Should Large But Not Systemically Important Banks Be Required to Issue More Long-Term Debt?
A comment letter review
Monday was the last day for the public to submit comments on the Federal Reserve Board/FDIC advance notice of proposed rulemaking on resolution-related resource requirements for large banking organizations. This post reviews the comment letters received by the agencies. It is organized as follows:
I. Background on the ANPR
II. Three Key Takeaways From Comment Letters Received
III. Detailed Summary of Comments in Favor
IV. Detailed Summary of Comments in Opposition
V. Other Comment Letters
VI. Brief Summary of Comments on Technical Details
I realize this is a very long post so, as always, thanks for reading! If you think I missed or mischaracterized something important in any of the letters, or just have other thoughts to share, feel free to email bankregblog@gmail.com.
I. Background on the ANPR
For better or worse, most posts on this blog assume familiarity with the underlying background. But because here it will be relevant to many of the specific arguments made in the responses received, I think it makes sense to start with a brief recap of the claims made and questions asked in last fall’s ANPR release.
GSIB Resolution Planning and Related Requirements. The ANPR began by noting that U.S. global systemically important banking organizations are subject to the most stringent rules regarding resolution resources and preparedness. These firms are required to, among other things, maintain minimum levels of total loss-absorbing capacity (TLAC) and long-term debt (LTD), comply with rules that prohibit top-tier holding companies from issuing short-term debt or entering into certain other contracts that could impede orderly resolution (clean holding company requirements), and adopt provisions in certain of their contracts that prevent their counterparties, for a specified period of time, from terminating, liquidating or netting such contracts in the event that the GSIB enters resolution proceedings (QFC stay provisions).
On top of this, GSIBs are also subject to intense supervisory expectations regarding recovery planning (i.e., plans as to how a firm would right itself and restore market confidence in the event of distress) and resolution planning (i.e., a plan for what an orderly resolution would look like assuming the firm did fail), with updated resolution plans due every two years.
U.S. GSIB resolution plans feature single point of entry (SPOE) resolution strategies, in which only the top-tier holding company enters into bankruptcy while its subsidiaries continue to operate. The TLAC and LTD requirement discussed above is a key aspect supporting this strategy, as described by the agencies:
To facilitate this resolution strategy, the total loss-absorbing capacity (TLAC) rule requires a GSIB to maintain a minimum level of eligible long-term debt at the holding company level. Proceeds from issuance of long-term debt may be down-streamed to subsidiaries, such as in the form of internal debt, or maintained at the holding company to allocate as resource needs arise at particular subsidiaries. Prior to resolution, the top-tier holding company would down-stream all remaining available resources. Upon exhaustion of the remaining holding company resources it would enter resolution while the subsidiaries continue operating.
Non-GSIB Large Bank Resolution Panning and Related Requirements. For purposes of readability, and at a slight sacrifice to accuracy, in this post I will refer throughout to large banking organizations operating in the United States that are not U.S. GSIBs simply as “large banks.”1
Compared to U.S. GSIBs, large banks are subject to a comparatively more limited set of resolution-related requirements. Banks in this group are not subject to TLAC, LTD, clean holding company or QFC stay rules. These firms also file resolution plans less frequently (every three years).
Compared to their U.S. GSIB peers most large banks concentrate their activities to a greater degree on traditional banking, and thus their resolution plans differ not just in frequency but also in strategy. In general, large banks expect to rely on a multiple point of entry (MPOE) resolution strategy, meaning that more than one entity in the banking organization’s structure would enter resolution proceedings. For example, the top-tier holding company would file for bankruptcy, while the insured depository institution would be resolved by the FDIC under the Federal Deposit Insurance Act (FDIA), the firm’s broker-dealer would be dealt with if necessary under the Securities Investor Protection Act, and so on. As the FDIC explains, resolving a bank under the FDIA at least in theory means that it has various alternatives available to it:
[T]he FDIC has several options for carrying out the resolution of an insured depository institution, including selling assets and transferring deposits to healthy acquirers, transferring assets and deposits to a bridge bank (which, among other things, could either sell off assets over time or conduct a sale or an IPO once the restructured business has stabilized), or executing an insured deposit payout. In deciding which option to pursue, the FDIC must show how it would meet the least-cost test set forth in the FDI Act in furtherance of its key objective of protecting insured depositors.
Changed Circumstances. After laying out this background, the ANPR states that the “U.S. banking system has continued to evolve” since the above-described framework was originally adopted, such that the current resolution-related rules that apply to large banks may be insufficient. In particular, the APNR cites the following changes that have occurred for some or all large banks:
Increased size
Increased reliance on uninsured deposits to fund operations
Increased cross-jurisdictional activity or significance of non-bank operations
These factors, the agencies contend, could make a resolution more difficult and more costly. The agencies worry in particular about a scenario in which some of the options available to the FDIC under the FDIA as quoted above are unavailable, such that the only viable option is to sell the entire bank to an acquirer. If so, the agencies are concerned that the pool of potential buyers could be very small - basically limited to handful of other large banks and U.S. GSIBs - which could have negative implications for competition, financial stability, and so on.
Request for Comment on Long-Term Debt Requirement. In light of the above, the agencies believe that adding new resolution-related requirements could be helpful in expanding the range of options available to them if the resolution of a large bank is required. The ANPR offers various ideas as to what new requirements could be useful, but its main thrust relates to whether it might be necessary for the agencies to require “additional ex ante financial resources, such as qualifying forms of long-term debt.”
