Federal Reserve and the FDIC Jointly Issue Advance Notice of Proposed Rulemaking for Resolution Requirements for Large Banking Organizations
On October 14, 2022, the Board of Governors of the Federal Reserve System (the Fed) and the Federal Deposit Insurance Corporation (the FDIC, and together with the Fed, the Agencies) issued an Advance Notice of Proposed Rulemaking (ANPR) to explore whether and how to strengthen resolution-related standards applicable to large banking organizations (Large Banking Organizations) which, for purposes of the ANPR, refers to Category II and Category III banking organizations under the federal banking agencies’ Tailoring Rules,1 to enable the more efficient resolution of Large Banking Organizations while mitigating effects to the financial system. The ANPR is seeking comments with respect to the joint resolution plan requirements mandated under Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) for bank holding companies with $250 billion or more in total consolidated assets, as well as the separate resolution plan requirements for covered insured depository institutions (IDIs) under the FDIC’s covered insured depository institution rule.2 Comments to the ANPR must be received on or before December 23, 2022.
All bank holding companies with $250 billion or more in total assets, which include Category I, II and III banking organizations, are required to maintain a resolution plan, but global systemically important banks (GSIBs), which are commonly referred to as “too-big-to-fail,” are subject to the most stringent requirements to enhance the resolvability of such institutions in the event of failure and to avoid the need for a government “bailout” or sale to a peer GSIB, as occurred during the 2008 financial crisis. With the growth of large regional banking organizations, the Agencies are now considering whether Large Banking Organizations should be subject to resolution requirements similar to those required of GSIBs, appropriately tailored to be commensurate with the risk and complexity of these Large Banking Organizations. Specifically, the Agencies are soliciting public input on whether certain GSIB resolution plan requirements, including Total Loss-Absorbing Capacity (TLAC), long-term debt, separability, “clean-holding company,” and disclosure requirements, are necessary to enhance the resolvability of Large Banking Organizations and limit the effects of a Large Banking Organization’s failure on the financial stability of the banking system.
In the past, the FDIC has avoided grouping its resolution plan requirements for IDIs, promulgated under the Federal Deposit Insurance Act, with the resolution plan requirements for bank holding companies under the Dodd-Frank Act. Previous leadership of the FDIC has stressed the difference in purpose in requirements between the two sets of rules, and accordingly, rulemakings for the two sets of rules have been handled separately. However, with this ANPR, it seems that the Agencies are looking to coordinate efforts with respect to requiring additional resolution planning, at least for Large Banking Organizations. The ANPR is very much focused on ensuring that the FDIC has the support it needs to orderly resolve institutions and not put the Deposit Insurance Fund (the DIF) at risk.
Pursuant to Section 165 of the Dodd-Frank Act, the Fed and the FDIC have promulgated rules and guidance to support the orderly resolution of bank holding companies. Large banking organizations that are considered Category I, II or III banking organizations under the federal banking agencies’ Tailoring Rules are subject to resolution plan requirements under the joint regulations of the Agencies and/or the FDIC’s resolution plan requirements for IDIs.3 The most stringent requirements in the rules apply to GSIBs (Category I banking organizations) and include, among other requirements, submission of a resolution plan every two years, adherence to “clean holding company” requirements, adoption of resolution-related stay provisions in financial contracts and maintenance of minimum outstanding amounts of TLAC and long-term debt to recapitalize the bank in the event of failure. Large Banking Organizations that are not GSIBs, on the other hand, are generally not subject to such requirements and must submit a resolution plan every three years.
Following the enactment of the Economic Growth Act in 2018,4 which raised the applicability of enhanced prudential standards under Section 165 of the Dodd-Frank Act from $50 billion to $250 billion, bank merger activity and organic growth have increased the size of Large Banking Organizations, particularly Category III Banks. Per the ANPR, Category III Banks’ average total consolidated assets increased from $413 billion to $554 billion from December 2019 to December 2022. Although such Large Banking Organizations’ business models remained concentrated in traditional banking activities and their proportion of total banking sector assets has remained constant, the Agencies believe their larger size heightens the potential impact of a costly resolution. Fed Vice Chair Lael Brainard stated, “[The] increases in banking concentration [for Category III Banks] raise concerns. Since we know from experience that even noncomplex banks in that range can pose risks to the broader financial system when they experience financial distress, I am encouraged that the [Fed] is seeking comment on [the ANPR] to improve their resolvability through long-term debt requirements and is undertaking a serious review of [large banking organization] capital requirements.”
