It appears that no one likes "too big to fail" too much these days.
After a year that has seen increasing support for radically reshaping the banking industry, a new bipartisan bill called the Terminating Bailouts for Taxpayer Fairness Act to put additional regulations on banks so large that they would threaten the global financial system was unveiled this week by Sens. David Vitter, R-La., and Scott Brown, D-Ohio.
"Today, Sen. Vitter and I are presenting bipartisan legislation that will present Wall Street megabanks with a clear choice: Either have enough of your own capital to cover potential losses, or downsize until you are no longer a risk to taxpayers," Brown said at a press conference.
The bill is mostly concerned with making sure banks have enough capital in the form of equity (stock and retained earnings) to cover losses from bad assets such as unpaid mortgages in the event of another big economic downturn. It would scrap a more complex international Basel III framework in favor of simple hard minimums for equity cushions at banks, depending on their size.
"We've defined what capital to focus on. We set minimum requirements, but we also, I think importantly focus on common equity and other truly loss-absorbing capital, and we move away from this hyper-complicated, risk-weighted system that is very easy to be gamed," Vitter said.
For banks with less than $50 billion in assets, regulators would set a cushion at their discretion. Regional banks with assets of $50 billion to $500 billion would have a cushion of 8 percent. Megabanks with more than $500 billion in assets would have much larger required cushions of 15 percent or more.
That highest category really encompasses only four retail banks, JPMorgan Chase & Co., Bank of America, Citigroup and Wells Fargo, all of which would likely take a big hit to their profits from the increased equity requirements. That's because banks make a lot of their money by taking on lots and lots of debt, including some in deposits, which they then invest in large part by lending it out to consumers and businesses. Telling banks they need to keep a larger percentage of their balance sheet in equity in effect limits their ability to take on more debt and consequently their ability to make money.
That would be a stark contrast from recent years when large banks have grown and prospered, thanks to lower borrowing rates based on the belief by the market that taxpayers would step in to bail them out if they failed, Brown and Vitter said.
"The market knows that the government won't allow these big banks to fail," Brown said. "Since they won't fail, they can make riskier investments and lend money at a lower rate than regional banks and main street banks and credit unions."
So far, community banks have reacted positively to the bill. They have long been concerned about the potential impacts of Basel III, and Brown-Vitter would alleviate some of those concerns.
"ICBA applauds Sens. Brown and Vitter for advancing the debate to bring balance back to the financial services marketplace," said Bill Loving, ICBA chairman, CEO and president of Pendleton Community Bank in Franklin, W.Va., in a statement. "By imposing equity capital guidelines that are appropriately scaled to the size, scope and risk of the too-big-to-fail institutions, this legislation will reduce systemic risk, protect taxpayers and put our nation's community banks on a competitively balanced playing field."
It's hard to predict how the passage of Brown-Vitter would affect the landscape of the banking industry, said David O'Connell, a senior analyst at Aite Group.
For customers at banks in the top tier, any spinoffs or downsizing caused by the law may make managing their various accounts and services at those banks harder, O'Connell said.
"It'll get more confusing," O'Connell said. "It will be like all the weird names we have on our utility bills, and I can't figure out if it's electric or gas."
For customers at community banks, it may mean their banks are more likely to survive thanks to reduced competition from larger rivals, O'Connell said.
The question of Brown-Vitter's effect on the financial system as a whole is also an open question, said Cornelius Hurley, a professor and director of the Boston University Center for Finance, Law and Policy, in an email.
"The numbers set in Brown-Vitter are completely arbitrary and their consequences are unpredictable," Hurley said.
And while it's likely Brown-Vitter would take megabanks down a peg, regulators would get a lot more discretion over capital requirements at small banks, and that might be problematic, Hurley said.
Overall, O'Connell said, when it comes to regulation, simpler is also not necessarily better.
"It seems to be undoing a great deal of work the banks and regulators have been doing for the last couple of years," O'Connell said. "There's a dialogue that allows the banks and the regulators to get a view of that bank as it might look if things go wrong."
That dialogue will now be replaced by a more blanket approach that will inevitably leave some banks carrying more reserves than they need, and others, less, he says.
"It's this a terrible, brute-force rule of thumb that doesn't into account the particularities of the individual banks," O'Connell said.
What do you think of the proposal? Will this help to protect consumers?
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