The agencies’ thinking is that, if it came to it, this LTD could absorb losses and keep more options available to the FDIC.
The availability of this loss-absorbing resource at the insured depository institution would protect deposits and thereby increase the likelihood that a transfer to a bridge insured depository institution to preserve franchise value would be less costly to the DIF than a payout of insured deposits. Use of a bridge insured depository institution would enhance the FDIC’s ability to pursue options that could involve breaking the insured depository institution up for sale to multiple acquirers, and/or spinning off some remaining streamlined operations as a restructured entity with ongoing viability, depending on which strategy is most desirable. Generally speaking, the greater the extent of feasible options available to the FDIC as it undertakes resolution of an insured depository institution, the greater will be the chance that resolution can be conducted in an orderly manner.
Technical Questions About an LTD Requirement. After laying out their case for why an LTD requirement might make sense, the ANPR asks a number of technical questions about how, if the agencies do choose to go down this path, an LTD requirement ought to work. Paraphrasing, the agencies’ questions here include:
Who? To whom should the requirement apply? The ANPR says it is mainly concerned with Category II and Category III firms, the threshold for which generally starts at $250 billion in total assets.2 If that is the case, should these rules apply to all banking organizations with above $250 billion in total assets, or only to a subset of this group? If a subset, what factors should the agencies use to determine whether a firm is in scope?
Where? Regardless of the firms to which a new rule applies, should the LTD be required to be issued at the holding company level or at the bank level? A mix of both? Would internal issuance (e.g. issuance between the bank and its parent holding company) be okay, or should only external issuance (that is, to the market) count?
How much? How much LTD should be required? Current requirements for US GSIBs include a requirement measured as a percentage of risk-weighted assets and a separate leverage-based measure. Are both of those appropriate here?
What counts? What should count as LTD? For instance, should the requirements that apply for a debt instrument to count as LTD when issued by a GSIB (e.g., that the instrument be “plain vanilla”) apply here?
How Should Foreign Banks Be Treated? What about the U.S. operations of foreign GSIBs, such as the U.S. subsidiaries of Deutsche Bank and Credit Suisse? These firms are already required to organize their operations in the United States under intermediate holding companies (IHCs), which then are in turn required by U.S. rules to issue (internal) TLAC at the IHC level. Are additional rules a good idea for these firms, too?
Other Ideas. Finally, the ANPR asks whether there are other requirements that should be applied to large banks. For example, should a clean holding company requirement apply? Should there be triggers or other set-in-stone governance mechanisms laying out when LTD will be used to absorb losses, in order to make sure that the resolution process does not start too late?3 Should large banks be subject to additional rules requiring them to identify “separability options” - i.e., assets, portfolios or business lines that could be sold or transferred?
II. Three Key Takeaways From Comment Letters Received
In total, excluding letters written by individuals not associated with an academic institution or other recognized organization, the Board and FDIC as of this writing have posted just under 20 comments received on the ANPR, mainly from trade associations and banks, but also from academics, law firms, public interest groups, and U.S. Senators. (Necessary caveat, this is based on the letters that are currently public. I think the FDIC’s list is comprehensive of all letters received by the agency, but the Board’s page is missing a few letters posted by the FDIC yesterday, so it is possible that further letters will be posted by the Board.)
Before getting into the specific details, here are what I see as the three big picture observations on the comment letters.
No Detailed Arguments in Favor of the Proposal
Senator Brown and Senator Van Hollen wrote a short letter on Monday calling the ANPR a “step in the right direction” and encouraging the regulators to adopt (unspecified) “stronger separability and contingent capital requirements.” This letter is discussed in more detail below, as is a brief letter from the Independent Community Bankers of America that essentially reiterates the statements made by the regulators in the proposal and offers support for applying increased requirements to large banks.
Other than that, though, there was not any other support for the LTD requirement suggested in the ANPR. For example, the advocacy group Better Markets, although obviously not a fan of the state of financial regulation today, also is unconvinced by TLAC. The group submitted a letter calling on the Board and FDIC to “stop pretending” and to acknowledge that TLAC is “fundamentally flawed.”
Other advocacy groups that typically support more stringent bank regulation apparently have not submitted comment letters.
To be clear, an agency’s approach to the public notice and comment process is about much more than just totting up the comments in support and the comments in opposition, so this disparity between pro- and anti-letters on its own does not mean very much. And of course part of the reason why there are fewer comments on this side of the ledger this time around is because some of the more prolific bank-skeptical commenters over the past few years are now working in government (or on special projects for the government), a tradeoff that progressives would probably happily take. Still, if and when the agencies do decide to move forward (which I am guessing they will), I’ll be interested to see how they characterize the comments received on the ANPR.
Not Much Comment at This Stage on Technical Details
Perhaps unsurprisingly given that the rule is only at the ANPR stage, commenters generally devoted the majority of their respective submissions to calling into question the premises underlying the ANPR. For example, commenters say that the concerns cited by the agencies are not in fact as troubling as the agencies make out and, in any case, are mitigated by the work that has already been done by large banks on resolution planning. There are also ominous references to the absence of Chevron deference, the strictures of the major questions doctrine, and various other administrative law considerations intended to imply that if the agencies do move forward, they will be on shaky ground.
