On March 15, 2010, Senate Banking Committee Chairman Christopher Dodd (D-CT) released a revised draft of financial regulatory reform legislation, the Restoring American Financial Stability Act. After a 20 minute markup, on March 22, the Senate Banking Committee voted along party lines, 13-10, to report Chairman Dodd's bill to the full Senate for consideration, as modified by a Manager's Amendment (which was adopted by voice vote). The Senate action on financial regulatory reform legislation follows the passage by the House of Representatives on December 11, 2009 of its version of financial regulatory reform, H.R. 4173, the Wall Street Reform and Consumer Protection Act.

This is one in a series of alerts that will discuss the details of the proposed legislation and the potential impact it may have on the financial services industry if adopted in substantially its current form. This alert focuses specifically on the potential effects of Chairman Dodd’s bill on federal thrifts, as compared to the potential effects under the House-passed H.R. 4173. The establishment of the Financial Stability Oversight Council and its implications for the “Too Big to Fail” doctrine, the effects of Chairman Dodd’s bill and H.R. 4173 on bank holding companies, the impact of potential restrictions on proprietary trading under the “Volcker Rule” and the future of federal preemption over state law if Chairman Dodd’s bill’s preemption standards become law will be discussed in separate alerts.

A. Sea Change in Prudential Bank Regulation

Chairman Dodd’s bill would affect a “sea change” in the system of prudential bank regulation that has existed for the past 80 years by:

  • abolishing the Office of Thrift Supervision (“OTS”);
  • transferring supervisory authority over federal thrifts to the Office of the Comptroller of the Currency (“OCC”);
  • prohibiting the issuance of new federal thrift charters;
  • stripping the Board of Governors of the Federal Reserve System (the “Federal Reserve”) of its supervisory authority over state member banks and transferring such powers to the Federal Deposit Insurance Corporation (“FDIC”);
  • limiting the Federal Reserve’s supervisory authority over holding companies to bank and thrift holding companies with consolidated assets of $50 billion or more; and
  • transferring supervisory authority over bank and thrift holding companies with consolidated assets of less than $50 billion (the threshold for systemically important institutions1) to the OCC (in the case of national banks and federal thrifts) and the FDIC (in the case of state banks and thrifts).

While Chairman Dodd’s bill purports to “streamline bank supervision with clear lines of responsibility, reducing arbitrage and improving consistency and accountability,” the end results of the legislation, if enacted, will be that all federal thrifts, all state member banks, and all national banks and state non-member banks with less than $50 billion in consolidated assets will experience a change in their primary federal regulator at either the bank or holding company level.

Abolition of the OTS and the Federal Thrift Charter; Expanded Authority of the OCC. As was the case in H.R. 4173, Chairman Dodd’s bill would abolish the OTS and transfer supervisory authority over existing federal thrifts to the OCC. However, unlike H.R. 4173, Chairman Dodd’s bill does not create a Division of Thrift Supervision within the OCC and terminates the power to grant new federal thrift charters. As a result of these changes, the OCC would be the primary federal regulator for national banks and federal thrifts of all sizes and bank and thrift holding companies with less than $50 billion in consolidated assets.

Preservation of the Dual Banking System. By leaving in place the state banking system that governs many community banks, Chairman Dodd’s bill preserves the dual banking system. Under Chairman Dodd’s bill, all state chartered banks would continue to be regulated by their state banking regulator as their primary state regulator. However, the Federal Reserve would lose supervisory authority over state member banks as all state chartered banks, whether member or non-members banks, would be regulated by the FDIC as their primary federal regulator. The Federal Reserve would, however, retain rulemaking authority over transactions with affiliates, including Regulation W which has been expanded to include derivative transactions and any credit exposure by a bank to its limits and requirements for covered transactions. The FDIC also would continue to oversee the deposit insurance fund and retain its resolution authority over depository institutions.

For additional detail regarding the differences between the Chairman Dodd’s bill and H.R. 4173, please see Appendix A.

