National bank supervisor

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See also bank capital, liquidity and narrow banks.


Congressional oversight

Dodd will propose consolidated bank supervisor

"The senior Senate Democrat shepherding legislation to overhaul the nation’s financial system is planning to propose the merger of four bank agencies into one super-regulator, an idea that is significantly different from what President Obama envisions.

The legislation being prepared by Senator Christopher J. Dodd of Connecticut, who heads the Senate Banking Committee, would also differ from the Obama plan by diminishing the role of the Federal Reserve as a systemwide overseer.

Mr. Dodd’s plan is intended to be the starting point for the Senate as it redraws the financial landscape in response to the market crisis...

...Lawmakers and aides say the bill Mr. Dodd is preparing to make public in the coming weeks would be more ambitious and politically risky than the plan offered by the White House, which considered but then decided against combining the four banking agencies — the Federal Reserve, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Comptroller of the Currency — into one superagency.

The White House backed away from that plan to avoid a phalanx of industry opposition that might slow Congress. In the House, Representative Barney Frank of Massachusetts, a Democrat and the chairman of the Financial Services Committee, has been working on legislation that is closer to the Obama plan on consolidation of the agencies.

The Dodd plan is certain to run into sharp resistance from banking industry lobbyists, who have already been urging lawmakers to defeat it even before it is formally introduced.

It is also likely to face stiff opposition from bank regulators, who are protective of their turf and have already raised objections about the more modest Obama plan.

Mr. Dodd, who faces a difficult re-election campaign in Connecticut partly because of the perception that he is cozy with the banking industry, decided two weeks ago to remain chairman of the banking committee rather than succeed his close friend, the late Senator Edward M. Kennedy, as head of the health committee.

Senior Democrats in Congress say Mr. Dodd may have to thread a needle as he publicly takes on the financial services industry — whose members have a heavy presence in Connecticut and are some of his biggest campaign contributors — while trying to project an image of independence from it to get re-elected. But as chairman, he may also have to make compromises with industry lobbyists to move the legislation through a chamber in which bankers hold political sway.

Mr. Dodd said he decided to remain chairman after conversations with the senior committee Republican, Senator Richard Shelby of Alabama. He said Mr. Shelby persuaded him that it would be possible to get bipartisan support for stronger financial regulation despite major disagreements between even the two senators.

The industry has important allies among Democrats and Republicans on the banking committee. Industry lobbyists and colleagues said, for instance, that several Democrats were likely to oppose the Dodd plan to have one banking agency, a change that has been advocated by Senator Charles E. Schumer, Democrat of New York, and Senator Mark Warner, Democrat of Virginia.

Mr. Dodd and Mr. Shelby agree generally on some issues — including their skepticism of a more powerful Federal Reserve, reflecting a view shared widely among lawmakers. But among their disagreements are whether to have a new consumer financial protection agency that would regulate credit cards, mortgages and other loans.

The Dodd plan would reduce the stature of the Federal Reserve in several ways. The central bank, which has evolved since its creation nearly a century ago into a powerful banking regulator and has gained even greater power over the last year, would lose authority over banks, as well as its ability to regulate mortgages and credit cards.

Mr. Dodd has also rejected the administration’s proposal to have the Fed play the leading role as a so-called “systemic risk” regulator that examines the connections between regulated and unregulated companies for trouble spots that could disrupt the markets. That role would instead be filled by a council of regulators.

(Bowing to political skepticism about the Fed’s performance before the crisis began, the administration’s plan also would create a council, but it would put the Fed in the decisive role.)..."

"Senate Banking Committee Chairman Christopher Dodd’s plan for a single bank regulator may set up a fight with House colleague Barney Frank and the Obama administration and might slow the overhaul of financial rules.

Dodd, leading efforts to rewrite regulations, will suggest combining the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the Office of the Comptroller of the Currency into one agency, the senator’s office said yesterday.

“Establishing a single regulator is a very bad idea,” Camden Fine, president of the Independent Community Bankers of America, a Washington-based trade group with 5,000 members, said yesterday in an e-mail. “When you have a cyclopic regulatory system, it only takes one stick in the eye to blind it.”

Dodd’s proposal goes further than recommendations by President Barack Obama that are backed by Frank, chairman of House Financial Services Committee that resumes hearings on the issue this week. Dodd’s plan embraces ideas of Democratic Senators Charles Schumer of New York and Mark Warner of Virginia and has elements from measures introduced by House Republicans. Any differences must be resolved before the rules become law.

Obama in June recommended combining OCC, regulator of national banks including New York-based Citigroup Inc., and OTS, which regulates savings and loans including Paramus, New Jersey- based Hudson City Bancorp Inc.. His proposal leaves intact oversight powers of the Fed and FDIC.

The multiple-agency system has produced “some real costs ranging from inefficiencies and redundancies to the lack of accountability and regulatory laxity,” Dodd said at an Aug. 4 Senate Banking Committee hearing to consider the issue. “We are now paying a very high price for those shortcomings.”

FDIC Chairman Sheila Bair and Comptroller of the Currency John Dugan support Obama’s proposal.

Bair said merging the four agencies is “no panacea” for effective oversight, according to Banking committee testimony Aug. 4. “One of the advantages of multiple regulators is that it permits a diversity of viewpoints to be heard,” she said.

Fed officials including Chairman Ben S. Bernanke and Governor Daniel Tarullo, who is leading efforts to overhaul the Fed’s bank supervision, have testified that the central bank should retain its authority over U.S. banks.

The administration recognizes “many ideas” will be offered and will “work with the leadership” in the House and Senate committees “to get a bill done” this year, White House spokeswoman Jennifer Psaki said yesterday in a statement.

Frank, the Massachusetts Democrat leading his chamber’s efforts, supports Obama’s merger. Stripping the Fed and FDIC of their oversight powers would be “a big mistake,” Frank said.

Representative Spencer Bachus of Alabama, top Republican on the Financial Services panel, has proposed consolidation as a step to reduce duplication and avoid the separate Consumer Financial Protection Agency proposed by Obama.

“If structured like the House Republican plan, streamlining and consolidating the functions of the four bank regulatory agencies will address consumer protection without the need for a new and costly government bureaucracy,” Bachus said in a statement. “It will create smarter regulation, and will benefit both taxpayers and consumers.”

Schumer and Warner, along with Republicans on Frank’s committee, support a single regulator.

“It does not make sense for up to four different federal regulatory bodies to retain oversight over the safety and soundness of banks,” Schumer wrote in June to Treasury Secretary Timothy Geithner. This system “preserves the regulatory arbitrage that allows institutions to pick the oversight scheme that benefits them the most.”

Warner told Bloomberg News July 1 that the Fed and FDIC should cede their bank oversight role to an “end-to-end” supervisor.

Jonathan Graffeo, a spokesman for Senator Richard Shelby, top Republican on Dodd’s committee, in an e-mail yesterday said “we continue to review” Dodd’s proposal."

House to reinstate role for state regulators

"Large banks are on the verge of losing a key legislative battle over the shape of financial reform, an unusual setback that reflects the continued political backlash over their role in creating the financial crisis.

The House Financial Services Committee is expected to vote Tuesday to let state governments protect bank customers by imposing restrictions that go beyond existing federal laws, according to congressional and industry sources.

The move would roll back a doctrine called preemption that has allowed big banks to answer solely to federal regulators. The banks argue that operating under a single set of rules is more efficient and results in lower prices for customers. But the Obama administration, which is pushing for the change, regards preemption as a cause of the crisis because it prevented state regulators from quashing obvious abuses.

The change essentially would unleash 50 additional regulators on the largest banks.

Large banks have fought bitterly against the proposal, which they regard as one of the most problematic components of the administration's financial reform plan, but they have been unable to sway House Democrats.

By contrast, the committee last week granted a major concession to smaller, community banks, agreeing that they would not be directly supervised by a new federal agency devoted to protecting consumers of financial products.