The OCC does not have rulemaking authority with respect to resolution plan requirements, but Acting Comptroller of the OCC, Michael Hsu, has been outspoken on revisiting regulation around the resolution of Large Banking Organizations over the past year in connection with the ongoing review of the framework for evaluating bank mergers as mandated by President Biden’s Executive Order on Promoting Competition in the American Economy. Acting Comptroller Hsu remarked at the Wharton Financial Regulation Conference 2022 on April 1, 2022, “[W]hen considering the financial stability profile of [large banking organizations], we should not think solely in terms of the disruptive effects on financial markets and counterparties should that bank fail . . . . We should also ask: ‘How might the failed bank be resolved? And what would be the long-term consequences of that?’” As noted in the ANPR, for the vast majority of bank resolutions, the FDIC sells the failed insured depository institution to another depository institution, which strategy has been the least costly while also minimizing the disruption to local communities and the financial system. However, because of Large Banking Organizations’ increased size, reliance on uninsured deposits and legal structure, the FDIC’s resolution options for a failing Large Banking Organization may be limited because of the costs associated with assuming such uninsured deposits and the potential disruptions that may arise with a Large Banking Organization’s typical legal structure. According to Acting Comptroller Hsu, “The issue for [large banking organizations] can be boiled down to a simple question: ‘If one were to fail, how would it be resolved?’ If the answer is: It would have to be sold to one of the four megabanks, then . . . we have a financial stability problem.’”5
The ANPR’s Proposal
The Agencies recognize that requiring Large Banking Organizations to adhere to the same requirements as GSIBs may not be appropriate. Although Large Banking Organizations tend to offer a smaller array of banking products and have fewer complex operations than GSIBs—not to mention fewer resources in general, as Acting Comptroller Hsu put it, “The status quo . . . leaves a gap in our financial stability defenses.” As such, the ANPR seeks public input on the costs and benefits of additional resolution-related standards for Large Banking Organizations, including, among other things, (i) whether Large Banking Organizations should be required to maintain loss-absorbing capacity in the form of long-term debt that meets certain specified characteristics; (ii) whether any requirements for the issuance and maintenance of such resources should apply at the level of the bank holding company or the insured depository institution subsidiary; (iii) whether to apply adapted forms of the clean holding company requirements, recovery planning guidance and disclosure requirements to Large Banking Organizations; and (iv) whether establishing separability requirements would be appropriate.
Public Input Sought
To that end, in the ANPR, the Agencies are seeking public input on whether all or any GSIB-like resolution plan requirements should be applied to all Category II and Category III banking organizations, including savings and loan holding companies and IDIs without a holding company, and how such requirements should be calibrated to be effective but not overly burdensome for the banking organizations. The Agencies are also very much interested in expected costs to banking organizations and their customers if the Agencies were to impose certain requirements, like long-term debt requirements, and whether there are alternative approaches that the Agencies should consider that could address possible concerns about the resolvability of Large Banking Organizations. Specifically, the Agencies are seeking comment on, including but not limited to, the potential effect of a long-term debt requirement on Large Banking Organizations in different tiering categories and on the capacity of these firms to issue such debt into the market throughout an economic cycle. What are the potential effects of a long-term debt requirement on these firms’ funding model and funding costs, including any associated effect on market discipline and overall firm resiliency? What, if any, are the potential effects of a long-term debt requirement on the cost and availability of credit? The Agencies also are seeking comment on requirements on governance mechanics that will require entry into resolution when eligible long-term debt will be available to absorb losses, and what should be the essential characteristics of long-term debt instruments issued by Large Banking Organizations to ensure that the debt properly function as a loss-absorbing resource in resolution. The comment period is sixty days from the date of publication in the Federal Register notice.
