United States: Section 165 Revisited - Rethinking Enhanced Prudential Regulations

Last Updated: July 29 2014
Article by Andrew Olmem

In a recent speech, Federal Reserve Governor Daniel Tarullo proposed a "rethinking" of the aims of prudential regulation for bank holding companies.1 With his remarks, Governor Tarullo has sought to initiate a debate on how a "more precise specification of prudential regulatory aims" could provide a basis for recalibrating regulation.2 This debate is especially timely and much needed with respect to the Federal Reserve's new enhanced prudential standards issued under Section 165 of the Dodd-Frank Act, which have transformed the nature and scope of bank regulation.

Yet as important as it is to reconsider the aims of Section 165, it is equally important to reconsider its means. Congress was very specific in prescribing how it intended the Federal Reserve to implement Section 165's enhanced prudential standards. Therefore, any debate on how to recalibrate them must be grounded in an understanding of the parameters imposed by the statute.

There also is a more fundamental reason to reexamine Section 165's requirements: the current approach differs sharply from the approach set out in the statute. This divergence has resulted in bank holding companies being subject to enhanced prudential standards based primarily on whether they satisfy an arbitrary asset threshold rather than on the risks they present. Accordingly, the implementation of Section 165's enhanced prudential standards deserves a second look.

This article examines the legislative history of Section 165, with the purpose of showing how the statute envisions the implementation of enhanced prudential standards. This legislative history has important implications for how enhanced prudential standards could be recalibrated to be not only more effective but also more consistent with the provisions of Section 165.

Overview of Section 165

Section 165 of Dodd-Frank requires the Federal Reserve to establish enhanced prudential standards for bank holding companies with $50 billion or more in consolidated assets.3 The Federal Reserve must promulgate enhanced prudential standards for: (1) risk-based capital requirements and leverage limits; (2) liquidity requirements; (3) overall risk management requirements; (4) resolution plans and credit exposure reports; (5) concentration limits; (6) risk committees; and (7) company stress tests.4 On a discretionary basis, the Federal Reserve may establish additional enhanced prudential standards.5

To implement Section 165, the Federal Reserve has issued a series of rules that mostly apply uniformly to bank holding companies that satisfy the $50 billion threshold. These rules have implemented not only the mandatory enhanced prudential standards under Section 165 but also the Federal Reserve's annual Comprehensive Capital Analysis and Review, or CCAR.6 Additional enhanced prudential standards also apply at other asset thresholds, including at the $250 billion (or $10 billion in foreign exposures), $700 billion (or $10 trillion in assets under custody), and, for foreign banking organizations, $50 billion in U.S. assets levels.7 The Federal Reserve is expected to issue additional rules using similar asset thresholds.8 This reliance on asset thresholds, however, is not the approach set forth in Section 165.

The Legislative History

The legislative history of Section 165 begins in the U.S. Senate Committee on Banking, Housing, and Urban Affairs ("Senate Banking Committee"). The provision originated as Section 165 of legislation, S. 3217, the Restoring American Financial Stability Act of 2010 ("RAFSA"), passed by the Senate Banking Committee on March 22, 2010.9 The provision was amended several times by Congress, but ultimately became Section 165 of Dodd-Frank. The key legislative history lies in how Section 165 was incorporated into RAFSA, but, to fully understand this history, it is first necessary to understand the influence of Senate Banking Committee Chairman Christopher Dodd's discussion draft proposal of November 2009 ("Dodd Discussion Draft").

Dodd Discussion Draft

As Congress began considering financial regulatory reform during the 111th Congress, Chairman Dodd's initial proposal was the Dodd Discussion Draft.10 Its central reform was consolidation of all prudential regulation into a single regulator, the Financial Institutions Regulatory Administration ("FIRA").11 This restructuring of financial regulation was designed to streamline financial regulation, as well as to discipline federal banking regulators for their perceived regulatory failures in the lead-up to the financial crisis of 2008.

