The Pricing of Greatness

Credit: Federal Reserve Bank of Dallas - Q2 2012

Even within the population of 12 U.S. megabanks, as defined in the Fed's infographic above, there is a deep gorge between the on-balance sheet asset size of the big four commercial bank holding companies (BHCs) in the United States (JPMorgan Chase & Co., Bank of America Corp., Citigroup, Inc., and Wells Fargo & Co.) and the rest of the six commercial banks in U.S banking's top ten.  You could add the total assets of the banking companies from the fifth position through the tenth position and they would best Wells Fargo & Co, but only tie with Citigroup, Inc. 

At 9/30/2013, JP Morgan Chase & Co led the heavyweight division at $2.5 trillion in reported assets;  Bank of America Corp. tipped the scales at $2.1 trillion;  Citigroup, Inc. was at $1.9 trillion; and Wells Fargo & Co. followed with $1.5 trillion. The combined assets of all of the rest of the banks in U.S. banking's Big Ten - Bank of New York Mellon Corp. ($372B), U.S. Bancorp ($361B), HSBC North America Holdings ($309B), PNC Financial Services Group ($309B), Capital One Financial Corp. ($290B), and TD Bank US Holding Co. ($232B) - totaled $1.9 trillion.

My list differs from the Fed's official BHC list because mine has been adjusted to exclude the bank holding companies for the entities that are primarily investment banks, insurers, or commercial finance companies.  Those would be:  The Goldman Sachs Group ($923B),  Morgan Stanley ($832B), American International Group ($541B), and General Electric Capital Corporation ($529B).

The commercial banking industry is more concentrated now than it was at the beginning of the most recent financial crisis.  By one account, the largest banks, as a group, have become 37% larger owing to the effects of financial crisis emergency bank mergers, on one hand, and the shrinkage of the number of banks as a group, as a result of banks that were allowed to fail and the dearth of new de novo banks, on the other hand.

We are rightly preoccupied and mesmerized today with the remaining Dodd-Frank Act implementing regulations.  The context of our present focus on the issue of banking market concentration is on how it is related to Too-Big-to-Fail (TBTF).   But the market concentration statistics outlined above may also give us an inkling of an emerging industry battleground once Dodd-Frank becomes a rear-view mirror issue - the oligopolistic market pricing power of the megabanks and how they could use that pricing power to turbocharge their own organic growth at the expense of their competitors, the regional and community banks.

Remember that Section 622 of the Dodd-Frank Act established a financial sector concentration limit that prohibits, with only a few very specific exceptions, banking mergers and acquisitions if the resulting company would exceed 10% of the aggregate consolidated liabilities of all financial companies.  The Dodd-Frank concentration limit does not limit internal growth (nor does the Riegle-Neal nationwide deposit cap).  This means, for the largest banks, domestic growth by acquisition is out and organic growth is in.  We cannot dismiss the potential for the muscular use of pricing power as a lever for driving organic growth in our largest banks.

Market pricing power, in an oligopolistic marketplace, is a two-sided coin.  On one side, price increases by the dominant players in a market give competitors an opportunity to "free ride" by tacitly matching the increases, or alternatively, possibly build market share, by declining to match a price increase.  This is the situation we have today in the airline industry.  Shopping airline tickets among airlines is a pretty efficient, automated process, so tangible small-yardage market share gains are there to be had for those who decline to match the price increase.  That's why unmatched airfare increases usually cause the airline initiating the price increase to shortly roll it back.

In banking, at least on the transaction deposit-taking side of the business (the fulcrum of the typical full-service banking relationship), moving one's business has always been a bit of a hassle for a customer, made more so these days with the "stickiness" created by the advent of direct deposit, debit card loyalty programs, electronic bill pay, and ATM fee rebate add-ons.  Let's add to that list the primordial allure of monthly cash payments, like that offered by the much twittered-about new Santander plus $20 account.  With minor prospects for significant market share increases due to this marketplace "friction", price increases by the dominant players in banking may be more likely to be matched than not.

For the regional and community bank competitors that's the happier side of the two-sided coin.  Slow, incremental, price increases initiated by the dominant players, and tacitly matched by other banks, could provide the entire banking industry with wider, more comfortable, operating margins to help deal with increasing regulatory burden.  

It's the other, dark side, of the coin that community banks, in particular, may need to fear and be very alert to in the years ahead.  The dark side of the coin is predatory pricing.  Predatory pricing occurs when a dominant company, or group of dominant companies, either complicitly or tacitly, try to push product prices low enough to drive smaller rival firms out of the market or a smaller segment of it.

One bank's predatory pricing strategy is another bank's "targeted promotion" campaign, right?  It is not inconceivable to think about geographically-targeted price discrimination driven, in part, by Dodd-Frank Section 622 limitations.

Here's a hypothetical... Aided by the benefits of big data and the help of brainy quantitative financial engineers, a dominant megabank player could couple a predatory pricing strategy with a dedicated staff of hundreds of account transfer concierges (to help overcome the stickiness and friction in the customer account transfer process).  You now have the recipe for a barely-perceptible, but potentially highly effective, geographic locality-by-locality process of creating organic growth for the megabanks through a pricing war of attrition.

Once an acceptable level of dominance is established in one geographic area --- the political optics of the process require that token competition is left behind --- the effort marches on to new territory.  To avoid the perception of a pattern, desirable target geographies are randomized.

Just a point to ponder about potential post-financial crisis megatrends in our industry, as you cradle a Christmas eggnog in hand while sitting in your comfortable armchair before the crackling fireplace.  Is the plausible dark side scenario unimaginable?  Let's hope so.

Price surveillance should be a new frontier in terms of data collection by bank regulators, as bank geographic product pricing behavior is presently opaque because it is proprietary.

He Can be Boston Proud...

...of the fine work produced in such a short time by the authors of the International Peer Review of OCC Supervision of Large and Midsize Institutions.  Hailing from the Commonwealth of Massachusetts, Comptroller of the Currency, Tom Curry, now has the opportunity to reflect, in the operations of the agency he leads, the example of resolute resilience and courage (as exemplified by Boston's 2013 post-Marathon experience) and the 'roll up your sleeves' hard work of reestablishing the preeminence of a major league championship team (in the tradition of the 2013 World Champion Boston Red Sox).  All without growing a beard, if he chooses not to.

Last month, the National Bank Examiner ran a story called From Hubris to Humility, applauding the Comptroller's efforts to improve the post-financial crisis bank supervision process for large and midsize national banks by initiating a third-party peer review by highly respected members of the global bank supervision community.  Today, Comptroller Curry released the report to the public and also formally accepted it on behalf of the Office of the Comptroller of the Currency (OCC).  

While prudently keeping his options open regarding the specifics of implementation, he set a goal of having implementation plans in place within 120 days.  I say prudently, because in government life, it is in the details where you find all of the devils of frustration and many of the speed bumps.

