Crapo Bill Helps Smaller Banks, Highlights Problems With Bank Holding Companies

COMMENTARY Government Regulation

Crapo Bill Helps Smaller Banks, Highlights Problems With Bank Holding Companies

Mar 14th, 2018 8 min read
Norbert J. Michel, Ph.D.

Director, Center for Data Analysis

Norbert Michel studies and writes about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.
Sen. Mike Crapo, R-Idaho. Bill Clark/CQ Roll Call/Newscom

Key Takeaways

The Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155) is heading toward Senate passage, possibly as early as this week.

For the most part, it provides targeted exemptions from a few regulations for smaller banks, all of which will remain (heavily) regulated.

To help the most Americans, members of Congress should enact as many of these reforms as they can agree to.

The Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155) is heading toward Senate passage, possibly as early as this week. The bill will surely make many small bankers happy, but it’s a stretch to say it would undo Dodd-Frank.

That’s what makes headlines like these so ludicrous:

The Senate bill does not deregulate a single bank.

For the most part, it provides targeted exemptions from a few regulations for smaller banks, all of which will remain (heavily) regulated. More details on S. 2155 are here and here, but a few of the main regulatory changes are as follows:

  • Provides a limited regulatory off-ramp for some banks with less than $10 billion in total assets. This provision, known as a community bank leverage ratio, would exempt certain small banks from risk-weighted capital requirements. (Incidentally, these rules were first imposed in the 1980s, not by the 2010 Dodd-Frank Act).
  • Safe harbor for ability to repay rules. The Senate bill provides a qualified mortgage safe harbor for banks with less than $10 billion in total assets that hold mortgages on their books rather than sell them into the mortgage-backed security (MBS) market.
  • Volcker Rule relief. 2155 provides an exemption from the Volcker rule for banks with assets less than $10 billion and with total trading assets and liabilities not exceeding more than 5 percent of their total assets.

All of these changes are for smaller banks. Not one single bank with assets greater than $10 billion qualifies for any of these new rules.

One of the few provisions of the bill that targets larger banks would raise the Dodd-Frank threshold for enhanced supervision from $50 billion to $250 billion. This figure is known as the SIFI threshold because these large banks are often referred to as systemically important financial institutions (SIFIs). (Another pro-big-bank provision, relating to custodial deposits, appears likely to be amended before passage.)

Changing the SIFI threshold has always been controversial, but a close look at S. 2155 reveals that the bill only nominally changes the threshold from $50 billion to $250 billion. More importantly, this threshold applies to bank holding companies. That is, the threshold applies to the companies that own commercial banks, not to the commercial banks that actually hold consumers’ deposits.

Here’s a brief rundown of what the Senate bill actually does to the threshold.

  • Raise that threshold to $250 billion, but with several major caveats.
  • Authorize the Fed to “apply any prudential standard to any bank holding company or bank holding companies” with total assets of at least $100 billion. In other words, banks with at least $100 billion—not $250 billion—would still be subject to the Fed’s enhanced supervision.
  • Authorize the Fed to “tailor or differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate.”

It is accurate to say that the bill raises the threshold from $50 billion to $100 billion, while still allowing the Fed to apply special standards to bank holding companies with assets less than $100 billion. It is simply misleading to say the bill raises the SIFI threshold from $50 billion to $250 billion.

More substantively, the regulatory relief that this bill provides for bank holding companies – and, again, these are not the commercial banks that hold deposits – is relatively small.

One reason this relief is so minor is that S. 2155 does not provide a blanket exemption from the enhanced standards. Another reason is that the Dodd-Frank prudential standards are based partly on the Basel III capital rules, and nobody in this asset range will be exempt from the Basel III framework. As to the specifics of the enhanced standards, the Fed’s final rule states that:

enhanced prudential standards include risk-based and leverage capital requirements, liquidity standards, requirements for overall risk management (including establishing a risk committee), stress-test requirements, and a 15-to-1 debt-to equity limit for companies that the Financial Stability Oversight Council has determined pose a grave threat to financial stability.

If S. 2155 is enacted, banks between $50 billion and $250 billion will not be exempt from stress tests, risk management requirements, or from federal capital, leverage, and liquidity requirements. (The bill does tweak stress-testing requirements, but it doesn’t eliminate testing itself). And although some of the firms might be exempt from the 15-to-1 debt-to-equity limit, they will not be exempt from other leverage requirements.

All of the remaining rules will be more stringent than they were prior to the 2008 crisis, and the marginal difference between the enhanced standards and the regular standards is razor thin. One of the biggest differences is the level of responsibility for risk management that the enhanced rules place on the bank holding company’s board of directors (see page 17318). There is zero evidence that these special obligations make a commercial bank any safer than the regular rules.

The Congressional Budget Office claims rolling back these enhanced standards will “slightly” increase the probability that a large financial institution will fail, but it provides no analysis of exactly how these enhanced standards are superior to the conventional rules. Aside from the prudential standards, even the smallest commercial banks have to design liquidity management plans (page 66 of the Comptroller’s Handbook for community bank supervision) that are constantly monitored by bank examiners.

Ultimately, the Senate bill highlights two important regulatory issues that Congress appears unwilling to fully debate:

  • Usefulness of the bank holding company structure, and
  • Efficacy of relying on regulators’ discretion.

Bank holding companies developed in the 1950s to skirt bank-branching restrictions. Congress responded with the Bank Holding Company Act of 1956, giving the Fed oversight, but the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 eliminated those branching restrictions.

It makes little sense to focus so much energy on regulating the holding company instead of the actual depository institution, but that’s exactly what U.S. law requires. Regulators apply all sorts of risk and liquidity regulations to individual banks, and then add virtually the same layers of regulation on the shell company that owns the banks. (The Volcker rule fiasco highlighted this problem.)

One possible advantage of this dual framework is that the holding company can be called on to support a weak subsidiary, but that calls into question the idea of tying up so much capital in a shell company. It also leads one to doubt the effectiveness of the underlying regulations.

Next, Congress missed an opportunity to move to clear cut rules unclouded by what regulators might do in the future. The community bank leverage ratio in S. 2155 is a great example.

This provision provides a way out of risk-based capital requirements for some banks, but it allows regulators to decree that a bank is too risky to qualify for the exemption—even if the bank meets the ratio.

Some might see this discretion as a virtue, but the 2008 crisis provided iron-clad proof that regulators, no matter how well intentioned, are no better than other human beings at guessing the future path of asset markets. Regulators messed up: The very risk weights that were supposed to prevent such problems contributed mightily to the 2008 crisis.

The ratio should be clean and straightforward – any bank that meets the requirement should gain regulatory relief.

The Senate bill does not provide as extensive regulatory relief as the Financial CHOICE Act, the bill passed by the House last June. Nor does the Senate bill eliminate many of the existing problems created by the Dodd–Frank Act.

Still, there is overlap between the two bills, and the Senate bill includes several features that would provide significant regulatory relief to many financial institutions. To help the most Americans, members of Congress should enact as many of these reforms as they can agree to.

This piece originally appeared in Forbes