Much less space in the letters, and in many cases no space at all, was devoted to commenting in detail on the mechanics of how an LTD requirement ought to work if one is imposed.
So Far, Large Banks Adopt a Mostly United Front
In the ANPR, the agencies asked whether new rules, if new rules are indeed imposed, should be applied to large banks across the board (based, perhaps, on the risk-based categories adopted in 2019) or whether the agencies should look to new metrics for determining which banks should be subject to new rules. ICBA letter aside, for the most part banks are continuing to present a unified front, and not seeking to gain their own individual advantages by making the case, explicitly or implicitly, against other banks. That said, a few possible exceptions to this are discussed below.
III. Summary of Comments in Favor
As noted above, only two comments were explicitly in favor of ideas included in the ANPR, and both of them were brief.
It may even be going too far to say that the letter from Senators Brown and Van Hollen represents full-fledged support for the ANPR’s ideas. To be sure, the letter calls the ANPR a step in the right direction and later calls it “critical.” On the other hand, the main policy recommendation in the Senators’ short two-page letter is “Large banks should also have contingency funds, in the form of segregated capital, to support emergency liquidation; just like their customers have ‘rainy day’ funds for emergency expenses.” I guess that could be describing TLAC or a long-term debt requirement, but it is not typically the way the agencies describe it. In fact it sort of sounds like the “banks need to hold capital aside” thing that people were making fun of Jamie Dimon for a few months ago.
I also found the ICBA’s short letter somewhat unsatisfying as it essentially does nothing more than agree with the same claims made in the ANPR - citing to increased merger activity among large banks, an increase in uninsured deposits, and international activity and significant nonbank operations as justifications for an LTD requirement. Interestingly, ICBA also appears to recommend that the amount of LTD each large bank be required to maintain be calibrated individually for each bank, but should generally be close to the requirements applicable to GSIBs.
As will be discussed in detail below, a number of commenters opposed to the proposal cite, among a parade of other horribles, the effects that an LTD requirement could have on the cost or availability of credit. To be honest, those arguments sort of felt like throw-ins, and I did not find them all that compelling. On the other hand, is it too cynical to conclude, after reading this ICBA letter, that community banks seem to have an instinct as to what this sort of requirement is likely to do to the cost of credit offered by their larger competitors?
IV. Summary of Comments in Opposition
Summarized below are the key points made by commenters who believe an LTD requirement or other resolution-related requirements would be unhelpful (or worse).
A. Trade Group Comments
In terms of national banking trade groups, the agencies received letters from the American Bankers Association, the Bank Policy Institute, the Securities Industry and Financial Markets Association and the Institute of International Bankers. The Chamber of Commerce also submitted brief comments.
Some of these letters had more idiosyncratic focuses based on the interests of their members, but in general here is an abbreviated summary of the claims made across multiple of the trade group comments.
The Agencies’ Concerns Are Not Well Founded
Significant portions of the letters are devoted to challenging many of the claims made in the ANPR. For example, both the ABA and BPI letters spend time arguing that uninsured deposit levels do not present the level of risk the agencies believe that they might. ABA also notes that asset growth is not as concerning as the regulators make it out to be, as much of this asset growth reflects a sharp increase in banks’ holdings of safe assets. BPI avers that various aspects of the post-financial crisis regulatory framework “reduce both the risk that a non-GSIB LBO might fail and the losses uninsured depositors might face in the vent of failure.”
The failures of Washington Mutual and IndyMac have been cited by both FDIC Chair Gruenberg (multiple times) and Acting Comptroller Hsu as illustrating the risks that can be posed by the failure of firms that are large but not systemically important on a global scale. Those two firms are not explicitly mentioned in the ANPR itself, but their examples frequently loom over these sorts of discussions - indeed, they are cited in the Brown/Van Hollen letter noted above - so the BPI letter also addresses them.
BPI says that WaMu and IndyMac had different risk profiles than today’s large non-GSIBs and, as importantly, were also regulated much differently.
Mutual and IndyMac were regulated by the now-defunct Office of Thrift Supervision, which positioned itself as a “light touch” regulator. Those institutions had highly concentrated and risky business lines, loan portfolios and funding profiles. They also had weak underwriting and risk management practices.
For this and other reasons, BPI believes that these two firms are not relevant precedents. Incidentally, BPI also points out that though the Deposit Insurance Fund “did suffer a major loss from the failure of IndyMac, it had less than $50 billion in assets. Accordingly, the size of the loss was a function of the magnitude of the failures of management and regulators, as opposed to the size of the institution.”
Regulation Makes Distress Less Likely, and in Any Case Existing Resolution Plans are Credible
The trade group letters also make a two-fold point about the post-crisis regulatory regime. First, the trades discuss various aspects of the current regulatory framework and argue that these regulations and guidance make distress at a large bank less likely. Second, even in the event distress were to occur, the trades believe that existing large bank MPOE resolution plans are credible. Because MPOE plans are different from SPOE plans, and are credible as-is, they do not need the associated TLAC and LTD requirements that have been specifically designed to facilitate SPOE plans.
I am sure people will take issue with this claim that large bank resolution plans are credible, and not necessarily unfairly. Who knows what would happen if these plans actually were to be required to be put into practice? For what it’s worth, I tend to sympathize with those who are skeptical that bailouts are indeed now off the table. (Although I also think maybe in some cases bailouts are okay compared to the alternative.)
