Last week, on April 25, 2013, Senators Sherrod Brown (D-OH) and David Vitter (R-LA) introduced S.798, the “Terminating Bailouts for Taxpayer Fairness Act of 2013” (the “Bill”),[1] their effort to put an end to the too-big-to-fail phenomenon. While the Bill focuses on the largest banks[2], it contains several other provisions that would affect other banks in the United States. The prospects for passage of the Bill are remote, but the bipartisan nature of the Bill is likely to keep the too-big-to-fail debate alive.

The Bill employs four mechanisms to address too-big-to-fail: (i) an 8 percent leverage requirement for banks with more than $50 billion in consolidated assets, with a 7 percent surcharge for banks with assets of more than $500 billion; (ii) application of these requirements to each of the affiliates and subsidiaries of these banks (with certain exceptions); (iii) ring-fencing in the form of a ban on credit and certain other transactions between any depository institution with total consolidated assets of $50 billion or more and any of the institution's affiliates; and (iv) a broad prohibition on most forms of government support to any entity that is not an insured depository institution. The Bill also would bring to end U.S. participation in Basel III and would marginalize if not terminate risk-based capital requirements. Interestingly, however, the Bill imports a few concepts from Basel III and the risk-based rules into the leverage ratio calculation.

Community banks may be affected by two of these changes—revisions to the elements of capital now used to calculate the leverage ratio, and the end of Basel III—as well as by other provisions in the Bill that address balloon payment mortgage loans, privacy, and small business data collection.

Specific changes in the Bill include the following:

  • Leverage ratio. The Bill would change all three elements of this capital requirement—the numerical ratio, the numerator, and the denominator. Community banks should be mindful that, although the numerical leverage requirement would remain the same for them, the changes to the numerator and denominator would result in ratios different from those now reported.
    • Ratio. The Bill would create three categories of financial institutions with different requirements. Banks with $50 billion or less in total consolidated assets would remain subject to the existing requirement—as a practical matter, 5 percent.[3] Banks with more than $50 billion in total consolidated assets would have to maintain 8 percent leverage. Banks over the $500 billion threshold would be subject to a “surcharge” that would result in a leverage requirement of 15%. The Bill provides a five-year conformance period after the federal banking agencies issue final rules.  
    • Components of capital—the numerator. The Bill would change the definition of capital now used in calculating the leverage ratio. The Bill would limit qualifying capital to tangible common equity (common stockholders' equity less goodwill), deferred tax assets, accumulated other comprehensive income, treasury stock, and intangible assets plus retained earnings. This definition is more stringent than the one for Tier 1 capital now in use. Banks now may include noncumulative perpetual preferred stock and certain minority interests in the equity accounts of consolidated subsidiaries; these items would be excluded from equity capital. The new definition thus reflects (although it does not duplicate) the concept of common equity Tier 1 capital in Basel III. It appears that the Bill would treat intangible assets more leniently than does the current rule.  
    • Total consolidated assets—the denominator. The denominator of the leverage ratio in the Bill is total consolidated assets, a term that differs from the current denominator, adjusted total assets, in two respects. Both are based on risk-based capital concepts. First, derivative exposures would be part of the denominator; these exposures are not now included in adjusted total assets. (The calculation of derivative exposures would reflect qualifying netting arrangements.) Second, total consolidated assets also would include off-balance sheet assets in which the bank has guaranteed another party's performance or provided a liquidity backstop if another party is unable to perform. Loan commitments would not be included in calculating the leverage ratio for a bank holding company if provisions or covenants in the commitments would protect the company with respect to future draws of liquidity.  
  • Basel III. The Bill would abandon Basel III, including the pending regulatory capital proposals that were issued in June 2012.  
  • Risk-based capital. The Bill de-emphasizes risk-based capital to the point that the bank regulators must justify risk-based capital rules as something outside the mainstream of bank regulation. The Bill implies that banks with $20 billion or less in total consolidated assets would no longer be subject to risk-based capital requirements. For banks with more than $20 billion, risk-based rules would be permissible if the regulators determine that bank supervision is insufficient to prevent excessive concentration of riskier assets. Before proposing such rules, the regulators would have to conduct a study and report to Congress on their conclusion that such rules are necessary.

The Bill would render risk-based capital rules largely superfluous. A bank that met the new leverage requirement would be deemed to satisfy, as applicable, all prompt corrective action (at the depository institution level) or early remediation (for large bank holding companies) requirements. In addition, the promulgation of new leverage ratio rules by the Federal Reserve would satisfy its own duty to issue new risk-based capital rules as part of the enhanced prudential standards under Title I of Dodd-Frank.

