The New Future of U.S. Banking and Financial Services Regulation

The presidential election has opened the possibility of significant changes to the Dodd-Frank Act regime that has been implemented over the last six years. It remains to be seen what plans the incoming administration will bring to this area. However, new regulatory proposals and other developments continue to present a complicated regulatory climate for banks and other large financial institutions. 

This OnPoint discusses a number of potential regulatory restructuring proposals. The most far-reaching of these was recently offered by the Federal Reserve Bank of Minneapolis to address systemic risk by imposing a set of stringent capital requirements and other standards on large banking organizations (Plan).¹ These standards are intended to dramatically reduce the risk of systemic instability in the banking sector, and to avoid encouraging the movement of financial risk to other sectors of the financial services business, through the imposition of a tax on the borrowings of certain “shadow banks” (as defined below). 

The Minneapolis Plan 

The Plan is organized into four steps, as outlined below. 

Step One. The Plan proposes a new capital requirement for “covered banks” (i.e., those with more than $250 billion in assets – currently eight U.S. banking organizations). Pursuant to this requirement, a covered bank must issue common stock and closely-related items equal to 23.5% of risk-weighted assets (which the Plan describes as corresponding to a 15% leverage ratio). The Plan states that the 23.5% requirement is based on the highest amount a large banking organization would be required to maintain against risk-weighted assets under the Federal Reserve Board’s (FRB) total loss-absorbing capacity proposal for globally systemically important banks.² Covered banks would have five years to meet the new capital requirements.³ 

Step Two. Once the new capital requirement becomes effective, the Secretary of the U.S. Department of the Treasury (Treasury Secretary) would be required to determine whether to certify that a covered bank is no longer systemically important. If the Treasury Secretary does not make such a certification, the covered bank would be subject to higher capital requirements, which increase by 5% per year up to a maximum of 38% of risk-weighted assets. The Plan anticipates that the potential for such additional capital requirements would lead covered banks to restructure in order to avoid imposition of the heightened requirements. The Plan asserts that Step Two reduces the chance of future bailouts to 9% over 100 years. 

Step Three. All “shadow banks” would be subject to a tax on their borrowings. Under the Plan, shadow banks would include investment funds (including hedge funds, mutual funds and money market mutual funds) and broker-dealers.⁴ A shadow bank with more than $50 billion in assets (which includes on-balance sheet assets, off-balance sheet assets and assets under management) would be taxed at: 2.2% of borrowings if the Treasury Secretary treats it as systemically important; and 1.2% of borrowings if it is treated as not systemically important. These taxes are intended to impose costs on shadow banks similar to the heightened capital charges proposed for large banks, in order to create a “level playing field” and address concerns that the new capital requirements would drive the migration of banking activities from the banking sector to the less-regulated shadow banking sector. The Plan does not define “borrowing” and in certain instances refers to a “leverage tax,” and thus could contemplate applying the tax to transactions or positions that generate leverage, other than those involving borrowing. The Plan does acknowledge that shadow banks with no borrowings would not pay the tax. 

Step Four. The Plan proposes to reduce “unnecessary regulatory burdens” on community banks. Community banks (defined as banks with less than $10 billion in assets) would face a solvency, supervision and regulatory regime separate from that applicable to larger banks. The regulation of community banks would be less restrictive than for larger banks, and would be intended to focus only on bank activities that have a clear link to a bank’s potential failure (such as rapid asset growth or concentration in risky assets). Capital requirements would be simplified and less extensive, supervision would be less costly and less complex, and the Volcker Rule would not be applied to this category of institutions. 

Financial CHOICE Act 

The Financial CHOICE Act, which is sponsored by Rep. Jeb Hensarling and was passed by the House Financial Services Committee on September 13, 2016, would among other things: 

• Provide well-capitalized, well-managed banking organizations with an “off-ramp” from capital and liquidity standards imposed by U.S. regulators and the Basel III agreement, and provide exemptions from other regulatory restrictions. 
• Repeal the orderly liquidation authority provisions of Title II of the Dodd-Frank Act and replace such provisions with a new chapter of the Bankruptcy Code intended to accommodate the failure of a large financial institution. 
• Retroactively repeal the authority of the Financial Stability Oversight Council (FSOC) to designate systemically important financial institutions (SIFIs). 
• Repeal the Volcker Rule. 
• Restructure the Consumer Financial Protection Bureau into a bipartisan, five-member commission. 
• Require all U.S. financial regulators to conduct cost-benefit analyses of all proposed regulations, and expand financial agency review of existing regulations. 
• Narrow the Dodd-Frank Act’s executive compensation disclosure and clawback requirements. 
• Impose enhanced penalties for financial fraud and self-dealing. 

Status of Resolution Plans 

Section 165(d) of the Dodd-Frank Act requires SIFIs and bank holding companies with $50 billion or more in assets to periodically submit rapid and orderly resolution plans – commonly known as living wills – to the FRB and the Federal Deposit Insurance Corporation (FDIC). In April 2016, the FDIC and the FRB announced their joint determination that the living wills of five large banking organizations submitted in 2015 were not credible or would not facilitate an orderly resolution under the U.S. bankruptcy code.⁵ These firms were required to remediate the identified deficiencies by October 1, 2016. Firms that do not remediate those deficiencies could face more stringent capital, leverage or liquidity requirements, as well as restrictions on the growth, activities or operations of the firm or its subsidiaries until the deficiencies are remediated. If any deficiencies are not resolved within two years, the FRB and FDIC, in consultation with the FSOC, may jointly require the firm to divest certain assets or operations. 

The Return of Glass-Steagall 

Recently, members of both parties have expressed support for reinstating the Glass-Steagall Act’s separation of commercial and investment banking activities. Both Republicans and Democrats, in their respective party platforms, pledged to enact a modern version of Glass-Steagall.⁶ In 2015, Senators Elizabeth Warren and John McCain offered a bill to reinstate the Glass-Steagall Act’s provisions preventing investment banks from taking deposits and limiting how much of a commercial bank’s income could be derived from securities.⁷ 

Footnotes 

_{1) Fed. Reserve Bank of Minneapolis, “The Minneapolis Plan to End Too Big to Fail” (Nov. 16, 2016).
2) 80 Fed. Reg. 74925 (Nov. 30. 2015).
3) The Plan would leave unchanged the capital requirements for banking organizations with between $10 billion and $250 billion in assets.
4) The other entities that would be treated as shadow banks are funding corporations, real estate investment trusts, trust companies, finance companies and structured finance vehicles.
5) Agencies Announce Determinations and Provide Feedback on Resolution Plans of Eight Systemically Important, Domestic Banking Institutions (Apr. 13, 2016).
6) Republican Platform 2016, p. 28 (July 28, 2016); 2016 Democratic Party Platform, p. 11 (July 21, 2016).
7) 21st Century Glass-Steagall Act, S. 1709, 114th Cong. (2015).}