Anyways, regardless of how persuasive you find this argument overall, an argument that resolution plans filed by large but not systemically important banks are not feasible does seem like a claim that is, at the least, awkward for regulators to make. As the comment letters point out, no large U.S. regional bank has ever had its resolution plan found by the Board and FDIC to be not credible. Not under regulators appointed by President Obama, not under regulators appointed by President Trump, and not, per feedback released this past September and December, by regulators appointed by President Biden. Indeed, even CFPB Director and FDIC board member Rohit Chopra, who called GSIB resolution plans a “fairy tale,” evidently did not believe that any large regional resolution plans were not credible - or at least did not share any such concerns publicly.
Imposing an LTD Requirement Could Have Unintended Adverse Consequences
Various bad things are briefly mentioned as potential consequences of the agencies moving forward with a rule like the one floated in the ANPR. In addition to the expected arguments that this would adversely affect the cost and availability of credit, the trades also try to turn back on the agencies a few of the justifications underlying the ANPR. For example, BPI says that if competition is a concern, then imposing additional requirements on large banks could be counterproductive, in that it would dissuade them from growing and competing with their larger peers. Financial stability could also be harmed, BPI argues, through the imposition of LTD requirements that are procyclical and drive activity to non-bank providers.
The Agencies Would be Vulnerable to Lawsuits
After laying out their arguments why new resolution-related requirements would be a bad idea, ABA and BPI make a series of claims about why, if the agencies nonetheless move forward, a rule could be subject to various legal challenges. Even if you personally do not take these very seriously, others might, so I think at least some of them are worth paying attention to. I’ll briefly mention three here.
“Shall” Tailor. Section 165 of the Dodd-Frank Act was amended in 2018 to provide that the Federal Reserve Board “shall” tailor the application of enhanced prudential standards by differentiating based on riskiness, complexity, and any other factors deemed appropriate. (This used to say “may”.) ABA’s letter thus references the agencies “statutory obligation to tailor regulations to the relevant risks.” It is not clear to me how a court would treat this change in wording, although it could wind up being sort of ironic in hindsight that a certain Michael Barr in 2018 warned that this language would give banks a “litigation tool” against stronger standards.
Major Questions Doctrine. ABA’s letter also references the Supreme Court’s decision last year in West Virginia v. EPA, which the letter characterizes as standing for the proposition that under the major questions doctrine a clear statement from Congress is required before an agency can regulate a fundamental sector of the economy. Applying an LTD requirement to large banks, the ABA says, “is exactly the sort of regulatory action the doctrine is intended to govern.” Given the ongoing questions about how the courts will apply the major questions doctrine, I am not sure I could confidently say that anything is, or is not, “exactly” what the major questions doctrine is supposed to cover. But still I think the ABA is right that this question hangs over a number of forthcoming rulemakings.
I do wonder about how far the ABA is willing to take this line of argument, however. Aren’t GSIBs in some respects an even more fundamental element of the financial sector? Not all of the requirements imposed by the agencies on GSIBs are specifically contemplated by Section 165 (or other laws). Does the ABA think those requirements are on shaky ground, too?
When Can an Agency Change Its Mind? Each of the BPI and ABA letters cite to FCC v. Fox Television Stations, a 2009 Supreme Court case that addresses when an agency can change its position. BPI characterizes this case as holding that, “when an agency is changing position, ‘the agency must show that there are good reasons for the new policy.’” In addition, BPI says, sometimes an agency is required to provide a “more detailed justification” than what would typically be required if the agency was starting from scratch. This is so, for instance, if a new policy is based on factual findings different from those underlying the prior policy, or if reliance interests are implicated. BPI says this is the case here.
Even if the Agencies Do Decide to Move Forward, They Should Wait for the Basel Endgame and Other Regulations to be Finalized
Several letters argue that the agencies should take into the account the forthcoming Basel revisions and other regulatory updates, such as resolution planning guidance for Category II and III firms, before moving forward with an LTD requirement for large banks.
Is this argument in favor of delay pretextual? Yes, probably to some extent. On the other hand, it also seems to me sort of fair enough. If the regulators are going to give well-considered speeches about the need to look at how various parts of the capital rules “may interact with each other—as well as other regulatory requirements—and what their cumulative effect is on safety and soundness and risks to the financial system” and are going to delay action on, for example, the SLR, until this sort of “holistic review” can be completed, I am not sure it is unreasonable to expect the same standard to be applied here.
SIFMA and IIB Argue on Behalf of Their Constituencies
None of these claims are surprising given the interests of their respective members, but it is worth briefly noting the arguments made by the IIB on behalf of its members (foreign banks doing business in the United States) and by SIFMA on behalf of its members (broker-dealers and others involved in the securities industry).
IIB Letter. As noted above, the U.S. IHCs of foreign banks are already subject to (internal) TLAC requirements, and IIB’s letter says this is more than sufficient - no new requirements are merited. In fact IIB, as it has before, argues that if anything internal TLAC requirements for FBOs should be reduced. IIB bases this, in part, on claims that IHCs are less risky than similarly-sized U.S. banks and, moreover, have significantly reduced their risk profiles following the financial crisis. These are the same arguments put forward by IIB in connection with the 2018-19 tailoring proposals, generally with only very limited success. It is also worth noting that some (but to be fair, not all) of this post-2008 reduction in riskiness is probably less about risk having been reduced and rather about risk having been shifted into branches.
