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FDIC chair: We need to be preparing for the next downturn

Brian Cheung

One of the nation’s top banking regulators said Monday that she is staying vigilant for the next downturn and echoed concerns with leveraged lending.

In her first televised interview since becoming the head of the Federal Deposit Insurance Corporation, Jelena McWilliams told Yahoo Finance that the economy and the banking industry are doing well.

“Things are looking good. Having said that, it is times like this that we need to be looking ahead and preparing for the next downturn,” McWilliams said.

McWilliams is closely watching leveraged lending, the business of large and risky business loans that has the attention of regulators and lawmakers on Capitol Hill. Last week, the Federal Reserve released a report flagging growth in nonfinancial leveraged loans and warned that credit standards “appear to have deteriorated over the past six months.” The Office of the Comptroller of the Currency, the third major bank regulator, similarly reported that leveraged lending has suffered from “eased underwriting standards” and warned banks to be mindful of their direct and indirect exposure to corporate debt markets.

McWilliams said she is looking at bank exposure — for small and large firms alike — to leveraged loans and the collateralized loan obligations that they are rolled into. For the most part, she said risks live outside of the banking industry but noted that community banks have “really high” collateralized loan obligation holdings. CLOs were particularly popular securities for banks searching for yield during the period of zero-bound interest rates.

“We need to be constantly monitoring what’s happening in the marketplace and how are banks positioned,” McWilliams said. “Do [banks] hold enough capital against debt?”

Between 2015 and 2016, McWilliams said, there was a dip corporate leverage but said recent data shows levels at post-crisis highs.

The challenge for McWilliams, the Fed, and the OCC lies in identifying risk at nonbank institutions that they do not regulate; if mutual funds experience stress, the bank regulators may not be able to do much. McWilliams has also flagged another type of nonbank risk in the past: mortgages shifting from banks to large online lenders.

Not everyone is so concerned.

Fed Vice Chair of Supervision Randal Quarles mentioned that there are enough “touch points” between the banking industry and the non-regulated financial sector for regulators to adequately observe nonbank risks. Quarles said Monday that “we’re comfortable with what we’re seeing currently.”

‘War on Deposits’

McWilliams, who joined the FDIC in the summer of 2018 after being appointed by President Donald Trump in November 2017, said another big talking point in the banking industry is in the fight for deposits.

Ever since the Fed began its path of gradual rate hikes, banks have strategically timed increases in the interest rates they pay out on deposits. With the Fed continuing to raise rates, banks are now fighting to keep their deposits from neighboring (or online) banks that may offer more favorable interest rates.

McWilliams says the “war on deposits” is unfavorable to smaller community banks.

“A lot of larger banks can offer better deposit rates and attract small depositors with incentives, which is costly, sometimes prohibitively costly, for smaller banks,” McWilliams said.

Since becoming the FDIC head, McWilliams has moved on implementing the banking law that Trump signed in May rolling back a number of post-crisis Dodd-Frank rules. The bill offers some regulatory relief to community banks, which McWilliams said should be of some help to those smaller institutions trying to compete with the mega-banks.

The bill notably frees smaller banks with less than $10 billion from some regulations if they can show that they have a leverage ratio — a measure of healthy capital — above 9%. The bill also controversially gave the regulators the authority to “tailor” its approach to large banks up to $250 billion, which the regulators expanded in order to offer reduced liquidity and funding requirements to large firms like U.S. Bancorp (USB), PNC Financial (PNC), Capital One (COF), and Charles Schwab (SCHW).

“The bill allows us to appropriately calibrate how much relief we give to smaller banks versus larger banks versus very large banks,” McWilliams said.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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