Large Regional Banks Don’t Need New Resolution Requirements
BPI this week responded to the Federal Reserve and FDIC’s request for comment on whether the benefits of requiring large U.S. regional banks to maintain an extra layer of loss-absorbing capacity, on top of existing capital and resolution requirements, outweigh the costs when it comes to enhancing the resolvability of those banks.
What BPI is saying: “The idea for an extra layer of loss absorbency borrows from the resolution framework designed for the largest globally active banks, but it is an idea that is wholly ill-suited for large U.S. regional banks, which operate with entirely different business models and risk profiles. It would impose substantial and immediate additional costs on these banks, lead to competitive imbalance, and provide only modest potential benefit,” BPI General Counsel John Court said.
What’s happening: The Fed and FDIC are seeking input on whether large U.S. regional banks should implement resolution strategies like issuing an extra layer of unsecured, long-term debt to absorb losses if the bank fails. Policymakers designed those strategies specifically for Global Systemically Important Banks, which have very different business models and organizational structures than their large regional counterparts – for example, the GSIBs tend to have complex networks of material legal entities, significant international operations through multiple foreign subsidiaries, etc. The GSIB resolution strategies are both unnecessary and inappropriate for non-GSIB banks. The Fed and FDIC also assume that the failure of a large regional bank could have systemic consequences, but large regionals have much lower systemic risk scores than the largest global institutions. Additionally, while the agencies are seeking “optionality” in large regional bank resolution, regulators already have multiple options at their disposal in the event of a failure under the current framework.
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Four Key Things
1. BMO Goes West
Bank of Montreal and U.S. subsidiary BMO Financial Corp. received Federal Reserve and OCC approval this week to buy Bank of the West, headquartered in San Francisco and currently owned by BNP Paribas. The resulting bank will have about $256 billion in total assets, according to the OCC. The deal will give BMO a footprint in the western U.S.
- Backdrop: The approvals conclude a lengthy process for the two banks and come
samid scrutiny of bank mergers, particularly those involving large regional banks. The regulators recently approved U.S. Bank’s acquisition of MUFG Union Bank, and TD Bank’s proposed purchase of First Horizon is still awaiting a nod. Next week, comments are due on a Fed and FDIC release contemplating possible new resolution planning requirements for large regional banks.
- Financial stability factor: As BPI has noted in its research, bank mergers can strengthen financial stability, in part because larger banks are subject to intensified prudential standards. “[BMO Financial Corp.] is projected to become subject to additional enhanced prudential standards as a Category III U.S. intermediate holding company after consummation of the proposed transaction,” the Fed noted in its approval order. “These enhanced prudential standards are expected to offset the modestly increased systemic risks from the transaction.”
- Cautionary note: The Fed approved the merger with no dissenting votes, but Vice Chair Lael Brainard released a statement expressing concern about the large regional bank market. “As I have noted previously, the increases in banking concentration in the $250-700 billion asset size category raise concerns,” Brainard said. “Since we know from experience that even noncomplex banks in that range can pose risks to the broader financial system when they experience financial distress, I am encouraged that the Board is seeking comment on an advance proposal to improve their resolvability through long-term debt requirements and is undertaking a serious review of large bank capital requirements.”
2. Putting Bank Capital in Context
A Bloomberg editorial this week featured a chart showing that a version of banks’ leverage ratios (in particular, tangible common equity/tangible assets) are modestly declining, but provided no context about why that may be. A key reason: the addition of riskless assets – reserves and Treasuries — to the denominator of that ratio. Treasuries and reserves – bank deposits at the Fed – piled up because of regulatory requirements for banks to hold riskless assets for liquidity purposes and the Fed’s Treasury-buying stimulus spree during the pandemic.
- Adjusted for context: The same chart with those riskless assets deducted from the denominator shows the ratio nearly 2 percentage points higher. (See above.)
