FINANCIAL REGULATION | "Community Bank" Bill, a Trojan Horse?

The following is Update 254 from Dana Chasin and his 20/20 Team, reposted by permission with some small edits:

Washington, D.C., March 6, 2018 – Debate started on the Senate floor today on S. 2155. Is it a rare and shining example of bipartisanship breaking through D.C. gridlock to help community banks? The problem with that view is:

• The claim that community banks' profit margins are weak today is debatable.
•  S. 2155’s most significant impact has nothing to do with community banks. [And so the bill in that sense is a Trojan Horse.]

Community Banks – Profitable and Least Regulated 

Community banks reported $6 billion in profits in Fall 2017, a 9.4 percent increase from the year before. Community bank loan balances were up by 7.7 percent over this same period. Loan activity was widely dispersed throughout the community banking population, with 75 percent of community banks increasing their loan balances last year. These strong growth figures hardly paint a picture of an industry that’s drowning in regulatory burden.

Despite this, the community banking lobby has been actively lobbying Congress for regulatory relief for years. Republicans (and now some Democrats) have picked up this banner to argue that Dodd-Frank is crushing community banks.

No one did better in winning exceptions to regulation during the Dodd-Frank negotiating process than the Independent Community Banking Association (ICBA). The Dodd-Frank Act gave community banks regulatory exemptions such as:

• Flexibility in underwriting when issuing mortgages, allowing community banks to benefit from Qualified Mortgage safe harbor.
• Complete exemption from enhanced prudential standards including stringent capital rules, the LCR, and stress testing.
• Less expensive FDIC insurance coverage compared with larger banks.

Through the ICBA, community banks have long insisted that the cost of complying with regulations is too high. This is no more true in the post-Dodd-Frank era as it was prior to its passage. Dodd-Frank is not the problem.

How to Help Community Banks

Local banks are an important part of the small business ecosystem and community banks are four times more likely to operate in rural communities. They are a vital part of the national economy.

According to a GAO report published in February, community banks are mostly concerned about Home Mortgage Disclosure Act (HMDA), Bank Secrecy Act, and TILA-RESPA disclosure regulations.

While S. 2155 does attempt to address some of these concerns (in the case of HMDA requirements, quite controversially), the majority of the bill offers, at best, a bad magic trick for community banks. For instance, banks below $10 billion are exempt from the Volcker Rule which prohibits banking entities from proprietary trading or entering into relationships with equity funds. This is largely an empty gesture – few community banks engage in any of the activities outlawed by the Volcker Rule.

Mergers Incentivized, Costs Increased 

Any marginal gains for community banks will be offset by Title IV’s dismantling of requirements on medium-sized banks, which, paradoxically, could trigger further consolidation in the financial sector. The resulting spike in merger sand acquisitions will reduce in-market competition.

Many Republicans have lamented the original $50 billion SIFI threshold as being arbitrary and, by extension, inappropriate. Even granting the premise does not justify this new legislation. If the number is arbitrary then so is the $250 billion level they are raising it to. However, the change will have clear repercussions as institutions begin swelling their portfolios to raise to the new cap(s). Institutions that have previously floated just below the $50 billion threshold will start to consume community banks without any disincentive.

In a poll conducted by Americans for Financial Reform, 67 percent of people oppose the loosening of banking regulations in S. 2155. Voters have realized that this bill deregulates much bigger banks than the “mom and pop” institutions proponents of the bill like to emphasize. It is evident to 67 percent of voters polled that this bill is not only going to deregulate the same institutions that sent America into a financial crisis, it could also increase the deficit and hurt Americans for years to come.

CBO estimates that enacting the bill would increase federal deficits by $671 million over the 2018-27 period. That deficit increase comes from an increase in direct spending of $233 million and a decrease in revenues of $439 million. Some of that cost and reduction in revenues would be recovered through collections from financial institutions in years after 2027.

CBO also estimates that, assuming appropriation of the necessary amounts, implementing the bill would cost $77 million over the 2018-27 period. Like the tax bill, this act will kick the bill to the grandkids of today’s new voters.

