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FDIC Vice Chair Proposes Partitioning of Nonbanking Activities

Scott.Cammarn@cwt.com's picture
Commentary by Scott Cammarn

In remarks delivered at the Institute of International Bankers Annual Washington Conference, FDIC Vice Chair Thomas Hoenig (i) proposed a major alteration to the organization of financial holding companies ("FHCs") that are engaged in both "traditional" banking and "nontraditional" financial activities, and (ii) theorized that this approach could lead to a significant reduction in the regulations that would apply to traditional banking activities and nontraditional financial activities.

Under the proposal as outlined in a "Term Sheet" issued by Vice Chair Hoenig, a Financial Holding Company ("FHC") would have two intermediate holding companies – a bank intermediate holding company ("BIHC") and a nontraditional intermediate holding company ("NIHC") – which would be owned by the FHC. All non-traditional banking activities ("NTBAs") would be pushed into the NIHC. NTBAs would include acting as a broker-dealer, investment adviser, swap dealer or security-based swap dealer, merchant banking entity, or sponsor of private funds or securitizations. "Traditional" banking activities would be "limited to the 'business of banking' (as traditionally conceived)." Under the Vice Chair's proposal, certain regulatory restrictions would apply to the NIHC. For instance, an entity would have to be capitalized separately, have a liquidity requirement, and be subject to bankruptcy resolution.

There also would be affiliate transaction restrictions between the NIHC and BIHC entities, with the amounts to be determined by the capital and surplus of not only the bank (which is the current standard) but also the NIHC entity. For all practicable purposes, this means that an NIHC entity could enter into certain transactions with a bank affiliate if those transactions represented a fraction of the bank and the NIHC entity's capital.

Additionally, all capital requirements would be migrated to a 10% leverage test (instead of the risk-based capital standard). Volcker proprietary trading restrictions would continue to apply to the NIHC, but in a new formulation (based on a "trader mandate").

The proposal theorizes that each of the two types of holding companies and their subsidiaries would be subject to substantially reduced regulation. For example, the Vice Chair indicated this revised structure could eliminate the requirement for the development of certain stress testing, risk-based capital requirements, liquidity coverage ratios, and living wills.

Vice Chair Hoenig noted that the proposal contemplates a three-year period in which to restructure and separate the nontraditional banking activities, and a multi-year period in which to meet enhanced capital requirements.

Commentary

Vice Chair Hoenig's proposal would require push-out of certain activities that have long since been performed in a bank or bank subsidiary, including securities brokerage, investment advisory, Futures Commission Merchant, and swap dealing activities. Several of these activities are "agent" activities and it is unclear how or why the push-out of these activities would substantially reduce systemic risk. The other activities proposed for push-out – including merchant banking, securities dealing and underwriting, and insurance underwriting – already are pushed out of the banking structure into the holding company structure. The enhanced restriction on affiliate transactions and the separate capitalization requirements effectively mean that the banking and nonbanking arms of the FHC would be run as two largely standalone entities operating under a common brand.

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