SIFMA Letter. SIFMA uses its letter to make two points. First, large banks with significant retail brokerage operations should not be subject to resolution-resource or other enhanced requirements. (See discussion below for hints at whose concern this likely reflects.) Second, citing to the IIB letter, SIFMA argues that IHC subsidiaries of foreign banks should not be subject to any new requirements.
B. Comments From Ad Hoc Group of Five U.S. Banks
The longest comment letter on the ANPR was submitted jointly by five large U.S. banks: Capital One, Charles Schwab, PNC, U.S. Bank and Truist.4 In addition to repeating some of the points made in the trade group letters discussed above, this letter includes several graphics (including one credited to a textbook co-authored by Michael Barr). For example, the letter compares the number of material entities (as designated for resolution planning purposes) of large banks compared to the U.S. GSIBs. It also includes a chart demonstrating, for what it is worth, that the GSIB scores of non-GSIBs are not very close at all to the GSIB range.
The whole letter is pretty interesting and worth flipping through, but I’ll just mention here two arguments I thought were noteworthy.
Assertion That, If Anything, the Agencies’ “Evolution” Argument Cuts the Other Way
The letter includes its own reference to FCC v. Fox Television and states that the current policy was developed only in 2015. In light of that, the letter makes the case that it is tough to see what has materially changed since then, especially considering that the agencies just recently considered amendments to the framework in 2018 and 2019. As part of this recent rulemaking, the agencies explicitly declined to adopt rules making resolution planning requirements more stringent for large banks - this despite calls from various commenters, as well as then-FDIC Vice Chair Gruenberg, to do so.
The letter further points out that GSIB scores for four of the five banks writing the letter have either decreased or increased by no more than a point or two since 2019. If large banks have indeed become more risky as stated in the ANPR, it is not reflected in these GSIB scores, at least as of year-end 2021.
Validity of the “Capital Refill” Model
Assuming the agencies move ahead with a TLAC or LTD requirement, the letter recommends that the requirements be set much lower than they are for GSIBs. The banks argue that GSIB requirements were designed based on the assumption that going-concern capital would be fully depleted by the time GSIBs launch their SPOE resolution strategies. The letter asserts this is unlikely to be the case for the banks at issue here: “our required resolution plans may be activated based on an unexpected, large outflow of cash or other adverse event, while we still have a substantial portion of our regulatory going-concern capital.”
Further, the banks note, the GSIB TLAC rule was based on a “capital refill” model that assumes GSIBs will as part of a resolution need to fully recapitalize all of their material operating subsidiaries. The banks say they are different, and would need only enough capital to execute their MPOE resolution strategies, which is “only a fraction of the amount necessary for full recapitalization.”
C. Comments from Individual Banks
As noted earlier in this post, banks generally are presenting a united front in taking issue with the premises of the agencies’ ANPR. Still there are a few letters that attempt to engage in bank-specific pleading, some of it persuasive, some of it less so.
Can These Requirements Legally Be Applied to Charles Schwab? Even If So, Should They Be?
Currently, Charles Schwab is the only savings and loan holding company subject to the Board’s categorization framework.5 Among other differences in the regulation of SLHCs compared to bank holding companies, Schwab unlike its similarly-sized peers is not subject to holding company-level resolution planning requirements under Section 165(d) of the Dodd-Frank Act. (Its bank subsidiary, like other large banks, is subject to bank-level resolution planning requirements.) The agencies in their ANPR asked whether, even though Schwab isn't subject to a holding company-level resolution planning requirement, Schwab should nonetheless be subject to certain other resolution-related requirements.
The first half of Schwab’s 31-page comment letter is devoted to arguing that the agencies lack the authority to apply such resolution planning requirements to Schwab, either under the Dodd-Frank Act or under the Home Owners’ Loan Act, which governs SLHCs. I have written before that, as a statutory matter, I think Schwab is probably right.
I have also written before that I am less convinced as a policy matter that this is the right outcome, although Schwab does its best in the letter to convince me and the agencies otherwise. Indeed, Schwab starts its letter with the bold claim that “nowhere are these differences [between GSIBs and non-GSIB large banks] greater or clearer than with respect to CSC.” Schwab also later argues that, as compared to the regulation of BHCs, regulation of SLHCs is already in some respects “inappropriate and punitive.”
These claims go a little too far for me, but the letter does include various not-totally-crazy arguments supporting the claim that Schwab, despite featuring a business model heavy on broker-dealer nonbank assets, is less risky than some of its other large bank peers. On the other hand, some of these same arguments were made by Schwab in 2020 in arguing that it should be able to opt-out of the stress testing requirements to which BHCs are subject. The agencies were not convinced by them then, and I am not sure they will work any better here.
First Republic Enlists Outside Support
First Republic Bank is unique among other institutions of its size in that it does not conduct operations through a holding company. The bank currently has around $212 billion in total assets, and so is not currently subject to Category III enhanced prudential standards, but will be once it crosses the $250 billion threshold. In the ANPR, the agencies ask specifically how “IDIs that are not part of a group under a BHC” should be treated under any new rules.
The answer, according to a letter submitted by First Republic Bank, is not at all. Banks without a holding company, the letter asserts, “do not present the risks and complexities with respect to financial stability or resolvability as identified in Section 165 of the Dodd-Frank Act or the ANPR.” In particular, First Republic notes that it has a simple corporate structure, a limited number of subsidiaries, no foreign offices or branches, does not “maintain Critical Operations that pose a threat to U.S. financial stability,” and conducts internal critical services and operations wholly within the bank and its subsidiaries.