Next Steps

This morning the Senate cloture motion to proceed with debate on S.2155 passed 67-32. The 13 Democratic/Independent cosponsors were joined by four other Democrats:

Senator Debbie Stabenow (MI)
Senator Jeanne Shaheen (NH)
Senator Maggie Hassan (NH)
Senator Bill Nelson (FL)

All in all, 17 Democrats voted in support of the cloture motion. Senate Majority Leader Mitch McConnell will now have to decide whether he will allow an open amendment process to take place. Few expect an open process as it may force some difficult votes onto moderate Democrats. While this is happening, lobbyists are outspending progressives hundreds of dollars to one every day in defense of this bill.

Minority Leader Schumer and the Democratic caucus may be better off with a full tree and a closed amendment process. The next big ticket item to look out for would be the manager’s amendment sponsored by the architect of this bill, Sen. Crapo (R-ID).

Continuing to Watch the Process

See previous post: https://cityeconomist.blogspot.com/2018/03/financial-regulation-s-2155-systemic.html Also "Wall Street on Parade": http://bit.ly/2DeKeJq

Throughout the week, the 20/20 team collects relevant news clips, here: https://goo.gl/forms/7NoJ2CmPTzuSzzVZ2

An archive of past updates is here: https://dc-policyupdate.com/

FINANCIAL REGULATION | S. 2155, Systemic Risk

Here are some negative reviews of S.2155, collected by Sen. Sherrod Brown (D-OH).

The following is Update 253 from Dana Chasin, on S. 2155 and Systemic Risk.

Washington, DC, March 5, 2018 – With S. 2155, the "Economic Growth, Regulatory Relief, and Consumer Protection Act," set to hit the floor tomorrow, attention is now turning to the least discussed and most abstract — and systemically most consequential — part of the bill.

Title IV of S. 2155 is not like the first three titles, which involve benefits provided to a diverse range of stakeholders, with tradeoffs for competing stakeholders. Title IV's Section 401 provisions benefit just 30 out of the nation’s top 40 financial institutions, exclusively and generously.  One of those provisions was the ABA’s chief legislative goal for 2017.   

Section 401 of the Act has a negative  impact on the safety and soundness rules as they apply to the biggest financial firms in the country.

Section 401 Raises the Size Threshold Fivefold

Section 401 of S. 2155 provides for a five-fold increase in the size threshold for firms to be subject to enhanced prudential standards. These standards themselves are then weakened  further in the rest of the Section. 

The ABA-prize centerpiece of the legislation increases the asset threshold for the automatic application of post-crisis safeguards, known as enhanced prudential standards, from $50 billion to $250 billion. 

This change would deregulate 25 of the country’s largest 34 banking institutions. These 25 together hold $3.5 trillion in assets and collected a total of $47 billion in TARP funds after the financial crisis.  

Raising the asset threshold from $50 billion to $250 billion would amount to the largest rollback of Dodd-Frank to date. 

Section 401 gives the Fed discretion to re-apply enhanced prudential standards to financial institutions with total assets between $100 billion and $250 billion, should they pose substantial systemic risk.  Given the option, however, Trump appointees responsible for reapplying standards are likely to err on the side of under-regulation. Fed Governor Randal Quarles, a known opponent of the enhanced prudential regulatory regime under Dodd-Frank, is unlikely to retain many of these standards for institutions with assets under $250 billion.

Worse, it is possible that under the proposed law the Fed will lose discretionary powers to administer enhanced prudential standards even to the largest firms.  S. 2155 would amend Section 165 of Dodd-Frank by changing the word "may" (with regard to the Fed's ability to tailor the application of enhanced prudential standards, based on "risk-related factors") to "shall."  The wording change puts greater pressure on the Fed to weaken its enhanced prudential requirements even for the very largest SIFIs, and would encourage financial institutions to file lawsuits if the Fed decides to put them on the list.

Stress Tests: Deregulation as Data Deprivation

A mandatory system of regular and consistent stress tests is one of the most important policy innovations of the post-crisis era. Stress testing allows for more accurate projections of losses that banks would suffer under adverse financial conditions, which enables bank managers and regulators to determine whether a given bank would remain solvent under severe financial stress. [This was a major part of recovery from the bank panic in 1933.] 

Post-stress capital levels have increased substantially since the crisis, demonstrating the positive overall impact of mandatory stress testing on the health of the financial system. Last year, 33 of the nation’s largest 34 banks passed CCAR stress tests — an indicator that these institutions are better able to withstand crisis conditions.