The 23-page report of the International Peer Review of OCC Supervision of Large and Midsize Institutions endorsed several of the bank supervision initiatives taken by the OCC since the financial crisis and emphasized the importance of their effective implementation across the agency.  The authors also noted the highly motivated, experienced, and professional staff who were "eager to respond promptly and fully to the numerous questions posed" by this outside third-party review team. 

The peer review team made seven key recommendations:

1. Revise the mission and vision statements and the strategic goals to make safety and soundness of institutions the OCC’s primary objective, consistent with compliance with applicable laws and regulations, including those regarding fair access and fair treatment of customers.

2. Enhance risk identification by expanding the role of Lead Experts (LEs) and ensuring that they have the capacity to provide meaningful input into the supervision of large institutions through review of examination papers and through the initiation of horizontal reviews.

3. Better integrate the systems for assigning supervisory ratings to institutions (CAMELS ratings) and the Risk Assessment System (RAS), make examination ratings more forward-looking, and devise a more flexible approach to the consequences of certain ratings downgrades.

4. Move examination teams and subject matter experts from individual bank locations to shared OCC offices in the field, where practicable, to improve internal communications, sharing of information among examination teams, and workforce flexibility. This will facilitate horizontal supervisory reviews and help to address staffing shortfalls, particularly in specialized skill areas, by allowing specialists to work on several institutions over a shorter period of time.

5. To further address staffing shortfalls, devise a program to use retirement-eligible staff as mentors and explore how to accelerate the integration of private sector experts into the examination force.

6. Enhance the scope and consistency of supervisory planning, risk assessment and intervention by enhancing the existing peer review process to involve all relevant Examiners-in-Charge (EICs) and Lead Experts, and by elevating key supervisory decisions such as material acquisitions to the Committee on Bank Supervision (CBS) and/or Major Matters Supervisory Review Committee (MMSRC).

7. Ensure that the Enterprise Governance function commences its proposed work on documentation of quality management practices as soon as possible and that the OCC utilizes this to determine the standard and consistency of practices it wishes to put in place across the agency.

While, on the surface, these recommendations look rather straightforward, a few, in fact, create existential angst.  For example, the first recommendation of setting the safety and soundness of institutions as OCC's primary objective.  Well, it's going to be interesting to see if OCC is any more successful in redefining its dual mandate - charter and supervise - as the Federal Reserve has been in redefining its dual mandate of price stability and full employment.  A marketplace-responsive and technology-sensitive national bank charter is a key component in the architecture of keeping banks, like ships, "centered in the channel" and for helping keep the "shadows" out of shadow banking.   A potentially sclerotic national bank charter, made so by mission redefinition, could be as much a danger to systemic financial stability as any possible neglect of bank supervision responsibilities.

OCC's own dual mandate is one reason why I urged last year that the Comptroller consider upgrading of the OCC's Licensing function to Executive Committee status in the National Bank Examiner story entitled License to Heal.

The remaining peer review report recommendations abound with complicating issues, but they are all fundamentally sound.  In fact, some restate longstanding, seemingly intractable, internal concerns.  Hopefully, these report recommendations can be implemented with a minimum of bureaucracy while retaining, and not diffusing, accountability.

A couple of incidental observations on the peer review report:

Interestingly, it seems that the innovative way now-Senior Deputy Comptroller Jennifer Kelly and Deputy Comptroller Bill Haas built the framework of supervision for midsize banks (literally a start-up operation several years ago) shows it to be a better model for large bank supervision rather than vice versa.

Again, through this report, we have a clarion call to revisit the CAMELS rating system, or more properly, the Uniform Interagency Financial Institutions Rating System (UIFIRS).  Getting the federal bank regulatory agencies to sit down and make this rating system responsive to modern risk management and preventive intervention principles seems like trying to make peace in the Middle East.  Adopted 34 years ago, in November of 1979,  and only lightly tweaked since, the UIFIRS is ripe for a sorely needed overhaul (or perhaps a re-imagining, replacing, and scuttling the old system after some statutory linkages are severed).

I echo the Comptroller's thanks to Jonathan Fiechter and his team of global bank supervision experts for creating a quality report within the time-frames established.  It is a template for change for the better.

From Hubris to Humility

It was April 25, 1991.  Senior regulators from all of the federal bank regulatory agencies met at the Fairmont Hotel in Dallas, Texas to discuss what began as the Savings and Loan Crisis but morphed into a general banking crisis that lasted from the late 1980's through the early 1990's.  A key speaker at this meeting was the fiery and plain-speaking Federal Deposit Insurance Corporation (FDIC) Chairman, L. William "Bill" Seidman.  I was in the audience that day in my capacity as Deputy Comptroller of the Currency for Compliance Management.

With great thanks to the curators of the L. William Seidman papers special collection at the Grand Valley State University, I was able to obtain both his typed talking points that day and his handwritten notes.  His talking points and notes provide a point-in-time, behind-the-scenes view of that banking crisis from a top regulator's perspective.

He leads off his talking points by saying that "supervision has failed."  

"Supervisors in Crisis [all emphasis is his] --- perhaps is identity crisis.  From insurers' viewpoint, supervision has failed.  S&L---the bank insurance fund has become insolvent."

Interestingly, his handwritten notes say "supervision has not cut the failed" 

And I vividly remember his departure from the text of those initial remarks when he bitingly said to the group:

"I'm standing here, as the FDIC Chairman, with a busted insurance fund.  What I really want to know is:  If you guys are so good, why did things get so bad?"

The group of senior federal bank regulators remained respectfully quiet, but one could discern that a very sensitive nerve had been struck.  However, whatever contemplative self-reflection or introspection took place among the senior bank regulators assembled, in the face of Bill Seidman's acerbic challenge, seemed to dissolve by the time the evening cocktail reception rolled around.

His talking points and notes can be accessed here:  seidmanspeech.zip  (Note: some corporate firewalls will block access to Google Drive.  You may need to use your personal computer, tablet, or smartphone.)

Fast-forward to the 2008 financial crisis and the Great Recession.  Many of the points made by Bill Seidman in 1991 and later, similar points made by a highly-respected Senior National Bank Examiner with the Office of the Comptroller of the Currency (OCC), Emory "Wayne" Rushton, in 1996, went, if not unheeded, at least insufficiently considered and executed by the state and federal regulators up until the financial crisis.

The majority Report of the Financial Crisis Inquiry Commission (FCIC) concluded, in part:

"We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation's financial markets.  The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves."

...and which of the sentries drew the short straw in the Dodd-Frank Act and was thrown into the smoldering crater of the volcano to appease the angry gods?  The Office of Thrift Supervision was abolished by the Act.

