion would also get relief. This proposal responds to that instruction.
At a meeting of the Fed’s governing board, the board approved a draft proposal that would divide big banks into four categories based on their size, risky short-term funding, off-balance sheet exposure, and how much business they do outside of the U.S. In a statement, Fed Chairman Jerome Powell said the proposals would “prescribe materially less stringent requirements on firms with less risk, while maintaining the most stringent requirements for firms that pose the greatest risks to the financial system and our economy.” This proposal would thus either partially or entirely release lenders from particular capital and liquidity requirements, or see the requirements reduced. Moreover, the lenders could be subject to less frequent stress tests.
The most noteworthy changes of the proposal would affect banks that will be classified in the lowest rung with assets between $100 billion and $250 billion. With the proposal, these banks would no longer have to follow the liquidity coverage ratio, which requires firms to maintain high quality liquid assets that they can sell for cash if needed. Furthermore, the proposal will give these banks flexibility in how “gains and losses in securities portfolios affect their capital levels,” which could have the effect of reducing the amount of capital that must be maintained. Furthermore, the proposal allows company-run and comprehensive stress tests to be done on a two-year cycle, rather than being done annually. The Fed’s annual stress tests publicly “grade” banks on whether they would be able to continue to lend during a severe recession.
Not only will the lowest category of banks be able to utilize the flexibility around the capital requirements, but the next category of banks such as U.S. Bancorp (USB), PNC Financial (PNC), Capital One (COF), and Charles Schwab (SCHW), with assets between $250 billion and $700 billion will also be able to benefit. Under the proposal, these larger banks will receive a less stringent liquidity-coverage-ratio requirement that is about 70-85% less than the one they currently have. This proposal could reduce the amount of liquid assets banks must have by about $43 billion. The third category would focus on the banks with “global scale,” or assets at $700 billion or more with $75 billion cross-jurisdictional activity. The proposal maintains this category will have “more stringent prudential standards.” The last category consisting of banks such as Wells Fargo, JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), considered global systemically important banks, will have the same highly restrictive standards as they have previously had.
The Reaction and Impact
Fed Governor Lael Brainard, who opposed the proposals, argued that the overhauls go beyond what is called for and would “weaken the buffers that are core to the resilience of our system.” She contended that weakening the rules would raise the risk that American taxpayers would be responsible for bailing out banks should there be another recession. On the other hand, banks have given mixed reactions to the proposal while some trade groups have praised it. Greg Baer, who heads the Bank Policy Institute, which represents large banks, stated that the proposal “does not do enough to tailor regulations” such as change primary stress tests for big banks or alter rules affecting foreign-owned banks with U.S. footprints.
According to a Fed memo, the overall aim of this proposal is to alleviate regulatory burdens “while still maintaining the gains made over the past decade” in terms of preventing another damaging financial crisis. Moreover, although the rules for the higher-level banks seem to remain in place, Fed officials say they are planning future proposals in these specific areas. Additionally, there is a possibility of adding a new system for foreign banks which were left out of the proposal.