On April 1, 2022, the Acting Comptroller of the Currency, Michael Hsu, announced that he is considering imposing new prudential standards on larger regional banks.1 These standards initially would be imposed on a bank-by-bank basis through conditions to merger approvals but have the potential to eventually become permanent for all larger regional banks through the interagency rulemaking process.
Acting Comptroller Hsu’s remarks represent a sharp pivot from the regulatory efforts to streamline and tailor financial regulation over the past few years. Indeed, if Acting Comptroller Hus’s proposal is adopted as policy, it would effectively roll back parts of the intent of the Economic Growth, Regulatory Relief, and Consumer Protection Act (S.2155), which Congress adopted just four years ago to, inter alia, tailor the regulation of regional banks based on their asset size and risk profile.2
Under the Dodd-Frank Act, banking organizations with more than $50 billion in total assets were subject to a wide range of enhanced prudential standards, including capital and resolution planning requirements.3 Over time, it became apparent to policymakers that this threshold was too low and resulted in mid-sized and regional banking organizations being subject to regulation that was inconsistent with the systemic risks presented by their generally non-complex operations.4
In 2018, Congress enacted S.2155, which raised the threshold for many of the enhanced prudential standards to $100 billion or $250 billion. Federal banking regulators implemented S.2155 through several rulemakings that tailored the application of the enhanced prudential standards to apply to banking organizations based on the asset size and complexity of each organization.5
Acting Comptroller Hsu used a speech last week at an academic conference on financial regulation to announce that he is reconsidering this tailoring approach in light of his concerns about the resolvability of larger regional banks and the adverse impact that the failure of such a bank could have on the competitiveness of the banking industry.
In his speech, Acting Comptroller Hsu indicated that he is concerned that if a larger regional bank were to fail, the only viable way for the Federal Deposit Insurance Corporation (“FDIC”) to resolve the bank would be to sell it to one of the eight US globally systemic banks (“US G-SIBs”) or a large regional bank. In his view, this approach would increase financial stability risks presented by the acquiring bank by making a large banking organization even larger and potentially decreasing competition within the US banking sector by concentrating market share in a smaller number of institutions. To reduce the likelihood of such an outcome, Acting Comptroller Hsu said that he is considering applying three enhanced prudential standards to larger regional banks, which his remarks implied are those banks with total consolidated assets of greater than $500 billion.
The first new standard is that larger regional banks would need to adopt the single-point-of-entry (“SPOE”) resolution strategy as opposed to the multiple-point-of-entry (“MPOE”) resolution strategy currently used by many of the larger regional banks. In an SPOE resolution, only the parent holding company would file for bankruptcy, while all of the material subsidiaries would continue to operate and function. SPOE is the strategy adopted by the Federal Reserve and the FDIC for all eight G-SIBs, although it is not explicitly required by US law.6 MPOE contemplates multiple points of entry with each (or many) of the legal entities resolved through separate proceedings. Acting Comptroller Hsu cited Lehman Brothers as an example of the MPOE approach and the problems presented.
The second new standard is that larger regional banks would be required to issue long-term debt consistent with total loss-absorbing capital (“TLAC”) requirements. Presently, the TLAC rules aim to ensure that G-SIBs hold sufficient long-term debt and tier 1 capital to facilitate the resolution of a banking organization without assistance by the federal government by requiring debt holders to absorb losses through the bail-in process. Notably, Acting Comptroller Hsu indicated that he is considering applying only the external long-term debt requirement from the TLAC rules to the parent companies of larger regional banks. It is worth nothing that the FDIC’s recent request for comment on bank mergers asks generally if the TLAC rules should be imposed on institutions to preclude the need for merger following failure.7
The third new standard is that larger regional banks would need to be separable, although it is not clear if the OCC intends for the separability to apply at the bank or holding company entity level. Separability is something that the FDIC and Federal Reserve have required in the resolution planning context for the G-SIBs. In this context, it generally requires a banking organization to identify lines of business and/or large portfolios that can be sold quickly during times of stress or in a receivership and operate these businesses in a manner such that a sale can be effectuated quickly. This requires institutions to address intra-corporate operational relationships and limit potential interdependencies of each subsidiary or business line to facilitate a sale. As a result, market participants will often see service provider agreements precluding termination and requiring that the services continue for any spun-off entity for a certain period. While this standard does not currently exist in banking law or regulation, the US banking regulators have used guidance and the resolution planning process to set supervisory expectations that compel the US G-SIBs to be separable.