"The big banks don't have much political power, and the big banks are the ones that care about preemption because they operate in so many states," said Rep. Barney Frank (D-Mass.), the committee chairman. "The community banks were worried about examinations, and that's why we compromised, appropriately, on the examinations. They have political clout. . . . They're respected members of the community in everybody's district."

The Obama administration has proposed eliminating the ability of federal regulators to override state laws, but Frank said he supported a compromise under which federal regulators would retain a limited amount of override authority.

Senate hearing, October 14, 2009

The Senate Banking Committee’s Subcommittee on Financial Institutions held a hearing entitled “Examining the State of the Banking Industry.” Witnesses testifying before the Subcommittee included:

  • Sheila Bair, Chairman, Federal Deposit Insurance Corporation;
  • John C. Dugan, Comptroller of the Currency;
  • Daniel K. Tarullo, Member, Board of Governors of the Federal Reserve System;
  • Deborah Matz, Chairman, National Credit Union Administration;
  • Timothy T. Ward, Deputy Director, Examinations, Supervision, and Consumer Protection, Office of Thrift Supervision;
  • Joseph A. Smith, North Carolina Commissioner of Banks and Chairman, Conference of State Bank Supervisors; and
  • Thomas J. Candon, National Association of State Credit Union Supervisors.

Senate hearing, August 4th

For further details see NBS Senate hearing August 4th, 2009.

Strengthening and Streamlining Prudential Bank Supervision

View archived hearing webcast

Tuesday, August 4, 2009, 09:00 AM, 538 Dirksen Senate Office Building, room 538

The witnesses were:

  • The Honorable Sheila Bair, Chairman, Federal Deposit Insurance Corporation; (Testimony)
  • The Honorable John Dugan, Comptroller of the Currency (Testimony)
  • The Honorable Daniel Tarullo, Member, Board of Governors of the Federal Reserve System (Testimony)
  • Mr. John Bowman, Acting Director, Office of Thrift Supervision (Testimony)

These witnesses were postponed:

  • The Honorable Eugene A. Ludwig, Chief Executive Officer, Promontory Financial Group
  • The Honorable Richard S. Carnell, Associate Professor, Fordham University School of Law
  • The Honorable Martin N. Baily, Senior Fellow, Economic Studies, The Brookings Institution.

Source: Fed Plans to Strengthen Bank Examinations With Teams of Experts Bloomberg, August 4, 2009

Executive branch efforts

Overview of the Presidents proposal

Source: New Playing Field for the Banking Industry: the National Banking Supervisor and Systemic Risk K&L Gates, August 11, 2009


The Obama Administration delivered to Congress proposed legislation that would create a National Bank Supervisor and new resolution authority for large, interconnected financial firms.

Fact Sheet: Administration’s Regulatory Reform Agenda Moves Forward National Bank Supervisor and Resolution Authority Legislation Sent to Capitol Hill

The Administration today will deliver proposed legislation to Capitol Hill that would address an important source of regulatory arbitrage by creating a National Bank Supervisor and consolidating two federal bank regulators.

Over the past two years, the financial system has been threatened by the failure or near failure of some of the largest and most interconnected financial firms.

The federal government's ability to deal with these events was severely complicated by the lack of a statutory framework for avoiding the disorderly failure of a nonbank financial firm.

That is why the legislation that the Administration will deliver today would also establish a resolution authority for the largest and most interconnected firms to help ensure that the federal government does not, in the future, have to choose between bailouts and financial collapse.

Address Regulatory Arbitrage in the Bank Regulatory System

Create New National Bank Supervisor:

The legislation creates a National Bank Supervisor through the consolidation of the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC). This consolidation will also eliminate the thrift charter and thrift holding company framework and remove one of the central sources of arbitrage in the bank regulatory system.

End Arbitrage on Bank Regulatory Fees:

The legislation requires the Federal Reserve, FDIC, and the National Bank Supervisor to adopt joint rules on bank regulatory fees to end arbitrage between regulators based on bank examination fees. Banks over $10 billion in assets will pay bank examination fees regardless of charter, based on their size, complexity, and financial condition.

Lower Regulatory Fees for Community Banks:

The legislation requires that fees assessed on national banks with less than $10 billion in assets cannot be higher than the average charged by states for banks of similar size. This will lower the effective fees for many community banks. There will be no basis for the Federal Reserve or the FDIC to impose new fees on community banks under the Administration's proposal.

Providing a Regulatory Regime That Can Adequately Respond To A Financial Crisis

Provide The Government With Emergency Authority To Resolve Any Large, Interconnected Financial Firm In An Orderly Manner:

The Administration's plan gives the federal government the authority necessary to avoid the disorderly resolution of large, interconnected firms when the stability of the financial system is threatened. The proposed resolution authority would supplement (rather than replace) bankruptcy laws and be modeled on the existing resolution regime for insured depository institutions under the Federal Deposit Insurance Act. Use of the authority will be subject to a strict regime of checks and balances, including requiring two-thirds vote by the Federal Reserve Board and the Board of the FDIC or the SEC, as well as the approval of Treasury.

Authority to Appoint a Conservator or Receiver:

The resolution authority will give Treasury the ability to appoint the FDIC or the SEC as conservator or receiver for a failing financial firm that poses a threat to financial stability. The conservator or receiver of the firm will have a broad set of powers including authority to take control of the operations of the firm and to sell or transfer all or any part of the assets of the firm. The resolution authority will also include the ability to provide loans, assume liabilities, or inject capital subject to checks and balances and only if a systemic risk determination has been made.

Require Prompt Corrective Action From Large, Interconnected Firms Should Their Capital Levels Decline:

Tier 1 FHCs will be subject to a prompt corrective action regime that would require the firm and its supervisory agency to take corrective actions as the firm's regulatory capital levels decline. This regime will mirror the prompt corrective action regime for insured depository institutions established under the Federal Deposit Insurance Corporation Improvements Act (FDICIA).

Require Resolution Plans From All Large, Interconnected Firms: The Federal Reserve will require each Tier 1 FHC to prepare and maintain a credible plan for the rapid resolution of the firm in the event of severe financial distress.


Treasury proposes stronger capital/liquidity standards

Source: Stronger Capital and Liquidity Standards for Banking Firms US Treasury, September 5, 2009

"Stronger capital and liquidity standards for banking firms:

  • Capital requirements should be designed to protect the stability of the financial system, not just the solvency of individual banking firms, including banks, bank holding companies, financial holding companies and large, interconnected firms.
  • Capital requirements for all banking firms should be increased, and capital requirements for financial firms that could pose a threat to overall financial stability should be higher than those for other banking firms.
  • The regulatory capital framework should put greater emphasis on higher quality forms of capital that enable banking firms to absorb losses and continue operating as going concerns.
  • The rules used to measure risks embedded in banks' portfolios and the capital required to protect against them must be improved. Risk-based capital requirements should be a function of the relative risk, including systemic risk, of a banking firm's exposures, and risk-based capital rules should better reflect a banking firm's current financial condition.
  • The procyclicality of the regulatory capital and accounting regimes should be reduced and consideration should be given to introducing countercyclical elements into the regulatory capital regime.
  • Banking firms should be subject to a simple, non-risk-based leverage constraint.
  • Banking firms should be subject to a conservative, explicit liquidity standard.
  • Stricter capital and liquidity requirements for the banking system should not be allowed to result in the re-emergence of an under-regulated non-bank financial sector that poses a threat to financial stability.
  • A comprehensive agreement on new international capital and liquidity standards should be reached by December 31, 2010 and should be implemented in national jurisdictions by December 31, 2012.

"...Key details remain undecided, such as whether to assess firms on a sliding scale or whether to create tiers, imposing the same requirements on every firm in a given tier.

The industry, chastened by the crisis, has generally accepted the necessity for more rigorous rules. But the details of the administration's plan -- particularly the size of the penalties assessed on large and risky firms -- are likely subjects for intense debate.

Scott Talbott of the Financial Services Roundtable, a group that represents the largest financial firms, said the group supported additional capital requirements focused on risk, so as not to hobble large firms.

