Wednesday, May 24, 2017

FDIC's Hoenig Offers Market-Based Cure for Regulatory Ills

Urges Openness to Regulatory Alternatives

Author: David Schwartz J.D. CPA

In a keynote address before the Systemic Risk and Organization of the Financial System Conference in California on May 12, 2017 FDIC Vice Chairman Tom Hoenig announced his novel market-based proposal to strengthen the financial system and provide regulatory relief and foster long-term economic growth.  According to Hoenig, even after the financial crisis, "the U.S. financial system remains heavily subsidized, increasingly concentrated, and, despite a host of new efforts to safeguard the system, it continues to be vulnerable to inevitable financial shocks.” Mr. Hoenig has long been a proponent of a new organizational model that would turn the industry back toward capitalism. The Vice Chairman’s proposal is a plan whose goal is to "ensure that the public safety net is not expanded beyond the traditional banking activities that it was originally designed to support and to restore open market competition within the financial services industry.”


According to Hoenig, the entire financial system has become “heavily subsidized, increasingly concentrated, and less competitive” as a result of the largest banks having grown disproportionately large and their activities overly consolidated. This has led the financial safety net away from its original purpose of “depositor and payment system protection” and toward merely perpetuating the overly consolidated status quo and protecting the largest players to the detriment of others. His plan would require the biggest banks to hold more capital and also mirrors in part the “ring-fencing” concept adopted in the UK, whereby non-banking activities are walled off from the protections of the social safety net.  Adopting his plan, He says, would increase competition by leveling the playing field among insured and noninsured financial institutions.  


Hoenig’s market-based plan divides bank activities between traditional banking activities (TBA) and nontraditional banking activities (NTBA). He leaves some flexibility in his TBA definition, however, in order to capture certain activities that are vital to “traditionally conceived “ banking activities. Otherwise, his definition of NTBA encompasses everything else banks do today.    


"TBA would be limited to the 'business of banking' (as traditionally conceived) but a discussion of TBAs would be necessary to ensure that appropriate depository, credit intermediation and payment systems services are conducted. In no case should TBA include activities associated with insurance underwriting, securities or swaps; and as such, should not include underwriting, market making, broker-dealer, futures commissions merchant (FCM), investment advisory, asset management, investment company, hedge fund/private equity investment, or swaps dealing activities.”


Under the Hoenig plan, NTBA would be relegated to separate but affiliated holding companies with their own capitalization and management. Thus, ring-fenced, these activities effectively would be isolated from the protections of the social safety net afforded to TBA.


Hoenig’s plan also contemplates the segregation of banks’ traditional custody and trust services as well as central clearing activities. These affiliated holding companies would also be required to be separately capitalized and managed.  


"An FHC would be permitted to establish a special Safekeeping Intermediate Holding Company (SIHC) to conduct Safekeeping Banking Activities (SKBAs). SKBAs would be limited to the safekeeping of assets on behalf of customers under a safekeeping arrangement. Such activities would include custodial services, trust services, and central clearing on behalf of clients. If elected, each SIHC would be a separate affiliate, which is separately managed and capitalized.”


The rest of Mr. Hoenig’s plan looks very much like Rep. Jeb Hensarling’s Financial CHOICE Act. Like Hensarling’s bill, Hoenig’s plan would offer banks who meet a simple 10% leverage ratio relief from all the rest of the Dodd-Frank Act’s requirements like:


a. The comprehensive capital analysis and review (CCAR) exercise;

b. Dodd Frank Act Stress Testing (DFAST);

c. Regulatory risk-based capital (as a primary measure of capital adequacy);

d. Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR);

e. Title II and living wills; and

f. Other enhanced requirements under section 165 of the DFA.


Tom Hoenig’s plan leaves the roles of regulators relatively unchanged. Unlike the Financial CHOICE Act, under his proposal, there would be no change to the current structure of the prudential banking agencies or market regulatory agencies. 


a. The primary regulator of the FHC, BIHC, NIHC, and SIHC would be the Federal Reserve;

b. Insured depository institutions subsidiaries of the BIHC or SIHC would continue to be regulated based on charter affiliation;

c. Entities within the NIHC and entities other than the Safekeeping Bank within the SIHC would be regulated by the current applicable regulator.


Hoenig concluded his remarks by pushing back against the inevitable opponents of his approach, particularly those who benefit most from the status quo. In doing so, he urged the American public to speak out and demand an open discussion of regulatory alternatives.


"As we again attempt to address these unresolved issues, we have an opportunity to better balance regulation and markets and to improve industry performance, innovation, and economic growth.

Under the proposal I offer, we could achieve many of these outcomes. Not surprisingly, however, the most vocal criticisms of the proposal come from those who benefit most from the safety net’s rich subsidy. I respect the right of those who oppose such a solution and encourage them to speak out. Indeed, the American public should insist that regulators and the industry give their full attention to and engage in an open discussion of the implications of the current state of the industry, its growing power and influence in Washington, and its long-run effects on growth and jobs for our economy. This is nothing less than a discussion about the future of capitalism and economic opportunity for our country."


The full text of Mr. Hoenig’s plan may be found via: