Capital Is King

New TBTF Act would impose stricter capital rules on largest banks to rein in risk

By Karen Thomas

The renewed debate over too-big-to-fail heated up even more with the introduction of legislation to impose stricter capital rules on the largest financial firms. The Terminating Bailouts for Taxpayer Fairness Act of 2013 (TBTF Act, S. 798), introduced by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.), is designed to end federal subsidies for too-big-to-fail firms by pegging capital requirements to bank size. It also includes several provisions to ease regulatory burdens on community banks.

There’s little question as to why Washington is again consumed by the too-big-to-fail problem. The nation continues to struggle under the weight of the economic collapse brought on by Wall Street. Meanwhile, the megabanks are only getting bigger, with the 10 largest now holding assets equal to more than 70 percent of the gross domestic product, up from 58 percent in 2006.

Further, new authority given to regulators to close megabanks in case they approach failure and “living will” requirements for the largest institutions are largely reactive—they provide instructions on what to do after the next catastrophe. Setting capital standards that vary depending on the size and complexity of the financial institution is a more active approach to reduce the likelihood that megabanks would reach the brink of failing and that the financial system would collapse if they do.

The objective of the TBTF Act is straightforward: to promote a less concentrated and more diverse financial system, limit systemic risks, and lower taxpayers’ exposure to Wall Street bailouts. Here’s a closer look at what it would do.

Capital concerns

To protect against future crises, the TBTF Act would set capital standards that vary depending on the size and complexity of the financial institution so larger institutions can absorb losses without taxpayer assistance. The bigger the bank, the greater its risk, and the higher its capital rate would be. Community banks under $50 billion in assets already have strong capital ratios that are appropriate to their business model and are not subject to higher capital requirements.

The legislation would impose a minimum 15 percent equity capital requirement on institutions with at least $500 billion in assets and an 8 percent minimum equity capital requirement on banks between $50 billion and $500 billion in assets. The new equity capital requirement would equal a financial institution’s equity capital divided by its total consolidated assets without risk weighting. Equity capital would consist of tangible common equity, deferred tax assets, accumulated other comprehensive income, intangible assets and retained earnings. Total consolidated assets would include derivative exposures (with certain restrictions on netting) and certain off-balance-sheet items.

The equity capital requirement for financial institutions with assets of $50 billion or less will be comparable to the risk-based and leverage requirements in effect as of May 1.

Financial institutions would have five years from the date of the final rules to comply with the new equity capital requirement. Meanwhile, the legislation would prohibit U.S. regulators from implementing Basel III rules on U.S. financial institutions.

Safety net assets

The act also would limit the federal safety net so it does not extend beyond commercial banks. It would end broad government assistance, such as access to Federal Reserve discount window lending, deposit insurance and other federal support programs, for nonbank financial institutions and affiliates or subsidiaries of financial institutions, except in connection with a resolution. In addition, the systemic-risk exemption under the Federal Deposit Insurance Act would be terminated, as would any lending to systemically important financial market utilities.

Red tape rescue

S. 798 also includes a number of regulatory relief provisions drawn from the ICBA Plan for Prosperity legislative agenda. These provisions would:

– expand the definition of “rural” under the Consumer Financial Protection Bureau’s mortgage rules so that more mortgages will be considered qualified mortgages;

– create a bank examiner ombudsman to receive complaints and process appeals;

– support investment in mutual banks with new dividend waiver rules;

– reduce impediments to raising debt or equity for a larger number of community bank and thrift holding companies;

– relieve banks of the requirement to mail annual privacy notices when the bank has not changed its privacy practices or policies;

– exempt community banks from new small-business data collection requirements; and

– allow thrift holding companies to use the new 1,200-shareholder Securities and Exchange Commission deregistration threshold.

ICBA strongly supports the TBTF Act and encourages community bankers to ask their senators to sign on as co-sponsors. With too-big-to-fail financial firms growing larger and increasing their risks to the nation’s financial system, these reforms will help remove excessive government distortions in the nation’s financial sector and put the “capital” back in capitalism.

Karen Thomas is ICBA senior executive vice president of government relations and public policy.

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