However, the bill would make the current system of stress testing more complicated, fragmented, and potentially much less effective. Broken down by asset holdings, we can see these potential effects as follows:

• $50 billion to $100 billion in assets: Banking institutions in this asset class would no longer be subject to Fed-run stress testing.
• $100 billion to $250 billion in assets: 18 months after the enactment of this legislation, banking institutions in this asset class would no longer be subject to annual Fed-run stress tests.  A substitute test would simulate performance only under an adverse economic scenario, meaning these banks would no longer undergo stress testing that measures baseline and extremely adverse economic scenarios, and would likely be tested less frequently. As with other enhanced prudential standards, S. 2155 grants the Fed additional authority to exempt banks in this asset class from stress testings before the 18 month review period. 
• Banks with $250 billion or more in assets: 18 months after the enactment of this legislation, banking institutions with at least $250 billion in asset size will no longer be subject to Fed-run stress testing that measures adverse economic conditions. These banks will only undergo stress testing that measures performance under baseline and extremely adverse economic conditions.

Liquidity Coverage Ratio

The Liquidity Coverage Ratio (LCR) directs financial institutions to hold a certain amount of High Quality Liquid Assets (HQLA), relative to their net outflows.  This ensures that SIFIs are able to cover losses in the event of a market shock without defaulting or contributing to a crash.  As with all “enhanced prudential standards,” this bill would allow the Fed to relieve banks with less than $250 billion in total assets from the constraints of the LCR — a uniquely excessive deregulatory measure. 

The Fed has already “tailored” the LCR for banks between $50 and $250 billion in asset size by adopting what is known as the modified LCR (mLCR). This means that the Fed has already decided that these institutions should have different regulations and apply them appropriately. The Fed is also currently considering changing the mLCR for these institutions on a sliding scale with new ratios. Codifying that they “shall” consider each institution individually and quintupling the asset threshold will either be irrelevant or, given the current and incoming crop of regulators, extremely dangerous.

Living Wills: Unwarranted, Unwanted Relief 

As with the other enhanced prudential standards, S. 2155 would mean that:

• Banks with total assets between $50 and $100 billion would be immediately exempt from the requirement to submit annual living wills.
• Banks between $100 and $250 billion would be subject to the Fed’s discretionary oversight, pending an 18-month review period.  The extent to which the Fed would require these firms to continue resolution plan submissions is unclear.  Chairman Powell has been broadly supportive of living wills and the other pillars of Dodd-Frank, but others at the Fed, including the new Vice Chair for Supervision Randal Quarles, have been less supportive in the past.  

In his remarks before the Senate Banking Committee on Thursday, Chairman Powell remarked that the financial system is much healthier now than it was in 2007-08, and specifically cited living wills as having contributed to this stability.  

The banking industry is generally supportive of the provision. In December, JPMorgan Chase Chairman and CEO Jamie Dimon expressed his belief that living wills were “good for industry.” It is widely acknowledged that the very process of preparing these submissions, under an explicit mandate of the law, actually helps banking institutions’ management to gain a better enterprise-wide view of their businesses.

There is also begrudging Republican acceptance for living wills.  Resolution planning prepares firms for potential liquidation, and makes it less likely that they will have to go through the FDIC’s Orderly Liquidation Authority (OLA).  Many Republicans claim this special resolution alternative distorts the market by circumventing the bankruptcy process, and this mistrust of OLA tempers their distaste for living wills. Despite this broad acceptance of the importance of resolution planning, S. 2155 would mean that many the nation’s largest banks would no longer be required to submit these plans.

Missing the Forest for the Trees

Just a decade after the largest financial crisis in nearly a century, S. 2155 seeks to deregulate some of the most systemically important banking institutions in the country.  The bill’s creators set out to bring regulatory relief to community banks which they claim are overburdened by onerous compliance costs. While the bill does bring some modest relief to these small banks, the most impactful section of the bill is focused on reducing burdens on much larger banks that have registered record profits in recent years.

A cloture vote on S. 2155 is scheduled in the Senate tomorrow.  That procedural measure is expected to pass easily.  And then comes the floor debate and possibly amendments, but possibly with an agreement among the bill’s supporters to lock arms as was done in a Senate Banking markup that saw no amendments adopted.  The floor speeches may be more interesting.  

*DB USA Corporation and Santander USA Inc are Intermediate Holding Companies of foreign-based banking institutions.

See also:
https://cityeconomist.blogspot.com/2018/03/financial-regulation-community-bank.html
and "Wall Street on Parade": http://bit.ly/2DeKeJq.