The Dodd Discussion Draft also would have created the Agency for Financial Stability ("AFS"), which would have been responsible for designating any financial company (whether a bank holding company or nonbank financial company) whose "material financial distress" would "pose a threat to the financial stability of the United States or the United States economy during times of economic stress."12 Any designated company would have been subject to enhanced prudential standards set by the AFS. These enhanced prudential standards would have been required to be "more stringent than [the standards] applicable to financial companies that do not present similar risks to United States financial system stability and economic growth" and to "increase in stringency with the size and complexity" of the designated financial company.13

In devising enhanced prudential standards, the AFS also would have had to take into account a long list of specific factors, including "the amount and types of the liabilities of the company"; "the amount and nature of the financial assets of the company"; "the extent and type of the off-balance-sheet exposures of the company"; the company's relationships with other major financial companies; and its ownership of any clearing, settlement, or payment businesses.14 As this list demonstrates, these enhanced prudential standards were supposed to reflect a variety of factors, rather than just the amount of assets held by a designated company.

Although the Dodd Discussion Draft failed to garner sufficient support and was never voted on by the Senate Banking Committee, its provisions for streamlining financial regulation under FIRA and its approach to enhanced prudential standards laid the foundation for Section 165.

RAFSA

After abandoning the Dodd Discussion Draft, Chairman Dodd scaled back his reforms and proposed RAFSA in March 2010. Nevertheless, Section 165 of RAFSA reflects many of the same approaches and goals of the Dodd Discussion Draft.

Under Section 165 of RAFSA, the Federal Reserve, like the AFS under the Dodd Discussion Draft, was required to establish enhanced prudential standards for certain financial companies. Section 165 explicitly sets forth the aim of these enhanced prudential standards: "to prevent or mitigate risks to the financial stability of the United States that could arise from the material distress or failure of large, interconnected financial institutions."15

RAFSA also established the Financial Stability Oversight Council ("FSOC") and made it responsible for designating the nonbank financial companies that would be subject to Section 165's enhanced prudential standards.16 Unlike the AFS under the Dodd Discussion Draft, however, the FSOC was authorized to designate only nonbank financial companies because RAFSA explicitly provided that Section 165 applied to all "large, interconnected" bank holding companies with consolidated assets of $50 billion or more.17

The $50 Billion Threshold

What was the rationale for the $50 billion threshold? In isolation, it seems very arbitrary and over-inclusive. The reason is that the $50 billion threshold was not designed to identify companies that pose risks to financial stability but rather to advance two other objectives of RAFSA.

First, RAFSA sought to continue the Dodd Discussion Draft's goal of streamlining prudential supervision. However, unlike the Dodd Discussion Draft, which would have eliminated entirely the Federal Reserve's jurisdiction over bank holding companies, RAFSA instead would have reduced the Federal Reserve's jurisdiction to only bank holding companies with consolidated assets of $50 billion or more.18 All other bank holding companies were to be regulated by the primary regulator of their depositories, either the OCC or the FDIC.19

According to the Senate Banking Committee Report on RAFSA, the Federal Reserve's jurisdiction over bank holding companies was set at the $50 billion threshold because data demonstrated that "in almost all instances of banking organizations with less than $50 billion in assets, the vast majority of assets are in the depository institution."20 The aim was to have the Federal Reserve regulate bank holding companies that had securities, insurance, and other nonbank activities and to consolidate the regulation of bank holding companies that had few or no nonbank assets under the OCC or the FDIC. By doing so, RAFSA sought to "enhance the accountability of individual regulators," "reduce the regulatory arbitrage in the financial regulatory system," "reduce regulatory gaps in supervision," and limit the regulatory burden on industry.21 As this report language reveals, the $50 billion threshold was not intended to separate companies based on whether they presented risks to financial stability. Indeed, the Committee Report states that the Federal Reserve's jurisdiction would "include, but not be limited to, those companies whose failures potentially pose risk to U.S. financial stability."22

