Megabank Matters


Too-big-to-fail lingers on the policymaking stage, with more work to do

By Karen Epper Hoffman

You can still hear Americans throughout the country intensely discuss too-big-to-fail. What necessitated the public bailouts of Wall Street’s giant too-big-to-fail institutions in 2008 has never fully been put to rest in the policymaking arena, and the conditions that required the bailout have far from dissipated.

Nearly eight years after the Wall Street financial crisis, despite systemic risk provisions adopted by the Dodd-Frank Wall Street Reform Act that ICBA supported, too-big-to-fail is prominent on the minds of America’s voters and, therefore, of policymakers’ in Washington, D.C.

But too-big-to-fail remains far more than a theoretical concept or a debating point. It’s a reality.

Virtually all of the so-called Systemically Important Financial Institutions, or SIFIs, are more crucial (and bigger) than they were just eight years ago. The 10 largest U.S. banks now hold more than $10 trillion in assets, more than 80 percent of those assets held by the top four banks alone.

“We seem to be progressing to a more level playing field, but we still have a long way to go,” says Chris Cole, ICBA’s executive vice president and senior regulatory counsel. “The Dodd-Frank Act and regulations under Dodd-Frank and the Basel III regulations have made some progress toward addressing too-big-to-fail. But it’s an unfortunate fact that once you’ve reached that vast size, you continue to enjoy market advantages of being perceived as too-big-to-fail and there’s almost nothing to slow you down.”

ICBA’s public policy resolutions state that the ongoing dominance of a small number of too-big-to-fail banks creates an overly concentrated financial system, imposes unacceptable moral hazard and systemic risk, thwarts the free market, and harms consumers and business borrowers. Cole underscores ICBA’s position that the greatest ongoing threat to the safety and soundness of the U.S. banking system is the overly concentrated power and dominance of a small number of too-big-to-fail megabanks.

This ongoing imbalance between Wall Street and Main Street has kept too-big-to-fail institutions in the spotlight, and the outcome of the federal elections in November will certainly influence how policymakers address this issue. Recently, the Federal Reserve Bank of Minneapolis, for example, convened a conference on too-big-to-fail this spring. As a result, the Minneapolis Fed launched a yearlong study on bank and nonbank SIFIs, and their impact on the financial system and broader economy.

Largely boycotted by the nation’s biggest banks, Cole says, the Minneapolis Fed-led conferences have sparked new thoughts and discussions about addressing too-big-to-fail, with input from academics, members of the industry and government regulators, all seeking solutions for curbing the potential impact of a top-heavy banking industry. The study undertaken by the Minneapolis Fed, spearheaded by Neel Kashkari, the Minneapolis Fed’s president and CEO, is designed to examine the effectiveness of too-big-to-fail policies undertaken so far and determine whether more action is necessary.

“ICBA is of the mind that we do need to go further,” Cole says. “It’s quite likely that we’ve reached a point that we’ll see these giant institutions are still much too big to fail, and that the government is not going to allow these institutions to fail.”

ICBA continues to support the full implementation of the Dodd-Frank Act’s too-big-to-fail policy measures for SIFIs, including enhanced supervision measures, stricter capital reserve provisions and orderly liquidation requirements. To address too-big-to-fail beyond the measures still slowly unfolding, however, ICBA believes policymakers need to take additional steps to reduce the likelihood that megabanks will fail and, if they were to fail, ensure that they can be liquidated in an orderly fashion without destabilizing the country’s overall financial system and economy.

Four particular too-big-to-fail policy issues remain in play in Washington. But in each of these areas, ICBA believes that policymakers can and should do more.

“We seem to be progressing to a more level playing field, but we still have a long way to go.”
—Chris Cole, ICBA’s executive vice president and senior regulatory counsel

  1. Enhanced prudential capital standards. The Dodd-Frank Act established the Financial Stability Oversight Council (FSOC) to determine which bank and nonbank SIFIs should be subject to increased prudential supervision. Taking effect at the end of 2019 and the end of 2021 are the Basel III capital adequacy rules and the Federal Reserve’s Total Loss-Absorbing Capacity (TLAC) requirements, which will impose higher capital and long-term debt requirements on these systemically important banks.

