Three developments this last week illustrate how the arcane field of bank regulation and developments in that area need to be attended to by a broad range of commercial firms as, more and more, bank clients are increasingly being indirectly affected by bank regulation.
Today, April 1, new FDIC deposit insurance pricing went into effect. Many do not realize that banks pay insurance premiums to the FDIC for their deposit insurance. For many years, those premiums have been risk-based with riskier banks paying higher premiums. While historically deposit insurance premiums were assessed against the amount of deposits held by the paying bank, the Dodd-Frank Act mandated that premiums, instead, be assessed on the amount of a bank's assets thereby eliminating a perceived subsidy that small banks paid to cover the risks at larger banks financed by borrowings other than deposits. In order to do this while still keeping the premiums risk-based, the FDIC proposed charging higher premiums to banks with riskier assets. The FDIC concluded that construction and development loans, leveraged loans, subprime loans, and nontraditional mortgage loans and securitizations backed by these types of loans represented higher risk, and, thus, large banks holding such assets should pay higher deposit insurance premiums. This not only affects banks; it also affects bank customers as banks will be disincented from making these kinds of loans or buying securities backed by such loans.
Somewhat similarly, last week the Basel Committee of bank regulators from around the world issued two proposals likely to have effects far beyond just banks.
First, last week, the Committee issued a proposal "for measuring and controlling large exposures." Bank regulators call this "concentration risk," and every bank in the U.S. is subject to comprehensive legal lending limits limiting its exposure as a percentage of its capital to any single borrower and affiliates of that borrower. However, the Basel Committee is concerned that there is not international uniformity on how such exposure is measured and aggregated and, therefore, it has proposed a framework for bringing international uniformity to the definition of capital on which limits are based, how exposure is calculated, and how credit risk mitigation is treated. The logic behind this is that the well-known international Basel capital standards do not consider concentration risk, and, therefore, a need exists. The Committee also noted that this effort could help mitigate the risk of contagion between globally systemically important banks. To the extent that this will eventually lead to a change in U.S. legal lending limits to conform to new international standards, large borrowers may well be affected and may expect to receive eventually unpleasant calls from their bankers, reducing their credit limits.
Second, the Basel Committee also released a proposal called "Recognizing the Cost of Credit Protection Purchased." This essentially deals with credit default swaps(CDS) as has been widely reported. However, what has not been widely reported is that the proposal would greatly increase the capital costs of any bank that purchases CDS.
Regulators require that banks maintain amounts of capital related to the amount of risk on a bank's balance sheet. Thus, no capital needs to be maintained against risk-less U.S. Treasury obligations as the credit risk of such assets is specified in the regulations as zero. Historically, a non-mortgage consumer or commercial loan carried a risk weighting of 100%, thus requiring that 100% of the minimum capital requirement be maintained against such loans. This also applies to off-balance sheet obligations such as commitments to make a loan. The Basel Committee proposal is that a bank calculate the present value of the premiums it would pay for CDS and that amount would be risk-weighted at 1,250%, i.e. 12 ? times the risk weighting of a loan commitment. This would require 12 ? times as much capital be held against the obligation to pay for CDS as would be required against a standard loan or loan commitment, and that would likely disincent banks from purchasing CDS and, thus, increase the risk and the costs of exposures that banks have to customers or securities. Again, not only banks would be affected.