Five Key Points from the Financial Regulation Relief Law

[May 24], the President signed the Economic Growth, Regulatory Relief, and Consumer Protection Act, the first major financial services legislation since Dodd-Frank. The act received crucial bipartisan support in the Senate and passed the House on May 22nd to triumphant cheers from the banking industry.

It is not a major overhaul of Dodd-Frank, nor is it strictly a community bank law, as headlines alternatively suggest. In reality, it makes several meaningful technical changes—most notably by raising the threshold at which a bank is considered a systemically important financial institution (SIFI) from $50 billion to $250 billion—while keeping the main pillars of post-crisis regulation intact. Mid-size banks will be the biggest winners as they will now be able to make plans for growth, including acquisitions, without considering the added compliance costs that come with breaching the systemically important threshold. Smaller community and rural banks also will see plenty of benefits from this law, including relief from the Volcker rule and a number of mortgage and lending requirements.

The biggest banks are not entirely left out of the law as they will see some relief in terms of liquidity treatment of municipal debt and risk-weighting of high-volatility commercial real estate loans, but they have not been the loudest critics of the post-crisis regulatory framework. While Dodd-Frank and its related rulemakings have been challenging and painful to adopt and implement, the biggest banks have largely already taken the medicine and have become more globally competitive despite the pain (or perhaps because of it).

Further, banks also have substantial reasons outside the law to celebrate. They have recently had a highly profitable quarter, due in part to tax reform, and they are continuing to see relief from the new referees, or regulators, in charge of the Federal Reserve (Fed), Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), and soon at the Federal Deposit Insurance Corporation (FDIC). In fact, the referees plan to propose Volcker rule modifications at the end of this month.

Therefore, despite the law’s passage, our longtime mantra—that the most impact will be felt from changing the refs rather than the rules—remains true. In contrast, it is unlikely that any more financial services laws will pass the Senate this year, and what’s possible next year will depend on the outcome of the midterm elections. Regardless of legislative prospects, it is clear that the tide of financial regulation has turned away from rising requirements and toward relief.

1. Mid−size banks win big. A key win for mid−size banks is a change to the threshold at which banks must comply with additional regulatory requirements known as enhanced prudential standards (EPS). The law would raise the threshold for a US bank holding company (BHC) to be considered a SIFI from $50 billion to $250 billion in total consolidated assets, which would leave 13 SIFIs [1] in place and release approximately 30 BHCs from mandatory application of EPS. Firms with between $50 billion and $100 billion in total assets are released immediately, while “middle tier” BHCs with $100 billion to $250 billion in total assets will be released in 18 months although they will still need to meet certain EPS, such as “periodic” (rather than annual) stress tests. The middle tier group also could face similar or additional requirements at the discretion of the Federal Reserve Board (Fed) based on a to-be-developed framework that considers safety and soundness and financial stability risks. Accordingly, all but the 13 biggest banks should get ready for greater flexibility to grow organically or through business combinations without the significant incremental compliance costs. In an age of increased competition for deposits, particularly with the growth of digital banking platforms, we would not be surprised to see more mergers over the next year or two, particularly between digital−savvy banks and those with loyal customer bases but little investment in technology.

2. Focus on the Fed. All eyes now turn to the Fed, which could take a year or more to design a new regulatory framework for the middle tier of banks. The Fed has not indicated what form this framework would take, but the law stipulates that it must consider banks’ capital structure, riskiness, complexity, and other factors. As EPS requirements were drawn from the arsenal of safety and soundness guidelines and tools, the Fed could apply EPS requirements it deems necessary to certain banks depending on their business model and risk profile rather than just based on asset size as under Dodd−Frank. For example, traditional banks with plain vanilla lending businesses will likely be subject to lower or even no EPS requirements. Separately, the Fed will also need to deal with the fact that custody banks would get duplicative leverage ratio relief from a provision in the law and a recent Fed proposal. [2]

