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AmericasJanuary 2 2020

Are Fed latest regulations a change for the better?

The Banker recently assembled an expert panel to give their reaction to the US Federal Reserve's latest batch of regulations, issued in late 2019. Silvia Pavoni reports.
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The US Federal Reserve’s final package of rules tailoring bank regulation to business models largely benefits smaller and foreign banks. The Banker has polled a group of senior and diverse professionals about the implications of these changes, which were released in October 2019, following 2018 legislation rewriting the Dodd-Frank Act.

Among other actions, the new rules raise the asset threshold that requires annual supervisory stress tests to $250bn from $50bn; exempts most domestic banks with assets between $100bn and $250bn from enhanced capital and liquidity rules, and reduces the frequency of stress testing from annual to biannual; and scraps initial plans to consider foreign banks’ subsidiaries as well as branches in stress-testing scenarios. Below, our panel looks at the implications of the new rules for banks.

Will the easing off of regulatory pressures on smaller and foreign banks introduce systemic risk?

April Frazer: I don’t believe so. The recent regulatory relief has not significantly relaxed capital requirements for regional and community banks, with most regulatory relief being recognised in the lifting of operational burdens, such as the frequency of stress testing, required documentation and disclosure requirements. While the regulatory requirements for items such as capital and liquidity stress testing have been relaxed, many of these institutions will continue to perform these actions in normal course because the banks view it as an integral part of best-in-class risk management practices.

Richard Gray: The word deregulation has been thrown around a lot but we are not in an environment of deregulation in any way, shape or form. Capital has increased very significantly; liquidity requirements have been increased very significantly. All of these measures have been taken since Dodd-Frank was proposed, since Basel III was proposed, over the past nine years, and we are now looking at [whether they are] fit for purpose and doing some fine-tuning that makes the system more efficient.

The panel 

  • April Frazer, head of banks, Wells Fargo
  • Bain Rumohr, senior director, North American banks, Fitch Ratings
  • Carolyn Rogers, secretary general, Basel Committee on Banking Supervision  
  • Mark Sobel, US chairman, Official Monetary and Financial Institutions Forum
  • Richard Gray, deputy director, regulatory affairs, Institute of International Finance

[With regards to foreign banks] I think it was just a pragmatic final decision by the Fed. [Foreign banks’ subsidiaries and branches] have got to be kept distinct because the branch is really just a part of the head office. You have still got internal total loss-absorbing capacity arrangements where the foreign holding company ensures sufficient capital for the local operation. The Fed did listen to the [concerns of] foreign banks and the industry. I do want to give it credit for that because... in our experience, whatever is proposed, [irrespective of industry suggestions, stay] in the final rule. 

Do these changes contribute to a more level playing field among jurisdictions?

Carolyn Rogers: I think that what the US has done with the recent changes to smaller banks’ regulation is what the Basel Committee often refers to as ‘proportionality’, which is a principle that has been embedded in the Basel standards for years and it is something that I would say almost every member of the Basel Committee practises to some degree. Here in Switzerland, for example, there is a different regime for smaller domestic banks. In the jurisdiction I come from in Canada, we have a different regime for those smaller banks.

[With these changes] from my understanding, the US adhered to Basel core principles, which I’m glad to see. We need to have consistent implementation in the US, and across the EU, of the Basel III final reforms for large, internationally active banks and it is important that we discern between efforts by Basel Committee member jurisdictions to apply proportionality to their regimes for smaller, domestic banks or branches, from regulatory changes that would deviate from the agreed Basel III reforms.

Foreign bank activity in the US has been patchy but largely diminishing over the past few years. Will this continue?

Mr Gray: One thing that our data shows is that over the past five years, on a relative basis, the level of activity among foreign banking operations [in the US] has been lower than for comparable domestic operations. Foreign banks play a special role because they sometimes operate in sectors that the domestic banks don’t, such as project [and infrastructure] finance [such as that done by European and Japanese banks in financing projects through their balance sheet].

The US banking market is very corporate bond dominated. During the construction [phase, for that type of] risk you can’t do corporate bonds because they would not be rateable. I don’t agree with [US president] Donald Trump about a lot of things but the one thing I do agree with him about is that they need a lot of infrastructure investment in the US. [If a foreign bank is providing infrastructure financing], it does really help to have a local presence.

Bain Rumohr: There has certainly been a risk-weighted asset reduction from European subsidiaries in the US over the past few years. I don’t necessarily think that European banks are less interested in being in the US. I think that the US remains a very attractive market, particularly for European banks; even in a slower gross domestic product growth environment, [the US market] still appears to be in a much better position than the EU.

Will new rules also encourage consolidation among smaller players?

Mr Rumohr: Under the regulatory relief, the $50bn asset threshold [that previously brought up] capital stress testing and liquidity stress testing requirements has gone away and I think that [might encourage] the pairing up of the mid-size regional banks that might [previously have been hindered] by [concerns over] crossing the $50bn asset mark. I think that is where you will continue to see consolidation. The merger of Texas Capital Bancshares and Independent Bank Group [in December 2019] came together for myriad reasons but certainly the lack of the $50bn threshold [helped].

What are the biggest risks facing US banking in 2020?

Mark Sobel: While extreme vigilance is needed with respect to the health of the banking system, I’m still concerned that risks in the [non-banking financial] system are underappreciated and could pose a great danger to the US financial system and economy. The supervision and regulation of non-bank actors appears far less rigorous and more lax than that of the banking system.

Ms Rogers: If we think about the next generation of risks that both banks and regulators need to turn their mind to, climate change is one of those risks. The other big risk facing this sector right now and which regulators are focused on is the role of technology and how technology is changing the business models of banks. Cryptoassets have not made their way into the banking sector in material ways yet, but [we are looking] at how that may roll out.

Mr Rumohr: [At Fitch] we do have a stable outlook on the sector. While not necessarily being a challenge, we do not think that there is a lot of room upward for earnings growth going into 2020 given the rate environment and given the fact that a lot of the low-hanging fruits from a cost perspective have already been [taken]. The Office of the Comptroller of the Currency Semiannual Risk Perspectives report pointed out [the risk] for smaller banks that are perhaps lagging in their technology investments, and as that gap continues to grow their ability to catch up becomes that much [weaker]. That is [another] huge reason why you might see continued consolidation in the US banking sector going into 2020. 

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Read more about:  Americas , Regulations , Americas , US
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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