Reading Bill Seidman's remarks in 1991, the wise words of  Wayne Rushton in 1996, and the FCIC conclusions in 2011, you can understand the colloquial definition of insanity as it applies to banking supervision: doing the same thing over and over, expecting to get different macroeconomic results.

There was/is something still not right with the model of banking supervision and regulation in its present incarnation and as presently practiced by state and federal banking regulators.  Particularly as that model has been applied to the largest banks in the U.S. banking system.

Looking Forward

Enter Thomas J. Curry, sworn in as the 30th Comptroller of the Currency in April 2012 after having been a member of the Board of Directors of the FDIC since 2004.  He sports a strong resume as a former Commissioner of  Banks for the Commonwealth of Massachusetts for many years.

Not a (socioeconomic) climate change denier, shortly after his arrival he assembled his senior executive team to produce eight strategic initiatives within a program called: One Vision - A Stronger OCC.  The initiatives are: aligning, supervising, leading, funding, connecting, engaging, messaging, and assessing.

The last strategic initiative - assessing - deals with building consistent and disciplined processes for self-assessment and self-improvement.  The comptroller spoke of this eighth strategic initiative recently at the American Banker Regulatory Symposium on September 23, 2013.

He spoke of strengthening internal quality assurance processes and publicly unveiled an effort "for senior supervisory personnel from three countries that exhibited great resilience during the financial crisis—Australia, Singapore and Canada—to participate in an independent peer review of the process we use for the supervision of large banks and thrifts..."

Leading the independent peer review effort is Jonathan Fiechter, a former Senior Deputy Comptroller at the OCC with broad bona fides across the Federal Government and with experience at the International Monetary Fund and at the World Bank.

"Assisting Jonathan in the review will be Ted Price, recently retired Deputy Superintendent for Canada's Office of the Superintendent of Financial Institutions (OSFI), Keith Chapman, Executive General Manager, Diversified Institutions, the Australian Prudential Regulatory Authority (APRA), Teo Swee Lian, Deputy Managing Director, Financial Supervision, the Monetary Authority of Singapore (MAS), and Brigitte Phaneuf, Managing Director, Supervision Sector, OSFI...  The review team is scheduled to begin their onsite work in mid-October 2013 with their analysis completed by the end of November 2013. [OCC System News - 9/20/2013]"

This effort, maybe more than any of the projects associated with the eight strategic initiatives, holds the promise and the potential to make organic, constitutional changes to a bank supervision model that hasn't undergone a self-initiated third-party review since Comptroller Jim Smith, almost four decades ago and in the wake of several national bank failures, engaged the accounting and consulting firm of Haskins & Sells to review OCC supervision processes in 1975.

The findings of this independent peer assessment effort could be evolutionary, possibly revolutionary, but, given the experiences of the 2008 financial crisis, will definitely not be stationary for the supervision of our largest banks.  Let's see how Comptroller Curry rolls out the results of this independent assessment effort over the next couple of months.

Strategic Initiatives: There Will Be Speed Bumps

As for all comptrollers of the currency, time is not on Tom Curry's side.  The biggest risk to effective, lasting, and legacy-defining change at the OCC has always been the inexorable and relentless daily countdown to the end of a comptroller's five-year term of office.  The payoff, though, is that the vast majority of OCC staff will welcome and embrace recognizable change for the better.

But there will be a small minority, some in key executive positions, who will show outward support, but harbor private skepticism and fears.  They will use dilatory arguments, delaying maneuvers, and other passive-aggressive behaviors, to retard anything more than superficial and easily-reversible change.  Their behavior is anchored in the fact that, for many, their present career success has been based largely on their familiarity with and ability to navigate the organizational status quo.

Ginning up complicated, over-engineered IT projects, sending issues into legal research black holes, or getting into interagency concurrence quagmires are the classic derailleurs of this resistance.

In the end, having run out the clock, and breathing sighs of relief; the resistors will then turn to the task of somberly escorting the now-outgoing comptroller to the door, while soaking their handkerchiefs with rivulets of their crocodile tears.  Keep a very, very close eye on the clock, Tom.

OMG, Has it Been a Year?

Wow, time flies when you are doing something you love.  We are celebrating the first anniversary of the publication of  The National Bank Examiner, a financial services issues blog .  We went from zero to 12,866 page views as-of noon today, with 1,508 page views in just the last month.  The latest monthly volume of page views translates into a pro-forma annual total of 18,096.   For a blog devoted to the arcane topic of banking supervision and regulation commentary, that seems like a nice large and very satisfying number of  visitors.  Thank you all very, very much for being readers.  As another year begins, I'm looking forward to continuing the tradition of  "Adding Another Voice to the Mix".

One question that I have been getting many e-mails on, is whether the blog title, The National Bank Examiner, is focused solely on federally-chartered banks and savings associations.  Not at all.

The blog title was intended to be some wordplay meant to combine my background as a National Bank Examiner (retired) and the "Examiner" mastheads of some current newspapers and news sites - The San Francisco Examiner,  The Washington Examiner, The Glen Innes Examiner, etc.   So you can take meaning from the title, The National Bank Examiner, by reading it slowly, one word at a time, or as a complete phrase.  The National Bank Examiner analyzes and comments on issues related to the entire global financial services arena.

All revenue from what little advertising exists on the National Bank Examiner is sent to the Humane Society of Nassau County in Fernandina Beach, Florida.  This no-kill animal shelter's present facility is more than 40 years old, open-air, crudely roofed, and dilapidated.  Nassau County, Florida is an area where daily temperatures can reach 95+ degrees Fahrenheit in the summer and fall below freezing in the winter (it does get that cold here, it is North Florida).  The Humane Society is trying to raise funds to build a proper cat and dog adoption center and shelter.

As the end of the U.S. tax year approaches and you review your plan for tax-deductible charitable giving, I want to encourage you to consider helping the Humane Society of Nassau County meet its fund raising goal.  They accept online donations.  This new Adoption Center will make a world of difference for some very needy animals. Your kind and valuable financial contribution would help make it a reality.

Reining in Third Party Risks

Yesterday, the Office of the Comptroller of the Currency (OCC) issued one of the most important statements of policy guidance to national bankers this year, particularly for community bankers.  And I say that knowing about all of the Dodd-Frank rulemaking and Basel III-related bank capital and liquidity management guidance recently proposed.

The OCC policy guidance relates to assessing and managing risks associated with third-party relationships.  It is contained in OCC Bulletin 2013-29, Third-Party Relationships: Risk Management Guidance.

What precipitated this update in the OCC's guidance on third-party relationships?  Here are the stated reasons:

"Banks continue to increase the number and complexity of relationships with both foreign and domestic third parties, such as

• outsourcing entire bank functions to third parties, such as tax, legal, audit, or information technology operations.
• outsourcing lines of business or products.
• relying on a single third party to perform multiple activities, often to such an extent that the third party becomes an integral component of the bank’s operations.
• working with third parties that engage directly with customers.
• contracting with third parties that subcontract activities to other foreign and domestic providers.
• contracting with third parties whose employees, facilities, and subcontractors may be geographically concentrated.
• working with a third party to address deficiencies in bank operations or compliance with laws or regulations.

