• The Regulation of Depository Institutions: Seismic Change Coming?
  • April 1, 2009 | Authors: Joseph P. Daly; Paul M. Aguggia; Christina M. Gattuso
  • Law Firm: Kilpatrick Stockton LLP - Washington Office
  • Except for the elimination of the Federal Home Loan Bank Board and Federal Savings and Loan Insurance Corporation and the creation of the Office of Thrift Supervision in 1989, the basic structure of the U.S. bank regulatory system, developed in a patchwork of legislation dating back to 1863, has remained unchanged since the 1930’s. That is true despite numerous comprehensive reorganization proposals from government, academic and business sources over the years including, most recently, one from former President George W. Bush’s Treasury Department. None, however, saw the light of day. Despite near universal recognition that the existing system has flaws, a comprehensive restructuring plan never advanced very far for a variety of reasons. Those include a feeling of “if it ain’t broke, don’t fix it” and a recognition that any restructuring effort would be hampered by bureaucratic in-fighting among federal and state regulatory agencies in an effort to preserve or increase their roles.

    With the existing economic crisis, and turmoil in the financial services industry, it appears that significant regulatory restructuring will finally occur, as many have concluded that the system is broken and no longer works. President Obama has said that updating the financial regulatory system is one of the top legislative priorities of his administration. Senator Christopher Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, recently pledged “an intensive schedule of hearings, briefings and meetings to modernize our financial regulatory system.” The Chairman of the House Committee on Financial Services, Barney Frank, has indicated he intends to pursue restructuring of financial services regulation in two steps: first, the big picture issue of the creation of a systemic risk regulator and, second, the question of how to modernize the agencies that currently regulate the financial services industry. So it appears that the financial services regulatory system that bankers have become so used to is in for a substantial overhaul.

    The concept of a “systemic risk regulator” has been advanced by numerous officials and commentators. Such a regulator would be responsible for dealing with threats to the entire financial system rather than individual components. Presumably, such a regulator would have authority across all financial services sectors including banking, capital markets and insurance and the entire issue of “too big to fail” is an integral component of systemic risk. A related concept is the possible designation of an agency that would resolve failed financial firms that pose systemic risk, similar to the way in which the Federal Deposit Insurance Corporation (“FDIC”) resolves failed banks or savings associations. Both the Federal Reserve Board (“FRB”) and the FDIC have been mentioned as possibilities for a systemic risk role.

    Then there is the issue of day to day regulation of financial services companies themselves. The clamor to modernize the financial services regulatory system, both as to matters of safety and soundness and global competitiveness of U.S. financial companies, has grown over the past decade. The existing economic crisis has created a sense of urgency that is likely to trump all of the typical arguments for the status quo and stifle the regulatory turf battles that have arisen in the past. The current framework of multiple federal depository institution regulators with overlapping jurisdiction appears unlikely to survive.

    On March 19, the Senate Banking Committee held a hearing to solicit the views on restructuring of the current depository institution regulators. As would be expected, a wide variety of views and proposals were presented.

    Comptroller of the Currency Dugan noted that making the FRB the systemic risk regulator made sense in view of the FRB’s current role, but questioned if doing so would place too many functions and too much authority in one agency. Comptroller Dugan was not in favor of making the FDIC the authority to resolve systemically important nonbanks, citing the FDIC’s bank-centric mission. He also argued for preserving the FRB’s role as bank holding company regulator, to continue the FRB’s window into the banking industry in view of its monetary policy function, and for retaining a separate dedicated prudential bank supervisor at the federal level.

    FDIC Chairman Bair noted the difficulties caused under present law by the FDIC not having receivership authority over a failed bank’s holding company and affiliates but only over the bank itself. She also stressed the need for a special resolution process outside bankruptcy for financial firms that pose systemic risk, just as there is for insured depository institutions, and suggested that forming a new agency to perform that function may not be economic or efficient. She cautioned that the creation of a systemic risk regulator would not, in and of itself, prevent a future systemic crisis but would rather depend upon the willingness to use its authority effectively and aggressively. Further, she suggested that Congress should examine the “fundamental question” of whether there should be limits on the size and complexity of systemically significant financial companies.

    FRB Governor Tarullo stressed the need for a comprehensive supervisory framework, similar to the Bank Holding Company Act, for all systemically significant financial firms. Like FDIC Chairman Bair, he called for a resolution regime outside bankruptcy for systemically important financial organizations including bank holding companies. He expressed the belief, as FRB Chairman Bernanke has before, that the FRB, as central bank, would at least need to be involved in identifying and addressing systemic risk if it was not itself the systemic risk regulator.

    North Carolina Banking Commissioner Smith, representing the Conference of State Bank Supervisors, argued against the consolidation of financial regulation at the federal level, instead suggesting a coordinated system of state and federal supervision. Commissioner Smith also called for a bifurcated regulatory system whereby systemically important institutions would be much more stringently regulated than less complex regional and community banks. He also urged Congress to eliminate federal preemption of state consumer protection laws as to federally chartered banks and savings associations.

    Acting Office of Thrift Supervision Director Polakoff supported the creation of a systemic regulator. He also advocated establishing two depository institution regulatory agencies at the federal level, one to charter and supervise depository institutions of all sizes that primarily engage in providing products to consumers and communities and one to charter and regulate entities that primarily provide services to commercial enterprises. The two agencies also would be the primary federal regulator for state chartered depository institutions that primarily engage in the functions within their jurisdictions and would also have regulatory authority over non-depository institutions that engage in similar activities. Holding companies would be regulated by one of the two agencies depending upon the activities of the largest institution within the holding company structure. Acting Director Polakoff also noted that the mutual form of organization should continue to be available.

    National Credit Union Administration Chairman Fryzel argued that the credit union industry was generally strong and that credit unions should retain a distinct regulator and deposit insurer.

    The restructuring process raises numerous questions for bankers who have been used to, if not entirely satisfied by, the existing regulatory system. Will the FRB’s role as regulator of bank holding companies be eliminated in favor of it becoming the systemic risk regulator? Will depository institutions continue to be regulated by charter or will they have separate regulators based on their sizes or lines of businesses? Will the roles of the states in banking regulation be diminished? Will the Office of Thrift Supervision and the Office of the Comptroller of the Currency be merged? Exactly what agency or agencies will be responsible for day to day depository institution regulation at the federal level? Will there continue to be multiple federal depository institution charters available or will there be a single uniform charter? Will the FDIC continue as a bank regulator or become solely a deposit insurer? Will the FDIC take on a broader role of resolving failed systemically significant financial firms in addition to depository institutions? Will legislators be sensitive to the concerns of organizations that are in the mutual structure or will such institutions be harmed by a failure to recognize their unique characteristics? Will there be a separate regulatory and examination authority for consumer compliance laws? Will credit unions continue to be insured and regulated at the federal level by a separate agency or will they be brought into an overall streamlining effort? How will nondepository lenders be regulated? Those issues relate only to the narrow topic of depository institution regulation without even considering the changes that may occur in the regulation of other financial services such as investment banking, capital markets, commodities markets and insurance.

    Depository institutions of all types, sizes and characteristics have every reason to be extremely attentive to ongoing legislative developments concerning financial services regulatory restructuring. Today’s bankers have never experienced regulatory changes such as those that are likely to arise from this restructuring process.