WASHINGTON, D.C. – U.S. Sen. Sherrod Brown (D-OH) – ranking member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs – today urged federal regulators to protect rules that require the largest financial institutions to hold more capital and that limit the type of risk-taking that contributed to the 2008 financial crisis. Brown pressed regulators to resist calls from Wall Street banks to weaken the rules, which are critical to preventing another crisis and shielding taxpayers from another bailout of the financial system.
In a letter to the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC), Brown stressed the importance of the enhanced supplementary leverage ratio (SLR) for the largest financial institutions and the margin rules for derivatives transactions. Both of these rules are required by the Wall Street Reform Act.
“I write out of concern with the arguments made by large Wall Street banks and their allies that these rules – particularly the treatment of margin for cleared derivatives and rules governing trades among affiliates – should be watered down. I urge you to reject these calls and maintain adequate taxpayer protections,” Brown wrote.
In April 2014, the Fed, FDIC, and OCC approved a final SLR of 6 percent on the largest federally insured depository institutions. This required the largest banks to increase the amount of capital they use to fund the assets on their books, not just the risky ones. The rule supplemented a 3 percent ratio required in the implementing rules for the Basel III international banking accords.
In October, regulators finalized the new margin rules for derivatives transactions in order to prevent the kind of risky trading that almost destroyed the financial system and led to the taxpayer bailout of firms like the insurance conglomerate AIG.
“Enhancing capital and limiting leverage at the largest financial firms will help ensure that risky, complex, opaque financial transactions never again threaten the entire U.S. financial system and broader economy. As we have seen repeatedly, better capitalized firms are in a stronger – not weaker – position to continue lending and take on risk throughout the credit cycle, including stepping in to assume others’ positions,” Brown wrote.
The full text of the letter is as follows:
November 20, 2015
The Honorable Janet L. Yellen
Board of Governors of the
Federal Reserve System
Washington, D.C. 20551
The Honorable Martin J. Gruenberg
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429
The Honorable Thomas J. Curry
Comptroller of the Currency
Administrator of National Banks
Washington, D.C. 20219
Dear Chair Yellen, Chairman Gruenberg, and Comptroller Curry:
Large financial institutions using opaque derivatives trades to accumulate excessive leverage were a significant contributing factor to the 2008 financial crisis. When the assets of these largest banks declined in value, they did not have enough capital and liquidity to remain viable, and instead relied upon unprecedented efforts by your agencies and taxpayer bailouts to stay afloat.
The Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act sought to prevent another financial crisis, and ensuing bailouts, by strengthening bank balance sheets and reining in excessive risk taking. Two of the key rules implemented to prevent a repeat of the crisis are the enhanced supplementary leverage ratio (SLR) for the largest financial institutions, finalized in 2014, and the margin rules for derivatives transactions, finalized in October. I write out of concern with the arguments made by large Wall Street banks and their allies that these rules – particularly the treatment of margin for cleared derivatives and rules governing trades among affiliates – should be watered down. I urge you to reject these calls and maintain adequate taxpayer protections.
I am troubled by calls to weaken the enhanced SLR by excluding margin posted for derivatives cleared through a central counterparty (CCP). Institutions have ample incentives to clear their trades without weakening the SLR. Dodd-Frank contains a clearing mandate, and the Commodity Futures Trading Commission issued rules, in November 2012, identifying six classes of swaps that are required to be cleared. The Board of Governors of the Federal Reserve System’s recent final rule requiring margin for uncleared swaps also accounts for the increased risk associated with uncleared swaps trades and will provide incentives for clearing, as contemplated by Dodd-Frank. Importantly, the treatment of margin under the leverage ratio is identical for both cleared and uncleared swaps, requiring capital to support derivatives activity without subsidizing any favored subset of that activity. In addition, the agencies’ final rules implementing the Basel III International Capital Accords on risk-based capital provide a lower risk weighting for trades using qualified CCPs.
While risk-based capital rules favor cleared trades, excluding some assets from the SLR would undermine the purpose of a leverage ratio to capture all possible exposures and treating all assets equally. That is why I joined two of my colleagues two years ago in calling on your agencies to closely scrutinize derivatives trades and reject arguments to exclude cash or excess reserves. In the past, banking restrictions have generally been dismantled through piecemeal exceptions, exclusions, and interpretations, not wholesale repeals. Excluding collateral for cleared swaps from the leverage ratio would be another step in the wrong direction.
I am encouraged by your requirement that insured depository institutions (IDIs) collect margin on their trades with affiliates and subsidiaries. Derivatives contracts are generally exempt from the automatic stay in bankruptcy, potentially requiring the Federal Deposit Insurance Corporation’s Deposit Insurance Fund – and ultimately, the U.S. taxpayer – to absorb an IDI’s derivatives losses in the event that an affiliate or subsidiary lacks adequate capital and has failed to post sufficient margin. The interaffiliate rule is an important tool that will help minimize IDIs’ exposure to risky trading, and it has a clear basis in past experience. For example, the trades made by the so-called “London Whale” that resulted in a $6 billion loss were booked in an Edge Act subsidiary of the London branch of a national bank. The interaffiliate component of the rule is consistent with the spirit of sections 23A and 23B of the Federal Reserve Act, as amended by Dodd-Frank, while filling an important gap in those provisions by applying these standards to subsidiaries.
Enhancing capital and limiting leverage at the largest financial firms will help ensure that risky, complex, opaque financial transactions never again threaten the entire U.S. financial system and broader economy. As we have seen repeatedly, better capitalized firms are in a stronger – not weaker – position to continue lending and take on risk throughout the credit cycle, including stepping in to assume others’ positions. I commend your ongoing commitment to more stringent capital, leverage, and margin requirements, and I urge you to continue your efforts to protect U.S. taxpayers and the financial system.
United States Senator
Cc: The Honorable Mary Jo White
The Honorable Timothy G. Massad
 See Letter from Sherrod Brown, David Vitter & Carl Levin, United States Senators, to Ben Bernanke, Chairman, Board of Governors of the Federal Reserve System (Nov. 22, 2013) available at http://www.brown.senate.gov/newsroom/press/release/sens-brown-vitter-and-levin-urge-regulators-to-increase-capital-requirements-preventing-future-bailouts-for-largest-institutions.