    “The big banks have long transition periods to phase in TLAC and Basel III requirements. However, I think that we’re all going to realize these requirements are not enough,” Cole says.

    ICBA generally endorses imposing higher capital, leverage, liquidity standards, concentration limits and contingent resolution plans for SIFIs. ICBA supported a current requirement for a higher supplementary leverage ratio on the largest banks and their holding companies adopted by bank regulators. The association also currently advocates establishing a significant capital surcharge for SIFIs and supports imposing the greater capital and long-term debt reserve requirements on globally significant banks.

    Additionally, Dodd-Frank defines SIFI institutions as banks with assets of $50 billion or more as well as nonbank financial companies designated by FSOC as systemically important. Although ICBA fully supports higher prudential standards for the largest bank holding companies, the association also believes the $50 billion threshold is too low and should be raised. Cole says ICBA’s position is that a higher threshold and a more flexible SIFI definition would more accurately identify those institutions that truly impose systemic risks to our banking system.

  2. Liquidating failed SIFIs. ICBA supports the Dodd-Frank orderly liquidation authority provisions that provide a process for the orderly liquidation of an SIFI and the appointment of the FDIC as receiver. ICBA also supports the FDIC’s and the Federal Reserve’s rules requiring SIFIs to submit contingent resolution plans that enable the FDIC, acting as a receiver, to resolve the institution under the Federal Deposit Insurance Act.

    The Dodd-Frank Act directed the FDIC and the Federal Reserve to issue new rules requiring those too-big-to-fail institutions to annually submit contingent resolution plans—so-called living wills or funeral plans—that are intended to outline a workable plan of action for a rapid and orderly resolution in bankruptcy of those companies were they to fail. In April, regulators rejected the living wills of JPMorgan Chase & Co., Bank of America Corp., Wells Fargo, Bank of New York Mellon Corp. and State Street Corp. for failing to satisfy requirements, and the banks need to resubmit new plans by Oct. 1.

    “The too-big-to-fail banks know they have a lot to do,” Cole points out. “They are under a lot of pressure right now to come up with workable living wills, and they have a lot of lawyers and consultants working to help them figure this out.”

    Cole says ICBA believes that it’s important that the largest financial companies submit credible contingent resolution plans that would allow for a rapid and orderly resolution should they fail. If a company cannot submit a credible plan, the FDIC and the Federal Reserve should exercise their authority under the Dodd-Frank Act to order a divestiture of those assets or operations that might hinder an orderly resolution.

  3. The Volcker Rule. The Federal Reserve also has issued rules barring depository institutions and their affiliates from engaging in short-term proprietary trading for a banking entity’s own account. The so-called Volcker Rule prohibits these institutions from owning, sponsoring or having certain relationships with hedge funds or private-equity funds. Institutions with significant trading operations must establish an internal compliance program and report certain quantitative measurements on a regular basis to help agencies identify prohibited trading.
    Although two years ago the banking agencies ruled that trust preferred securities issued by community banks are not covered by the Volcker Rule’s provisions, ICBA believes that community banks should be completely exempt from the rule.
  4. The Hoenig proposal. ICBA supports a plan drafted by FDIC Vice Chairman Tom Hoenig that would restrict banking organizations to core banking activities of making loans and taking deposits. Accordingly, Hoenig’s plan would prohibit banks from engaging in certain non-banking activities, such as dealing and market making and proprietary trading. Further, banking organizations would be prohibited from holding “complicated” securities such as multilayered securities because of the difficulty of determining and monitoring their credit quality.
    ICBA believes the Hoenig proposal would better align the interests of banks and their customers. Trading activities can set up a conflict of interest between a bank and its customers. The proposal would reduce risk among large financial institutions and shadow banks and improve overall stability in the financial system.
    “We want the industry to concentrate on traditional banking, and we don’t want any institution to have an unfair advantage,” Cole says. “And when the next recession occurs, we don’t want community banks to be affected by the bad actions of a few institutions.”

  5. Karen Epper Hoffman is a financial writer in Washington state.