The OCC is concerned that the quality of risk management over third-party relationships may not be keeping pace with the level of risk and complexity of these relationships. The OCC has identified instances in which bank management

• failed to properly assess and understand the risks and direct and indirect costs involved in third-party relationships.

• failed to perform adequate due diligence and ongoing monitoring of third-party relationships.

• entered into contracts without assessing the adequacy of a third party’s risk management practices.

• has entered into contracts that incentivize a third party to take risks that are detrimental to the bank or its customers, in order to maximize the third party’s revenues.

• engaged in informal third-party relationships without contracts in place.

Possibly, one background reason for the issuance of this OCC Bulletin may be the recent concerns about "the world's largest global provider dedicated to banking and payments technologies" (2012 Annual Report for FIS).  Check out this write-up on the distinguished news site Krebs on Security.

Key Points to Keep in Mind

Every banker needs to be aware that third-parties are not just defined as transaction processing entities.  The OCC definition includes ALL third-party arrangements, including arrangements with independent consultants.  Here's the definition:

"...activities that involve outsourced products and services, use of independent consultants, networking arrangements, merchant payment processing services, services provided by affiliates and subsidiaries, joint ventures, and other business arrangements where the bank has an ongoing relationship or may have responsibility for the associated records. Affiliate relationships are also subject to sections 23A and 23B of the Federal Reserve Act (12 USC 371c and 12 USC 371c-1) as implemented in Regulation W (12 CFR 223). Third-party relationships generally do not include customer relationships."

It sets formal risk management expectations for these third-party relationships so that they are managed in a safe and sound manner.  The OCC Bulletin provides comprehensive guidance and is an excellent template for every bank to use to assess the degree of risk present in the bank's existing or contemplated third party relationships.  It is incumbent on every bank board of directors to use the guidance outlined in this Bulletin to benchmark their own bank against these standards.

Time is of the essence since examiners will be referring to this guidance during the course of their regular bank examinations going forward.

Here are the highlights:

• A bank should adopt risk management processes commensurate with the level of risk and complexity of its third-party relationships. 
• A bank should ensure comprehensive risk management and oversight of third-party relationships involving critical activities.
• An effective risk management process throughout the life cycle of the relationship includes
• plans that outline the bank’s strategy, identify the inherent risks of the activity, and detail how the bank selects, assesses, and oversees the third party.

• proper due diligence in selecting a third party.

• written contracts that outline the rights and responsibilities of all parties.

• ongoing monitoring of the third party’s activities and performance.

• contingency plans for terminating the relationship in an effective manner.

• clear roles and responsibilities for overseeing and managing the relationship and risk management process.

• Documentation and reporting that facilitates oversight, accountability, monitoring, and risk management.

• Independent reviews that allow bank management to determine that the bank’s process aligns with its strategy and effectively manages risks.

Many community banks may already be informally doing several of these things under earlier guidance provided by the OCC, but now that guidance has been significantly expanded and clarified.  It is extremely important that the risk management process over third-party relationships be formalized so that they can be reviewed by examiners through the periodic examination process.  The guidance is very specific about the duties and responsibilities of boards of directors, senior bank management, and bank employees who directly manage these relationships.  It also sets very granular standards for required independent reviews of the bank's third-party risk management process.  

My biggest concern with the OCC guidance, typical of major policy guidance issuances from all federal bank regulatory agencies, is that no grace period (like 60/90/180 days) has been specified before examiners would begin to enforce this updated guidance and write up Matters Requiring Attention (MRAs) in their reports of examination.

The slow unbundling of the typical community bank, over the last three decades, into a amalgamation of platforms and services provided by other parties makes this bank supervision initiative by the OCC a major, vital, and welcome exercise of its prudential bank supervision authority.  Unfortunately, for many community bank boards of directors, it also comes with a lot of work involved and little time to do it.

Bank Examiners and Reputation Risk

There have been a series of think pieces over the summer railing about the seemingly unfettered authority of bank examiners in the field to cite reputation risk as a means to steer bank executives away from business that, at least in the mind of the examiner, presents a significant level of reputation risk to the bank.  There's one piece on Examiners' Growing Misuse of  'Reputation Risk', another titled Bankers and Processors Are Not Moral Police, an another Is FDIC Waging Stealth Crackdown on Online Lenders?

The common theme being... how far should bank examiners go, in using their assessment of reputation risk to the bank, to question bank dealings with customers engaged in legal commerce, where the bank has already complied with its legal compliance obligations?

The Framework

Bank regulatory agencies have historically held themselves out as being rather agnostic about products, services, and customer relationships that are within the orbit of the legal powers granted in their bank charters, as long as the panoply of applicable risks, including compliance risk, are adequately identified, measured, monitored, and managed.  And, frankly, it's important that they stay agnostic in a banking system that is still loosely based on market capitalism.

But both bankers and regulators would also agree that the liquidity of the bank, indeed the very existence of every bank, is predicated on the confidence that depositors, creditors, and contractual counterparties have in the integrity of the operations of the bank.  The bank's ability to earn profits, internally generate capital, attract external capital, and other funding is dependent on the willingness of others to do business with it.  Public confidence in a bank is directly linked to its reputation in the marketplace.  So a bank's ability to manage the reputation risk presented by its customer relationships is a valid bank supervisory concern for regulators.

Former Comptroller of the Currency, Eugene Ludwig, characterized the situation very well in a piece called Reputation Risk Goes Well Beyond Bad Press:

"Reputation is a misunderstood concept, too often confused with a company's advertising or PR strategy. It is something much broader: the faith that outsiders — from counterparties, to shareholders, to regulators — have in a firm's ability to conduct itself well.  It's difficult to measure, because it is related to everything a company does in the public eye."

The latest attempt to strike an appropriate balance between choice and risk can be seen in the FDIC's recent Financial Institutions Letter 43-2013: FDIC Supervisory Approach to Payment Processing Relationships With Merchant Customers That Engage in Higher-Risk Activities.:

"Facilitating payment processing for merchant customers engaged in higher-risk activities can pose risks to financial institutions; however, those that properly manage these relationships and risks are neither prohibited nor discouraged from providing payment processing services to customers operating in compliance with applicable law."

Reputation Risk

An examiner's rating of reputation risk is a tender topic precisely because the topic is fundamentally subjective.  This subjectivity is acknowledged, by the Office of the Comptroller of the Currency (OCC) at least, by the fact that its Risk Assessment System (RAS) does not ask examiners to derive conclusions regarding "Quantity of Risk" and "Quality of Risk Management" in the areas of Strategic Risk and Reputation Risk.  The examiners are simply asked to do the not so simple,... rate the aggregate reputation risk (high, moderate, low) and the direction of risk (increasing, stable, decreasing).