First Republic also appears to have enlisted outside support in its fight against these requirements. The California Bankers Association, in a short comment letter, argues that the agencies should not apply these requirements to (unnamed) banks without a holding company. Similarly, the law firm Arnold & Porter submitted a letter written by a longtime advisor to First Republic that, without naming any specific bank, warns the agencies against imposing resolution-resource requirements on IDIs without holding company. The major questions doctrine is again invoked.
Individual U.S. Bank and PNC Letters
In addition to their joint letter with Capital One, Schwab and Truist as described above, U.S. Bank and PNC each submitted their own individual letters. To highlight one interesting thing from each:
U.S. Bank Further Supports Its Calibration Argument. As noted above, in the joint letter the five banks argue that, if the agencies do impose new requirements, minimum requirements should be calibrated lower than the standards currently applicable to U.S. GSIBs. In its comment letter, U.S. Bank puts a finer point on this argument, laying out in detail why it believes the LTD requirement should be no more than 2.5% of risk-weighted assets and 0.35% of total leverage exposure. See the final page of the letter for the visual.
PNC Argues For a PNC Exception. PNC states in its letter that “[e]ven among non-GSIB LBOs, there could be significant differences in complexity and resolution capabilities.” PNC argues, therefore, that the agencies should exempt from LTD requirements “any non-GSIB LBO, such as PNC, that includes a feasible option in its resolution plans to separate its business and sell it to multiple purchasers in a reasonable period of time without creating financial stability risks.”
Banks That Did Not Write Letters
I would not read much into this, but even so I could not help but note those banks that did not write individual comment letters. In this group are all of the foreign banks in Category II or Category III. Maybe the foreign banks figure, reasonably enough based on some of the statements from the agencies, that they are not the main targets of this rulemaking and that the IIB letter is therefore good enough.
Or maybe just in general, for various internal reasons, these banks figured keeping their head down was the better approach. A letter from Credit Suisse, for instance, arguing that its U.S. activities are nothing to worry about may be poorly received at this time.
[Note: The original version of this post stated that Northern Trust did not write a comment letter. That was true based on what the agencies had made available when the post was first published, but the Federal Reserve Board has since posted a comment received from Northern Trust.]
V. Other Comment Letters
There were a few comments from serious individuals or groups that did not fit perfectly into any of the discussion above. Broadly and perhaps unfairly speaking, all these letters come from pretty obvious anti- or pro-bank positions, but do not necessarily embrace the same sort of arguments as found in the letters above.
Better Markets Believes TLAC Doesn’t Work
After a brief detour to make an argument that it is important for the Board to refer to firms with $250-$700 billion in total assets as DSIBs, Better Markets in its letter jumps right in with a five-point argument against TLAC requirements. Paraphrasing slightly:
TLAC requirements implicitly acknowledge that capital requirements are not high enough. But rather than addressing this by raising capital requirements, TLAC rules “place unearned faith in the possibility of a smooth resolution of a failing large banking organization.”
TLAC debt can result in contagion, as it can be held by large and interconnected financial institutions.
To the extent that TLAC is not held by large and interconnected financial institutions, it may be held by individual retail investors (directly or through things like pension funds). It is doubtful that politics would allow TLAC debt in these sympathetic persons’ hands to be converted into (potentially worthless) equity. If so, then politicians are likely to instead choose to give banks another bailout.
Banks could need to increase debt service payments, negatively affecting their liquidity positions.
Although better than short-term wholesale funding, relying on TLAC debt for funding, if not accompanied by heightened capital requirements, “by definition would make these banks more leveraged.”
In sum, Better Markets believes that TLAC requirements have been designed to support “an unproven and unlikely-to-be-successful resolution process.” Therefore, Better Markets advises the agencies not to adopt them.
To be clear, Better Markets agrees with the agencies that large banks are now more risky. Without citing to much concrete data other than asset size, it says that such banks are “becoming not only much larger but significantly more complex and interconnected … while engaging in more potentially high-risk activities.”
But rather than addressing this perceived increase in risk through TLAC requirements, Better Markets instead believes the agencies should do the following:
Increase overall equity capital requirements
Mandate pre-positioning of liquidity and capital at subsidiaries through binding rules (currently for GSIBs this is done through guidance, and for other firms not at all)
Adopt rules setting out separability requirements
Require all large banks, not just GSIBs, to comply with clean-holding company requirements and to adopt QFC stay provisions
Require full resolution plan submissions every two years
Consider giving “independent advisory committees of bankruptcy scholars, lawyers and judges” a role in assessing resolution plan submissions
Thomas Hoenig Also Skeptical of TLAC; Thinks a Modest 15-19% Leverage Ratio Requirement Would Be Nice
Former FDIC Vice Chair Thomas Hoenig, now a distinguished senior fellow at the Mercatus Center at George Mason University, wrote a comment along with Stephen Matteo Miller, a senior research fellow at GMU.
Hoenig was a Republican appointee to the FDIC, but is of the school of thought — sometimes also seen in the Wall Street Journal editorial pages, in the “off-ramp” provisions of the never enacted Financial CHOICE Act, and arguably I guess in the community bank leverage ratio — that capital requirements could stand to be much higher, perhaps in exchange for a lessening of other regulation.
