FDIC Chair Gruenberg Signals Tougher Regulations for Large Regional Banks
On August 14, 2023, Federal Deposit Insurance Corporation (FDIC) Chair Martin Gruenberg gave remarks at the Brookings Institution during which he outlined additional steps federal banking regulators are taking to strengthen the oversight of large regional banks. Gruenberg’s remarks come against the backdrop of the failure of three large regional banks earlier this year and the recent publication of the federal banking agencies’ proposed regulations implementing the remaining Basel III accord, referred to as the Basel III Endgame. In discussing the “lessons learned” from the recent bank failures, Gruenberg indicated that the regulatory oversight of large regional banks will be strengthened significantly. Specifically, the proposed regulatory changes include a new long-term debt (LTD) requirement, strengthened resolution planning for banks with more than US$50 billion in assets, enhanced supervision of large regional banks with higher concentrations of uninsured deposits to address the liquidity risks of uninsured deposits, and previously proposed tougher capital requirements for banks with more than US$100 billion in assets. This Advisory will briefly discuss each of these initiatives.
Long-Term Debt Requirement
Gruenberg stated that, in the near future, the banking agencies will propose an LTD requirement for banks with US$100 billion or more in assets to issue LTD sufficient to recapitalize the bank in resolution. He added that the new proposal will likely require the issuance of additional debt beyond what many regional banks currently have outstanding. Gruenberg explained that the issuance of additional LTD can absorb losses before the depositor class takes losses, thereby lowering the incentive for uninsured depositors to run and creating additional options in resolution such as recapitalizing the bank under new ownership or breaking and selling portions of the bank to different acquirers. In October 2022, the FDIC and Federal Reserve issued an Advanced Notice of Proposed Rulemaking on resolution-related resource requirements for large banking organizations. See our prior Advisory here. Gruenberg mentioned that the Office of the Comptroller of the Currency is working with the FDIC and Federal Reserve to develop a proposed rulemaking for this requirement.
The FDIC will issue a notice of proposed rulemaking to strengthen resolution plan requirements for banks with more than US$100 billion in assets under the FDIC’s covered insured depository institution rule, which is separate from the Dodd-Frank Act Title I resolution plan requirement. The current regulation requires insured depository institutions (IDIs) with US$50 billion or more in total consolidated assets to prepare a resolution plan,1 but in 2019, the FDIC imposed a moratorium on resolution plan requirements under the rule, and in 2021 released a policy statement that the requirement would only be enforced with respect to banks with US$100 billion or more in assets. While Gruenberg’s statements do not suggest that IDIs with less than US$100 billion in assets will be subject to full resolution plan requirements, it seems that the FDIC will require information from IDIs with more than US$50 billion to inform the FDIC’s resolution planning for such institutions.
Specifically, Gruenberg stated that the proposed rule would require an IDI with US$100 billion or more in assets to explain how it could be placed into a bridge, how operations could continue while separating itself from its parent and affiliates, and the actions that would be needed to stabilize a bridge. In addition, the proposed rule would require IDIs to identify franchise components, such as asset portfolios or lines of business that could be separated and sold, in order to provide additional options for exiting from resolution by disposing of the IDIs in parts, thereby expanding the number of potential acquirers.
Enhanced Supervision Due to Risks of Uninsured Deposits
Gruenberg cautioned that a heavy reliance on uninsured deposits for funding carries significant liquidity risks. Noting that reliance on uninsured deposits is not exclusively a large bank issue, Gruenberg pointed out that uninsured deposits comprise the majority of domestic deposits for about 15% of banks with assets between US$1 billion and US$50 billion. Gruenberg stated that the FDIC is reviewing whether its supervisory instructions on funding concentrations for large regional banks should be bolstered to better capture risks related to high levels of uninsured deposits generally or types of deposits more specifically. He further noted that FDIC examiner instructions may establish a threshold for concentrations of uninsured deposits and that more frequent and granular reporting of uninsured deposits may be beneficial. These measures would appear to amount to a potential directive for overall increased examiner supervision of institutions with high concentrations of uninsured deposits, regardless of the size of the institution. In addition, Gruenberg suggested possible changes to the Deposit Insurance Fund premium calculations based on the level of unstable funding sources to deter banks from relying too heavily on uninsured deposits.
Capital Treatment of Unrealized Losses
During his speech, Gruenberg praised the recent notice of proposed rulemaking (NPR) to implement the remaining Basel III standards. Under the proposal, banks with more than US$100 billion in assets would have to flow unrealized losses on available-for-sale securities through the calculation of regulatory capital, which in turn would require such banks to retain or raise more capital as these unrealized losses occur to maintain adequate capital levels. For more information about this NPR, check out our prior Advisory.
Takeaways for Financial Institutions
FDIC Chair Gruenberg’s remarks represent the continuation of a clear message from the federal banking regulators that they are substantially strengthening the regulatory oversight of large regional banks in light of a string of bank collapses earlier this year. Some key takeaways from Chair Gruenberg’s remarks:
- Gruenberg placed great emphasis on the capital calculation adjustment for available-for-sale investment securities and the requirement for added LTD. Even with an expected transition period for these requirements once the rules are finalized, we would not be surprised to see a rush to the debt capital markets as interest rates eventually start to come down.
- Gruenberg made clear that concerns for institutions with between US$50 billion and US$100 billion in assets will be dealt with through information submissions and enhanced examiner oversight. Arguably, this is in recognition of the Economic Growth, Regulation Relief, and Consumer Protection Act of 2018, which increased the threshold for the applicability of Dodd-Frank Act enhanced prudential standards from US$50 billion to US$250 billion, with Federal Reserve discretion to apply any such standards to banking organizations with US$100 billion or more in assets, thereby effectively limiting the possibility for Dodd-Frank Act enhanced prudential standards to be directed to banks with less than US$100 billion in assets.
- Banks with higher percentages of uninsured deposits should expect significantly enhanced examiner scrutiny, which could lead to new matters requiring attention and lower ratings in the next safety and soundness exams.
- The rules for resolution plans for IDIs may be substantially revised as the existing plans for the banks that failed turned out to be of little use. Further, IDIs with over US$50 billion in assets should expect to be required to commence resolution planning well before they cross the US$100 billion asset threshold.
- Boards and management teams should begin to get educated on the impact of the coming new regulations and evaluate their impact on capital, liquidity, and strategic planning.
- Financial institutions should prepare to submit any comments they may have regarding the regulatory changes when the proposed rules are issued in the near future.
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Financial institutions interested in how the proposed regulatory changes may impact their businesses may contact any of the authors of this Advisory or their usual Arnold & Porter contact. The firm’s Financial Services team would be pleased to assist with any questions about the proposed regulatory changes, preparing a comment on the upcoming proposed rules, or banking regulation more broadly.
© Arnold & Porter Kaye Scholer LLP 2023 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.