A top bank regulator on Monday offered a compromise proposal for the largest too-big-to-fail financial institutions -- set up separately capitalized banking and investment units and in exchange, get significant relief from Dodd-Frank stress tests.
"We need regulatory reforms, but they must be grounded in capitalism that permits failure and improves economic efficiency," Federal Deposit Insurance Corp. vice chairman Tom Hoenig told the Institute of International Bankers' annual conference in Washington. "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."
The move, if legislated into existence, would have a major impact on the largest U.S. banks, including Bank of America , JPMorgan Chase & Co. , Wells Fargo and Citigroup .
To help ensure that the separately capitalized divisions are maintained, the biggest banks would need to set up two corporate boards, one for each partitioned business. Commercial banks, under this approach, would need to hold minimum tangible equity of 10% of their assets, while investment banks' capital requirements could be "examined and calibrated," he said.
The move, Hoenig suggested, would reverse a trend in which the U.S. taxpayer-backed safety net has been allowed to cover a large financial institution's "expanded activities conducted within commercial banks," which gave an edge to investment banking operations affiliated with those companies.
In exchange, Hoenig proposes that the largest financial institutions would receive relief from a number of the most costly and complex aspects of the Dodd-Frank Act, legislation written after the 2008 financial crisis, when the government spent billions on bank bailouts to shore up the financial system. Specifically, such banks could be exempted from two forms of stress tests designed to identify whether they have enough capital to withstand a hypothetical financial crisis.
They also would no longer have to write annual so-called "living wills," Hoenig said, which are currently required to explain how they would unwind themselves without damaging markets in the event of a failure.
Hoenig doesn't give big banks a reprieve from the Volcker Rule, a provision in Dodd-Frank that prohibits big banks from engaging in speculative proprietary trading or owning or sponsoring private equity firms or hedge funds. Based on the proposal, however, a separately managed and capitalized unit would be permitted to own and sponsor a buyout shop or hedge fund.
Just two years ago, then-President Barack Obama signed a must-pass spending bill with a provision repealing a Dodd-Frank clause that would have required big banks to make riskier credit derivatives trades through separately capitalized unit. The aim of the now eliminated measure was to ensure that a trading failure there would not have affected the institution's commercial bank division, which is backed by insured deposits and taxpayers through the Federal Reserve's discount window.
In addition, Hoenig's proposal will compete with a proposal introduced by House Financial Services Committee Chairman Jeb Hensarling, R-Texas, who has recently become a power broker on efforts to repeal and shake up Dodd-Frank.
Hensarling earlier this year introduced a legislative package that would completely repeal the Volcker Rule and other sections of Dodd-Frank in exchange for tougher leverage and capital restrictions at the biggest banks. Hensarling's bill would also exempt small and mid-sized institutions from a requirement that they are supervised by a consumer financial protection bureau.
In some ways, Hoenig's position isn't much of a surprise, since he has previously pushed to reinstate some form of the Depression-era Glass-Steagall Act, which mandated the separation of investment and commercial banks.
This latest proposal, in some ways, appears to be a compromise approach that wouldn't require the biggest banks to break up. Still, it's unclear how much influence Hoenig has on Capitol Hill and with the White House.
Washington insiders have speculated in the past that Hoenig could be considered as the next FDIC chairman or for a much-coveted position as the Federal Reserve's top bank supervisor. The Fed governor who handled much of the duties associated with that role, though he didn't have the title, said in February that he plans to step down next month.
One candidate for the post, David Nason, the head of GE Energy Financial Services, withdrew from consideration earlier this month.
However, a decision by the Trump administration to nominate Hoenig for the top Fed supervisor post or to head the FDIC could send a loud message that his proposal is one that White House wants to support. The proposal also comes after President Donald Trump called for a 21st Century Glass-Steagall Act, which would break up the biggest banks, on the campaign trail. In addition, the Trump Administration's Treasury Secretary, Steven Mnuchin, said he supported a 21st Century Glass-Steagall Act in some form, at his confirmation hearing.
Jaret Seiberg, analyst at Cowen Washington Research Group, said in a March 8 note that Nason's decision to pull out suggests to him that candidates like Hoenig, former BB&T chairman John Allison and Minneapolis Federal Reserve Bank President Neel Kashkari are back in the discussion.
"Of these three, Hoenig remains the one to watch," Seiberg said. "He spoke at CPAC -- the conservative convention -- just a few hours after White House adviser Steve Bannon. He is a conservative populist who got the FDIC post thanks to Senate Majority Leader Mitch McConnell, who remains one of the most important players in moving the President's agenda."
Editors' pick: Originally published March 13.
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