WASHINGTON, D.C. – U.S. Senator Susan Collins (R-ME) has introduced a financial reform amendment that would help prevent future economic crises by directing regulators to impose tough risk-and sized-based capital standards on financial institutions. The amendment tackles the “too big to fail” problem by requiring financial firms to have adequate amounts of cash and other liquid assets available under new regulatory capital standards. Senator Collins’s amendment has won the endorsement of Sheila Bair, chairman of the nation’s Federal Deposit Insurance Corporation (FDIC), who expressed her "strong support" for the amendment in a letter to Senator Collins.
Senator Collins plans to offer her amendment next week to the financial regulatory reform legislation being debated by the Senate.
“If financial firms, including bank holding companies, were required to meet stronger capital standards, they would be far less likely to fail and to trigger the kind of cascade of economic harm that we experienced starting in 2008,” Senator Collins said Friday. “This amendment strengthens the economic foundation of these firms, increases oversight and accountability, and helps prevent the excesses that contributed to the deep recession that has cost millions of Americans their jobs. Increasing capital requirements as firms grow provides a disincentive to their becoming ‘too big to fail’ and ensures an adequate capital cushion in difficult economic times.”
In Bair’s letter supporting the amendment, the FDIC chairman calls Senator Collins’ proposal “a critical element to ensure that U.S. financial institutions hold sufficient capital to absorb losses during future periods of financial stress. With new resolution authority, taxpayers will no longer bail out large financial institutions. This makes it imperative that they have sufficient capital to stand on their own in times of adversity.” The FDIC has advocated for minimum leverage requirements for many years.
The Collins’ amendment directs federal regulators to impose minimum leverage and risk-based capital requirements on banks, bank holding companies, and non-bank financial firms identified by the new Financial Stability Oversight Council for supervision by the Federal Reserve. Neither current law nor the Senate Banking Committee bill requires regulators to adjust capital standards for risk factors as financial institutions grow in size or engage in risky practices. The amendment directs the regulators to use a ratio of “Tier 1 capital” to risk-adjusted assets. Tier 1 capital, which is comprised of cash, the value of common stock, and some types of preferred stock, reduced by unrealized losses, is closely correlated with bank liquidity and stability and thus is a measure of an institution’s economic health.
The current Senate financial regulatory reform bill also does not require regulators to apply minimum capital and risk measures across financial institutions. “It does not make sense that under current law, the nation’s largest banks and bank holding companies are not required to meet the same capital standards imposed on smaller depository banks, when the failure of larger institutions is much more likely to have a broad economic impact,” Senator Collins said.
Senator Collins’ amendment tightens the standards that will apply to larger financial institutions by requiring them to meet, at a minimum, standards that already apply to small banks. Chairman Bair has noted that the regulatory capital differences in current law have created a situation where certain large bank holding companies have become significantly more leveraged than smaller insured banks.
The full text of Chairman Bair’s May 7 letter follows (Click here for PDF):
Dear Senator Collins:
I am writing to express my strong support for your amendment to ensure strong capital requirements for our nation’s financial institutions. This amendment is a critical element to ensure that U.S. financial institutions hold sufficient capital to absorb losses during future periods of financial stress. With new resolution authority, taxpayers will no longer bail out large financial institutions. This makes it imperative that they have sufficient capital to stand on their own in times of adversity.
During the crisis, FDIC-insured subsidiary banks became the source of strength both to the holding companies and holding company affiliates. Far from being a source of strength to banks as Congress intended, holding companies became a source of weakness requiring federal support. If, in the future, bank holding companies are to become sources of financial stability for insured banks, then they cannot operate under consolidated capital requirements that are numerically lower and qualitatively less stringent than those applying to insured banks. This amendment would address this issue by requiring bank holding companies to operate under capital standards at least as stringent as those applying to banks.
The crisis also demonstrated the dangers of excessive leverage undertaken by large nonbanks outside of the scope of federal bank regulation. Notable examples included the excessive leverage of the largest investment banks during the run-up to the crisis, and the extremely high leverage of Fannie Mae and Freddie Mac. To remedy this, and prevent regulatory gaps and arbitrage, large nonbank financial institutions deemed to be systemic must be held to the same, or higher, capital standards as those applying to banks and bank holding companies. Again, the amendment accomplishes this goal simply and directly.
Finally, and more broadly, the crisis identified the dangers of a regulatory mindset focused exclusively on the soundness of individual banks without reference to the “big picture.” For example, an individual overnight repo may be safe, but widespread financing of illiquid securities with overnight repos left the system vulnerable to a liquidity crisis. A financial system-wide view requires regulators, working in conjunction with the new Financial Services Oversight Panel, to develop capital regulations to address the risks of activities that affect the broader financial system, beyond the bank that is engaging in the activity.
We at the FDIC remain committed to working with you towards a stronger financial system. This amendment will be an important step in accomplishing this goal.
Sincerely,
Sheila C. Bair