"Those who argue that big is bad are misguided," Talbott said. "You need large financial institutions in this global economy, or you won't be able to service the needs of large multinational corporations."

While the plan itself does not require legislation, its success depends in part on the passage of the administration's broader plan for financial reform, which calls for a systemic risk regulator. Without such an authority, imposing additional requirements on banks could simply squeeze financial activity outside the scope of regulation.

The administration also needs the support of banking regulators. One of those regulators, Sheila C. Bair, chairman of the Federal Deposit Insurance Corp., endorsed the idea of increased capital requirements in an article in the September issue of a journal published by the Banque de France.

"It is now clear that the international regulatory community relied too heavily on the supposed benefits of diversification and modern risk-management practices when setting minimum regulatory capital requirements for large, complex financial institutions," Bair wrote.

FDIC head opposes supervisor consolidation

Source: The Case Against a Super-Regulator Op Ed by Sheila Bair, New York Times, August 31, 2009

”… Concentrating power in a single regulator would inevitably benefit the largest banks and punish community ones. A single regulator’s resources and attention would be focused on the largest banks. This would generate more consolidation in the banking industry at a time when we need to reduce our reliance on large financial institutions and put an end to the idea that certain banks are too big to fail. We need to shift the balance back toward community banking, not toward a system that encourages even more consolidation.

A single-regulator system could also hurt the deposit-insurance system. The Federal Deposit Insurance Corporation currently supervises state banks. The loss of a significant regulatory role would limit its ability to protect depositors by identifying and assessing risks in the financial system.

We can’t put all our eggs in one basket. The risk of weak or misdirected regulation would be increased if power was consolidated in a single federal regulator. We need new mechanisms to achieve consensus positions and rapid responses to financial crises as they develop.

I have advocated the creation of a strong council of federal financial regulators. This council would monitor the financial system to help prevent the accumulation of systemic risks and would also have the authority to close even the largest institutions. But we don’t need — and can’t afford — to depend on one supreme regulator to have sole decision-making authority in times when our entire financial system is in flux….”

Source: FDIC’s Bair Opposes Single Regulator, Saying Plan ‘No Panacea’ Bloomberg, August 4, 2009

Aug. 4 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair opposes the merger of four existing federal bank regulators into a single agency, saying for the first time such a plan is “no panacea” for effective oversight.

Consolidating agencies would disrupt regulatory staffs and may overlook the needs of community banks that rely on state supervision, Bair said in testimony prepared for a Senate Banking Committee hearing today in Washington and obtained by Bloomberg News. Bair supports other aspects of Obama’s plan.

“Proposals to create a unified supervisor would undercut the benefits of diversity that are derived from the dual banking system,” Bair said. “Political capital could be better spent on more important and fundamental issues which brought about the current crisis.”

President Barack Obama is proposing to create a National Bank Supervisor by merging the Office of Thrift Supervision that oversees savings and loans with the Office of the Comptroller of the Currency that regulates national banks. Legislators are pressing further, suggesting Bair’s agency, regulator of some state-chartered banks, and the Federal Reserve, which has a similar role, give up supervision power to a single agency.

Comptroller of the Currency John Dugan, OTS Acting Director John Bowman and Federal Reserve Governor Daniel Tarullo also are scheduled to testify today.

Consolidating the agencies would cause “distractions and organizational confusion” at a time when staff is tied up with banking industry challenges, Bair said.

Austria, the U.K. and Belgium have single financial regulators and have suffered in the crisis, Bair said."

Source: Geithner Vents at Regulators as Overhaul Stumbles WSJ, August 4, 2009

Fed's oversight of nonbank subsideries

"... Most subprime affiliates began life as independent consumer finance companies, beyond the watch of banking regulators. These firms made loans to people whose credit was not good enough to borrow from banks, generally at high interest rates, often just a few thousand dollars for new furniture or medical bills. But by the 1990s, thanks to big changes in laws, markets and lending technology, the companies increasingly were focused on the much more lucrative business of mortgage lending.

As profits soared, hundreds of banking companies took notice, buying or creating finance businesses for themselves. Consumer advocates demanded that regulators take notice, too.

The advocates amassed evidence of abusive practices by lenders, such as Fleet Finance, an affiliate of a New England bank that eventually paid the state of Georgia $115 million to settle allegations that it charged thousands of lower-income black families usurious interest rates and punitive fees on home-equity loans. The National Community Reinvestment Coalition pressed the Fed to investigate allegations against other affiliates.

On Jan. 12, 1998, the Fed demurred. Acting on a recommendation from four Fed staffers including representatives of the Philadelphia, St. Louis and Kansas City regional reserve banks, the Fed's Board of Governors unanimously decided to formalize a long-standing practice, "to not conduct consumer compliance examinations of, nor to investigate consumer complaints regarding, nonbank subsidiaries of bank holding companies."

The Fed could balk because Congress had allowed the laws governing the financial industry to become outdated.

Banks and the companies that own them, known as holding companies, have long operated under federal oversight. But a growing share of loans were made by companies that competed with banks, such as consumer finance firms. The money they gave to borrowers came from Wall Street rather than depositors. As a result, those firms operated beyond the authority of banking regulators, and Congress did not task anyone else with oversight.

The Fed Board decided that even when a nonbank was purchased by a bank holding company, the Fed still lacked authority to police its operations.

Fed staff recommended that it continue to investigate complaints from Congress, which oversees the central bank's performance as an industry regulator. Everything else was passed to the Federal Trade Commission, which has law-enforcement powers but neither the authority nor the resources to oversee the fast-growing industry.

The Fed's hands-off policy was quickly criticized by other parts of the federal government.

A 1999 report by the General Accounting Office warned that the Fed's decision created "a lack of regulatory oversight," because the Fed alone was in a position to supervise the affiliates.

"If the Fed really wants to take action against predatory lending, here is a clear opportunity," John Taylor, president of the National Community Reinvestment Coalition, told Congress after the report was issued.

A 2000 joint report on predatory lending by the Treasury Department and the Department of Housing and Urban Development made a similar recommendation. The report said the Fed clearly had the authority to investigate evidence of abusive lending practices, and urged a policy of targeted examinations.

Even inside the Fed, there was dissent. Gramlich was starting to express concern about predatory lending in his public speeches. He had voted for the hands-off policy in 1998, but by 2000 concluded that the Fed could demonstrate leadership by subjecting the lending affiliates to examinations. "A good defense against predatory lending, perhaps the best defense society has devised, is a careful compliance examination for banks," Gramlich later told a 2004 meeting of bankers in Chicago.

Alan Greenspan, then chairman of the Fed, recalled that Gramlich broached the subject at a private meeting in 2000. Greenspan said that he disagreed with Gramlich, telling him that such inspections would require a vast effort with no certainty of results, and that the Fed's involvement might give borrowers a false sense of security.

Gramlich did not press the issue. Years later, in 2007, after an account of the meeting appeared in newspapers, he sent Greenspan a note that read in part, "What happened was a small incident, and as I think you know, if I had felt that strongly at the time, I would have made a bigger stink."

After the Fed's decision, several of the largest bank holding companies added finance arms, expanding into the regulatory vacuum.

In March 1998, First Union bought the Money Store, a California lender with a ziggurat for a headquarters, ads featuring baseball Hall of Famers Jim Palmer and Phil Rizutto, and a catchy phone number: 1-800-LOAN-YES.

In April 1998, Citibank announced a merger with Travelers and its finance arm, which was renamed CitiFinancial. Two years later, Citigroup added the nation's largest consumer finance company, paying $31 billion for Associates First Capital. Both the Justice Department and the FTC were investigating Associates for abusive lending practices, but Citi executives promised reforms. In 2002, the company agreed to pay the FTC a record fine of $215 million to settle allegations that Associates had "engaged in systematic and widespread deceptive and abusive lending practices."