 As laid out in the OCC Community Bank Supervision Handbook, :

"Reputation risk is the risk to current or anticipated earnings, capital, or franchise or enterprise value arising from negative public opinion. This risk may impair a bank’s competitiveness by affecting its ability to establish new relationships or services or continue servicing existing relationships. Reputation risk is inherent in all bank activities and requires management to exercise an abundance of caution in dealing with customers, counterparties, correspondents, investors, and the community.

A bank that actively associates its name with products and services offered through outsourced arrangements or asset management affiliates is more likely to have higher reputation risk exposure. Significant threats to a bank’s reputation also may result from negative publicity regarding matters such as unethical or deceptive business practices, violations of laws or regulations, high-profile litigation, or poor financial performance. The assessment of reputation risk should take into account the bank’s culture, the effectiveness of its problem-escalation processes and rapid-response plans, and its deployment of media."

During the Examination

So where does that leave us with the hypothetical bank examiner who wrinkles her nose, or rolls his eyes, or openly opines about the unsavory nature of a customer's business?

Use the opportunity to demonstrate the extent of the bank's due diligence prior to the acquisition of the customer relationship and the risk management controls that have been installed subsequent to the establishment of the relationship.

As a big believer in the effectiveness of basic blocking and tackling, I recommend that you focus on the specific examination policy direction given to field examiners by the bank regulatory agency as it relates to reputation risk.  Use that as a tool to make your case that the reputation risk in a customer relationship is being managed appropriately at your bank.  Examiners are granted lots of scope in exercising their judgement, but they still have to follow their own rules.

So What are the Rules?

This is one area where specific guidance may vary widely among federal bank regulatory agencies, but for illustration purposes, here is the framework with which OCC examiners make their determinations of reputation risk for national banks and federal savings associations.

Those determinations are circumscribed through the use of an illustrative set of Reputation Risk Indicators.  These Reputation Risk Indicators are sorted into low/moderate/high reputation risk buckets.

The Reputation Risk Indicators can be accessed here.

Where the discussion you have with the examiner leads to at the end of the day will depend on many factors.  But just having that communications opportunity, and the ability to make your case, is an important step.   And remember, if you feel strongly that the reputation risk of your bank is being inappropriately rated, consider using the examination appeals process.  Ultimately, reasonable arguments will yield reasonable results.

Talking Past Each Other on TBTF

Note to Readers:  For those of you who knew about my recent hip joint replacement surgery, thank you for your kind words and support over the last few weeks.  For those who didn't know about it, thank you very much for your patience.  I hadn't planned on such a long hiatus between blog postings.

I'm now sporting a Titanium Stryker Accolade II 127-degree Total Hip System, which I'm told is a 'de rigueur' fashion accessory among the mobility-challenged geriatric cognoscenti these days.  So far, up to a mile and a half daily (with a cane) and should be back to walking unassisted in a couple more weeks.

With the arrival of the Lehman Brothers +5 anniversary, we have had to endure a flurry of articles analyzing the current state and future prospects for our financial system, generally split into glass half-empty and glass half-full factions.  The most contentious issue being whether the Too Big to Fail (TBTF) phenomenon has been appropriately addressed through the Dodd-Frank Act and its excruciatingly slow crawl of implementing regulations.

The Obama Administration, through the U.S. Treasury Department, claims that the TBTF phenomenon has been ended.  Officials have been crowing about it in speeches and in this self-congratulatory Lehman +5 memorial document - The Financial Crisis Five Years Later: Response, Reform, and Progress.  The Administration asserts that, with living wills, orderly liquidation authority, and other prudential supervision enhancements, even the largest banks can be resolved without the need for taxpayer-funded federal government bailout assistance.

Others, like the American Enterprise Institute, in a piece called Taming the Megabanks, assert that the Too Big to Fail issue has only been partially addressed.  Many who believe so, myself included, believe the Dodd-Frank orderly resolution regime does not take into account the knee-buckling knock-on economic losses that will result from the resolution of one (or more) of the global systemically important financial institutions.

Owing to their size, relative to the Gross Domestic Product (GDP) of their home countries, any loss large enough to trigger the orderly resolution regime for a megabank will likely be large enough to send those economies plummeting into recession.   At that point, the issues are, first, how large are the losses to existing shareholders, as well as the cumulative financial losses sustained by those bailed-in; and second, how will those financial losses subsequently propagate and radiate outward through the national and world economies.  As important as an orderly resolution regime is, as a component of macroprudential policy, containment of the Day 2+ costs of megabank failure should also be a critical policy component for reducing ultimate costs to the government.

To get a sense of scale, as of June 30, 2013, JPMorgan Chase & Co. reported assets of $2.4 trillion and equity capital of $210 billion.   Putting all other resolution-related costs aside as well as whatever contagion multipliers might exist due to leverage in the system, just a $210 billion hit to the economy would be, to say the least, seismic.

It is the size of the cumulative loss to existing shareholders, the bailed-in creditors and uninsured depositors that needs to be reduced in order to limit the impacts of bank failure to the national and world economies.  That argues for less market share concentration in the market for banking services in the United States (and globally). That also means cutting these megabanks down to more easily digestible sizes through legislation, like the proposed 21st Century Glass-Steagall Act.

One other option, that I haven't heard kicked around, is to restore the national bank borrowing limit (12 USC 82), which was repealed by the Garn-St. Germain Depository Institutions Act of 1982.  The national bank borrowing limit stated that bank indebtedness could not exceed the amount of the bank's capital stock plus 50% of its unimpaired surplus, subject to certain specific exceptions.  That would limit non-deposit bank leverage and bank size.

As long as the world's megabanks are as large as they are, even in a perfect world of workable global resolution regimes, national governments will always be holding the bag for outsize losses relative to the size of their economies.  Instead of direct bank bailout costs, the government pays in other ways, through economic shock absorbers such as increased unemployment compensation, food stamp assistance, and economic stimulus initiatives as it picks its way through the resulting economic carnage and its collateral damage.

Governments, like ours in the U.S., who believe that they are opting-out of megabank rescue scenarios by merely bailing-in creditors and uninsured depositors through orderly liquidation authorities, while ignoring the current size of global megabanks, are engaging in a form of dangerous, and ultimately costly, self-deception.

Beasts of Regulatory Burden

Jack Hartings, President of the Peoples Bank Co. of Coldwater Ohio, and Vice-Chairman of the Independent Community Bankers of America (ICBA), wrote an op-ed recently in the Cleveland Plain Dealer, speaking to the issue of regulatory burden on community banks.  He proposed several actions that might reduce regulatory burden on community banks.  One of which is: "Require cost-benefit analyses by regulators to ensure quantitative justification of new regulations."