- Above and beyond: For definitive proof that bank capital is robust, look at the stress tests. Total loss absorbency for the 33 banks included in the 2022 stress tests exceeded $2.8 trillion, more than 9x net stress losses under last year’s stress scenario.
3. Who Wants a Fed Account? The Answer Should Be Public
Congress recently established new requirements for the Fed to publish an online database of firms seeking access to Federal Reserve master accounts and services. The requirement will improve transparency around the process, but the Fed should also implement its own measures to shed light on account applications, BPI said in a letter this week.
- What BPI is saying: “Public transparency helps to improve accountability and oversight, increases trust in the process and leads to a safer overall financial system for all participants,” stated Paige Pidano Paridon, senior vice president and senior associate general counsel.
- Why it matters: Fed master accounts connect firms directly to the U.S. payments system, enabling them to clear and settle private transactions without concern about liquidity or credit risk. Fintech firms with “novel charters” that lack consolidated supervision and deposit insurance have sought these accounts in recent years, but the Fed’s deliberations on them have been behind closed doors. Linking these firms with regulated banks via master accounts without adequate safeguards could transfer risks posed by novel charters to Reserve Banks, the payments system and its participants. Ultimately, that could threaten financial stability and jeopardize the Fed’s ability to conduct monetary policy.
4. Fed Releases Climate Scenarios for Large Banks
The Federal Reserve this week released the details of its climate scenario analysis exercise for the six largest U.S. banks. The central bank reiterated that the exploratory exercise is “distinct and separate from bank stress tests” and has no capital or supervisory implications. Submissions will be due by July 31, 2023.
- Physical risks: The exercise includes scenarios assessing “physical risks” of climate change such as natural disasters. One physical risk scenario involves a hurricane in the northeast U.S. affecting commercial and residential real estate.
- Transition risks: The pilot also covers transition risks – intangible risks related to a transition to a lower-carbon economy, including climate policies or government actions, such as a carbon tax. In the Fed’s scenarios, banks will consider the effect on corporate loans and commercial real estate portfolios through a scenario based on current policies and a scenario under the assumption of net zero greenhouse gas emissions by 2050.
- The goal: The exercise aims to help banks further hone climate risk management practices.
- Stepping back: Banks are constantly monitoring the risks in their portfolios, including climate-related risk. But policymakers should approach climate risk with caution, given the gaps, double-counts and shortcomings in climate data and the mismatch between shorter bank risk management time horizons and long climate-related time windows. Studies have also shown that banks, particularly larger banks, can withstand severe weather events with no damaging effects.
In Case You Missed It
The Crypto Ledger
Genesis Global Holdco LLC and two lending subsidiaries filed for bankruptcy this week, according to Bloomberg. Here’s what else is new in crypto.
- Dirty money: In the latest federal crypto crackdown, the U.S. Department of Justice and Treasury Department targeted crypto exchange Bitzlato and its founder with sanctions and money laundering charges.
- FTX hack: Bankrupt crypto exchange FTX told unsecured creditors that $415 million in crypto has been stolen by hackers since the exchange filed for bankruptcy.
- Ripple effects: A recent Bloomberg piece explores how an upcoming court ruling on Ripple could shape the crypto regulatory landscape. The key question: whether the XRP digital token should be considered a security, and therefore fall under SEC jurisdiction.
- Crypto rehab? If crypto trading is like gambling, as some have suggested, what happens if you have a problem? A recent American Banker piece features the manager of “luxury crypto rehab centers” in Mallorca, Switzerland and London that treat crypto addiction much like a gambling addiction.
BofA $1 Million Donation Will Boost STEM Education, Career Development
Bank of America recently donated $1 million to Discovery Place, a STEM learning organization in the Carolinas, to support science, technology, math and engineering education and career development opportunities for local students in the Charlotte, N.C. area. The donation will enable students from diverse and underrepresented backgrounds to access high-quality jobs in tech and science fields.