US bank regulators delay ‘too big to fail’ reform

Friday, 1 October 2010 23:04 -     - {{hitsCtrl.values.hits}}

Washington: US banking regulators on Monday put off proposing how the government would use its new authority to dismantle large, collapsing financial companies, saying they need more time for industry and other regulators to weigh in.

The Federal Deposit Insurance Corp had tentatively planned to vote on Monday on issuing an interim final rule that would have put in place some aspects of how the agency would handle the winding down of large financial firms previously considered “too big to fail.”

The so-called resolution authority was a main plank in the financial reform legislation, and is designed to avoid massive government bailouts such as the one for AIG, and destructive bankruptcies like Lehman Brothers’.

On a separate matter, the board approved on Monday a final rule that gives federal protection to securities backed by home loans and other consumer debt if they meet higher standards and banks retain some of the risk associated with the products. Industry officials criticised this move, saying the FDIC rule only applies to part of the market, creating an uneven playing field.

Regarding resolution authority, the FDIC delayed a vote and instead the staff briefed the board on a draft proposal that describes the FDIC’s authority under the new law. The draft proposal clarifies a few areas in the law that industry officials complained are ambiguous, and seeks comment on a range of questions that will be used to craft the final regulation, officials said.

An FDIC official said the board would likely vote soon on this proposal and that the goal is to have a final rule in place sometime during the first quarter. Regulators who sit on the new Financial Stability Oversight Council asked the FDIC to give them more time to weigh in on the issue, the FDIC official said. The council will meet for the first time on Oct. 1.

Under the law, the government would designate certain companies as systemically important to the financial system. The FDIC has the power to seize and break them up if they are heading toward collapse. The new authority is part of an effort to end the notion that certain institutions are “too big to fail.” As part of this new authority, large financial institutions must write living wills that regulators would use to dismantle them if they became insolvent.

The law allows the FDIC to move certain parts of failing institutions’ business into a separate entity so that they can be sold at a later date.

An FDIC official said on Monday the agency staff has decided that subordinated debt, long-term bondholders and shareholders should not be allowed to be moved into this entity.

The official said the agency hoped this would clear up industry questions on the issue and further the idea that there is no support for the idea that some institutions are “too big to fail.” “We do want to make clear that this is not the case,” FDIC Chairman Sheila Bair said.

The rule would also clarify that under the liquidation authority, contingent claims would be treated the same as they are during the bankruptcy process. The securitisation measure adopted by the board is designed to help boost a market that virtually froze during the financial crisis by giving investors confidence that the financial products are sound.

It was not well received by some industry officials. “The FDIC’s action today will seriously harm a bank’s ability to sponsor a new securitisation and, therefore, will create an uneven playing field, pushing securitisation activity to unregulated non-bank organisations,” the American Securitisation Forum said in a release.

“This will clearly hurt liquidity but will also mean that future securitisation may take place outside of a regulated structure, posing new risks to the system instead of eliminating them.”

Acting Comptroller of the Currency John Walsh cast the lone vote against the rule, arguing that under the Dodd-Frank Act, regulators are charged with drawing up a similar plan for the financial industry as a whole. He said the FDIC should wait for that process to conclude before proceeding on its own.

“The United States should have a single straightforward regulatory framework for securitisation that applies to all markets, all products and all securities,” he said. Supporters of the rule countered that it includes a provision that would give precedence to the interagency rule mandated by Dodd-Frank, when it is finalised, regarding risk retention.

Under the rule the FDIC will provide banks with “safe harbor” protection for securitisation if banks met higher loan origination standards and retained 5 per cent ownership interests in the loans. It would also require more disclosure of the underlying loans and long-term pay for the credit rating agencies rating the asset-backed securities.

The board also approved for comment a proposed rule that for two years would provide unlimited deposit insurance coverage on non-interest bearing transaction accounts at FDIC regulated banks. These accounts are often used by businesses for payroll and similar purposes, according to the FDIC.