FDIC Plans to Impose Higher Capital Requirements on Regional Banks

Acting Chairman of the Federal Deposit Insurance Corporation (FDIC) Martin Gruenberg. FDIC photo

Federal regulators proposed a new set of regulations that would impose higher capital requirements on regional banks.

The Federal Deposit Insurance Corporation (FDIC) is attempting to prevent another crisis that shook the banking world this spring when four mid-sized lenders failed.

The smaller banks will be ordered to issue debt and set up so-called living wills to protect the public in case of further failures, according to an FDIC press release on Aug 29.

This would make it easier for the FDIC to unwind their operations if they were to go down in the future.

Regional Lenders Ordered to Raise Capital Debt Cushion

Smaller lenders would be required to hold at least $100 billion in assets to issue enough long-term debt and absorb losses in case of a potential government seizure, according to a joint notice from the Treasury Department, Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC.

Impacted banks will also have to maintain long-term debt levels equal to 3.5 percent of average total assets or 6 percent of risk-weighted assets, whichever is higher.

Regional lenders lack the “bail-in” long-term debt (LTD) or the prepped data rooms that the megabanks do, Michael J. Hsu, acting U.S. comptroller of the currency, told The Washington Post.

He said that left the government with few options to prevent the financial chaos when Silicon Valley Bank, Signature Bank, and First Republic failed.

Mr. Hsu called for LTD and separability/data room requirements to be extended to all banks with $100 billion or more in assets, which would have left their failures less chaotic if the they had enough capital that was separable.

He said that loss-absorbing capital and LTD requirements would have ensured that the vast majority of losses were been borne by the bank’s investors, not the FDIC’s deposit insurance fund.

That would have made their break up quick and systematic, and would have minimized uncertainty for the entire banking sector.

Regulators Aim to Prevent Future Bank Failures

The proposed changes were drafted after the FDIC had pledged in March to cover all uninsured depositors at Silicon Valley Bank and Signature Bank in the wake of their collapse due to the grave risks they posed to the U.S. financial system.

First Republic Bank, another regional lender, was sold to JPMorgan Chase by the federal agency following the bank’s seizure in May.

Those moves by the FDIC have been estimated to cost its Deposit Insurance Fund more than $30 billion.

The nation’s largest banks will absorb those costs in the form of special assessments paid to the FDIC.

The regional banking crisis damaged the earnings of others lenders as well, as depositors emptied their accounts in the first quarter.

Regulators released their first outline of expected changes last month with a sweeping set of proposals meant to raise capital requirements for banks with $100 billion or more in assets and standardize risk models for the industry to avoid further disasters.

The larger financial institutions would have to raise capital by as much as 19 percent, while smaller banks with $100–250 million in assets would see an average rise of 5 percent.

Regulators said they would accept comments on these proposals through the end of November after the industry criticized reports of  the new rules after they were published in late July.

Banking Industry Protests Proposed Rule Changes

FDIC Chair Martin Gruenberg said on Aug. 14 that the new proposed requirements would “marginally increase funding costs” and may reduce a key measure of bank profitability by roughly three basis points.

Mr. Gruenberg said “the experience of the three large bank failures this spring should focus our attention on the need for meaningful action to improve the likelihood of an orderly resolution of large banks.”

He noted that the three banks seized by authorities this spring each had disproportionally large amounts of uninsured deposits, which were one of the biggest factors in their failures.

However, the issuing of more long-term debt to regional bank balance sheets may add too much pressure for the industry after the three big credit ratings agencies downgraded the ratings of dozens of lenders this year.

Financial institutions are already struggling to keep their costs down as higher interest rates apply further pressure to their balance sheets while the costs to retain depositors has gone up, digging into their profits.

Many economists and banks are highly critical of any major changes to capital requirements at this time.

“If the only tool available is a hammer, every problem looks like a nail. This is another example of regulators doing the only thing they know—adding more rules. This will hurt the already weakened regional banks and further strengthen the TBTFs,“ Michael Wilkerson, a strategic adviser, investor, and columnist, told The Epoch Times, referring to institutions that are ”too big to fail.”

The Bank Policy Institute expressed concern earlier in August about the costs of imposing these new requirements at a time when “these banks are already facing significant deposit funding cost increases.”

“With this proposal, the government will be forcing a large supply of bank debt into the market, but it’s unclear whether there is going to be sufficient demand for it, meaning this proposal could end up doing more harm than good,” Tabitha Edgens, a BPI senior vice president and senior associate general counsel, wrote in a statement.

The financial industry will have three years to conform to the new rules if they are enacted.

The FDIC said most banks already hold acceptable forms of debt and estimated that regional banks have roughly 75 percent of the debt that they needed to hold already.

Some mid-size lenders may be forced to issue more corporate bonds or replace existing funding sources with more expensive forms of long-term debt to comply with the rules, said Manan Gosalia, a bank analyst with Morgan Stanley in an Aug. 28 research note.

She said this may lead to higher annual costs for those banks as much as 3.5 percent as they attempt to meet the new requirements, adding further pressure to their margins.