Thursday, January 19, 2017
Author: David Schwartz J.D. CPA
Republican control of Congress and the White House has put financial regulatory reform back on the legislative agenda. As an indication of Republicans' preliminary plans, the Financial CHOICE Act (H.R. 5983), proposes a regulatory capital “off-ramp” for banks which restrain their leverage and self-insure against losses. The centerpiece of the Financial CHOICE Act is the optional exemption from many Dodd-Frank regulations in exchange for higher capital reserves. The bill achieves this by creating a single leverage limit.
Elimination of Risk-Based Capital Requirements
Banks and bank holding companies willing to maintain a 10% ratio of “common equity Tier 1" capital (CET 1) to “total leverage exposure” would be exempt from other Dodd-Frank regulations, such as:
The Financial CHOICE Act’s leverage ratio-based capital election provision is premised on the notion that firms that absorb their own risks, as highly capitalized banks do, need not be heavily regulated. This is a boon for smaller and mid-sized banks, and community banks, because the CHOICE Act’s simpler leverage ratio calculation methodology rewards banks with no trading assets or liabilities and limited interest rate and foreign exchange swaps. Whether large banking organizations would take advantage of these regulatory exemptions in exchange for higher capital reserves is not clear. So, large banks will need to do some significant examination of their business lines, profitability, and cost-benefit calculus to determine if they come out ahead and remain competitive by exchanging higher capital charges for regulatory relief. Presumably, however, banks not opting into the CHOICE Act leverage ratio would remain subject to the Basel III and Dodd-Frank Act framework to the extent it is left intact.
Leverage Ratio Compliance
Banks opting into the CHOICE Act’s regime that fail to maintain the required leverage percentage would have a year’s grace period to restore its leverage ratio. However, if they fail to do so, the bank would lose its status as a qualified banking organization and all of the accompanying regulatory exemptions. During the grace period, banks would still enjoy regulatory exemptions but would be required to:
Elimination of the Volcker Rule and Various Dodd-Frank Regulations
In addition to the “off ramp from Basel III,” the Financial CHOICE Act eliminates a host of Dodd-Frank regulations, including:
Fed and Agency Reforms
The CHOICE Act makes many major improvements to the Federal Reserve’s emergency lending authority and to the Fed’s regular operating procedures. In addition, the CHOICE Act:
Limits on Agency Rulemaking
Notably, the Act would not only require all proposed federal financial regulations to be subjected to enhanced cost benefit analyses, but would also require that “major regulations” issued by financial regulators only become effective if approved by Congress. This provision, if enacted, could raise some interesting separation of powers issues in the courts. Also, the CHOICE Act would repeal the “Chevron Doctrine” requiring the judiciary to give deference to financial regulatory agencies’ interpretation of the law.
Too Big to Fail
The CHOICE Act would repeal parts of the Dodd-Frank Act by eliminating the power of the FSOC to designated non-banks, financial market utilities, and clearing organizations as Systemically Important Financial Institutions. In addition, the Act also:
Community Bank Relief
Community and small banks receive a number of exemptions from CHOICE Act requirements applicable to larger and more complex financial institutions, including:
In its present form, the Financial CHOICE Act is a sweeping piece of legislation proposing a regulatory framework and provisions some see as a wish list for the financial industry. At this point, the Trump administration has yet to weigh in on the specifics of Hensarling's bill. Steven Mnuchin, Donald Trump’s Treasury Secretary designee, has stated that rolling back parts of Dodd-Frank would be a Treasury Department priority should he be confirmed. However, whether the solutions proposed by Rep. Hensarling conform to Mr. Mnuchin's remains to be seen.
 The bill was introduced in July, 2016, by Representative Jeb Hensarling (R-TX), Chairman of the House Financial Services Committee, and reported out in September, 2016. However, the bill failed to make the legislative calendar prior to the start of the election season recess. A revised version is expected to be introduced in the new Congress.
 The Act’s language expressly exempts “Qualifying Banking Organizations” (i.e., those opting into the capital reserve regime) from all Dodd-Frank Section 165 “enhanced standards” other than subsection (c) public disclosures and subsection (k) inclusion of off-balance sheet exposures in capital computations. It would also perforce eliminate risk-based capital requirements. The Act would also require banks opting in to the leverage ratio to maintain a Camels rating of 1 or 2.
 While higher leverage requirements contemplated by the CHOICE Act may be desirable, the stricter leverage requirements cannot in themselves replace the Basel III risk weighted asset, leverage, and liquidity requirements implemented in Dodd-Frank. Relying solely on leverage requirements ignores entire categories of risk.
 The Act basically adopts the text of the 2015 Fed Oversight Reform and Modernization Act (H.R.3189) https://www.congress.gov/bill/114th-congress/house-bill/3189
 The Fed finalized its Total Loss Absorbing Capacity Rules (TLAC) on December 15, 2016, after Rep. Hensarling released his latest draft of the Act. Subsequent drafts of the legislation will presumably eliminate TLAC.