The Federal Reserve’s Dodd-Frank enhanced prudential standards (“EPS”) final rule requires a foreign banking organization with $50 billion or more in U.S. non-branch/agency assets (“Foreign Bank”) to place virtually all of its U.S. subsidiaries underneath a top-tier U.S. intermediate holding company (“IHC”). The IHC will be subject to U.S. Basel III, capital planning, Dodd-Frank stress testing, liquidity, risk management requirements and other U.S. EPS on a consolidated basis.
Posts Tagged ‘Financial institutions’
U.S. banking regulation resembles a cat-and-mouse game of industry change and regulatory response. Often, a crisis or industry innovation will lead to a new regulatory regime. Past regulatory regimes have included geographic restrictions, activity restrictions, disclosure mandates, risk management rules, and capital requirements. But the recently enacted Dodd-Frank Act introduced a new strain of banking-industry supervision: regulation by hypothetical. Regulation by hypothetical refers to rules that require banks to predict future crises and weaknesses. Those predictions—which by definition are speculative—become the basis for regulatory intervention. Two illustrative instances of this regulation were codified in Dodd-Frank: stress tests and living wills. They are two pillars on which Dodd-Frank builds to manage risk in systemically important financial institutions (SIFIs).  As I argue in my forthcoming article, regulation by hypothetical in Dodd-Frank should be abandoned for three reasons: it relies on a faulty premise, tasks an agency with a conflicted mission, and likely exacerbates the moral hazards involved with governmental sponsorship of private institutions. Because of these weaknesses, the regulation-by-hypothetical regime must be either abandoned (my first choice) or strengthened. One way to strengthen these hypothetical scenarios would be to conduct financial war games.
In a comment letter and supporting paper to the FDIC on its single-point-of-entry (SPOE) resolution concept release, Karen Shaw Petrou, managing partner of Federal Financial Analytics, argues that SPOE is conceptually sound and statutorily robust. However, progress to date on orderly liquidation has been so cautious as to cloud the credibility of assertions that the largest U.S. financial institutions, especially the biggest banks, are no longer too big to fail (“TBTF”). Crafting a new resolution regime is of course a complex undertaking that benefits from as much consensus as possible. However, if definitive action is not quickly taken on a policy construct for single-point-of-entry resolutions resolving high-level questions about its practicality and functionality under stress, markets will revert to TBTF expectations that renew market distortions, place undue competitive pressure on small firms, and stoke systemic risk. Even more dangerous, the FDIC may not be ready when systemic risk strikes again.
Questions addressed in detail in the paper and Ms. Petrou’s answers to them are summarized below:
Excessive risk-taking by financial institutions and overly generous executive pay are widely regarded as key factors in the 2007-09 crisis. In particular, it has become commonplace to blame banks and securities companies for compensation packages that reward managers (and more generally, other risk-takers such as traders and salesmen) generously for making investments with high returns in the short run but large risks that emerge only in the long run. As governments have been forced to rescue failing financial institutions, politicians and the media have stressed the need to cut executive pay packages and rein in incentives based on options and bonuses, making them more dependent on long-term performance and in extreme cases eliminating them outright. It is natural to ask whether this is the right policy response to the problem. It is crucial to ask what is the root of the problem—that is, precisely which market failure produced excessive risk-taking.
In the paper, Breaking Bad? Too-Big-To-Fail Banks Not Guilty As Not Charged, forthcoming in the Washington University Law Review, Vol. 91, No. 4, 2014, I focus on the benefits that the largest financial institutions receive because they are too-big-to-fail. Since the 2008 financial crisis, rating agencies, regulators, global organizations, and academics have argued that large banks receive significant competitive advantages because the market still perceives them as likely to be saved in a future financial crisis. The most significant advantage is a government implicit subsidy, which stems from this market perception and enables the largest banks to borrow at lower interest rates. And while government subsidies were the subject of a November 2013 Government Accounting Office report, in the paper I focus on a specific aspect of the benefits the largest banks receive: the economic advantages resulting from exempting the largest financial institutions from criminal statutes. I argue that this exemption—which has been widely discussed in the media over the last few years, following several scandals involving large financial institutions—not only contributes to the subsidies’ economic value, but also creates incentives for unethical and even criminal activity.
Ever since the Treasury Department’s Office of Financial Research (“OFR”) released its report on Asset Management and Financial Stability in September 2013 (“OFR Report” or “Report”), the industry has vigorously opposed its central conclusion that the activities of the asset management industry as a whole make it systemically important and may pose a risk to US financial stability.
Several members of Congress have also voiced concern with the OFR Report’s findings, particularly during recent Congressional hearings, as have commissioners of the Securities and Exchange Commission (“SEC”). Further complicating matters, a senior official of the Office of the Comptroller of the Currency (“OCC”) recently expressed alarm about banks working with alternative asset managers or shadow banks on “weak” leveraged lending deals.
The seemingly never ending scandals in the world of finance with their damaging effects on value and human welfare (that continue unabated in spite of all the various efforts to curtail the behavior that results in those scandals) argues strongly for an addition to the current paradigm of financial economics. In our paper, Putting Integrity Into Finance: A Purely Positive Approach, which was recently made publicly available on SSRN, we summarize our new theory of integrity that reveals integrity as a purely positive phenomenon with no normative aspects whatsoever. Adding integrity as a positive phenomenon to the paradigm of financial economics provides actionable access (rather than mere explanation with no access) to the source of the behavior that has resulted in those damaging effects on value and human welfare, thereby significantly reducing that behavior. More generally, we argue that this addition to the paradigm of financial economics will create significant increases in economic efficiency, productivity, and aggregate human welfare.
The Federal Reserve has issued a final rule adopting a tiered approach for applying Dodd-Frank enhanced prudential standards to foreign banking organizations (“FBOs”). Under the tiered approach the most burdensome requirements (e.g., the requirement to establish a top-tier U.S. intermediate holding company) will only apply to FBOs with large U.S. operations, whereas fewer requirements will apply to FBOs with limited U.S. footprints.
We have summarized below the Dodd-Frank enhanced prudential standards that will apply to the following FBOs with limited U.S. footprints:
There has been no shortage of press coverage about the lack of employment diversity in the financial services sector. Now, both the US Congress and the European Union have taken action in an attempt to remedy historical practices. The increased focus on the adequacy of an institution’s diversity and inclusion initiatives warrants their reexamination in light of regulatory developments and evolving best practices.
Background—The Statutory Requirements of Section 342 of Dodd-Frank
Section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Section 342”) was adopted to help correct racial and gender imbalances at financial institutions and their regulators by prescribing inclusion requirements at the specified US government agencies that regulate the financial services sector, entities that contract with the agencies and the private businesses they regulate. Congresswoman Maxine Waters of California, the author of Section 342, noted that “many industries lack the inclusion and participation” of minorities and women, with none “more egregiously … than the financial services sector.” Section 342 provides the opportunity to “not only give oversight to diversity, but to help the Agencies understand how to do outreach [and] how to appeal to different communities.”
This post describes the final regulations issued by the Federal Reserve Board (the “FRB”) on February 18, 2014, that radically modify the former requirements applicable to foreign banking organizations (“FBOs”) pursuant to the FRB’s Regulation K. The final rules (the “Final Rules”) impose various requirements on large FBOs that previously have been applied to large U.S. domestic bank holding companies and banks under the Dodd-Frank Act. In addition, however, the Final Rules also alter many of the former approaches to the regulation of FBOs in general, including the necessity for many FBOs to form “U.S. intermediate holding companies” for their U.S. operations.
Regardless of the category an FBO falls into, the Final Rules present significant additional compliance burdens.