So, for example, in 2017 while still at the FDIC Hoenig proposed a “market-based” approach to regulatory relief, in which a 10% leverage ratio requirement would be imposed along with other measures designed to ensure that non-traditional banking activities could not rely upon the federal safety net. In exchange, Hoenig said, “many of the complex regulations under the Dodd-Frank Act” such as stress testing, risk-based capital requirements (at least as a primary measure of a firm’s capital position), liquidity requirements, resolution planning requirements, and other enhanced prudential standards, would then be unnecessary.
Hoenig’s 2017 proposal never gained much traction, but in light of his previous efforts and commentary the recommendations in this letter on the ANPR are not surprising. In particular, Hoenig and Miller believe that imposing an LTD-requirement on large banks would be unhelpful, in that it would mandate and subsidize “leverage for an already highly leveraged industry.”6
Instead, Hoenig and Miller would look to the trusty leverage ratio. They think a level of “15 percent at the bank subsidiary level” would be about right, as it would “pass[] a cost-benefit analysis under many plausible assumptions.” In fact, the authors believe “the optimal rate [would be] equal to 19 percent.”
Hoenig and Miller say in their comment letter that “many bank holding companies already meet this [15%] minimum threshold.” I have to be honest in saying I don’t fully follow their math or why they appear to be using leverage ratio to mean something different than the U.S. capital rules do,7 but usually when I read something that I think doesn't make sense the issue is with me, not with the authors.
Piper Sandler Mostly in Tune With Its Larger Clients, With Maybe One Off-Key Recommendation
The investment bank Piper Sandler wrote its own comment letter, saying it was commenting based on its background as a firm with a 120-year history of advising the financial sector. The letter notes that Piper Sandler, is “currently ranked as the leading M&A financial advisory services for depository institutions,” has “been ranked #1 based on number of deals of the past ten years,” and has also “consistently been among the top advisors for debt and equity capital raising for U.S. banks and their holding companies.”8
The main points of the Piper Sandler letter are consistent with the anti-case summarized above. That is, Piper Sandler believes the regulatory framework for large banks is already robust, and subjecting more banks to an LTD requirement would merely serve to increase costs, without corresponding benefits.
I expect most large banks would nod along with those arguments. Piper Sandler also, however, closes with one additional comment with which I am not sure all large banks would actually agree:
Before adding a requirement for TLAC based solely on asset size, we would suggest amending the existing Category I, II, III and IV frameworks to better reflect and calibrate any perceived increase in risk.
They would probably not be thrilled with either, but if given the choice, would Category III firms, for example, really be so opposed to an LTD requirement that they would be willing to give up some of the gains they made as a result of the 2019 tailoring changes (e.g., AOCI opt-out, reduced LCR and NSFR) in order to avoid it? I am not sure of the answer, but it is an interesting hypothetical to think through.
The Voice of the Buyside
The Credit Roundtable, “a group of large institutional fixed income managers…responsible for investing more than $4 trillion of assets” calling itself the Voice of the Buyside,9 submitted a brief comment letter with a few recommendations not included in the other letters received by the agencies:
Mandate Holding Company Issuance. The letter calls for a “clear ruling” on which entities are permitted to issue LTD. The Credit Roundtable believes that holding company issuance would be best, even though it is true that “issuance of this holding company debt will likely be at higher cost and lower rated than comparable bank debt.” The letter asserts that “international peers including the midsized European banks are operating under similar debt requirements so questions regarding competitiveness should be placed within that context.”
Calibration Based on a Sliding Scale. Like some of the other comment letters, the Credit Roundtable letter calls for any LTD requirement to be calibrated based on complexity of the individual firms subject to the rule. More interestingly, though, the group also appears to call for the requirements currently applicable to U.S. GSIBs to also be on a sliding scale: “the exact calibration of long-term debt should reflect a sliding scale from the more complex GSIBs to the lesser complex regional banks comprising of Category II and Category III firm.”
The letter then includes a statement that I am not sure I follow: “The proposed scaling of a qualifying long-term debt requirements driven by an institution’s size will likely result in more firms qualifying to become GSIBs as they grow, as well as allow firms to shed the GSIBs status should their size be reduced.” Unless the Credit Roundtable is also recommending an adjustment in GSIB thresholds themselves, I don’t see how the introduction of a sliding scale would necessarily change anything. Maybe the argument is that, if GSIB requirements were applied on a sliding scale basis, even if the GSIB/non-GSIB threshold was left unchanged, firms would be less reticent to become (small) GSIBs, knowing they wouldn’t necessarily be subject to the full array of GSIB regulation?
Market Making. The Credit Roundtable observes that there is currently limited willingness by “the larger regional banks’ securities arms to trade in regional bank paper.” The letter notes that liquidity could further be reduced if restrictions are placed on regional banks holding other regional banks’ TLAC debt. So the letter calls for regional banks to be able to make markets in each others’ debt similarly to how U.S. GSIBs are, subject to restrictions, allowed to make markets in the TLAC debt of fellow GSIBs.
Talk to Us. The letter closes by noting that participation of institutional debt investors will be “integral to the success” of a resolution involving a bridge bank, as that bank will need external debt financing as part of its transition. The letter calls on regulators to “engage institutional debt investors on an annual basis.”
