Martin Gruenberg, acting chairman of the Federal Deposit Insurance Corp. (FDIC), speaks during an Urban Institute panel discussion in Washington, D.C., on Friday, June 3, 2022.
Ting Shen | Bloomberg | Getty Images
U.S. regulators on Tuesday unveiled plans to force regional banks to issue debt and bolster their so-called living wills, steps meant to guard the general public within the event of more failures.
American banks with no less than $100 billion in assets can be subject to the new requirements, which makes them hold a layer of long-term debt to soak up losses within the event of a government seizure, in accordance with a joint notice from the Treasury Department, Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp.
The steps are a part of regulators’ response to the regional banking crisis that flared up in March, ultimately claiming three institutions and damaging the earnings power of many others. In July, the agencies released the primary salvo of expected changes, a sweeping set of proposals meant to heighten capital requirements and standardize risk models for the industry.
Of their latest proposal, impacted lenders may have to take care of long-term debt levels equal to three.5% of average total assets or 6% of risk-weighted assets, whichever is higher, in accordance with a fact sheet released Tuesday by the FDIC. Banks might be discouraged from holding the debt of other lenders to cut back contagion risk, the regulator said.
Higher funding costs
The requirements will create “moderately higher funding costs” for regional banks, the agencies acknowledged. That might add to the industry’s earnings pressure in any case three major rankings agencies have downgraded the credit rankings of some lenders this 12 months.
Still, the industry may have three years to adapt to the new rule once enacted, and lots of banks already hold acceptable types of debt, in accordance with the regulators. They estimated that regional banks have already got roughly 75% of the debt they’ll ultimately must hold.
The KBW Regional Banking Index, which has suffered deep losses this 12 months, rose lower than 1% at midday.
Indeed, industry observers had expected these latest changes: FDIC Chairman Martin Gruenberg telegraphed his intentions earlier this month in a speech on the Brookings Institution.
Medium is the new big
Broadly, the proposal takes measures that apply to the most important institutions — known within the industry as global systemically essential banks, or GSIBs — all the way down to the level of banks with no less than $100 billion in assets. The moves were widely expected after the sudden collapse of Silicon Valley Bank in March jolted customers, regulators and executives, alerting them to emerging risks within the banking system.
That features steps to boost levels of long-term debt held by banks, removing a loophole that allowed midsized banks to avoid the popularity of declines in bond holdings, and forcing banks to provide you with more robust living wills, or resolution plans that will take effect within the event of a failure, Gruenberg said this month.
Regulators would also take a look at updating their very own guidance on monitoring risks including high levels of uninsured deposits, in addition to changes to deposit insurance pricing to discourage dangerous behavior, Gruenberg said within the Aug. 14 speech. The three banks seized by authorities this 12 months all had relatively large amounts of uninsured deposits, which were a key consider their failures.
What’s next for regionals?
Analysts have focused on the debt requirements because that’s probably the most impactful change for bank shareholders. The purpose of raising debt levels is in order that if regulators must seize a midsized bank, there may be a layer of capital able to absorb losses before uninsured depositors are threatened, in accordance with Gruenberg.
The move will force some lenders to either issue more corporate bonds or replace existing funding sources with costlier types of long-term debt, Morgan Stanley analysts led by Manan Gosalia wrote in a research note Monday.
That can further squeeze margins for midsized banks, that are already under pressure due to rising funding costs. The group could see an annual hit to earnings of as much as 3.5%, in accordance with Gosalia.
There are five banks specifically which will need to boost a complete of roughly $12 billion in fresh debt, in accordance with the analysts: Regions, M&T Bank, Residents Financial, Northern Trust and Fifth Third Bancorp. The banks didn’t immediately reply to requests for comment.
Bank groups complain
Having long-term debt readily available should calm depositors during times of distress and reduces costs to the FDIC’s own Deposit Insurance Fund, Gruenberg said this month. It also improves the probabilities that a weekend auction of a bank may very well be kept away from using extraordinary powers reserved for systemic risks, and provides regulators more options in that scenario, like replacing ownership or breaking up banks to sell them in pieces, he said.
“While many regional banks have some outstanding long-term debt, the new proposal will likely require issuance of new debt,” Gruenberg said. “Since this debt is long-term, it would not be a source of liquidity pressure when problems turn into apparent. Unlike uninsured depositors, investors on this debt know that they’ll not have the ability to run when problems arise.”
Investors in long-term bank debt may have “greater incentive” to watch risk at lenders, and the publicly traded instruments will “function a signal” of the market’s view of risk in these banks, he said.
Regulators are accepting comments on these proposals through the tip of November. Trade groups raised howls of protest when regulators released a part of their plans in July.
Correction: FDIC Chairman Martin Gruenberg gave a speech in August on the Brookings Institution. An earlier version misstated the month.