In his remarks, Acting Comptroller Hsu recognized that imposing these new standards on all larger regional banks would require interagency rulemakings by the OCC, FDIC and Federal Reserve, which would take time.8 Therefore, he is considering using the merger review process to apply these standards. Specifically, he would condition the approval of mergers involving larger regional banks on “actions and credible commitments to achieving SPOE, TLAC,9 and separability.”
Acting Comptroller Hsu’s remarks are sure to generate much debate. To start, it is far from clear that SPOE is the appropriate resolution strategy for regional banks, many of which hold nearly all of their assets in their insured depository institution. SPOE is designed for banking organizations with substantial subsidiaries and a depository that are highly interconnected, making it difficult to resolve one entity alone. However, where all the assets of the organization are in the depository institution, the resolution of the depository institution by the FDIC effectively resolves the entity organization. Further, a mandate to issue significant long-term debt may be expensive for regional banks, which generally rely on deposits for funding. It is also hard to see how the imposition of a long-term debt requirement would address Acting Comptroller Hsu’s antitrust concerns. Rather, by increasing the costs of operating a regional bank, such a requirement could actually reduce competition in the banking industry.
Further, all regional banks should be on notice that the US banking regulators are considering changes to the application of enhanced prudential standards and competition law policy more generally. While the acting comptroller’s announcement focuses on banks with more than $500 billion in assets, there is no limiting principle that would prevent regulators from conditioning adherence by smaller banks engaged in other types of transactions (e.g., nonbank acquisitions). Therefore, to the extent that they have not yet done so, regional banks should consider amending their indentures now to remove provisions that would impair senior debt securities that are issued going forward from qualifying as eligible long-term debt under TLAC if and when such a requirement is imposed. Such indenture amendments would be accompanied by additional disclosures in the offering documents for any new issuances that highlight the changes to acceleration events and covenants and the differences in newly issued debt securities from outstanding senior debt securities.
Finally, Acting Comptroller Hsu’s plan to adopt his proposal through informal revisions to the bank merger review process raises Administrative Procedure Act concerns in that it would deny stakeholders and the public the opportunity to comment on a major regulatory change. This approach also raises the question of the limits of the comptroller’s authority under existing law to impose significant and permanent regulatory requirements as conditions to merger approvals. While courts have been reluctant to allow regulators to create new merger standards, the practical difficulties associated with challenging bank merger application denials in court may prevent banks from seeking review of these OCC actions.10
1 OCC, NR 2022-33 (Apr. 1, 2022), https://occ.gov/news-issuances/news-releases/2022/nr-occ-2022-33.html.
2 Please see our Legal Update on the 2018 legislation at https://www.mayerbrown.com/en/perspectives-events/publications/2018/05/congress-passes-regulatory-reform-for-financial-in.
4 E.g., Global and US financial regulators have devised several quantitative measures of a banking organization’s systemic risks, which revealed the vast differences in systemic risk among institutions. Office of Financial Research, Bank Systemic Risk Monitor (Apr. 3, 2022), https://www.financialresearch.gov/bank-systemic-risk-monitor/.
5 See Press Release, Federal Reserve Board finalizes rules that tailor its regulations for domestic and foreign banks to more closely match their risk profiles (Oct. 10, 2019), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20191010a.htm.
7 87 Fed. Reg. 18,740, 18744 (Mar. 31, 2022) (“Are there attributes of GSIB resolvability, such as a Total Loss-Absorbing Capacity (TLAC) requirement, that could be put into place that would facilitate the resolution of a large insured depository institution without resorting to a merger?”). As noted below, the OCC does not regulate the parent companies of banks and, therefore, could not directly impose this requirement on a bank or savings and loan holding company. See e.g., FDIC OIG, Material Loss Review of Corus Bank NA at 11-12 (Jan. 24, 2012) (describing how the OCC was unable to compel a bank’s holding company to downstream funding to a failing bank and was unsuccessful in convincing the Federal Reserve to exercise its authority to issue such an order).
8 Further, the OCC has no role in the resolution planning process under the Dodd-Frank Act and cannot regulate the activities of holding companies, which would make it difficult, if not impossible, for the agency to directly impose the SPOE and TLAC standards on banking organizations through a standalone rulemaking.
9 While the body of the announcement indicates that the TLAC standard for larger regional banks would be limited to the long-term debt requirement, it arguably could be expanded to the other requirements under TLAC (e.g., the clean holding company requirement) if the regulators desired to do so.
10 See, e.g., Security Bancorp v. Federal Reserve, 655 F.2d 164, 168 (9th Cir. 1980) (“Since Congress has chosen not to make such a requirement, we hold that the Board cannot create one under the guise of managerial resources.”).