The last of the large finance companies was also snapped up in 2002, as HSBC agreed to pay $14 billion for Household International. The Chicago firm described itself as the nation's oldest finance company and boasted in its corporate history that it pioneered direct-mail loan solicitations in 1896. More recently, it had become the subject of a massive investigation by state attorneys general who charged that it routinely misled borrowers about the true cost of refinance loans. Immediately before announcing its deal with HSBC, Household agreed to pay $484 million to settle those charges.

By 2004, the consumer finance industry had largely been folded into the banking industry, and the finance arms of bank holding companies were making at least 12 percent of all mortgage loans with high interest rates, according to data reported by lenders under the Home Mortgage Disclosure Act.

The rapid growth of subprime lending by affiliates renewed the interest of the GAO, which repeated its call for the Fed to examine affiliates in a 2004 report on shortcomings in federal efforts to combat predatory lending. The report noted the FTC investigations of Fleet Finance and Associates as reasons for concern...."

Bank regulators exert more oversight

Source: Regulators Are Getting Tougher on Banks WSJ, July 31, 2009

"Federal regulators have escalated the number of wounded banks they have essentially put on probation, with some of the targeted banks complaining that the action is too harsh.

The Federal Reserve and the Office of the Comptroller of the Currency, two of the primary U.S. banking regulators, have issued more of the so-called memorandums of understanding so far this year than they did for all of 2008, according to data obtained from the agencies under Freedom of Information Act requests.

At the current rate of at least 285 so far, the Fed, OCC and Federal Deposit Insurance Corp. are on track to issue nearly 600 of the secret agreements for the full year, compared with 399 last year. Memorandums of understanding can force financial institutions to increase their capital, overhaul management or take other major steps.

Such sanctions typically aren't publicly disclosed to avoid possibly rattling depositors and shareholders. Institutions hit with memorandums this year range from giant Bank of America Corp. to regional bank Colonial BancGroup Inc., based in Montgomery, Ala., to Berkshire Bancorp Inc., a New York bank with just 12 branches.

The sharp increase comes as Congress considers changes proposed by the Obama administration that would overhaul the way the U.S. government oversees banks. Many bankers and analysts believe those changes would result in an even more assertive regulatory apparatus. Regulators have been criticized for going too easy on banks and securities firms."

2009 Shared National Credit Program

The US financial sector’s losses on large loans exploded over the past year, exceeding the combined losses since 2001, with hedge funds and other members of the “shadow banking system” hit the hardest, official figures revealed on Thursday.

Regulators’ annual review of “shared national credits” – loans larger than $20m shared by three or more federally regulated institutions – highlighted the toll taken by the crisis on financial groups outside the traditional banking sector.

More than one in three dollars lent by non-bank institutions such as hedge funds, securitisation vehicles and pension funds, went sour, according to the figures, compared with 11.5 per cent for US banks.

The results will increase fears that, in spite of a recovery in the shares and balance sheets of many banks, the epicentre of the crisis has moved to the hedge funds and investors that gorged on cheap credit in the run-up to the turmoil.

The importance of these non-bank institutions was underlined by the review’s finding that they held 47 per cent of problem loans, in spite of accounting for only 21.2 per cent of the total loan pool.

Overall, the US financial sector’s losses on loans in early 2009 reached a record of $53bn, almost triple the previous high in 2002.

The number of loans edging into the danger zone has also surged.

Some 15 per cent of the $2,900bn SNC portfolio was classified as “substandard” – the second of the four categories used by regulators – and worse, up from 5.8 per cent in 2008.

The pace at which loans got into serious trouble accelerated significantly. The dollar volume classed as “doubtful” or loss-making increased 14-fold over the past year to $110bn. “Doubtful” loans are so weak that collection or liquidation is highly improbable.

The review is conducted each year by the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

They look at a sample of banks’ and non-banks’ shared loans to check that they are marking them in the same way.

This review found that loans to media and telecommunications companies were proving the most troublesome, followed by the finance and insurance sector and real estate.

The review said that underwriting standards had improved last year, but loans originated in the credit boom years before mid-2007 had continued to drag down the quality of the SNC portfolio.

More than one fifth of the portfolio fell into “criticised assets” category, which includes loans that are potentially weak but not yet of serious concern.

Some 40 per cent of that chunk was in the form of leveraged finance loans.

Federal Financial Institutions Examination Council (FFIEC)

See also FFIEC

The Federal Financial Institutions Examination Council (FFIEC) was established on March 10, 1979, pursuant to title X of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 (FIRA), Public Law 95-630.

In 1989, title XI of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) established The Appraisal Subcommittee (ASC) within the Examination Council.

The Council is a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions by five federal overseers and to make recommendations to promote uniformity in the supervision of financial institutions.

The Council was given additional statutory responsibilities by section 340 of the Housing and Community Development Act of 1980 to facilitate public access to data that depository institutions must disclose under the Home Mortgage Disclosure Act of 1975 (HMDA) and the aggregation of annual HMDA data, by census tract, for each metropolitan statistical area (MSA). The Council has established, in accordance with the requirement of the statute, an advisory State Liaison Committee composed of five representatives of state supervisory agencies.

FFIEC Regulatory supervisors

  • National Credit Union Administration (NCUA)

Global banking oversight

Federal Reserve's view of global oversight

The Response to the Crisis Was Global

Given the global factors that helped spread the crisis, the response to the crisis needed to be global as well. And many of the responses were indeed global--or at least were quite similar across various jurisdictions. Everyone was reacting to the same types of problems, but the similarities also reflected a high degree of global consultation and collaboration.

We can see this in the actions of many central banks. Beginning in late 2007, central banks generally reacted to funding problems and incipient runs with similar expansions of their liquidity facilities. They lengthened lending maturities, in many cases broadened acceptable collateral, and in several instances initiated new auction techniques for distributing liquidity to overcome the inertia from stigma. Central banks were in constant contact through this period, although they arrived at many of these actions separately.

However, we did explicitly coordinate to address problems in dollar funding markets. The Federal Reserve entered into foreign exchange swaps with a number of other central banks to make dollar funding available to foreign banks in their own countries. By doing so, we reduced the pressure on dollar funding markets here at home.

Governments also reacted similarly when in late 2008 the turmoil deepened and many countries saw a need to provide broad support to their banking systems. The rescue plans in different countries contain similar elements: expanded deposit insurance, guarantees on nondeposit liabilities, and capital injections. Although most countries wound up in a similar place, the process was not well coordinated, with action by one country sometimes forcing responses by others.

Many countries also took measures to deal with financial distress at systemically important firms. Efforts in this area were much messier. The failure of Lehman Brothers highlighted the lack of a framework that would allow for the orderly resolution of a systemically important nonbank financial institution in the United States. Even where formal crisis-management frameworks existed, such as within the European Union, they were not always used in the heat of the crisis. The reality is that the resolution of failing firms is still a national responsibility, even for institutions that operate globally.

Early on in the crisis, authorities recognized that addressing the deficiencies made apparent by the crisis required an international effort. Many of those deficiencies--for example, in bank capital and liquidity requirements and in accounting systems--were embodied in internationally agreed regulations, standards, and codes of conduct. Addressing them would require working through global bodies of national and international standard setters and they would require broad agreement among national authorities. The Financial Stability Forum (now renamed the Financial Stability Board) brought central banks, regulators, and finance ministries together to identify the problems, suggest avenues for addressing those problems, and push for timely solutions.

What Remains to Be Done?

The process of addressing the problems is still at an early stage. Now that the crisis seems to be abating, we can better identify the causes of the crisis and work on finding the best solutions. Deficiencies must be fixed on a global basis to forestall gaps and regulatory arbitrage that could undermine the effectiveness of regulation. And countries need to have confidence that others are implementing tighter standards in a consistent way. But at the same time, regulations must be passed and implemented nationally. On one level, this type of action is simply what is required under existing legal structures. On another level, it reflects the reality that taxpayers in individual countries end up bearing much of the cost when home-country institutions need to be stabilized. I'll highlight four of the many areas that require international coordination.