His position echoes a plank in ICBA's Plan for Prosperity:

"Rigorous and Quantitative Justification of New Rules: Cost-Benefit Analysis.  In addition, the agencies would be required to identify and assess available alternatives including modifications to existing regulations. They would also be required to ensure that proposed regulations are consistent with existing regulations, written in plain English, and easy to interpret.  Provide that financial regulatory agencies cannot issue notices of proposed rulemakings unless they first determine that quantified costs are less than quantified benefits.  The analysis must take into account the impact on the smallest banks which are disproportionately burdened by regulation because they lack the scale and the resources to absorb the associated compliance costs."

It's a bit bewildering.  Why does this continue to be an issue 33 years after the passage of the Regulatory Flexibility Act of 1980 and the issuance of numerous Presidential Executive Orders requiring such to be the case?

For readers of the National Bank Examiner who might not be familiar with the rulemaking process at the federal level, the Administrative Procedures Act of 1946 governs the way in which agencies of the Federal Government propose and establish regulations.  There have been several subsequent legislative updates to its rulemaking requirements including two with burden-reducing intent: the Regulatory Flexibility Act of 1980 (5 USC 601 et seq.) and the Paperwork Reduction Act of 1980 (44 USC 3501 et seq.).

Absent urgent matters or other emergencies, where prior notice may be legally waived, generally a Notice of Proposed Rulemaking (NPR) is issued by the agency (or agencies) of jurisdiction soliciting public comment prior to the issuance of a Final Rule.   The NPR is required to be published in the Federal Register. 

Occasionally, when a regulatory agency is unsure about the regulatory approach to take on an issue, it may issue an Advance Notice of Proposed Rulemaking (ANPR).  An ANPR typically solicits ideas and comments from the public to questions posed by the staff of the regulatory agency prior to an eventual issuance (or non-issuance) of a NPR.

Federal-level rulemaking that may impact "small entities", as defined by the Small Business Administration (SBA), generally must include a Regulatory Flexibility Analysis as required by the Regulatory Flexibility Act.  The SBA has defined "small entities" for banking purposes to include banks or savings associations with $175 million or less in assets.

In the Small Business Administration's Guide to the Regulatory Flexibility Act (RFA), it states that:

 "The RFA requires federal agencies to consider the impact of regulations on small entities in developing the proposed and final regulations. If a proposed rule is expected to have a significant economic impact on a substantial number of small entities, an initial regulatory flexibility analysis must be prepared. The initial regulatory flexibility analysis or a summary of it must be published in the Federal Register with the proposed rule.

An initial regulatory flexibility analysis is prepared in order to ensure that the agency has considered all reasonable regulatory alternatives that would minimize the rule's economic burdens or increase its benefits for the affected small entities, while achieving the objectives of the rule or statute. The analysis describes the objectives of the proposed rule, addressees its direct and indirect effects and explains why the agency chose the regulatory approach described in the proposal over the alternatives.

Under Section 603(b) of the RFA, each initial regulatory flexibility analysis is required to address: (1) reasons why the agency is considering the action, (2) the objectives and legal basis for the proposed rule, (3) the kind and number of small entities to which the proposed rule will apply; (4) the projected reporting, recordkeeping and other compliance requirements of the proposed rule, and (5) all federal rules that may duplicate, overlap or conflict with the proposed rule.

While these five factors are necessary elements to an adequate [initial regulatory flexibility analysis], they are not the sole factors necessary to perform an adequate analysis. Most important, section 603(c) requires that each initial regulatory flexibility analysis contain a description of any significant alternatives to the proposal that accomplish the statutory objectives and minimize the significant economic impact of the proposal on small entities. These alternatives could include the establishment of differing compliance or reporting requirements or timetables that take into account the resources available to small entities; the clarification, consolidation or simplification of compliance and reporting requirements under the rule for small entities; the use of performance rather than design standards; or an exemption from coverage of the rule or any part of the rule for small entities.

Although agencies often overlook this possibility, regulatory flexibility alternatives may include less stringent requirements for all regulated entities or for different classes of regulated entities. [my emphasis]"

Since reducing regulatory burden is one of those mom-and-apple-pie issues, successive Presidents of the United States have issued Executive Orders (EOs) setting policy guidelines for the regulatory rulemaking process, all generally applying to executive branch agencies.   Like the Office of the Comptroller of the Currency, for example.  Currently those Executive Orders that still apply to regulatory planning and review are President Clinton's EO 12866 (as amended), and President Obama's EO 13563, 13579, and 13610.

All of the rulemaking-related Executive Orders, to the present day, give a nod and a tip-of-the-hat to quantitative cost-benefit analysis.  President Clinton's EO 12866, (20 years ago in 1993) states:

(a) The Regulatory Philosophy.  Federal agencies should promulgate only such regulations as are required by law, are necessary to interpret the law, or are made necessary by compelling public need, such as material failures of private markets to protect or improve the health and safety of the public, the environment, or the well-being of the American people.  In deciding whether and how to regulate, agencies should assess all costs and benefits of available regulatory alternatives, including the alternative of not regulating.  Costs and benefits shall be understood to include both quantifiable measures (to the fullest extent that these can be usefully estimated) and qualitative measures of costs and benefits that are difficult to quantify, but nevertheless essential to consider. [my emphasis]  Further, in choosing among alternative regulatory approaches, agencies should select those approaches that maximize net benefits (including potential economic, environmental, public health and safety, and other advantages; distributive impacts; and equity), unless a statute requires another regulatory approach.

So what gives? Why are distinguished bankers and banking trade associations continuing to complain about the lack of credible or reliable quantitative cost-benefit analysis in the federal rulemaking process?  One hopes that it can't be just because they may not like the rulemaking results.

Community bankers need to hold bank regulatory agency management accountable for complying with the letter and, more importantly, the spirit and intent of the law and policy guidance.  Particularly holding accountable those newbies in that carousel of an executive suite over at the Consumer Financial Protection Bureau (CFPB).

In a previous blog post, I mentioned that community bankers will continue to get it as long as they continue to take it.  It's time to stop taking it when it comes to required regulatory flexibility analyses that may be interpreted or perceived as superficial, perfunctory, lightly documented, narrowly focused, overoptimistic, self-justifying, or lacking creative regulatory alternatives.

We need to stop complaining about something that is already supposed to be taking place.  Community bankers and their trade associations should endeavor to enforce a measure of substantive accountability to existing legal and policy requirements for federal rulemaking.  Perhaps through the congressional oversight process first.