VI. Comments on Technical Details
As noted above, most commenters passed on the opportunity to respond to the agencies’ questions about the technical mechanics of how an LTD requirement should work, if imposed. To conclude, then, set out below are what I see as the highlights of the comment letters that did respond, in whole or in part, to these additional questions.
Preserving Flexibility
The BPI letter, the ad hoc five bank letter, and the individual PNC and U.S. Bank letters, among others, stress the need for the agencies to preserve flexibility by allowing large banks to select from various options as to how to satisfy such a requirement. For example, the five bank letter recommends that, if gone-concern LTD requirements are imposed, banks be given the flexibility to choose:
To issue debt at the top-tier parent level or the subsidiary level
To issue either external or internal debt
To satisfy any requirement with CET 1 or AT1 equity capital, rather than long-term debt, if the firm so chooses
To satisfy any subordination requirement by structural or contractual subordination, for example through the use of a secured support agreement
In addition, the letter recommends that large banks be given the option to contractually subordinate “any internal liability, including any internal deposit liability, to the claims of short-term creditors or other runnable liabilities, but not to the claims of long-term creditors or other liabilities that do not give their holders the contractual or other legal right to be paid within one year of the date of issuance of such internal liabilities.”
Transition Period
For comparison, the TLAC and LTD rules currently applicable to U.S. GSIBs were finalized in December 2016, with compliance required by January 1, 2019. A few commenters also noted specifically the need for a transition period here as well.
The five bank letter, for example, says that “non-GSIB LBOs may need a longer transition period than the U.S. GSIBs, given that non-GSIB LBOs have traditionally been more reliant on stable deposit funding (as opposed to market-based LTD funding) than the GSIBs.” For its part, U.S. Bank in its individual letter asks for a transition period of “no less than three years after finalization” of any LTD rule.
That all seems reasonable to me, especially considering that the U.S. GSIB rules themselves provide that if a firm becomes newly subject to TLAC and LTD requirements, it has three years to come into compliance. So if you start with that as the rough baseline and then take into account any accommodations necessary to account for the fact that large banks are not as frequent issuers as U.S. GSIBs, balanced I suppose against the fact that the overall requirements will likely be lower than as compared to GSIBs, it probably washes out to at least a similar transition period.
BPI: Stick With the Categorization Framework
Finally, one thing I thought was interesting in the BPI letter compared to letters from some of the individual banks was BPI’s rejection of the idea raised in one part of the ANPR that it might be helpful for the agencies to differentiate between firms in Categories II and III based on additional factors not included in the current categorization framework. BPI says:
The Agencies should use the existing framework, which is designed to reflect the differing size and risk profiles of institutions, to determine the scope of application of any potential long-term debt requirements. Any further consideration of GSIB-like resolution-related requirements should not undermine the existing framework for assigning firms to Categories I through IV and therefore should not “sub-categorize” institutions within existing categories. “Sub-categorizing” institutions within existing categories would create a more complex regulatory structure without any corresponding safety and soundness or other benefits.
None of the individual bank letters explicitly call on the agencies to look past the categorization framework, but I think that is implicit in some of their letters, which make the case that, for various reasons, some firms of similar size and risk profile (according to the category framework) are in fact less risky than some of their peers.
I thought about going with “large regionals” but that is not a perfect description of all the U.S. firms in Category II or Category III. I also thought about going with “non-GSIB large banks” but I thought this could be confusing too because Category II and Category III also includes the U.S. operations and intermediate holding companies of a number of foreign banks that are regulated as GSIBs in their home country.
As a few commenters pointed out, however, FDIC Chair Gruenberg in a statement accompanying the ANPR said that “[e]ven the acquisition of a $50 or $100 billion institution is a significant challenge.”
For example, U.S. GIBs are subject to an expectation that they will “establish clearly identified triggers linked to specific actions for: (A) The escalation of information to senior management and the board(s) to potentially take the corresponding actions at each stage of distress post-recovery leading eventually to the decision to file for bankruptcy; (B) Successful recapitalization of subsidiaries prior to the parent's filing for bankruptcy and funding of such entities during the parent company's bankruptcy to the extent the preferred strategy relies on such actions or support; and (C) The timely execution of a bankruptcy filing and related pre-filing actions.” The Board and FDIC require that these triggers “be based, at a minimum, on capital, liquidity, and market metrics.”
Synchrony Financial recently crossed the $100 billion threshold and thus will soon be subject to certain requirements (e.g., annual capital planning and once-every-two-years supervisory stress testing requirements), assuming its four-quarter rolling average total assets stay over that threshold.
First Republic Bank actually cites this statement from the Hoenig and Miller letter in its own letter - see footnote 15. FRB doesn’t say whether it is also up for adopting the leverage ratio requirement Hoenig and Miller propose.
See pages 8 and 9 of the letter. The authors say they are looking at “the average ratios of total equity to total assets measured using estimated market values and book values for the so-called advanced approaches banks, … as well as all other banks from Q1 2000 through Q4 2020 using the approach used by Alistair Milne.” Milne’s approach is then described in footnote 18 to the comment letter, which to give you an idea of things includes this formula:
Piper Sandler’s clients are obviously not exclusively community banks, but they have a pretty decent collection of such banks on their deal sheet. I am guessing it will all be fine - everyone gets the realities here - but I wonder if this will cause any tension between Piper Sandler and any of its smaller bank clients, given the differing perspectives in the ICBA letter and the Piper Sandler letter.