First, we need to identify the global risks that can affect local banks. One obvious issue is cross-border exposures, especially when banks in many countries have similar exposures. On a global level, international groups like the Financial Stability Board have an important role to play in looking for these kinds of vulnerabilities. For individual banks that operate across borders, supervisory colleges bring the key supervisors together and can improve the flow of information. These groups can also help raise supervisors' awareness of the risks that occur when the business plans of local banks evolve and shift to take on more global exposures.

Of course, we shouldn't expect too much from these exercises. In identifying risks, false positives will be common, and some mispricing of assets is inevitable as people attempt to evaluate the implications of broad economic trends and innovations. But looking in a focused way across markets and institutions may help to identify areas where greater supervisory attention could result in a more resilient system.

A second area that is likely to involve international collaboration is the development of a more macroprudential approach to supervision and regulation. One aspect of such an approach is higher standards for systemically important institutions; another is supervisory and regulatory measures to offset procyclical tendencies of the financial sector. Formulating higher standards for systemically important, globally active institutions will require international coordination to avoid uneven playing fields. And, offsetting procyclical tendencies presents a difficult question: Should authorities aim at damping such tendencies at a global level or at the level of an individual country? If only global risks are addressed, vulnerabilities will persist at the local level; however efforts to address local problems could disadvantage domestic banks relative to those headquartered abroad.

Third, we need to improve our ability to resolve systemically important institutions without generating spillovers that spread systemic risk across firms or across borders. Clearly, each country should have the legal authority to wind down a systemically important institution in an orderly way, taking account of the international dimensions. Beyond this, there is not yet a consensus on exactly what to do, but a range of promising proposals have been suggested to facilitate orderly resolutions. One is for supervisors to press firms to strengthen their ability to quickly provide the information on exposures, funding, and counterparties that would be needed for crisis management. Another would have supervisors recommend changes to simplify the organizational structures of systemically important firms to make it easier to deal with their failure. A related proposal would require firms to maintain a so-called living will, a written contingency plan that provides for an orderly wind-down should severe financial distress lead to failure.

Fourth, we need to address home-host issues that arise in the supervision of cross-border firms. For example, some global banks can expose a host country to a withdrawal of risk-taking caused by problems outside its own borders. This exposure understandably makes host countries uncomfortable with the traditional division of responsibility that restricts a host-country to supervising only the activity of a global bank within its own country. One possible response here would be more information sharing from home to host, to better enable host countries to protect themselves. Another response would be restrictions by host countries on cross-border operations of global banks, perhaps going so far as requiring global banks to operate through separately capitalized subsidiaries. However, this requirement, in addition to imposing costs on the banks, might also impede the ability of the global financial system to channel capital to where it is most likely to enhance productivity and growth.

FSA announces tough new code for financial disclosure

"The Financial Services Authority (FSA) has announced today that the major UK-headquartered banks have agreed to implement a tough new code for financial reporting disclosure.

The code forms part of proposals, designed to enhance investors’ confidence in financial reporting and to aid their ability to compare and contrast banks’ performance. It is based on an overarching principle that UK banks are "committed to providing high quality, meaningful and decision-useful disclosures to users to help them understand the financial position, performance and changes in the financial position of their businesses".

The FSA is inviting views on the application of this code to banks and other credit institutions. In the meantime, the major banks, at the FSA’s request, have agreed to implement the code in their 2009 year end annual reports.

If the banks are unable to sufficiently improve the quality and comparability of their disclosures in their 2009 annual reports, the FSA is also seeking views as to whether the code needs to be supplanted by more detailed disclosure templates.

Paul Sharma, FSA director, prudential policy, said:

"In the Turner Review we set out our view that the financial crisis had raised questions as to the adequacy of financial disclosure by banks throughout all major economies and the level of confidence that investors could place in their financial reports.

"The tough disclosure code published today puts UK banks further ahead of the game internationally in addressing these concerns. But when applying this code to their 2009 year end accounts, the FSA expects firms to achieve significant improvement in the quality and comparability of disclosures."

The code is being launched to the industry by the British Bankers Association (BBA) today.

The Turner Review identified a concern that in spite of banks’ efforts to enhance disclosures during 2008 and 2009, investor confidence in financial reports appeared to remain low.

The FSA has worked closely with the BBA and major firms to develop the code, which sets out key principles accompanied by explanatory text to highlight how the principles should be applied in practice.

  1. The code of practice.
  2. The Turner Review.
  3. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.

UK review of banks oversight

"The government's plans for reforming the regulation of banks are "largely cosmetic" and "lack clarity", MPs in the Treasury Select Committee say.

In its report on the banking crisis, the committee says that responsibility for strategic decisions and action remains "a muddle".

The report also says that the Financial Services Authority (FSA) "failed spectacularly" in supervising banks.

The FSA said it has "changed radically" since an internal review in 2008. Earlier this month, Chancellor Alistair Darling said banks would face tougher regulation and consumers would get more protection.

The reforms are specifically designed to try to prevent the current financial crisis happening again.

But the plans have been criticised for not going far enough.

For example, the current tripartite system, where the Bank of England, the Treasury and the FSA oversee the financial system, would remain intact.

The Tories want to abolish the system and hand more power to the Bank of England.

'Extremely perturbed'

The Treasury Committee report, entitled Banking Crisis: Regulation and Supervision, does not advocate "substantial change" to the tripartite system.

But it does criticise the government's reform plans.

The report "considers the reforms to the institutional structure of the Tripartite Committee to be largely cosmetic. Merely rebranding the committee will do little in itself".

The real problem lies in the fact that responsibilities are not properly allocated, it argues. "Where responsibility lies for strategic decisions and executive action was, and remains, a muddle," it says.

It also highlights a lack of co-ordination and admits to being "extremely perturbed" by evidence from Mervyn King, Governor of the Bank of England, that he had "no idea" of what the government's plans for reform were.

John McFall, the chairman of the Treasury Select Committee, said: "Change and co-ordination are needed to clarify responsibilities."

Financial Stability Board capital requirements

"The Group of Central Bank Governors and Heads of Supervision, the oversight body of the BCBS, reached agreement in September on the following key measures to strengthen the regulation of the banking sector:

  • Raise the quality, consistency and transparency of the Tier 1 capital base. The predominant form of Tier 1 capital must be common shares and retained earnings. Appropriate principles will be developed for non-joint stock companies to ensure they hold comparable levels of high quality Tier 1 capital. Moreover, deductions and prudential filters will be harmonised internationally and generally applied at the level of common equity or its equivalent in the case of non-joint companies. All components of the capital base will be fully disclosed.
  • Introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework with a view to migrating to a Pillar 1 treatment based on appropriatereview and calibration. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for differences in accounting.
  • Introduce a framework for countercyclical capital buffers above the minimum requirement. The framework will include capital conservation measures such as constraints on capital distributions. The BCBS will review an appropriate set of indicators, such as earnings and credit-based variables, as a way to condition the build-up and release of capital buffers. In addition, the BCBS will promote more forward-looking provisions based on expected losses. The BCBS will also assess the need for a capital surcharge to mitigate the risk of systemic banks.

The BCBS will issue concrete proposals on these measures by the end of this year, consistent with the timelines established by the G20 and the FSB. To date:

  • The BCBS issued in July final standards to raise capital requirements for the trading book, resecuritisations and the treatment of liquidity lines to asset backed commercial paper conduits. As a result of these proposals, average trading book capital requirements for the major internationally active banks will more than double between now and the end of 2010 when the new rules take effect. This does not factor in the higher charges for securitisations that will be applied to the trading book, which could add significant additional capital requirements for trading books. The BCBS also has started a review of the role of external ratings under Basel II and its treatment of securitisations.
  • The BCBS has developed objectives for what a countercyclical capital buffer should achieve and concrete proposals for how it could work. An integrated proposal will be developed by year-end. Proposals for contingent capital can be integrated into this work program, for example by assessing the pros and cons of meeting a portion of the capital buffer with certain contingent capital instruments. The BCBS is also actively engaged with accounting standard setters to move provisioning practices towards an expected loss framework. Finally, the BCBS continues to work on approaches to address any excessive cyclicality of minimum capital requirements.

