House Committee, Treasury Propose Systemic Risk Bill

By Richard Roth, J.D., Editor, the CCH Federal Banking Law Reporter, CCH Bank Compliance Guide and Bank Digest, October 28, 2009.

The Treasury Department and the House Financial Services Committee leadership have jointly drafted a bill that is intended to address both systemic risk in the financial system and the problem of institutions that are seen as “too big to fail.” The proposal, designated as a “discussion draft,” is intended to create a way to monitor and reduce the threats posed by systemically risky firms and establish a process for resolving large, financially-troubled non-bank financial institutions in an orderly manner.

A Financial Services Oversight Council to identify financial companies and activities that pose a threat to financial stability would be created by the bill. The Council would be responsible for prudential oversight, standards and regulation of these firms and activities, and it would have similar responsibilities for systemically important financial market utilities and payment, clearing and settlement activities. Council members would be the Secretary of the Treasury, Federal Reserve Board Chairman, Comptroller of the Currency, the chairs of the Securities and Exchange Commission, Commodities and Futures Exchange Commission, Federal Deposit Insurance Corp. and National Credit Union Administration, and the Director of the Federal Housing Finance Agency. A state insurance commissioner and state banking supervisor would be nonvoting members.

Holding Company Regulation

The bill would consolidate holding company regulation by removing restraints on the Federal Reserve Board's authority over companies that are subject to consolidated regulation. Federal financial regulatory agencies would be given specific authority to regulate for financial stability purposes. Non-bank institutions such as industrial loan companies would become subject to more intrusive federal regulation and future exemptions for these companies would be ended. Existing institutions would have to be placed in regulated bank holding companies, and limits would be imposed on any transactions between a holding company and its commercial affiliates. No additional commercial companies would be able to own banks, ILCs or other specialty bank charters.

The Fed would be authorized to set concentration limits for large holding companies that would prohibit them from having credit exposures for buying any unaffiliated company that exceeded 25 percent of the holding company's capital stock and surplus. The Fed could set an even lower limit, at its discretion.

Systemic Risk Supervision

The bill would impose information gathering and sharing requirements on the Council, the federal bank and thrift regulatory agencies, the SEC and the CFTC. The Council would have the authority to make formal recommendations that any federal regulatory agency adopt heightened prudential standards, and the Fed would be designated as the “back-up” regulator in the event other regulatory agencies did not act quickly enough to impose the heightened standards called for by the Council.

The proposal provides that the agencies may not publicly identify firms that are subjected to heightened prudential standards.

An effort to mitigate one specific securitization risk is included in the bill. The federal banking regulatory agencies and the SEC would be required to jointly adopt rules under which lenders would be required to retain at least 10 percent of the credit risk of any loan transferred or sold. The regulators would have the authority to adjust the retained risk percentage either up or down, but could not set it at less than 5 percent. If loans were securitized that were not originated by the creditors, the securitizer would be subject to the risk-retention requirement.

Large Failing Institutions

The FDIC would be given the job of closing down failing large, complex financial companies outside of bankruptcy. The goal would be to allocate the losses properly and prevent disruption of the financial system and the economy at large. If the costs of resolving an institution exceeded the assets, the excess would be paid through assessments on other large financial firms—those with assets of $10 billion or more—not by the government (or, ultimately, the taxpayers).

Additionally, the FDIC could—with the approval of the Fed and Treasury—make loans or offer guarantees to a solvent financial firm if doing so was necessary to prevent financial instability during difficult periods.

The bill also would give the Fed the authority to file an involuntary bankruptcy petition against a critically undercapitalized financial holding company.

Federal Thrifts

Unlike earlier proposals, the federal savings association charter would not be eliminated. However, thrifts would be supervised by a separate division of the OCC, and thrift holding companies would be regulated by the Fed. This change is intended to eliminate regulatory arbitrage—the practice of changing charters in order to come under a regulator deemed to be more favorable to the institution.

Fed Program Limits

The bill would restrict the Fed's ability to unilaterally create liquidity assistance programs. The Treasury Secretary's approval would be required, and only “generally available facilities” could be created.

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