A Risk Appetizer

Flying under the media radar in the last couple of weeks was a very important announcement by the Financial Stability Board (FSB).  On July 17, the Board released a Consultative Document on the Principles for an Effective Risk Appetite Framework.  The press release stated:  "The Principles will enhance supervisory oversight of firms, in particular of systemically important financial institutions (SIFIs), by establishing minimum expectations for the key elements contained in an effective risk appetite framework, such as: an actionable risk appetite statement; quantitative risk limits; and clearly defined roles and responsibilities of the board of directors, senior management and business lines."

An aim as important as the minimum expectations is "to establish a common nomenclature for terms used in the risk appetite framework, which will help to facilitate a common understanding between supervisors and firms and to narrow any gaps between supervisory expectations and firms’ practices." 

For readers of The National Bank Examiner who are not bankers, bank directors, or bank supervisors:  An effective risk appetite framework is the foundation of good risk management.  A bank’s risk appetite represents the aggregate level and types of risk the bank is willing to assume within its risk capacity to achieve its strategic objectives and business plan, and this should be set out in written form in a risk appetite statement.  The bank’s risk appetite statement should be linked to the bank’s short- and long-term strategic, capital and financial plans, as well as compensation programs.  It should assess the bank’s material risks under both normal and stressed market and macroeconomic conditions, and set clear boundaries and expectations by establishing quantitative limits and qualitative statements for risks that are difficult to measure.

To gain a full appreciation for the bank's risk appetite, it's also important that the risk appetite statement be able to be viewed from a minimum of six optical angles: consolidated entity, business line, legal entity, product line, balance sheet concentrations, and by geography.

Incidentally, a reminder to foreign banks with presences in the United States.  Foreign Banking Organizations (FBOs), with assets in the United States, need to pay particular attention to the issue of geography, as the Board of Governors of the Federal Reserve has a pending regulation that would require the establishment a U.S. Risk Committee for any FBO with global assets exceeding $10 billion, regardless of the size of its U.S. presence.  Even community bank-sized FBO presences in the U.S. will need to operate under the umbrella of a U.S.-specific risk management architecture.

As many of you know, who have wrestled with the task of creating a risk appetite statement for on-strategy and off-strategy risk management at the board of directors level, the lack of an industry standard or common practice guidelines make the effort both frustrating and time-consuming.  For each bank, the risk appetite statement wheel gets invented over and over again, amply profiting the bank consultants brought in to facilitate the process with their own in-house incarnations of how a risk appetite document ought to be prepared.

A global industry standard established by a common set of expectations and a shared risk management language, would really advance the ball in this necessarily  fundamental, and perhaps, the trickiest part of a bank's risk management architecture.  While these principles are designed to apply primarily to SIFIs, the concepts behind them are universally applicable, the difference being that of scale and complexity. 

The Financial Stability Board is welcoming comments on this Consultative Document until September 30th, 2013.  I would advise that you consider overlaying the template outlined in the Consultative Document over your own bank's risk appetite statement.  If your risk appetite statement has aspects or dimensions that are not in the FSB template, but which you feel especially proud or fond of, and that you also consider fundamentally important to the proper design and practical application of a risk appetite statement, please let the Financial Stability Board know at fsb@bis.org

If you are interested in following one of the premier thinkers in the area of banking risk management, let me also refer you to the writings of Dennis Chesley, Global Leader of Risk Consulting at PwC  and the PwC Resilience website.  I don't hawk the wares of banking consultants, that's caveat emptor for the buyer, but I do occasionally want the readers of  The National Bank Examiner to consider bookmarking their browsers to the published products of the current  "thought leaders" in our industry.  Their morsels of shared wisdom are free, and the enlightenment that may come to you from connecting-the-dots, or a pop-up insight, or even an "aha! moment", can be very valuable.

I had the personal privilege of working with Dennis as a fellow member of the team that stood up, and made operational, the U.S. Government's Troubled Asset Relief Program (TARP) in the dark days of early October of 2008.  As an important member of what forever will be a unique "band of brothers and sisters", Dennis and his team helped the government officials involved design the internal controls and risk management architecture surrounding what is, thus far, the largest and fastest delivery of U.S. Government financial assistance to Corporate America in the history of the United States.

Kabuki Week

Well, this week in banking news ought to go down in the annals of U.S. banking history as Kabuki week... a highly-stylized drama with elaborate make-up worn by its performers.

First, Senator Elizabeth Warren (D-Massachusetts) came out and proclaimed herself a stalwart champion of community banks in an article, appropriately titled, Elizabeth Warren, Champion of Small Banks.  Yes, this is the same Elizabeth Warren who's ideas spawned the Consumer Financial Protection Bureau (CFPB).  The federal agency that is the source of much of today's (and tomorrow's) new regulatory burden for the community banks she so loves and cherishes.

Consumer protection is an important public policy priority, but in the hands of an unaccountable agency with a single head and boundless financial resources, it can become the nanny of all nannies when it comes to layering on burden and compliance obligations for community banks.

The second piece of Kabuki theater came from the Financial Services Roundtable and the American Bankers Association.  Both are squawking about the new interagency leverage ratio proposal for the eight largest U.S. banks.  They claim that the new leverage requirements would put U.S. banks at a significant competitive disadvantage and threaten our economic expansion by adversely affecting the level and cost of credit.

To the first issue, competitive disadvantage, I invoke the concept of American Exceptionalism.  Americans are leaders, not followers.  When the policy leadership is about a stronger, more resilient global banking system, through the mechanism of a stronger U.S. banking system, that's a good thing.  Americans have never thought that keeping company with the lowest-common denominators was a virtuous American value.  Plus fortress-like balance sheets, in our present risk-on/risk-off anxiety-ridden funding markets, ought to be a competitive advantage, not a disadvantage.  

Regarding the level and cost of credit issues, let's start with the level of credit.  Don't underestimate the new lending opportunities that will now accrue to the regional banks and the other 7,500 banks in the United States because leverage requirements are being raised on eight U.S. mega-banks.  In the old days of double and triple the number of commercial banks that we have now, the United States had a highly developed bank correspondent network for syndicating and participating loans so that the largest corporate customers could be adequately served.  Securitization has changed the nature of that business in a big way over time, but the bones of the old system are still there.

As to the cost of credit, the large bank trade groups are probably exactly right.  With the eight largest banks accounting for more than half of the market share in the United States, credit spreads (above the cost of funds) are likely to rise nationwide.  Most economists specializing in market structure and competition would agree that a small group of market participants with a majority share of any given market are, in their parlance, "price leaders" and not "price-takers".  The structural credit spreads above the cost of dollar funding will likely increase to compensate for higher common equity capital requirements.

The Wall Street Journal "prime" base rate, at 3.25% today, is about 3% above the target federal funds rate of .25%.  Any increase might be constrained to some degree, however, by the banks in the next tier of the marketplace, the large regional banks (though some will be free-riders), and potentially lower funding costs owing to stronger mega-bank balance sheets.

