In connection with its ongoing evaluation of the asset management industry, the U.S. Financial Stability Oversight Council (the “FSOC”) recently issued a notice seeking public comment (the “Notice”) on whether asset management products and activities may pose potential risks to U.S. financial stability.  Specifically, the FSOC seeks comment on the systemic risks posed by: (1) liquidity and redemption practices; (2) use of leverage; (3) operational functions; and (4) resolution, i.e., the extent to which the failure or closure of an asset manager, investment vehicle or an affiliate could have an adverse impact on financial markets or the economy. Comments on the Notice must be submitted by February 23, 2015; and we are working with several clients to prepare and submit such comments. This post summarizes some of the FSOC’s key concerns and questions outlined in the Notice.
Posts Tagged ‘Leverage’
The U.S. banking agencies have finalized revisions to the denominator of the supplementary leverage ratio (SLR), which include a number of key changes and clarifications to their April 2014 proposal. The SLR represents the U.S. implementation of the Basel III leverage ratio.
Under the U.S. banking agencies’ SLR framework, advanced approaches firms must maintain a minimum SLR of 3%, while the 8 U.S. bank holding companies that have been identified as global systemically important banks (U.S. G-SIBs) and their U.S. insured depository institution subsidiaries are subject to enhanced SLR standards (eSLR).
Regulatory delay is now the established norm, which continues to leave banks unsure about how to prepare for pending rulemakings and execute on strategic initiatives. With the “Too Big To Fail” (TBTF) debate about to hit the headlines again when the Government Accountability Office releases its long-awaited TBTF report, the rhetoric calling for the completion of these outstanding rules will once more sharpen.
This rhetoric should not be confused with reality, however. At about this time last summer, Treasury Secretary Lew stated that TBTF would be addressed by the end of 2013—a goal that resulted in heightened stress testing expectations and a vague final Volcker Rule in December, but little more. Since then, the slow progress has continued, with only two key rulemakings completed so far this year: the finalization of Enhanced Prudential Standards for large bank holding companies (BHCs) and a heightened supplementary leverage ratio for the eight largest BHCs (i.e., US G-SIBs).
The U.S. banking agencies have finalized higher leverage capital standards for the eight U.S. bank holding companies that have been identified as global systemically important banks (“U.S. G-SIBs”) and their insured depository institution (“IDI”) subsidiaries. The agencies also proposed important changes to the denominator of the U.S. Basel III supplementary leverage ratio (“SLR”). A number of these proposed changes are intended to implement the Basel Committee’s January 2014 revisions to the Basel III leverage ratio.
Pursuant to Section 165 of the Dodd-Frank Act, the Federal Reserve has issued a final rule to establish enhanced prudential standards for large U.S. bank holding companies (BHCs) and foreign banking organizations (FBOs).
U.S. BHCs: The final rule represents the latest in a series of U.S. regulations that apply heightened standards to large U.S. BHCs. As the graphic below illustrates, under the emerging post-Dodd-Frank prudential regulatory landscape for U.S. BHCs, the number and stringency of prudential standards generally increase with the size of the banking organization.
In our recent NBER working paper, Financing as a Supply Chain: The Capital Structure of Banks and Borrowers, we propose a novel framework to model joint debt decisions of banks and borrowers. Our framework combines the models used by bank regulators with the models used to explain capital structure in corporate finance. This structure can be used to explore the quantitative impact of government interventions such as deposit insurance, bailouts, and capital regulation.
In the paper, Bank Capital and Financial Stability: An Economic Tradeoff or a Faustian Bargain?, forthcoming in the Annual Review of Financial Economics, I review the literature on the relationship between bank capital and stability. Higher capital contributes positively to financial stability. On this issue, there seems to be little disagreement. There is, however, disagreement in the literature on whether the high leverage in banking serves a socially-useful economic purpose, and whether regulators should permit banks to operate with such high leverage despite its pernicious effect on bank stability, and this disagreement seems at least as strong as that over the causes of the subprime crisis (Lo (2012)). Some of the disagreement over higher capital requirements is between those who emphasize the potential benefits of this in terms of reducing systemic risk and those who believe that sufficiently high capital requirements will generate various costs (e.g., lower lending and liquidity creation and the migration of key financial intermediation services to the unregulated sector).
Following a robust 2012, the financing markets in 2013 continued their hot streak. Syndicated loan issuances topped $2.1 trillion, a new record in the United States. However, as in 2012, financing transactions in the early part of 2013 were devoted mostly to refinancings and debt maturity extensions rather than acquisitions. In fact, new money debt issuances were at record lows during the first half of 2013. The second half of 2013, though, saw an increase in M&A activity generally, and acquisition financing in the fourth quarter and early 2014 increased as a result.
On January 12, 2014 the Basel Committee on Banking Supervision (Basel Committee) issued the near final version of its leverage ratio and disclosure guidance (B3LR). The B3LR will be subject to further calibration until 2017 with final implementation expected by January 1, 2018.
The B3LR makes a number of significant changes to the Basel Committee’s June 2013 consultative paper (Consultative Paper) by easing the approach to measuring the exposures of off-balance sheet items. These changes address the industry’s concern that the Consultative Paper’s definition of exposure was too expansive (i.e., the leverage ratio’s denominator was too large).
In January 2014, the Basel Committee on Banking Supervision finalized its revisions to the Basel III leverage ratio. Compared to its June 2013 proposed revisions, the Basel Committee has made several important changes to the denominator of the Basel III leverage ratio, including with respect to the treatment of derivatives, securities financing transactions and certain off-balance sheet items.