Today, the Federal Deposit Insurance Corporation is taking an important step to reduce bailout risk among a group of systemically important financial institutions and guard against increasing concentration in banking. In conjunction with the Federal Reserve Board of Governors, the FDIC Board of Directors is issuing an Advanced Notice of Proposed Rulemaking to help prepare for a potential failure of a very large bank that isn’t one of the big Wall Street banks.
Here’s the pickle that we’re in. The United States now has a substantial number of massive banks with over $100 billion in assets.1 These aren’t the very biggest banks that are deeply integrated into the global financial system, like JPMorgan Chase and Citigroup.2 These are domestic systemically important banks that are heavily focused on retail and commercial banking.3 They have grown much larger over time given that the Justice Department and the bank regulators have been relatively strict when reviewing small bank mergers and quite lax when evaluating big bank buyouts.
If one of these domestic systemically important banks were to fail, we would be in trouble. Avoiding a severe disruption to households and the broader economy would likely require a bailout or a government-facilitated sale to an even larger bank. The sales of Wachovia to Wells Fargo and Washington Mutual to JPMorgan Chase helped the FDIC avoid enormous losses to the Deposit Insurance Fund, but also increased the concentration of banks that were already too big to fail.4
This Advanced Notice of Proposed Rulemaking seeks public input on whether a domestic systemically important bank needs to have a funding structure that gives the FDIC more options to deal with its failure beyond selling it to a much larger bank.5
I support the issuance of the Notice, and I also want to offer a few cautionary notes.
First, if we do pursue rulemaking in this area, this should not serve as a rationale for continuing a lax and opaque merger review process. I fear that merger applicants might point to enhanced resolvability upon failure as the basis for allowing very large mergers to proceed without a rigorous analysis grounded in law. I look forward to the FDIC updating its Bank Merger Act policy statement to address some of these challenges.
Second, our effort to reduce the risk of bailouts or increased concentration upon the failure of domestic systemically important banks should be complemented by efforts to reduce the probability of their failure. One of the best ways to limit the harms associated with large bank failures is to stop them from happening in the first place. We should continue our work to better utilize our existing tools to accomplish this, particularly given the loosening of certain prudential requirements in recent years.
Third, our increased attention on domestic systemically important banks should not be interpreted to mean that it is “mission accomplished” when it comes to the very largest, global systemically important banks. If one of these institutions runs into trouble, there is still a risk that it will create chaos and require taxpayer support or a backdoor bailout. The work on this front is far from over.
2. The eight U.S. banks that qualify as Global Systemically Important Banks include JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, and State Street.
3. As the Basel Committee on Banking Supervision has noted, “There are many banks that are not significant from an international perspective, but nevertheless could have an important impact on their domestic financial system and economy compared to non-systemic institutions.”
5. In particular, the ANPR solicits comment on whether domestic systemically important banks should be required to issue a minimum amount of unsecured long-term debt. This debt could be used to absorb losses and recapitalize the bank after failure. Such a requirement could facilitate the FDIC’s execution of a “bridge bank” resolution strategy or a single point of entry resolution strategy. Today, only the global systemically important banks are subjected to this type of long-term debt requirement.