MVA White Collar Defense, Investigations, and Regulatory Advice Blog

In the fourteen years since the 2008 financial crisis, significant actions have been taken by Federal banking agencies to make the largest financial institutions more resilient and less likely to fail and to require planning that would facilitate their orderly resolution, if necessary. These risk mitigation measures are tailored, however, with the most stringent requirements, and highest regulatory expectations, appropriately reserved for the eight U.S. banks designated as posing the greatest risk to financial stability (global systemically important banks, or GSIBs: Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, the Bank of New York Mellon, and State Street). Smaller institutions that individually pose no threat to broader financial stability are exempt from these requirements. Larger regional banks find themselves in the middle, subject to some, but not all, of the same requirements applicable to GSIBs.

Notwithstanding the regulatory measures that have already been taken, the risks large banking institutions may pose to financial stability remain top-of-mind for regulatory agencies. This is most recently evident in the context of proposed mergers involving large regional banks, where regulators have identified a “gap” in the regulatory resolution framework and political pressure is being deployed to prevent further “concentration” within the financial services industry. The confluence of these factors may result in large regional banks either, in the longer term, being subject to new rules requiring them to adhere to currently GSIB-only resolution requirements or, in the shorter term, agreeing to voluntarily undertake them as a condition for regulatory approval of their merger applications.

In a recent address at the Wharton Financial Regulation Conference, Acting Comptroller of the Currency Michael J. Hsu discussed a gap in the current resolvability framework for large banks. He noted that if a large regional bank were to fail, it is not subject to the same requirements that are imposed on US GSIBs that enhance their resolvability, including requirements to:

• utilize a single point of entry, or SPOE, resolution strategy that relies on placing only the parent bank holding company into bankruptcy or receivership while material subsidiaries continue their operations and functions or are wound down outside of bankruptcy,
• hold sufficient long-term debt at the parent bank holding company to absorb losses in the event of bankruptcy or receivership (a total loss absorbing capital requirement, or TLAC), and
• identify and develop an operating strategy that would allow for the prompt sale of lines of businesses and portfolios of assets (a separability requirement).

In contrast, the resolution plan of a non-GSIB typically contemplates actions taken by more than one resolution authority and over multiple legal entities in the corporate structure (referred to as a multiple point of entry resolution strategy, or MPOE), and these institutions are also not subject to either a TLAC or a separability requirement. The resolution of the bank may instead rely on the use of a purchase and assumption transaction with an acquiring institution. In the case of a failed large regional bank, however, the only institutions practically capable of acquiring it are GSIBs, which would result in a GSIB that is even larger, more complex, and more systemic.

One factor that agencies evaluate in reviewing a merger application is the risk posed to financial stability. As a result, recent merger activity involving larger, non-GSIBs has served to highlight this gap. Some may argue that the answer is simple: transactions allowing mergers that could create another GSIB should not be approved. Agencies, however, also most evaluate other factors in considering merger applications, including the impact on the convenience and needs of, and competitiveness within, the communities served. The reality is that large financial institutions provide significant benefits to their customers and some retail customers and large corporate clients may require larger institutions with larger regional, nationwide, or international reach and the broadest set of product offerings. A bank may need to merge with another institution to meet these needs. Categorically denying an application from a large regional bank simply because it results in a larger institution has, as Acting Comptroller Hsu notes, the anomalous result of insulating GSIBs, in some areas, from further competition and limits the options for customers who choose or need the reach and service offerings of larger institutions. 

To address the gap in the regulatory resolution framework through development of new rules requiring large regional banks to meet the SPOE, TLAC, and separability requirements will take time. Rulemaking, however, is not the only tool available to regulators, and the Acting Comptroller noted that the OCC is currently evaluating merger applications from larger institutions and considering whether to condition its approval on commitments by the acquirers to adopt these requirements. Using this approach would allow the OCC to address regulatory concerns for ensuring effective enhanced resolution strategies are in place for those institutions posing the greatest risk to financial stability while at the same time not unnecessarily inhibiting large regional banks from competing more effectively with their GSIB competitors.

While the remarks were directly focused on the four largest regional banks (identified in the remarks as those with more than $500 billion of total consolidated assets), smaller regionals with aggressive strategic plans for market and product expansion through mergers and acquisitions may also benefit from proactively evaluating resolution strategies in connection with these planning efforts.