The agreed measures will result over time in higher capital requirements and less leverage in the banking system, less procyclicality and greater banking sector resilience to stress. The Group of Central Bank Governors and Heads of Supervision endorsed the following principles to guide supervisors in the transition to a higher level and quality of capital in the banking system:

  • Building on the framework for countercyclical capital buffers, supervisors should require banks to strengthen their capital base through a combination of capital conservation measures, including actions to limit excessive dividend payments, share buybacks and compensation.
  • Compensation should be aligned with prudent risk-taking and long-term, sustainable performance, building on the FSB Principles for Sound Compensation Practices.

Banks will be required to move expeditiously to raise the level and quality of capital to the new standards, but in a manner that promotes stability of national banking systems and the broader economy.

Going forward, the BCBS will carry out an impact assessment at the beginning of next year, with calibration of the new requirements to be completed by end-2010.

Appropriate implementation standards will be developed to ensure a phase-in of these new measures that does not impede the recovery of the real economy. Government injections will be grandfathered.

G-20 proposes new capital rules

"Perhaps banking reform hasn't stalled after all. This weekend's announcements by [G20|G-20] finance ministers, central bankers and regulators suggest new rules are on their way -- including higher levels of better-quality capital, a new leverage ratio and new liquidity rules. That makes the continued surge in European bank stocks Monday all the more surprising.

The devil will be in the detail. And a lot of detail remains hazy. For example, the Basel Committee has tightened its definition of Tier 1 capital. But it hasn't yet increased the minimum level of Tier 1 capital, currently 4%, or the 50% minimum that must be common equity.

Similarly, the commitment to introduce a leverage ratio is sketchy. There isn't yet any agreement on how leverage should be defined or measured. And policy makers are planning that the ratio won't be a hard regulatory tool but a backstop measure to stop banks from gaming the risk-weighted regulatory capital regime, according to someone familiar with the committee's thinking.

There is no agreement on hybrid debt, which can currently form as much as 15% of a bank's Tier 1. New countercyclical rules designed to stop banks from creating systemic risks by crowding into similar trades remain to be worked out.

But the direction seems clearer, particularly given Treasury Secretary Timothy Geithner's backing for reform. Perhaps bullish investors are betting countries will fail to agree on rules or the political commitment will weaken from fear lower returns on equity could reduce lending.

Alternatively, they are hoping reforms will be pushed into the future and, meantime, central banks will keep conditions sweet for banks to mint money."

[HSBC's] Mr Geoghegan was also bearish on the outlook for banks’ regulatory capital – in particular the so-called tier one ratio that measures the top grade of capital as a proportion of risk-weighted assets, and the “core” tier one ratio that counts mainly equity. He said he expected the requirement for core tier one capital ratios to be “around the 10 per cent mark”. That is far higher than the 8 per cent that regulators have been suggesting in private.

HSBC is among the better capitalised banks, with a core tier one ratio of 8.8 per cent and headline tier one of 10.1 per cent.

Risk and the corporate structure of banks

We identify different sources of risk as important determinants of banks' corporate structures when expanding into new markets. Subsidiary-based corporate structures benefit from greater protection against economic risk because of affiliate-level limited liability, but are more exposed to the risk of capital expropriation than are branches. Thus, branch-based structures are preferred to subsidiary-based structures when expropriation risk is high relative to economic risk, and vice versa. Greater cross-country risk correlation and more accurate pricing of risk by investors reduce the differences between the two structures. Furthermore, the corporate structure affects bank risk taking and affiliate size.

IMF Working Paper "Recovery Determinants of Distressed Banks"

Based on detailed regulatory intervention data among German banks during 1994–2008, we test if supervisory measures affect the likelihood and the timing of bank recovery. Severe regulatory measures increase both the likelihood of recovery and its duration while weak measures are insignificant. With the benefit of hindsight, we exclude banks that eventually exit the market due to restructuring mergers. Our results remain intact, thus providing no evidence of “bad” bank selection for intervention purposes on the side of regulators. More transparent publication requirements of public incorporation that indicate more exposure to market discipline are barely or not at all significant. Increasing earnings and cleaning credit portfolios are consistently of importance to increase recovery likelihood, whereas earnings growth accelerates the timing of recovery. Macroeconomic conditions also matter for bank recovery. Hence, concerted micro- and macro-prudential policies are key to facilitate distressed bank recovery.

IMF Working Paper - Quality of capital

The crisis has sparked intense discussions about the quality of capital, the significance of which is highlighted in supervisory guidelines.

For example, Basel Committee Banking Supervision (BCBS) Guidelines noted that core Tier 1 capital should be a predominant part of Tier 1.

The Turner Review pointed out that “The FSA therefore believes that required capital ratios for such banks should be expressed entirely in terms of high quality capital—broadly speaking the current Core Tier 1 and Tier 1 definitions—and should not count dated subordinated debt as providing relevant support.

This is in line with the direction of Basel Committee deliberations.” The US Supervisory Capital Assessment Program (SCAP) argued that “Supervisors have long indicated that common equity should be the dominant component of Tier 1 capital….”.

French banks had a higher capital quality initially, but their lead was eroded following the raft of global recapitalizations across the industry.

Both French banks and their European peers increased the share of Tier II capital in the capital structure in 2008, although the increase was somewhat smaller for French banks.

With investors putting less emphasis on Tier II capital, several European banks, including some French banks, have considered or conducted liability management operations to buy back their lower Tier II capital to improve the quantity and quality of capital.

The core Tier I ratio of French banks was about 15 basis points above that of others in 2007, and stood on par with their peers after the wave of government recapitalizations in 2008.

China tells banks to conduct quarterly stress tests

China's banking watchdog has instructed lenders to carry out quarterly stress tests as part of a drive to strengthen credit controls and liquidity management, state media reported on Friday.

A recent circular from the China Banking Regulatory Commission orders banks to measure their capacity to withstand liquidity risks and work out a corresponding strategy to handle those risks, the China Securities Journal quoted an unnamed source as saying.

"The directive is expected to be implemented by the end of this year. Commercial banks should conduct a regular stress test every quarter," the newspaper quoted the source as saying.

Banks made a total of 8.67 trillion yuan ($1.270 trillion) in new loans in the first nine months, 75 percent more than in all of 2008, triggering concern about how the money will be repaid.

CBRC Chairman Liu Mingkang sounded a fresh warning on Wednesday about the risks posed by such strong credit growth and told banks to lend at a more "reasonable" pace for the rest of the year.

In a separate report, the 21st Century Business Herald said the CBRC had modified a proposed ban on banks counting subordinated debt sold to other banks as part of their capital.

The final version of the regulations says only subordinated debt issued after July 1, 2009, would be subject to cross-holding restrictions, the paper said.

And, in contrast to the draft regulations issued in August, the final rules make no mention of hybrid debt instruments.

The paper cited an unnamed commercial banker who has received a copy of the rules. It described them as a compromise between the views of the regulator and lenders, which protested that the draft regulations were too tough.

The CBRC has also ruled that subordinated bonds -- which rank as supplementary capital -- may not exceed 25 percent of a major bank's core capital, the paper said.

Australian review of bank concentration

A Senate committee has recommended more transparency and reporting about bank mergers and the state of competition in the banking sector.

The Opposition majority on the Economics Committee want a joint annual report from the Australian Competition and Consumer Commission, the banking regulator (APRA) and the Reserve Bank on competition in the banking sector, with a particular focus on affordable banking for those on low incomes.

The committee noted that Australia's big four banks now hold around three-quarters of deposits and 90 per cent of home loans in Australia, and says they got to this position through taking over smaller rivals.

"Indeed, the big four banks have essentially grown their market share over the past century by successively taking over the various banks and building societies established in the previous century - other than the Commonwealth Bank (only established in 1912), the increases in their market share are more than accounted for by their acquisitions," the majority report noted.

"There are now few smaller banks left for them to take over, so they will face the novel challenge of having to compete among themselves for market share in coming years."

It has also recommended monetary penalties be imposed on banks which do not comply with the conditions of approved mergers.

