March 23, 2017 / 6:13 PM / 2 years ago

Banking 'partition' proposal by FDIC's Hoenig adds to Dodd-Frank revamp momentum

NEW YORK (Thomson Reuters Regulatory Intelligence) - A senior federal regulator has provided momentum to calls within President Donald Trump’s administration to change the structural rules for big banks, with his proposal to separate traditional retail banking activities such as deposit taking and making loans from the riskier businesses such as investment banking and insurance underwriting.

FDIC Vice Chair Thomas Hoenig (L) testifies before the House Financial Services Committee hearing on "Examining How the Dodd-Frank Act Could Result in More Taxpayer-Funded Bailouts" on Capitol Hill.

Federal Deposit Insurance Corporation (FDIC) Vice Chairman Tom Hoenig floated his "partition", or ring-fencing, idea this week in a speech at the Institute of International Bankers' annual conference in Washington (here).

This, coupled with a requirement for a flat 10-percent leverage ratio at the intermediate holding company level, would substantially reduce other parts of the Dodd-Frank Act regulatory requirements, if implemented.

“We can best achieve these goals if the largest banks were to partition their commercial and investment banking activities and also hold tangible equity capital at a level where bank owners — not the taxpayer — cover the cost of inevitable failures” Hoenig said.

Hoenig has been rumored to be a possible contender for the position of vice chair for supervision at the Federal Reserve Board – a senior regulatory policy position.

His words built upon the new administration's intention to significantly revise the Dodd-Frank regulatory framework passed after the financial crisis of 2008 (here). The proposal was also loosely in line with Treasury Secretary Steven Mnuchkin's idea of a "21st century Glass-Steagall."

That idea was floated by Mnuchin in his Senate confirmation hearing. He said a return to the strict post-Great Depression separation of commercial and investment banks was unpractical but something short of that was needed.

Observers viewed Mnuchin’s call as echoing the UK’s 2013 Financial Services (Banking Reform) Act. That plan permits a “ring-fenced” traditional bank to provide a safe-haven for market transactions, investment banking, wealth management, and certain payment services now housed under the banking book.

The retail side of the institution comes under extra-tough capital requirements and other rules designed to insulate it against the more risk-taking activities of the rest of the company.

DODD-FRANK REQUIREMENTS

Hoenig said his proposal would render some Dodd-Frank requirements obsolete. These include exemption from the annual comprehensive capital analysis and review (CCAR) exercises, Dodd-Frank stress tests, as well as standards established by the Basel Committee of global regulators, namely the liquidity coverage ratio and the net stable funding ratio.

Under the proposal, banks also would no longer have to write annual “living wills,” providing detailed explanations as to how they would unwind without damaging markets in a crisis environment.

It would in effect replace the risk-based capital model with the leverage ratio as the primary measure of capital adequacy.

VOLCKER KEPT, BUT WATERED DOWN

Hoenig’s proposal would maintain the so-called Volcker rule’s ban against speculative proprietary trading by insured banks. However, he said, “the separately managed and capitalized affiliates would be able to do so with proper controls in place and assurances that the safety net was appropriately confined and risk adequately capitalized.”

He did not elaborate on the types of controls and assurances he would favor.

FOCUS ON THE BANK HOLDING COMPANY MODEL

According to the proposal, large banks would set up distinct corporate boards for each separately capitalized partitioned holding company. This would keep the synergies of commercial and investment bank activities, while reducing the moral hazard to the depositor, deriving from one holding company model which houses both the traditional and non-traditional activities under same structure.

“While my proposal would set the level of capital —minimum tangible equity of 10 percent of their assets, for the insured (commercial) bank, the level for nontraditional intermediate holding companies and the entities housed underneath it could be further examined and calibrated,”

said Hoenig.

This separation would ensure that the U.S. taxpayer would not be on the hook to cover a large financial institution’s “expanded activities” conducted within commercial banks.

To further highlight the delineation of the traditional and non-traditional activities, Hoenig stressed the need for “stricter” quantitative limits on capital and surplus that can be exchanged among affiliates – the rules known as the section 23A and 23b of Bank holding company requirements.

“COMMON DENOMINATOR”

Hoenig’s proposal could clarify the regulatory revamp agenda of the Trump administration by helping to establish a “lowest common denominator” of fewer rules in exchange for structural safeguards.

In particular, it hits the same chord as U.S. House of Representatives Financial Services Committee Chairman Jeb Hensarling, who has advocated a uniform 10 percent leverage ratio instead of relying on risk-based capital ratios of DFA. Unlike Hensarling, however, the Hoenig proposal stops short of a complete repeal of the Volcker rule.

-Proposal by FDIC Vice Chairman Thomas M. Hoenig: here

(Bora Yagiz, FRM is a New York-based Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, specializing in risk. He is a certified Financial Risk Manager. Mr. Yagiz has held positions as a bank examiner for the Federal Reserve Bank of New York, as senior consultant with Ernst & Young and vice president at Morgan Stanley. Follow Bora on Twitter @Bora_Yagiz. Email Bora at bora.yagiz@thomsonreuters.com)

This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Mar. 16. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters

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