B. Effect on Federal Thrifts

As was the case in H.R. 4173, Chairman Dodd’s bill would abolish the OTS and transfer supervisory authority over existing federal thrifts to the OCC. Both bills provide for a one year transition period before the OTS would be abolished and supervisory authority over federal thrifts would be transferred to the OCC and provide for employee protections for OTS employees. However, unlike H.R. 4173, Chairman Dodd’s bill does not create a Division of Thrift Supervision within the OCC, thereby reducing the likelihood that the individual examiners of the depository institutions would remain the same.

Unlike H.R. 4173, Chairman Dodd’s bill would terminate the power to grant new federal thrift charters. In doing so, Chairman Dodd’s bill would lay the groundwork for the phase out and eventual extinction of the federal thrift charter. It is possible that the OCC (or the Federal Reserve for larger savings and loan holding companies) could accelerate such a phase out by conditioning certain regulatory approvals, including but not limited to new activities, on conversion to a national bank charter. In addition, as the federal thrift charter is phased out over time, it is possible (if not likely) that several advantages of the federal thrift charter, including expanded branching authority and preemption protection, would be further eroded.

Unlike H.R. 4173, Chairman Dodd’s bill does not eliminate the savings and loan holding company or expressly provide that savings and loan holding companies will be regulated as bank holding companies. However, by vesting rulemaking authority over savings and loan holding companies with the Federal Reserve, existing savings and loan holding companies may become subject to consolidated capital requirements, activities restrictions and other new regulatory requirements to which they may not have previously been subject.

Each of H.R. 4173 and Chairman Dodd’s bill have bolstered the requirements for interstate acquisitions, now requiring that the acquiring financial institution be well-managed and well-capitalized, as opposed to the current requirement that such institution be adequately capitalized and adequately managed. In addition, Chairman Dodd’s bill expands the branching authority of national banks to eliminate state reciprocity requirements, thereby effectively eliminating the primary state obstacle to de novo branching. National banks and state insured banks will be allowed to establish a de novo branch in a state if a bank chartered by such state would have been permitted to establish the branch, which removes one of the significant distinctions between the current federal thrift and national bank charters.

Given these regulatory uncertainties and the prospect of a new holding company regulator under both H.R. 4173 and Chairman Dodd’s bill, federal thrifts should consider whether or not it is in their best interests to convert to either a national bank charter or a state bank charter. A significant aspect of weighing the charter choices has traditionally been not just the activities, but also the background, experience and personality of the various regulators. As discussed above, by leaving in place the state banking system that governs many community banks, Chairman Dodd’s bill preserves the dual banking system and one crucial remnant of charter choice. In fact, by distinguishing between holding company regulators for national banks and federal thrifts on the one hand and state chartered banks on the other, Chairman Dodd’s bill may have expanded the opportunities for regulatory arbitrage by permitting banks to choose not only their charter but also their holding company regulator. In light of this unprecedented regulatory uncertainty, federal thrifts may wish to reconsider their chartering options. At a minimum, the new regulatory regime will pose significant legal and compliance challenges for federal thrifts, all of which should review their regulatory compliance programs to ensure that they can comply with their new obligations under the new bank regulatory regime.

C. Next Steps

With the passage of comprehensive health care legislation on March 23, the White House and Congressional leaders have both stated that enacting financial regulatory reform is now their top domestic policy priority. The White House and Senate Democrats have set forth an aggressive timetable for passing financial regulatory reform legislation. The Senate will likely take up Chairman Dodd’s bill in late April or early May. Chairman Dodd’s bill, once passed by the Senate, will then be subject to a conference committee to reconcile the bill with the House-passed H.R. 4173 before legislation can be sent to the President to be signed into law. The press of other legislative business may extend the timetable for enactment of financial regulatory reform legislation, but most observers believe that financial regulatory reform will become law this year.

Given the number of provisions in H.R. 4173 and Chairman Dodd’s bill that would greatly affect federal thrift institutions, we recommend that officers and directors of federal thrift institutions stay apprised of the details of the reform proposals and begin preparing for substantial regulatory reform of their industry.