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

It has been a busy couple of weeks with a lot of new material to read. We hope that you enjoy the following selection of readings. With a focus on international banking given the Fed’s foreign banking organization (FBO) rule and reaction, we are also pleased to invite you to our conversation on the role of global banking in our economy, taking place on Tuesday afternoon at BPC (register here). We hope you enjoy the material. 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.

The Bipartisan Policy Center’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. 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.

Compiled by Aaron Klein, Peter Ryan and Justin Schardin

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Federal Reserve Staff Memo on Final Rules to Implement Enhanced Prudential Standards of Section 165 of the Dodd-Frank Act
By Daniel K. Tarullo, Governor, Federal Reserve Board and Federal Reserve Board Staff

“For foreign banking organizations, the draft final rule would establish a U.S. intermediate holding company requirement for foreign banking organizations with $50 billion or more in U.S. non-branch assets and impose enhanced risk-based and leverage capital requirements, liquidity requirements, risk management requirements, and stress test requirements on foreign banking organizations with total consolidated assets of $50 billion or more.” Read the full memo here.

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Global Financial Stability – the Road Ahead
By William C. Dudley, President and CEO, Federal Reserve Bank of New York

“[S]ufficient long-term debt that can be converted to equity is an important element of an effective resolution mechanism for G-SIFIs. While the magnitude of this long-term debt needs to be sufficient to ensure that public funds are not at risk in the event that a resolution of a firm is necessary, making this long-term debt a component of management compensation might also be used to help reduce the likelihood of a default. Long-term debt provided by outside creditors exposed to risk of default can create useful market discipline. However, outside creditors do not have the same information or decision rights as inside management. Structuring a long-term debt requirement so that a meaningful component consists of deferred compensation held by senior management would presumably strengthen the incentives for proactive risk management. In my opinion, more research is needed into how the structure of management compensation for financial firms could incentivize good risk management and limit the appetite for excessive risk.” Read the full speech here.

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Fed’s Final Foreign Bank Rule Increases Risk in Global Banking
By Louise Bennetts, Associate Director of Financial Regulation Studies, the Cato Institute and Arthur S. Long, Partner, Gibson, Dunn & Crutcher

“At its core, the rule evinces a clear theme: that policymakers believe the actual corporate structures of large banking groups are a threat to financial stability, and banks must undertake costly restructuring exercises to mitigate this risk. We disagree. The rule prohibits the largest, most sophisticated foreign banks from allocating capital and liquidity in a manner they deem to be most efficient. This may be an acceptable price to pay if the overall result were enhanced stability. However, trapping capital and liquidity in particular jurisdictions is likely to make large banks less resilient in times of crisis, not more.” Read the full article here.

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Letter to Fed Chair Yellen, Regarding Supervisory and Enforcement Actions
By Senator Elizabeth Warren (D-MA) and Representative Elijah Cummings (D-MD)

“We respectfully request that the Fed revisit its existing delegation rules and require that the Board retain greater authority over the Fed’s enforcement and supervisory activities in the future. We recommend that, at a minimum, a formal vote of the Board be required before the Fed can enter into consent orders that equal or exceed $1 million or that include a requirement that a bank officer be removed and/or new management installed.” Read the fullletter here.

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The Bank Rescue, Five Years Later
By Phillip Swagel, Co-chair, Financial Regulatory Reform Initiative

“… the program sketched out by Mr. Geithner both came to pass and made a difference. Five years later, the United States financial sector is in much better condition. Banks have absorbed losses from loans made during the bubble and rebuilt their capital, and investor confidence has returned. Mr. Geithner’s proposals did not all work right away or in the scale initially envisioned. In the end, however, Secretary Geithner deserves credit for making good on what he promised.” Read the full article here.

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Federal Open Market Committee (FOMC) 2008 Transcripts
By the Federal Reserve Board

Read the full transcripts of meetings held as the financial crisis unfolded here.

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Regulators Must Preempt Volcker Fire Sales
By Aaron Klein, Director, Financial Regulatory Reform Initiative

“[R]egulators may have created a scenario where the rule they are proposing could inadvertently create an unnecessary fire sale. The proposed Volcker Rule contains a restriction on banks owning certain types of assets, known as collateralized loan obligations (CLOs). Volcker prohibits banks from owning equity or equity-like interests in CLOs. If this prohibition were only forward looking, no fire sale would result; banks could simply refrain from buying and the market would adjust. However, the prohibition as currently written prohibits banks from owning certain CLOs, including legacy CLOs. It requires banks to divest themselves of these assets within a specific timeframe… Forcing a select group of banks to sell these assets over a short time is not the optimal solution.” Read the full article here.

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The Camp and Obama Financial Institution Tax Proposals: A Comparison
By Aaron Klein, Director and Peter Ryan, Policy Analyst, Financial Regulatory Reform Initiative

“Several commentators have noticed a parallel between the Camp plan and the Financial Crisis Responsibility Fee proposed by President Obama in January 2010… Despite the similarities between the two proposals, there are three critical differences. First, the baseline used to calculate the two differ. The Camp proposal is based on assets – such as loans, securities and reserves – while the Obama plan is based on certain debt liabilities… Second, owing to the $500 billion in consolidated assets exemption, the Camp plan would impact far fewer institutions than the Obama proposal would… Finally, and perhaps most notably, the fee proposed by the administration was to be temporary, expiring after ten years, assuming that all TARP monies had been repaid at that point. By contrast, the Excise Tax proposed by Representative Camp would become a permanent feature of the tax code.” Read the full blog post here.

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For more information on FRRI, including recent research and upcoming events, please visit https://bipartisanpolicy.org/projects/financial-regulatory-reform-initiative.