What We're Reading in Financial Regulatory Reform, March 28

We hope that you enjoy the following selection of readings this weekend. As always, the views expressed in these articles do not necessarily represent the views of the initiative, its co-chairs, task force members or the Bipartisan Policy Center (BPC).

BPC’s Financial Regulatory Reform Initiative (FRRI) highlights news articles, papers and other important work which illuminate current and new thinking within financial regulation. We circulate these articles to provide a full view of cutting edge ideas, reactions and positions. For more information on FRRI, including recent research and upcoming events, click here.

Compiled by Aaron Klein, Peter Ryan and Justin Schardin

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Cost Analysis of 12 CFR Part 44 (the Volcker Rule)
By the Office of the Comptroller of the Currency

“Because we estimate the costs associated with the final rule range from $412 million to $4.3 billion, we believe the rule is a ‘major rule’ under the CRA [Congressional Review Act]. Our estimate does not capture some costs that are quantifiable but difficult to estimate, such as indirect costs due to decreased market liquidity and the impact this decrease in liquidity may have on the market value of some assets and the cost to corporations of issuing debt. Additionally, certain benefits of the regulation can be difficult to quantify including the value of enhanced economic stability and benefits associated with reduced risk.” Read the report here.

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CFPB Data Point Report on Payday Lending
By the Consumer Financial Protection Agency (CFPB) Office of Research

“Over 80 percent of payday loans are rolled over or followed by another loan within 14 days (i.e., renewed)… We define loan sequence as a series of loans taken out within 14 days of repayment of a prior loan. While many loan sequences end quickly, 15 percent of new loans are followed by a loan sequence at least 10 loans long. Half of all loans are in a sequence at least 10 loans long … For more than 80 percent of the loan sequences that last for more than one loan, the last loan is the same size as or larger than the first loan in the sequence. Loan size is more likely to go up in longer loan sequences, and principal increases are associated with higher default rates.” Read the report here.

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Dodd-Frank Stress Test 2014: Supervisory Stress Test Methodology and Results
By the Board of Governors of the Federal Reserve System

“[T]he largest banking institutions in the United States are collectively better positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago. This result reflects continued broad improvement in their capital positions since the financial crisis.” Read the press release here and the report here.

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Comprehensive Capital Analysis and Review 2014: Assessment Framework and Results
By the Board of Governors of the Federal Reserve System

“U.S. firms have substantially increased their capital since the first set of government stress tests in 2009. The aggregate tier 1 common equity ratio, which compares high-quality capital to risk-weighted assets, of the 30 bank holding companies in the 2014 CCAR has more than doubled from 5.5 percent in the first quarter of 2009 to 11.6 percent in the fourth quarter of 2013, reflecting an increase in tier 1 common equity of more than $511 billion to $971 billion during the same period. That trend is expected to continue. All but two of the 30 participants in this year’s CCAR are expected to build capital from the second quarter of 2014 through the first quarter of 2015.” Read the press release here and the report here.

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Building the Financial System of the Twenty-first Century: An Agenda for Europe and the United States
By Daniel Tarullo, Governor, Board of Governors of the Federal Reserve System

“There must be some assurance beyond mere words from parent banks or home-country supervisors that a large FBO [Foreign Banking Organization] will remain strong or supported in periods of stress. After all, as we saw in the crisis, while a parent bank or home-country authorities may have offered those words with total good faith in calm times, they may be unable to carry through on them in more financially turbulent periods. None of this means that we need be at odds with one another. On the contrary, these very circumstances call not only for more tangible safeguards in host countries, but also for more genuine cooperation among supervisory authorities. Indeed, as I hope will continue to be the case with the international agenda on resolution, total loss absorbency, and related matters, we should aspire to converge around the kinds of protections that we can expect at both consolidated and local levels.” Read the full speech here.

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Evidence from the Bond Market on Banks’ “Too-Big-to-Fail” Subsidy
By João Santos, Federal Reserve Bank of New York

“Using information from bonds issued over the past twenty years, this study finds that the largest banks have a cost advantage vis-à-vis their smaller peers. This cost advantage may not be entirely due to investors’ belief that the largest banks are ‘too-big-to-fail’ because the study also finds that the largest nonbanks, as well as the largest nonfinancial corporations, have a cost advantage relative to their smaller peers. However, a comparison across the three groups reveals that the largest banks have a relatively larger cost advantage vis-à-vis their smaller peers.

“Since the sample ends in 2009, these findings do not reflect any changes in bond investors’ expectations resulting from the regulatory interventions that occurred during the financial crisis. Similarly, our findings do not account for any effects resulting from the regulatory changes that were introduced following the financial crisis, in particular those that aim at addressing the too-big-to-fail problem.” Read the paper here.

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Do Deposit Rates Show Evidence of Too Big To Fail Effects?
By Aditi Kumar and John Lester, Oliver Wyman Inc.

“Deposit funding cost advantages for the largest banks amount to just 4 bps over the 2010-2012 period. Our results generally coincide with that of the earlier study in finding that large banks had a funding cost advantage of more than 30 bps on uninsured MMDAs [money market deposit accounts] prior to 2010. Using updated data, and after controlling for common balance sheet measures of risk, we find that this advantage had shrunk dramatically by the end of 2012. However, the estimated funding cost differences between large and small banks likely incorporate effects unrelated to TBTF [too-big-to-fail] perceptions.” Read the study here.

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The Three Key Risks for Global Banking in 2014 are the Economy, Regulations, and Government Support
By Standard & Poor’s Ratings Services

“Risks in the global banking sectors have sharpened in 2014 and are likely to weigh on the financial institutions in a number of ways. Although the economic backdrop has generally improved, emerging risks can be fast-moving and shift credit conditions. The three most common risks that banks globally are facing this year are changing monetary policy and its effects on the economy and financial markets, the impact of regulatory reforms on business models and risk-taking, and the potential reduction or removal of government support in some jurisdictions.” Read the report here.

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Regulating Systemic Risk in Insurance
By Daniel Schwarcz, University of Minnesota Law School and Steven L. Schwarcz, Duke University School of Law

“[T]he insurance industry as a whole can pose systemic risks that regulation should attempt to identify and manage. Traditional state-based insurance regulation, the Article contends, is poorly adapted at accomplishing this given the mismatch between state boundaries and systemic risks and states’ limited oversight of non-insurance financial markets. As such, the Article suggests enhancing the power of the Federal Insurance Office – a federal entity currently primarily charged with monitoring the insurance industry – to supplement or preempt state law when states have failed to satisfactorily address gaps or deficiencies in insurance regulation that could contribute to systemic risk.” Read the article here.

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Feedback on OFR Study on Asset Management and Financial Stability
By BlackRock Inc.

“We assume policy-makers are concerned about situations where a firm’s failure would require government intervention for either recovery or resolution, and that this intervention may include financial support. Banks and broker-dealers that have experienced problems requiring intervention fall into two primary categories: i) a liquidity crisis in which they cannot fund their daily operations; or ii) a credit problem exacerbated by a leveraged balance sheet. While we have been asked about the likelihood of the failure of an asset manager, asset managers are extremely unlikely to ‘fail’ as they are not exposed to short-term funding and they do not have leveraged exposure to credit on their balance sheet. The business model of asset management is fundamentally different than that of other financial institutions and thus the winding up of asset managers is also fundamentally different. A more appropriate question to ask is ‘Under what circumstances would an asset management firm go out of business, and what would be the implications for clients and creditors of the firm?’” Read the letter here.