3. What about other thresholds? The law would change the key threshold for EPS, but the Fed, along with other regulators, will need to decide whether to adjust other thresholds from different post−crisis rules that have been pegged to Dodd−Frank levels. For example, while the legislation would raise the threshold for Dodd−Frank statutory stress tests, it does not directly impact the $50 billion threshold for the Fed’s Comprehensive Capital Analysis and Review (CCAR). Similarly, the OCC’s heightened standards and recovery planning, and the FDIC’s insured depository institution resolution requirements both apply to banks with over $50 billion in assets. We do not expect significant industry pressure for requirements that most banks have already taken significant steps to follow, like the heightened standards, but the agencies may nonetheless choose to uniformly raise all thresholds for consistency. The law is significant in terms of revisiting previously untouched post-crisis statutes, but ultimately much of the actual relief and guidance will need to come from the regulatory agencies.

4. Foreign bank limbo. While the US banks have had immediate cause to celebrate, their foreign bank counterparts have been left with questions and an ongoing debate. Currently, the Fed applies additional scrutiny to Foreign Banking Organizations (FBOs) holding $50 billion or more in total global assets, but applies increasingly stringent requirements based on US asset size—including the requirement to establish an intermediate holding company (IHC) in the US for FBOs that also hold $50 billion or more in combined US non-branch assets. Dashing hopes that the increased SIFI threshold would also apply to FBOs, the law clarifies that the Fed still maintains discretion to apply EPS and IHC requirements to FBOs with global assets over $100 billion. In the immediate term, this seems to indicate that FBOs will not receive significant regulatory relief, even if they hold less than $250 billion in assets in the US. Ultimately, we expect the Fed to consider raising EPS and IHC thresholds for FBOs while retaining discretion in the name of systemic risk to impose more stringent requirements on the largest FBOs.

5. Freedom for Main Street. Democratic support in the Senate hinged on relief for “Main Street” banks, so this legislation does in fact provide smaller community banks with a great deal of freedom from regulation. For one, the law exempts banks with less than $10 billion in total consolidated assets from risk based capital and leverage requirements if they maintain a leverage ratio of 8-10%, with the exact figure to be determined by regulators. Notably, the law also exempts from the Volcker rule banks with less than $10 billion in total consolidated assets and trading assets that are less than five percent of total assets. Furthermore, the law contains numerous provisions for relief from mortgage and consumer lending rules. As such, this law was cheered by the community banks as taking significant steps toward alleviating what many had considered unfair burden by Dodd−Frank requirements aimed at their much larger counterparts.

What’s next? While House Financial Services Committee Chairman Jeb Hensarling (R-TX) previously said that he would not pass the law without additions from the House, he ultimately agreed to pass the existing legislation in exchange for another de-regulatory package later this year. However, we don’t have high hopes for Hensarling’s other laws to get a Senate vote this year, particularly as the midterm elections approach. After that, there will be a new Financial Services Committee Chairman, or Chairwoman, to set the agenda.

As the spotlight fades from Congress, it will go back to being all about the refs at the banking agencies. In addition to following through with the law’s mandates, we expect the Fed, along with the FDIC and OCC, to take other steps to adjust post-crisis regulations—including further supervisory tailoring and cost/benefit analysis—consistent with the recommendations in last year’s Treasury reports on financial regulation. [3]

Endnotes

1The law designates US global systemically important banks (GSIBs) as SIFIs, and there is currently one GSIB that is under $250 billion in total assets.(go back)

2The law exempts certain central bank deposits from the supplementary leverage ratio (SLR) while the Fed’s recent proposal recalibrate the enhanced supplementary leverage ratio (eSLR), which is currently a flat two percent, to be set at half the GSIB surcharge. See PwC’s First take, Ten key points from the Fed’s stress buffer and leverage ratio proposals (April 2018).(go back)

3See PwC’s First takes, Ten key points from Treasury’s first financial regulation report (June 2017), Five key points from Treasury’s second financial regulation report (October 2017), and Ten key points from Treasury’s third financial regulation report (November 2017).(go back)