The Federal Reserve’s recommendations included in a report released today by the Federal banking agencies call for Congressional repeal of long-standing statutory merchant banking and commodities powers and the elimination of grandfather provisions for certain thrift and savings and loan holding companies 

BACKGROUND

In what can be termed a truly astonishing set of legislative proposals, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) has recommended Congressional reversal of a number of long-standing statutory powers and exemptions for financial institutions.

The recommendations were contained in a 107-page report issued today (September 8, 2016) by the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the Office of the Comptroller of the Currency (the “OCC”, together with the Federal Reserve and the FDIC, the “Federal banking agencies”).1 The report was issued pursuant to Section 620 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”),2 which required the Federal banking agencies to review and make recommendations regarding the activities and investments of banking entities. The report includes a review and a set of recommendations by each Federal banking agency with respect to the institutions that it supervises.

FEDERAL RESERVE’S RECOMMENDATIONS

After an overview of the background of the activities and investments authorized for bank holding companies (“BHCs”) and financial holding companies (“FHCs”) and a summary of risks posed by those activities and efforts to mitigate those risks, the Federal Reserve recommended that Congress:

  • repeal the authority of FHCs to engage in merchant banking activities;
  • repeal the grandfather authority for certain FHCs to engage in commodities activities under section 4(o) of the BHC Act;
  • repeal the exemption that permits corporate owners of industrial loan companies to operate outside of the regulatory and supervisory framework applicable to other corporate owners of insured depository institutions; and
  • repeal the exemption for grandfathered unitary savings and loan holding companies from the activities restrictions applicable to all other savings and loan holding companies.

The recommendations are extraordinary in two key aspects. First, if adopted, they would severely disrupt well-settled financial and economic expectations. Second, and relatedly, there is no identified problem of any significance that has emerged, in the Financial Crisis of 2008, or otherwise, that would have been prevented had these recommendations been enacted previously. Indeed, based on the information included in the report, the Federal Reserve’s decision to make these sweeping recommendations appears to be grounded in an assumption, without detailed analysis or explanation, that aspects of the activities described above either pose significant risks to financial institutions or allow certain institutions (such as industrial companies with a finance division) to benefit from a competitive advantage.

The report does not discuss the potential impact of these recommendations on financial institutions or the broader economy if implemented. Given the broad use of merchant banking authority and the diversity of companies that rely on statutory grandfather provisions, the proposals would not only have a significant impact on those financial institutions relying on the affected authorities or grandfather provisions but could also have a negative impact on the broader economy.

FDIC’S AND OCC’S RECOMMENDATIONS

The FDIC and the OCC also were required by Section 620 of the Dodd-Frank Act to undertake a comprehensive review of the activities and investments of state-chartered, non-member banks and state savings associations, in the case of the FDIC, and national banks, federal savings associations and federal branches and agencies of foreign banks, in the case of the OCC.

In contrast to the Federal Reserve’s approach, both the FDIC and OCC have indicated a need to continue to review certain activities and investments in order to enhance, reconsider and/or clarify existing policies and procedures and prudential tools and to build upon statutory reforms in order to enhance the safety and soundness of the institutions that they supervise.