President Biden is calling for tougher standards and supervision for large regional banks in the wake of recent instability in the US banking sector.

On March 30, 2023, the White House issued a Fact Sheet calling on the federal banking agencies, the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), in consultation with the Treasury Department, to safeguard the banking system by imposing stricter rules on certain financial institutions — mostly large regional banks with US$ 100-250 billion in assets.

Notably, the White House recommended that regulators reverse some of the deregulatory measures that the Trump Administration had enacted in 2018. The Fact Sheet argues that this weakening of safeguards and supervisory requirements under the Dodd-Frank Act led directly to recent banking industry failures and the resulting threat of contagion.

Specifically, the proposed reforms include the following:

• Reinstating Dodd-Frank liquidity requirements for banks in the US$ 100-250 billion range, so that more high-quality liquid assets are held to cushion outflows during a stress period
• Returning the frequency of supervisory capital stress tests for such banks from two years to one year
• Reinstating the requirement that such banks submit comprehensive resolution plans (also known as “living wills”) that would describe how they could be wound down without transmitting stress to the wider banking system
• Strengthening the capital requirement for such banks “at an appropriate time after a considerable transition period”
• Shortening the transition period for banks that cross the $100 billion threshold so that heightened prudential standards will apply more quickly
• Strengthening supervisory tools, including stress testing, to account for rising interest rates and other novel scenarios
• Assessing liquidity risks from accelerated outflows related to a concentrated group of depositors (e.g., a majority of clientele from the same industry)
• Expanding the current requirement imposed on the largest banks to hold long-term debt (on the theory that it serves as a loss-absorbing buffer in times of stress) to a broader range of banks
• Ensuring that community banks do not bear the cost of replenishing the FDIC’s Deposit Insurance Fund following the recent bank failures

According to the Fact Sheet, the recommendations can be achieved under existing legal mandates without additional legislation. Tougher standards, the White House argues, would reduce banking sector instability, contagion, and the risk of future banking crises.

Congressional Reaction

Congressman Patrick McHenry, chairman of the House Financial Services Committee, issued a negative response to the White House statement, stating that the recommended priorities are “unrelated to the causes of the collapses” and pointed to “supervisory incompetence” as the cause of recent banking sector instability. He asserted that there was no proof that the Dodd-Frank Act, as enacted, would have prevented the recent bank failures.

On the other hand, Congresswoman Maxine Waters, ranking member of the House Financial Services Committee, applauded the White House recommendations, noting that “there is bipartisan agreement on the need for stronger oversight” of the banking sector in light of recent failures. She emphasized, however, that it is “important that Congress act quickly” to enact “common-sense safeguards” to strengthen the banking system and protect consumers.

In a related development, 12 senators led by Senator Elizabeth Warren wrote a letter to Michael Barr, FRB’s vice chair for supervision, urging the FRB to “immediately exercise its authority to apply enhanced prudential standards and supervision to banks with $100-$250 billion in assets.”

Conclusion

Even before the recent bank failures, leaders of the federal banking agencies had indicated in their statements that they would be tightening regulations under the Dodd-Frank Act, which gives the agencies considerable discretion to impose tailored enhanced prudential standards for banks and bank holding companies with assets of $100 billion and more. However, prior to the failures, the targets were generally believed to be institutions with more than $250 billion in assets, some of which had been permitted to grow by acquisition in the last few years, and indeed some by acquisition with the approval of the current banking agency leadership. Now the threshold for increased standards clearly will be $100 billion in assets, at a time when higher interest rates have begun to slow the overall economy and some economists are predicting a recession. Since the issue now is not whether regulation will be tightened but rather by how much, the effects of tightening standards on the availability of credit should be a central focus when new regulations are proposed. Latham & Watkins will continue to monitor developments in this area.