On October 14, 2022, the Board of Governors of the Federal Reserve System (“Federal Reserve”) and Federal Deposit Insurance Corporation (“FDIC”) released an advance notice of proposed rulemaking on whether they should impose additional resolution-related obligations on larger regional banks (“ANPR”).1 The ANPR is an important development that could result in some larger regional banks being treated more like global systemically important banks (“G-SIBs”) despite their smaller size and less complex operations.
Comments on the ANPR must be submitted within 60 days of it being published in the Federal Register, which is expected shortly. We expect the Federal Reserve and FDIC will issue a further notice of proposed rulemaking in 2023 that contains draft rule text. In this Legal Update, we provide background on the ANPR and discuss some of its major themes.
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.2 In 2018, Congress enacted the Economic Growth, Regulatory Relief and Consumer Protection Act (S. 2155) (“Relief Act”), which raised the threshold for many of the enhanced prudential standards to $100 billion or $250 billion.3 Federal banking regulators implemented the Relief Act 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.4 These rulemakings established a framework that sorted banks with $100 billion or more in total assets into four different categories based on several factors, including asset size, cross-jurisdictional activity, reliance on short-term wholesale funding, nonbank assets, and off-balance sheet exposure.
However, in late 2021, the sands began to shift and federal banking regulators started to consider the application of additional requirements to larger banking organizations. In particular, the acting Comptroller of the Currency announced in April 2022 a bold framework of additional resolution-related standards that would be imposed on larger regional banks. This was even more notable given that his agency, the Office of the Comptroller of the Currency, did not administer most of the relevant standards being imposed.
Key Points in the ANPR
The ANPR focuses on Category II and Category III banking organizations and requests public input on a dozen specific questions covering a number of different topics. Category II banking organizations have $700 billion or more in average total consolidated assets or $75 billion or more in cross-jurisdictional activity. Category III banking organizations have between $250 billion and $700 billion in average total consolidated assets or $75 billion or more in off-balance sheet exposures, nonbank assets, or short-term wholesale funding. Currently, there is one US Category II banking organization, approximately five US Category III banking organizations, and a similar number of similarly sized US intermediate holding companies of foreign banking organizations.5
The ANPR states that the eight US G-SIBs have adopted a single-point-of-entry (“SPOE”) resolution strategy, in which only the top-tier holding company would enter a resolution proceeding and in which losses would be passed up from subsidiaries to the parent company shareholders and long-term debt holders to recapitalize the subsidiaries. This is in contrast to the multiple-point-of-entry (“MPOE”) resolution strategy adopted by US Category II and Category III banking organizations, in which the parent holding company would enter bankruptcy and the insured depository institution subsidiary would undergo FDIC-led resolution under the Federal Deposit Insurance Act.
Federal banking regulation does not require an organization to adopt SPOE or MPOE as a resolution strategy, but it is widely understood that regulators prefer SPOE for most larger banking organizations. For example, the ANPR notes that the regulators designed the total loss absorbing capacity (“TLAC”), long-term debt, and clean holding company requirements for larger banking organizations specifically to support an SPOE strategy.
Therefore, the ANPR requests comment on whether and how the Federal Reserve and FDIC should adapt G-SIB resolution-related requirements for larger banking organizations (presumably, Category II and Category III banking organizations). Specific requirements under consideration are:
- Requiring larger banking organizations (or their subsidiary insured depository institutions) to hold qualifying forms of long-term debt that could be used to absorb losses prior to or during a resolution event.
- Adopting eligibility criteria from the G-SIBs’ TLAC requirement for long-term debt instruments issued by larger banking organizations, such as the requirement that debt be issued by the top-tier holding company in a banking organization.
- Adopting the clean holding company requirements for larger banking organizations.
- Requiring larger banking organizations to disclose to holders of long-term debt the potential treatment of that debt in a resolution event.
Finally, the ANPR also requests comment on whether the Federal Reserve and FDIC should impose separability requirements on G-SIBs and larger banking organizations, which could include the identification and design of “separability options” that provide alternatives to a wholesale acquisition by a larger institution such as an existing GSIB. These options could involve the sale, transfer, or disposal of significant assets, portfolios, legal entities, or business lines on a discrete product line or regional basis and, in some ways, resemble the MPOE resolution strategy currently favored by many larger banking organizations.
The imposition of new prudential and resolution-related obligations on regional banking organizations would run counter to Congress’s intent in passing the Relief Act to differentiate regulation for GSIBs and regional banks. Hence, if the Federal Reserve and the FDIC proceed to propose a rulemaking to impose the proposals contained in the ANPR, we should expect a vigorous debate in and out of Congress.
Additionally, it is not clear how the changes described in the ANPR would interact with the ongoing review of the bank merger regime. Conceptually, approval of mergers should not be contingent on additional, permanent prudential standards as the existing regulatory requirements are based on where a bank falls into the existing categories. However, the Federal Reserve has indicated that in some cases, it will nevertheless impose new standards as a condition for approving a merger. This approach has the potential for creating an uneven playing field for otherwise similarly situated banking organizations.
Finally, the G-SIB requirements are a relatively blunt instrument that arguably addresses the unique characteristics of the largest organizations, which typically have significant capital markets activities and substantial assets held by non-bank affiliates. Applying the existing G-SIB framework to regional banking organizations, which do not have significant capital markets activities and, rather, have most of their assets held in the bank, may establish a regulatory regime that does not match those organizations’ risk profiles or imposes substantial costs.
1 Press Release, Federal Reserve Board invites public comment on an advance notice of proposed rulemaking to enhance regulators’ ability to resolve large banks in an orderly way should they fail (Oct. 14, 2022), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20221014a.htm.
3 E.g., Global and US financial regulators have devised several quantitative measures of a banking organization’s systemic risks, which have revealed the vast differences in systemic risk among institutions. Office of Financial Research, Bank Systemic Risk Monitor (Oct. 18, 2022), https://www.financialresearch.gov/bank-systemic-risk-monitor/.
4 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.
5 Federal Reserve, Supervision and Regulation Report, app. A (May 2022), https://www.federalreserve.gov/publications/2022-may-supervision-and-regulation-report-appendix-a.htm.