Differences between investment and commercial banking

Bookstaber talks about his new book about the economy. He suggests regulating large bank proprietary trading desks like hedge funds. Bloomberg News video, August 25, 2009 (running time 13 minutes)

"High-class financial utility"

This is the problem I identified last week, with the most powerful broker-dealer on Wall Street having the same privileges as the most mundane commercial bank. Not only does the fact that it may pay $23bn in bonuses this year upset people, but also its incentives are skewed.

Solving this requires two things to be addressed. First, Goldman’s intention to operate as a institutional Wall Street firm – complete with its own hedge and private equity funds – while having government and Fed support. Second, its tradition of setting aside half its revenues each year for employees.

On the first point, Goldman’s status strikes me as untenable. It may be better regulated by the Fed than the Securities and Exchange Commission but counting it as just another bank, with the same privileges and obligations as retail banks and credit card companies, makes little sense.

This is not to accuse it of being reckless, or insouciant about how it operates. It navigated the crisis best of all the investment banks and does not run itself as if it is bound to get bailed out. It is well capitalised and holds $170bn of cash and liquid assets to hand, just in case.

Nor is it merely a giant hedge fund. Its pure proprietary activities make up about 10 per cent of its revenues. Market-making in bonds and equities, now its main business, serves companies and investors, although it is a capital-intensive and sometimes risky activity.

But its business is different from the banks for which the discount window – the Fed facility that allows its regulated banks to borrow cash in exchange for securities in extremis – was invented. Until recently, no one would have suggested that Goldman deserved a place with them.

Mervyn King, governor of the Bank of England, put it well this week. The “utility aspects of banking where we all have a common interest in ensuring continuity of service are quite different in nature from some of the riskier activities that banks undertake, such as proprietary trading”.

One possibility is for Goldman to spin off its activities that come under the latter heading: the hedge funds and private equity investments in which it risks capital. That would leave its market-making activities and investment banking divisions as a high-class financial utility.

Even then, it should not be treated by the Fed like a retail bank which has its deposits guaranteed and is, as Mr King phrases it, “too important to fail”. Goldman must be structured and regulated in such a way that it could safely be allowed to fail in any future financial crisis.

"Carry trade", foreign investing and Fed borrowings

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People’s Daily; CNBC). US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up.

Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion? If this is temporary, is it envisaged that Goldman will cease being a bank holding company, or that it will divest itself shortly of activities not usually allowed (and with good reason) by banks? Or will all bank holding companies be allowed to expand on the same basis. (The relevant rules appear to be here in general and here specifically; do tell me what I am missing.)

Increasingly, the issue of “too big to regulate” in the public interest is being brought up – an issue that has historically attracted the interest of the Department of Justice’s Antitrust Division in sectors other than finance. Should Goldman Sachs now be placed in this category?

Given that the Fed has slipped up so many times and in so many ways with regard to regulation over the past decade, and given the current debate on Capitol Hill, now might be a good time to get ahead of this issue.

In addition, there is the obvious carry trade (borrow cheaply; lend at higher rates) developing from cheap Fed dollar funding to the growing speculative frenzy in emerging markets, particularly China. Are we heading for another speculative bubble that will end up damaging US bank balance sheets and all American taxpayers?

"...Goldman Sachs’s trading results reflected the firm’s willingness to take on more risk during the period. Value-at- risk, an estimate of how much the firm could lose in any given day, rose to an average of $245 million in the second quarter from $240 million in the first quarter and $184 million in the second quarter of 2008. Most of the increase in the second quarter came from bets on equities, the company said.

Banks such as Goldman Sachs are benefiting from lower borrowing costs after the Federal Deposit Insurance Corp. in October started guaranteeing bank debt issues that mature within three years. Goldman Sachs issued about $30 billion of debt guaranteed by the FDIC between November and March, according to company filings."

Commercial and investment banking commingled

"The SEC's own program of voluntary supervision for investment bank holding companies, the Consolidated Supervised Entity program, was put in place by the Commission in 2004. It borrowed capital and liquidity measurement approaches from the commercial banking world -- with unfortunate results similar to those experienced in the commercial bank sector. Within this framework, prior to the spring of 2008, neither commercial bank nor investment bank risk models contemplated the scenario of total mortgage market meltdown that gave rise to, for example, the failure of Fannie Mae and Freddie Mac, as well as IndyMac and 11 other banks and thrifts this year.

The creators of the Consolidated Supervised Entity program in 2004 had designed it to operate on the well-established bank holding company model used by regulators not only in the United States but around the globe. They decided that the CSE rules would permit the parent holding company to calculate its capital adequacy using an approach consistent with either of the Basel standards, adopted by the Basel Committee on Banking Supervision. But the market-wide failure to appreciate and measure the risk of mortgage-related assets, including structured credit products, has shown that neither the Basel I nor Basel II standards as then in force were adequate. Each had serious need of improvement.

As a result, since March 2008, the SEC and other groups in which we participate have focused on improving standards for capital, liquidity, and risk management in both commercial and investment banking. Following the sale of Bear Stearns, groups such as the Senior Supervisors Group, the Financial Stability Forum, the International Organization of Securities Commissions, and the Basel Committee all pointed to the need to strengthen and improve these standards.

In the meantime, beginning immediately in the wake of the Bear Stearns sale to JPMorgan Chase, the Division of Trading and Markets, working with the Federal Reserve, implemented substantially more rigorous approaches to supervision of liquidity levels and liquidity risk management. They have developed scenarios that are of much shorter duration and that are much more severe, including denial of access to secured as well as unsecured funding. Those more stringent scenarios assume no access to the Fed's discount window or other liquidity facilities, although in fact such facilities are now available to the major investment banks. As a matter of prudence, investment banks are urged to maintain capital and liquidity at levels far above what would be required under the standards themselves.

But beyond highlighting the inadequacy of the pre-Bear Stearns CSE program capital and liquidity requirements, the last six months -- during which the SEC and the Federal Reserve have worked collaboratively with each of the CSE firms pursuant to our Memorandum of Understanding -- have made abundantly clear that voluntary regulation doesn't work. There is simply no provision in the law that authorizes the CSE program, or requires investment bank holding companies to compute capital measures or to maintain liquidity on a consolidated basis, or to submit to SEC requirements regarding leverage. This is a fundamental flaw in the statutory scheme that must be addressed, as I have reported to the Congress on prior occasions.

Because the SEC’s direct statutory authority did not extend beyond the registered broker dealer to the rest of the enterprise, the CSE program was purely voluntary --something an investment banking conglomerate could choose to do, or not, as it saw fit. With each of the remaining major investment banks now constituted within a bank holding company, it remains for the Congress to codify or amend as you see fit the Memorandum of Understanding between the SEC and the Federal Reserve, so that functional regulation can work.

The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake. There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps -- double the amount outstanding in 2006 -- is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market. This is an area that our Enforcement Division is focused on using our antifraud authority, even though swaps are not defined as securities, because of concerns that CDS offer outsized incentives to market participants to see an issuer referenced in a CDS default or experience another credit event."

"Wells Fargo & Co.’s $12.7 billion purchase of Wachovia Corp., meant to bolster deposits and mortgage operations, has deepened the company’s commitment to investment banking as corporate stock and bond sales surge.

Wells Fargo ranked 13th in the second quarter among underwriters of U.S. bonds and 10th in global equity offerings, according to data compiled by Bloomberg. Last year, before the Wachovia acquisition, Wells Fargo failed to crack the top 30 in either category. Investment banking revenue jumped 29 percent in the second quarter from the first three months of 2009.

Chairman Richard Kovacevich said in 2005 that Wells Fargo’s consumer-oriented culture was “incompatible” with an investment bank, and Executive Vice President Bruce Helsel said in March 2008 that the businesses would be difficult to integrate. That was before Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. collapsed or were sold, allowing San Francisco-based Wells Fargo to expand, said Executive Vice President Tim Sloan, in an interview last week.