Because the $50 billion threshold included companies that do not pose risks to financial stability, its use in Section 165 also served a second objective of RAFSA: blunting criticism that any company subject to enhanced prudential standards would be considered systemically significant. Borrowing the $50 billion threshold established for allocating bank holding company regulation advanced this objective because, as noted above, the threshold was not established to determine whether a company presents risks to financial stability. In other words, Section 165 could apply to any "large, interconnected" bank holding company regulated by the Federal Reserve. As a result, it covered companies with a range of risk profiles. By then requiring that the Federal Reserve employ a "graduated approach" in implementing Section 165's enhanced prudential standards to this broad group (see below), RAFSA "intended to avoid identification of any bank holding company as systemically significant."23

These rationales for the $50 billion threshold have been obscured because, during the full Senate's consideration of RAFSA, an amendment (the Hutchison- Klobuchar Amendment) was adopted that restored the Federal Reserve's jurisdiction over all bank holding companies.24 As a result, the $50 billion threshold in Section 165 was no longer congruent with the Federal Reserve's holding company jurisdiction. Because Section 165 was not amended to reflect this change, it has permitted an inference, not supported by the record, that Dodd-Frank deemed any bank holding company with consolidated assets above $50 billion to be systemically significant.

To read this article in full, please click here.

Originally published by The Clearing House's Banking Perspective.

Footnotes

1. Daniel k. tarullo, Member, Board of Governors of the Federal reserve System, Rethinking the Aims of Prudential Regulation, remarks to the Federal reserve Bank of Chicago Bank Structure Conference, Chicago, IL (May 8, 2014) (Hereinafter tarullo (2014)).

2. Id. (He suggested that these aims should include protecting the deposit insurance fund, macroprudential aims and financial stability.)

3. Section 165 also applies to designated nonbank financial companies. Because the designation of, and application of enhanced prudential standards to, nonbank financial institutions raises numerous and complex issues unrelated to bank holding company regulation, this article focuses solely on the application of Section 165 to bank holding companies.

4. Dodd-Frank Act § 165(a), (h)(2), and (i)(2)(C).

5. Section 165(b)(1)(B) explicitly provides for discretionary standards on contingent capital requirements, enhanced public disclosures, and short-term debt limits.

6. See Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations, 79 Fed. Reg. 17,240 (Mar. 27, 2014).

7. See id. and Regulatory Capital Rules, 79 FR 24528 (May 1, 2014).

8. See Daniel K. Tarullo, Member, Board of Governors of the Fed. Reserve System, Dodd-Frank Implementation, Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate (Feb. 6, 2014).

9. Available at http://www.gpo.gov/fdsys/pkg/BILLS-111s3217pcs/pdf/BILLS-111s3217pcs.pdf. Restoring American Financial Stability Act of 2010, S. 3217, 111th Cong. (2010) (Hereinafter "RAFSA").

10. Available at http://www.llsdc.org/assets/DoddFrankdocs/bill-111th-s3217-discussion-draft.pdf (Hereinafter "Dodd Discussion Draft"). The formal title of the Dodd Discussion Draft was the "Restoring American Financial Stability Act of 2009."

11. Dodd Discussion Draft, Title III.

12. Dodd Discussion Draft §105.

13. Dodd Discussion Draft §107(a).

14. Dodd Discussion Draft §107(b)(3).

15. RA FSA § 165(a)(1) (this language was revised by the conference committee to also cover such risks arising from "ongoing activities" of these institutions). This language also largely mirrors the aim of enhanced prudential standards under the Dodd Discussion Draft § 107.

16. RA FSA § 111; § 113.

17. RA FSA § 312(a).

18. RA FSA § 312.

19. RA FSA § 313 eliminated the Office of Thrift Supervision.

20. T he Restoring American Financial Stability Act of 2010, S. Rep. No. 111-76, at 25 (2010) (Hereinafter "Committee Report").

21. Id. at 23, 25.

22. Id. at. 23.

23. Id. at 2.

24. Senate Amendment No. 3759, 111th Congress.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions