Federal banking regulators recently proposed changes to the enhanced supplementary leverage ratio, which currently applies to the 8 U.S. GSIBs. The proposal will result in a non-material decrease in aggregate bank capital requirements of about 0.74%, according to the most recent available data.
Despite this modest change, recent commentary argues that this proposal will make banks less resilient by lowering leverage capital requirements at bank subsidiaries. These latest assertions cite a 27% reduction in capital at the insured depository institution subsidiary under the proposal, which we’ve previously demonstrated is misleading. They also fail to account for the strict legal and supervisory constraints that continue to govern and restrict capital movements for both bank holding companies and their subsidiaries.
Bank Reg. 101: Insured Depository Institutions vs. Holding Companies
To understand how the proposal affects capital for different parts of banking organizations, it’s worth taking a closer look at how banks are structured:
- Insured Depository Institution (IDI). Only IDIs are authorized to accept deposits. IDIs must have FDIC insurance and are limited by law to banking and incidental activities.
- Bank Holding Company (BHC). A BHC may own one or more IDIs and can also engage in a broader set of activities closely related to banking (e.g., securities dealing, asset management or insurance) through other subsidiaries. Importantly, capital regulations apply both to the parent BHC and to each IDI, meaning that capital strength must be maintained throughout the organization, not just at the top.
What Obligation Do BHCs Have to Their Subsidiaries?
Holding companies are required under the Dodd-Frank Act to serve as a “source of strength” for their bank subsidiaries. That means the BHC must provide financial support when a subsidiary is under stress. Even when a subsidiary is well capitalized and not facing trouble, resolution planning requirements still apply. BHCs must assess the capital needs of each subsidiary in a potential resolution scenario and ensure that enough resources are either prepositioned at the subsidiary or readily available to support it if needed.
To meet these obligations, U.S. GSIBs (and any Category II or III banks using the “single point of entry” resolution strategy) use what’s known as “secured support agreements.” These legally binding contracts commit the parent company to provide capital to subsidiaries under defined stress or resolution conditions. The agreements are triggered by pre-defined thresholds, are reviewed as part of regulatory resolution plans and are designed to address the practical limitations seen in past crises.
How Capital Moves Within Bank Holding Companies
Capital flows between a bank subsidiary and its affiliates are governed by strict rules. Banks cannot simply transfer “excess” capital to other affiliates at will. Instead, any movement of funds is subject to regulatory restrictions, supervisory oversight and contractual limitations. These limitations remain untouched by the current proposal and include:
- Dividend Restrictions: National and state member banks are generally prohibited from paying dividends to their parent holding companies in excess of their current year’s net income plus retained net income from the prior two years, unless they receive explicit regulatory approval. Distributions that exceed these thresholds, or that represent a withdrawal of permanent capital, require prior approval from the relevant supervisory agency such as the OCC or the Federal Reserve.[1],[2]
- Capital Transfer Rules: To allocate capital to a non-bank subsidiary (e.g., a broker-dealer subsidiary of the parent holding company), the IDI must first distribute funds through dividends to the parent holding company (subject to the restrictions noted above). The parent company must then contribute capital to the target subsidiary. Each step of the process is regulated and, if thresholds are exceeded, it requires supervisory approval.
- Supervisory Oversight: Even if a bank meets the technical criteria for a dividend, supervisors can deny requests to distribute excess capital if they have safety and soundness concerns.
Conclusion
The claim that lower capital requirements at bank subsidiaries will necessarily make banking organizations less resilient is unfounded. These criticisms do not fully account for the robust regulatory limitations on capital distributions and the strengthened resolution planning requirements for large banking organizations. Aggregate reductions in bank capital remain immaterial, and holding companies are expected to leverage the current resolution process to deploy capital where it’s needed most.
The combination of dividend restrictions, supervisory overlays and enforceable support agreements for GSIBs and other large banks continues to ensure that capital remains available where it is most needed—even in times of stress.
[1] 12 CFR § 208.5; 5.64. For national banks and state member banks, approval is required if (i) the dividend, together with dividends in the current year, would be in excess of the amounts permitted under the recent earnings test (generally income for the YTD period and retained net income for the two prior years) or (ii) if the distribution is in excess of retained earnings and would represent a withdrawal of permanent capital.
[2] Bank Policy Institute, A Few Observations on Bank Dividends (June 18, 2020) available at https://bpi.com/a-few-observations-on-bank-dividends/.