  • Capital requirements for subsidiaries and affiliates. Under the Bill, all subsidiaries and affiliates of banking institutions with $50 billion or more in total consolidated assets would be required to meet the same (or, potentially, even more stringent) capital requirements as an affiliated bank or bank holding company. "Functionally regulated" entities—historically, securities, commodities, and insurance firms regulated by the SEC, CFTC, or state insurance regulator—would be exempt from these requirements. However, the Bill narrows the definition of "functionally regulated" in order to subject broker-dealers and most entities regulated by the CFTC[4] to leverage capital rules set by the Federal Reserve.  
  • Affiliate transactions. The Bill would prohibit any insured depository institution with $50 billion or more in total consolidated assets from engaging in a "covered transaction" with any nonbank affiliate or subsidiary. Covered transactions are defined in section 23A of the Federal Reserve Act to include any loan or extension of credit, any purchase of or investment in securities issued by an affiliate, any purchase of assets from an affiliate, the acceptance of securities issued by an affiliate as collateral for a loan to any person, and the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Currently, such an institution may engage in such transactions with one affiliate provided that the exposures do not in the aggregate exceed 10 percent of the bank's total capital; total transactions with all affiliates may not exceed 20 percent of total capital. These transactions currently must be over-collateralized, unless the collateral consists of obligations of the U.S. government or certain other assets.  
  • Safety net. The Bill would bar many (if not all) of the government assistance programs that were developed during the financial crisis, except as they would support insured depository institutions or would come into play in connection with a bank receivership or an orderly liquidation under Title II of Dodd-Frank. This prohibition would apply to the nonbank affiliates and subsidiaries of all insured depository institutions, regardless of size. Programs or actions no longer available would include asset purchases, debt or equity investments and injections of capital by the U.S. government. In addition, the Exchange Stabilization Fund, the Deposit Insurance Fund, the discount window, and funding through the Board's lending power in unusual and exigent circumstances would be unavailable. The Bill also would wipe out the ability of systemically important financial market utilities to access Federal Reserve Bank services and would repeal the systemic risk exception to the FDIC's least-cost resolution standard.  
  • Derivatives. These exposures are now subject to risk-based capital charges. With the de-emphasis of risk-based capital, the Bill would include derivative exposures in the calculation of the leverage ratio. As the risk-based capital rules have done, the Bill would recognize the benefits of qualifying netting arrangements.  
  • Off-balance sheet assets. Similarly, the Bill would place a 5, 8, or 15 percent capital charge on commitments to lend with an exception available (as in the current risk-based rules) for commitments with provisions that protect the holding company from future draws.  
  • Community bank provisions. The Bill includes several provisions to address specific community bank concerns.
    • Balloon-payment mortgage loans by lenders in rural areas. Under Dodd-Frank and recent CFPB regulations, "qualified" mortgage loans enjoy certain protections from liability under the Truth in Lending Act. Loans with balloon payment provisions that are originated by a bank in a "rural" or underserved area may qualify, even though balloon payment loans generally do not. In its recent rule, the CFPB identified rural areas on a county-by-county basis and generally defined a "rural" county as any county not either in a metropolitan statistical area (MSA) or adjacent to an MSA. The Bill would clarify and expand the term "rural" to include any area other than a city or town with a population of greater than 50,000 and any urbanized area contiguous and adjacent to such a city or town.  
    • Securities Exchange Act. The Bill would make savings and loan holding companies subject to the same registration requirements that apply to bank holding companies.  
    • Small Bank Holding Company Policy Statement. This Statement currently allows a bank holding company with less than $500 million in consolidated assets to issue debt to fund bank acquisitions under certain conditions—a practice generally not allowed for larger bank holding companies. The Bill would extend this policy to bank holding companies with less than $5 billion in consolidated assets. The importance of this expansion goes well beyond acquisition debt. Bank holding companies covered by the Statement enjoy various other regulatory benefits, which the Bill would make available to a larger group of institutions. It is not clear whether the Statement would apply to savings and loan holding companies.  
    • Mutual holding company dividend waivers. The Bill would allow all mutual holding companies to waive dividends declared on the stock of their bank or mid-size holding companies. This provision would effectively repeal the current waiver regulation in Regulation MM, 12 C.F.R. § 239.8(d).  
    • Small Business Data Collection. The Equal Credit Opportunity Act currently requires all financial institutions to keep records of and report annually to the CFPB on credit applications by women-owned, minority-owned, and small businesses. The Bill would limit this requirement to institutions with more than $10 billion in consolidated assets.  
    • Collins Amendment—small savings and loan holding companies. The Collins Amendment (section 171 of Dodd-Frank) sets current leverage and risk-based capital requirements as a floor for any future capital requirements and disallows certain hybrid instruments (e.g., trust preferred securities) from Tier 1 capital. By its terms, the Collins Amendment does not apply to bank holding companies with less than $500 million in total consolidated assets but does not extend this exemption to similarly sized savings and loan holding companies. The Bill would correct this anomaly: savings and loan holding companies with less than $500 million in consolidated assets would not be subject to the Collins Amendment.  
  • Office of Examination Ombudsman. The Bill would create a centralized ombudsman within FFIEC to consider complaints about examinations, examination practices, or examination reports, hold quarterly meetings around the country on examination issues, review the examination procedures of the member agencies, and conduct an examination quality assurance program. The FFIEC Ombudsman would hear appeals from material supervisory determinations and have the authority to overrule them. This provision borrows heavily from H.R. 1553, introduced on April 15, 2013.  
  • Privacy. The Bill would eliminate the current requirement that a financial institution provide an annual written privacy policy statement to its consumers, provided (i) that the institution has not changed its policies and procedures from those set forth in the most recent disclosure sent to consumers and (ii) that customers may access the most recent disclosure in electronic or other form.