Wednesday, June 19, 2013

Bi-Partisan Senate Legislation Would Delink Federally Insured Banks from Derivatives Dealers and Other Non-Bank Subsidiaries as Part of TBTF

Bi-partisan legislation introduced by Senators Sherrod Brown (D-OH) and David Vitter (R-LA) seeks to end too big to fail and protect federally insured financial institutions from being linked to securities underwriters and derivatives dealers. The legislation would also require federal regulators to walk away from Basel III and create a new capital regime based on two comment letters sent by Senators Brown and Vitter. Regulators would institute new capital rules that do not rely on risk weights and are simple, easy to understand, and easy to comply with. However, regulators would still be able to use risk-based capital as a supplement for banks over $20 billion, if their supervisory authority proves insufficient to prevent institutions from over-investing in risky assets.

The Senators noted that risk-weighting can obscure banks’ true capital situations, distorting the views of markets and regulators, and undermining investor confidence. They said that Basel II relied on a risk-weighting system that inaccurately assigned safe ratings to mortgage-backed security collateralized debt obligations and credit default swaps that actually amplified risk instead of mitigating it.

Under the legislation, bank holding companies will be restricted in their ability to move assets or liabilities from non-banking affiliates to a banking affiliate within the bank holding company structure. This will ensure that the government safety net begins and ends at the commercial bank and other subsidiaries, such as insurance, securities underwriters, and derivatives dealers must fend for themselves. Similarly, the Federal Reserve and other banking regulators will be prohibited from allowing non-depositories access to Federal Reserve discount window lending, deposit insurance, and other federal support programs. According to the Senators, this will help reduce market expectations of financial assistance for large, complex financial institutions.

The legislation would ensure that financial companies operating under one holding company would be adequately capitalized, as would be required if they were stand-alone companies. The Senators said that the legislation would ensure that highly-leveraged lines of business do not threaten the well being of other affiliates or the entire enterprise. The Senators noted that former FDIC Chair Sheila Bair has said that creating stand-alone subsidiaries will make large, complex financial institutions easier to put into resolution if they run into trouble.

Securities Industry Reaction. SIFMA, commenting on the legislation, noted that, since 2008, Tier 1 capital has more than doubled, reaching an historic high according to the FDIC. In SIFMA’s view, this legislation would force financial institutions to raise capital excessively higher than current levels, which would limit an institution's ability to lend to businesses, hampering economic growth and job creation.

SIFMA noted that the Brown-Vitter measure calls for the U.S. to pull out of the Basel Committee framework. In SIFMA’s view, such a move would be an abdication of U.S. leadership, would undermine uniform global capital standards, and actually increase systemic risk by driving more business outside the U.S. and into the shadow banking sector.

The Dodd-Frank Act set forth a framework that would effectively address too-big-to-fail through new, heightened prudential and capital standards, said SIFMA, and the focus should be on completing the remaining rulemakings mandated by Dodd-Frank instead of enacting new legislation that would undermine the U.S.'s standing in the global financial system.

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