“There are just fewer competitors out there,” said Sloan, 49, head of wholesale banking’s commercial, real estate and specialized financial services group in Los Angeles. “We’re out pitching business everyday.”

Earlier this month, the Wachovia Securities brand was changed to Wells Fargo Securities, a unit that includes the acquired investment banking and capital markets divisions as well as Barrington Associates, a Los Angeles-based investment bank that Wells Fargo bought three years ago. Former Wachovia executives Robert Engel and Jonathan Weiss were appointed in January to lead the groups.

The 2,800-person unit is part of Wells Fargo’s wholesale banking group, which generated $5.2 billion in second-quarter revenue, more than double a year earlier before the Wachovia deal. Wholesale banking accounted for 23 percent of Wells Fargo’s total revenue in the period."

Moody’s says risk governance at many big banks still lacking

Source: Moody’s Says Risk Governance at Many Big Banks Still Lacking ResearchRecap, July 24, 2009

"Moody’s thinks corporate risk governance is still lacking at many large banks.

In a Special Comment, Moody’s said there is significant room for improvement in the risk governance of many large banks and added that it will be looking closely at the issue in determining bank credit ratings. Moody’s singled out JP Morgan Chase (JPM), Macquarie (MQG) and Santander (BSCH) as exceptions, with all three banks having a powerful Chief Risk Officer reporting to the CEO and the Board. By contrast the CROs at Barclays, Goldman Sachs and HSBC report to the CFO. Santander also leads in the frequency of risk committee meetings at 120, followed by BBVA at 45 and then by TBD at 10.

With a focus on 35 large banks in Europe, North America and Asia-Pacific the report reviews risk governance practices, covering risk committee structure and frequency of meetings, risk committee composition and the existence, reporting line and status of the Chief Risk Officer (CRO).

Key findings:

  • Only half of the banks we examined have a dedicated board-level risk committee covering all risks.
  • Even in those firms with a board-level risk committee, meetings of this committee are not as frequent as we would expect, in particular considering the current market crisis.
  • For many banks the actual independence1 of the risk committee is not adequate and/or the professional experience and background of the committee members are not fully in line with the demands of the role.
  • Most banks have a dedicated CRO, but there is still a minority of banks where this is not the case.
  • For those banks that do have a CRO, not all report to the CEO. Moreover, a joint reporting line of the CRO to the CEO and the board occurs in only three banks (JPMorgan Chase, Macquarie and Santander).

“Only half of the banks we examined have a dedicated board-level risk committee covering all risks and meetings are not as frequent as we would expect. Moreover, for many banks, the actual independence of the risk committee is not adequate and/or the professional experience and background of the committee members are not fully in line with the role.” says Alessandra Mongiardino, a London-based Moody’s Vice President — Senior Credit Officer and main author of the report.

The report also notes that whilst most banks have a dedicated CRO, there is still a minority of institutions where this is not the case. “For those banks that do have a CRO, not all report to the CEO. A joint reporting line of the CRO to the CEO and the board, consistent with best practices, occurs in only three banks” adds Mongiardino.

Moody’s believes that strong checks and balances to a financial firm’s management, provided by the board, are an important rating consideration.

“The quality of a financial institution’s risk governance is a main input in the overall assessment of a firm’s risk management, representing one of the qualitative factors (incorporated in Moody’s methodology) with which to assess stand-alone financial strength of banks and other financial institutions.”

“Moody’s expects to see a strengthening of the risk governance of large financial institutions in the near-to-medium term, and will monitor this closely; in particular, the rating agency will look for any loss of momentum once the global financial crisis starts easing. Moody’s notes that its analysis is company-specific and considers the appropriateness of the changes in the context of the business model and the risk profile of each bank. The rating agency also observes that weaknesses in risk governance — if not adequately addressed — will continue to exert downward pressure on ratings in the current environment, and could constrain upward rating movement after the current financial crisis subsides.”

ABA and independent bankers nix single regulator proposal

"Two major bank industry groups said on Tuesday they oppose a congressional proposal to consolidate federal banking supervision into one regulator.

The American Bankers Association and the Independent Community Bankers of America jointly sent a letter to lawmakers saying that maintaining multiple federal regulators provides a helpful range of regulatory perspectives and is a healthy check against any one regulator neglecting its duties.

"A single regulator is only good when it is right," the letter said. "When wrong, the outcome could be catastrophic."

Christopher Dodd, chairman of the Senate Banking Committee, last month pledged to move forward with his efforts to consolidate bank supervision into a single federal regulator.

The proposal has drawn criticism from current bank regulators who do not want to lose power, and is more sweeping than what the Obama administration has recommended.

Tuesday's letter to lawmakers, including Dodd and House Financial Services Chairman Barney Frank, will add to pressure on lawmakers to give up on the consolidation proposal.

Dodd has not yet introduced formal legislation for the consolidation.

His plan would consolidate the Office of the Comptroller of the Currency and the U.S. Office of Thrift Supervision into one regulator. It would also strip direct bank supervision powers from the Federal Deposit Insurance Corp and the Federal Reserve, transferring those powers to the new regulator."

The world's safest banks

Source: The World's 50 Safest Banks Global Finance, August 25, 2009

"With bank stability still high on corporate and investor agendas,Global Finance publishes its 18th annual list of the world’s safest banks. After two tumultuous years that saw many of the world’s most respected banks drop out of the top-50 safest banks list, the dust appears to be settling. Those banks that kept an iron grip on their risk exposure before the financial crisis blew up have consistently topped the table and maintain their standing among the top echelon in this year’s ranking.

The Top Banks (until you find a US bank):

  1. . KFW (Germany)
  2. . Caisse des Depots et Consignations (CDC) (France)
  3. . Bank Nederlands Gemeenten (BNG) (Netherlands)
  4. . Landwirtschaftliche Rentenbank (Germany
  5. . Zuercher Kantonalbank (Switzerland)
  6. . Rabobank Group (Netherlands)
  7. . Landeskreditbank Baden-Wuerttemberg-Foerderbank (Germany)
  8. . NRW. Bank (Germany)
  9. . BNP Paribas (France)
  10. . Royal Bank of Canada (Canada)
  11. . National Australia Bank (Australia)
  12. . Commonwealth Bank of Australia (Australia)
  13. . Banco Santander (Spain)
  14. . Toronto-Dominion Bank (Canada)
  15. . Australia & New Zealand Banking Group (Australia)
  16. . Westpac Banking Corporation (Australia)
  17. . ASB Bank Limited (New Zealand)
  18. . HSBC Holdings plc (United Kingdom)
  19. . Credit Agricole S.A. (France)
  20. . Banco Bilbao Vizcaya Argentaria (BBVA) (Spain)
  21. . Nordea Bank AB (publ) (Sweden)
  22. . Scotiabank (Canada)
  23. . Svenska Handelsbanken (Sweden)
  24. . DBS Bank (Singapore)
  25. . Banco Espanol de Credito S.A. (Banesto) (Spain)
  26. . Caisse centrale Desjardins (Canada)
  27. . Pohjola Bank (Finland)
  28. . Deutsche Bank AG (Germany)
  29. . Intesa Sanpaolo (Italy)
  30. . Caja de Ahorros y Pensiones de Barcelona (la Caixa) (Spain)
  31. . Bank of Montreal (Canada)
  32. . The Bank of New York Mellon Corporation (United States)


The FBIIC is chartered under the President's Working Group on Financial Markets, and is charged with improving coordination and communication among financial regulators, enhancing the resiliency of the financial sector, and promoting the public/private partnership. Treasury's Assistant Secretary for Financial Institutions chairs the committee.

The National Information Center (NIC) is a central repository of data about banks and other institutions for which the Federal Reserve has a supervisory, regulatory, or research interest, including both domestic and foreign banking organizations operating in the United States. This web site provides access to NIC data, allowing the public to search for detailed information about banking organizations.

Analysis and discussion with Chairman of the Federal Deposit Insurance Sheila Bair. She says there's a lot of common ground in terms of overarching goals but there are different ways to approach different aspects of these issues.

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