Recent activity in Congress has brought forth specific banking reform bills and proposals, but they remain a long way from enactment. In the Senate Banking Committee, for example, a bold omnibus proposal was introduced but then withdrawn for further study after it received strong bipartisan criticism. Nevertheless, a few key reforms are likely to remain prominent issues and should be noted as the legislative caravan proceeds.

  • Systemic Supervision

A central feature is the creation of a systemic risk regulator. In the version approved by the House Financial Services Committee, a new Financial Services Oversight Council (Council) would have a limited role. It would make recommendations, but the Federal Reserve Board (FRB) would do much of the work to mitigate systemic risk and would gain corresponding authority. In the Senate proposal, a new Agency for Financial Stability (Agency) would have a larger role, and the FRB would be marginalized. These alternatives reflect critical and fundamental issues about the future of financial services regulation that need to be resolved.

Both the Council and the Agency would identify systemically significant financial companies (SSFCs), which would be subject to operating standards in addition to those currently applied to bank holding companies or financial holding companies (FHCs), such as limits on the concentration of their credit exposure and requirements for prompt corrective action (PCA). Each SSFC also would be required to maintain a plan for its rapid resolution, a partial response to the problem of organizations being "too big to fail." The House version also would authorize the FRB to break up healthy SSFCs. In the Senate proposal, the Agency would adopt its own regulations and would share supervisory responsibility with another new agency, the Financial Institutions Regulatory Administration (FIRA). The Senate proposal also would require SSFCs to issue long-term hybrid debt and would impose a new tangible capital requirement.

  • Resolution Authority

If a SSFC became critically undercapitalized, the responsible federal regulatory agency could place it into reorganization under Chapter 11 of the Bankruptcy Code. It also could be placed into non-bankruptcy receivership, following a collaborative evaluation involving the FRB (or the FIRA in the Senate proposal), the Federal Deposit Insurance Corporation (FDIC) or other appropriate financial agency, the Secretary of the Treasury and the President, in order to avoid or mitigate systemic risk. The FDIC would serve as receiver and would have powers similar to those it wields as receiver for insured depository institutions. FDIC receivership would create a process and produce outcomes different than those that would occur in bankruptcy. Investors, creditors and counterparties would need to recognize that a SSFC was subject to two different and possibly inconsistent resolution regimes and understand how that would affect their own interests. See Treasury Proposes Wide-Ranging Resolution Authority over Financial Institution Holding Companies: Proposes Other Significant Regulatory Changes, 20th Century Money, Banking & Commerce Alert® (Mar. 30, 2009).

To avoid bailouts, the FDIC could engage in financial transactions with a failed SSFC only if necessary to achieve systemic stability and only if the SSFC's senior management was removed. However, the FDIC could prefer certain creditors and provide them a larger recovery than they might receive in liquidation in bankruptcy in order to maximize the value of assets, minimize the loss to the Systemic Resolution Fund or mitigate systemic effects. The House version also would permit the FDIC, acting as a "qualified receiver," to carry on the business of a SSFC. Thus, the possibility of bailouts, moral hazard and the mis-allocation of credit do not appear to have been entirely eliminated.

  • Resolution Funding

The FDIC may borrow from the Treasury to fund SSFC receiverships, but its ultimate source of funds would be assessments on all financial companies with total assets of more than $10 billion. Not all such companies would be SSFCs, and the assessment rates would take into account the risk to systemic stability posed by an individual company. This weighting may impose a significant "assessment risk" on SSFCs, similar to a guarantor's credit risk. The assessments also would consider the benefit that a company derived from non-bankruptcy resolution, which appears to recognize that designating SSFCs would create a moral hazard.

  • Safety and Soundness

Several changes are intended to prune the banking agencies and strengthen prudential supervision. The House version would transfer thrift supervision from the Office of Thrift Supervision (OTS) to a new division within the Office of the Comptroller of the Currency (OCC) and would require savings and loan holding companies to register with the FRB as bank holding companies. Unitary savings and loan holding companies that were engaged in activities that were not permissible for FHCs could continue to engage in such activities, but they would be required to place all their permissible financial activities under an intermediate FHC (IFHC). Diversified SSFCs would be required to do the same, and the SSFC would be required to serve as a source of financial strength for its IFHC. Transactions by an IFHC and its subsidiaries with their non-IFHC affiliates would be subject to Section 23A of the Federal Reserve Act as if the IFHC group was an insured depository institution. Section 23A also would be expanded to cover credit exposure under repurchase, reverse repurchase, securities lending and derivatives transactions. All FHCs would be required to be well capitalized and well managed on a consolidated basis. Finally, risk to systemic financial stability would be considered when reviewing transactions under the Bank Holding Company Act (BHC Act) or the Bank Merger Act.

The Senate proposal would transfer all supervisory functions of the OTS, OCC, FDIC and FRB to the FIRA. No new thrift charters would be issued and all "non-bank bank" exemptions under the BHC Act would be eliminated. Savings and loan holding companies would be treated as described above. The FRB's source of strength doctrine would be elevated to statutory law, which would presumably lead to its more vigorous use. Supervisory fees would be paid primarily by organizations with $10 billion or more of total assets. Deposit insurance rates also would be based on assets, rather than deposits, which would tend to disfavor institutions with more diverse funding sources.

  • Consumer Protection

Fair lending, disclosure and other consumer finance supervision for depository institutions and for non-banking companies engaged in covered financial activities would be transferred to a new agency, the Consumer Financial Protection Agency. This would increase the prominence of consumer protection as an element of banking regulation and possibly increase the conflict between regulation to promote safety and soundness and regulation to promote consumer access to credit. State consumer finance laws that did not have a "discriminatory effect" on national banks, federal savings associations and their operating subsidiaries, including state standards tougher than their federal counterparts, would no longer be subject to federal preemption, and state authorities could bring suit against those organizations to enforce state law. Only the visitorial authority of federal banking agencies would remain an exclusive federal power. Reduced preemption would expose federally chartered institutions to significantly more state oversight than has been allowed for several decades.

There seems to be little chance that this legislation will pass in this session of Congress, and it is anyone's guess what Congress' mood will be when it returns in January. What has been proposed is the most sweeping reconstruction of the financial services industry and its regulatory apparatus since the Great Depression, yet it remains a mixed bag: Some of it would properly modernize the regulation of financial services; some of it would overburden companies with redundant political fixes; and some of it would simply rearrange the regulatory furniture without making any substantive improvement. With so much at stake, it also is possible that Congress may actually wait for the report, due late next year, of the commission it empaneled to identify the causes of the financial crisis.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.