Those higher credit costs will be paid by you and me, either directly through the consumer or mortgage loan process, or in the form of higher product prices generally as the higher costs of corporate credit works its way into the national economy.

Maybe also in bank fees, but, in my opinion, the jury is out.  Our glorious news media seems to have over-sensitized retail bank customers to bank fees (overdraft fees, for example) in the same manner that they have over-sensitized consumers to changes in gasoline prices.  A 5 cent increase in the cost of gasoline amounts to only $1 for the driver of a car with a 20-gallon fuel tank, but people will patronize the gas station across town if the price for a gallon of gasoline is a couple of cents cheaper over there.  Go figure.  The same may be presently true for retail banking services.

Higher credit costs are a difficult, but necessary public policy choice.  Would you pay a little extra for the things around you in exchange for a safer and sounder banking system?  Those who saw the values of their homes drop like boulders in the Great Recession... who also saw the value of their retirement savings evaporate or be subject to miniscule rates of return.... and who may have also lost their jobs in the process, would probably say yes.

Higher nationwide credit spreads could also be a very nice back-door market subsidy to community banks that have been valiantly battling net interest margin compression for the last few years.  A banking market-wide structural increase in credit spreads could spell a bit of sorely needed relief.  

Capital Punishment?

credit: macrobuiness.com.au

Was it capital punishment at today's meeting of the Board of Directors of the Federal Deposit Insurance Corporation (FDIC)?

Nope, not capital punishment, just a recipe for a better night's sleep and, with the supplemental leverage ratio proposal, the foundation for a safer, sounder, and more prosperous banking system in the United States.

I was watching the live webcast of today's meeting of the FDIC Board of Directors with intense interest.  Because yesterday, CNBC reported that the FDIC would propose a 5% common equity to assets leverage ratio for the largest and most interconnected U.S. banks - the global systemically important U.S. financial institutions.

The pure joy of such a potential development was driven to exhilarating heights as it comes on the heels of a troubling Basel III report just released by the Bank for International Settlements - the Vatican for Basel III worshipers.   

The Basel Committee on Banking Supervision just released a study,  Regulatory Consistency Assessment Programme (RCAP): Analysis of risk-weighted assets for credit risk in the banking book.   The study looks at risk weighting done by the world's largest banks, using their own models, with regard to the internal ratings-based approach (IRB) to credit risk - an "advanced" Basel III approach.  The report confirms that risk weights for credit risk in the banking book vary significantly across banks.  In fact, during a hypothetical portfolio bench-marking exercise: "...risk weight variation could cause the reported capital ratios for some outlier banks to vary by as much as 2 percentage points from the benchmark (or 20% in relative terms) in either direction."  

That, folks, is what passes as an advanced scientific approach to bank capital regulation!

The FDIC board meeting was a refreshing, but not a totally satisfying, event.  The Board took two substantive votes.  First, the Board voted on an interim final rule for domestic bank capital regulation that was substantially similar to that approved by the Board of Governors of the Federal Reserve System last week.

The vote was 4-1 with Director Hoenig dissenting primarily on the issue that a domestic capital rule should not be promulgated with, what almost everyone seemed to agree, was an inadequate supplementary leverage ratio.

The other vote was on an interagency Notice of Proposed Rulemaking (NPR) on a higher supplementary leverage ratio for the largest U.S. bank holding companies (BHCs).  The vote?  Unanimous for the NPR.

Under the proposed rule, top-tier bank holding companies with more than $700 billion in consolidated total assets or $10 trillion in assets under custody (covered BHCs) would be required to maintain a tier 1 capital leverage buffer of at least 2 percent above the minimum supplementary leverage ratio requirement of  3 percent, for a total of 5 percent.  The leverage buffer would function like the capital conservation buffer in the  previously-approved domestic capital rule. Failure to exceed the 5 percent ratio would subject covered BHCs to restrictions on discretionary bonus payments and capital distributions.  In addition to the leverage buffer for covered BHCs, the proposed rule would require insured depository institutions of covered BHCs to meet a 6 percent supplementary leverage ratio to be considered "well capitalized" for prompt corrective action purposes.

The supplementary leverage ratio includes many off-balance sheet items and, like all capital minimums, banks are expected to maintain a cushion comfortably above these capital floors.

The proposed rule would currently apply to the eight largest, most systemically significant U.S. banking organizations - JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc., Bank of America Corp., Morgan Stanley, State Street Corp., and Bank of New York Mellon Corp.

Plaudits to federal bank regulators today!  While the proposed supplementary leverage ratios may not be as high as some might prefer, federal bank regulators, looking out for the best interests of the U.S. economy, deserve positive recognition for well-executed public service.  They fought the pressure to lower leverage ratio minimums to levels that, internationally, would allow certain large European and Asian banks to appear properly capitalized, while also simultaneously strengthening the U.S. banking system.

As far as the FDIC board meeting not being totally satisfying, unfortunately we are prisoners of an old high school debate tactic...(s)he who frames the issue, controls the argument  (or in the realm of regulation-writing... (s)he who holds the pen, controls the draft).  The basic leverage ratio has been "tagged", by the risk-based capital regulation proponents, as a supplemental, and therefore secondary, capital measure since the inception of the risk-based capital regulation movement decades ago.

The basic leverage ratio has always been framed by the Basel Committee as the poor second cousin of the risk-based approach to capital regulation.  You know, something for the old-fashioned folk who prefer a mug of simple leverage beer to either a chilled glass of risk-based standardized approach Chardonnay wine or a nose-tingling flute of Advanced IRB Champagne.

In a do-over, I would prefer a doppelgänger world where the overly complex and easily gamed risk-based capital approach is itself supplemental to the basic leverage ratio.  The risk-based capital approach being a useful, though imperfect... additional, but not driving... capital surveillance tool.  

My biggest concern is not about risk-based capital regulation's over-complexity, leviathan-sized regulation books, nor the natural propensity for larger banks to game or circumvent the system.  My biggest concern is that risk-based capital regulation has a subterranean steering current that is the covert precursor to a potential world of capital-incentivized bank credit allocation by the Federal government.

Note how the risk-based capital rules follow the political winds when it comes to OECD sovereign debt, public sector enterprises (like the busted Fannie Mae and Freddie Mac), and real estate lending.  In the hands of some future government officials, who may be less sympathetic to the benefits of market capitalism, risk-based capital regulation becomes the slippery slope toward potential bank credit allocation by government incentive, rather than mandate.  Basic leverage ratios, on the other hand, are economic libertarians.

It's not cause to build a bomb shelter or hoard six months worth of food, but it is important to think about the impacts and implications of the regulatory momentum and inertia we have built up on the path we are presently following.  How will our present actions impact the future structure, operation, and risk profile of the U.S. banking system?