The ANPR is the first step by the Agencies in further tailoring resolution planning requirements of Large Banking Organizations. And while some ANPRs do not result in formal rulemakings, given the interest in protecting the financial stability of the banking system, and specifically protecting the DIF and avoiding any future government “bail-outs” or fueling the growth of GSIBs, it is likely that a proposed rulemaking and final rule will closely follow this ANPR.
Furthermore, the Agencies’ actions related to this ANPR could inform the resolution plan requirements of IDIs under the FDIC’s covered insured depository institution rule, which by rule applies to institutions with $50 billion or more in assets, but is currently only enforced with respect to banks with $100 billion or more in assets.6 The Agencies are focused on improving the resolvability of Large Banking Organizations and are being proactive about ensuring that banking organizations are thinking through resolvability issues with growth. No longer is the focus only on Large Banking Organizations that are deemed to be “interconnected,” systemically important or that have complex operations, but to also ensure that large, noncomplex banks can be resolved in the least costly manner.
As discussed in greater detail in our previous Advisories,7 the Fed, the FDIC and the OCC have been looking to further regulate banking institutions in the context of M&A-related transactions, which have been partially responsible for the accelerated growth of Large Banking Organizations and Category III Banks in particular. Of note, the Fed approved US Bancorp’s acquisition of MUFG Union Bank, National Association, on the same day the ANPR was published. In his remarks to Brookings, Acting Comptroller Hsu proposed, “One way to mitigate the [too-big-to-fail risk] while preserving opportunities for otherwise healthy mergers would be to condition approval on credible and verifiable commitments to achieving resolvability, tailored to the resolution risks of the resulting bank.” Although not present in the foregoing merger approval, such an approach could provide regulators with the ability for more nuanced resolvability requirements for the ensuing bank, though such an approach runs the risk of inconsistent application.
Financial institutions seeking advice on the ANPR, any of the developments discussed in this Advisory or general M&A planning should contact any of the authors of this Advisory or their usual Arnold & Porter contact.
© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
In 2019, as mandated by the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, the federal banking agencies adopted a tailoring framework for the applicability of enhanced prudential standards to banking organizations with $100 billion or more in total assets. Such banking organizations are grouped into one of four categories, based on total asset size and other risk-based factors, and regulations and guidance are scaled based on the complexity and risks of the institution, and the tailoring framework is referred to as the “Tailoring Rules.” Under the Tailoring Rules, a Category II banking organization has $700 billion or more in total assets, or $100 billion or more in total assets (but less than $700 billion) and $75 billion in cross-jurisdictional activity. A Category III banking organization has $250 billion or more in total assets, or $100 billion or more in total assets (but less than $250 billion) and $75 billion in weighted short-term wholesale funding, nonbank assets, or off-balance sheet exposure. Changes to Applicability Thresholds for Regulatory Capital and Liqu1idity Requirements, 84 Fed. Reg. 59230 (December 31, 2019); Prudential Standards for Large Bank Holding Companies, Savings and Loan Holding Companies, and Foreign Banking Organizations, 84 Fed. Reg. 59032 (November 1, 2019).
12 CFR Part 381 (FDIC); 12 CFR Part 243. In 2019, the Agencies amended their resolution plan regulations for bank holding companies to tailor requirements based on total asset size and other risk-based factors set forth in the banking agencies’ Tailoring Rules. Resolution Plans Required, 84 Fed. Reg. 59194 (November 1, 2019).
See Acting Comptroller of the Currency Michael J. Hsu Remarks at Brookings, “Bank Mergers and Industry Resiliency,” May 9, 2022, available here.
See “Federal Bank Merger Guidelines Under Review: Banks With $100 Billion or More in Assets Are in the Cross-Fire, and the FDIC Board is Divided,” December 21, 2021, available here; “Take Two: Banking Agencies Review Guidelines for Evaluating Bank M&A Transactions,” April 8, 2022, available here.