The March 12 decision to invoke the FDIC’s emergency powers to facilitate the resolutions of Silicon Valley Bank and Signature Bank was an admission that, despite 15 years of costly reform efforts, we still do not have an effective framework for resolving failed banks. The solution is not to pile on yet more prescriptive regulation or to otherwise push responsible risk taking out of the banking system. Instead, we should acknowledge that bank failures are inevitable in a dynamic and innovative economy. We should plan for those bank failures by focusing on strong capital requirements and an effective resolution framework as our best hope for eventually putting to an end our practiced habit of privatizing gains while socializing losses.
Toward that goal, I generally support today’s proposal to require certain large banking organizations to have outstanding a minimum amount of eligible long-term debt. While I share some skepticism of a regulatory requirement that mandates leverage, I also recognize that going-concern and gone-concern loss-absorbing capacity serve distinct policy objectives. Besides perhaps improving the resiliency of a banking organization (which admittedly equity capital better achieves), long-term debt requirements can, if appropriately designed and calibrated, enhance the resolvability of a banking organization.1 Enhanced resiliency and resolvability should improve our ability to impose losses on the shareholders and creditors of a failed banking organization, including its uninsured depositors, without undue risk to financial stability.
All that said, I do have some concerns with important aspects of today’s proposal, and I look forward to the views of commenters as I come to a view on its eventual finalization.
I have reservations that the proposal would deny the banking organizations that it would subject to a new long-term debt requirement (each, a “covered banking organization”) at least some degree of the flexibility that the U.S. GSIBs have to decide the extent to which resources are prepositioned at their insured depository institutions through the internal issuance of debt by that subsidiary. I acknowledge that many covered banking organizations might prefer to have their insured-depository-institution subsidiaries issue the required long-term debt to external investors. I also expect that a significant degree of prepositioning of resources at the insured depository institution is appropriate for many covered banking organizations to the extent their business activities, assets, and liabilities are concentrated at that subsidiary. However, it seems to me a problem that this key aspect of the proposal is actually more prescriptive than the prepositioning expectations applicable to U.S. GSIBs.
I am also concerned that this disparity could put covered banking organizations at a competitive disadvantage relative to the U.S. GSIBs, whether now or in the future. While most domestic covered banking organizations generally have a bank-centric business model today, these firms could find that their activities outside the insured depository institution evolve in ways that necessitate more flexibility in prepositioning to facilitate resolution planning, especially if the firm might someday shift from a multiple-point-of-entry to a single-point-of-entry resolution strategy. Lacking flexibility in prepositioning, covered banking organizations could face regulatory incentives that affect how they structure their businesses or that even deter them from growing their businesses. Similarly, the proposal’s prescriptive prepositioning mandate could give regulators more opportunities and incentives to prevent or deter changes in covered banking organizations’ businesses, particularly to the extent that some regulators might unofficially tend to prefer a resolution strategy that contemplates an FDIC receivership for the insured depository institution. To the extent these dynamics are real, the proposal’s prescriptive prepositioning requirement could tend to lock in the current structure of our banking system and shield the largest firms from competition.
Finally, I have some reservations about whether the “capital refill” framework for calibrating the long-term debt requirement is appropriate for all covered banking organizations. In assessing the costs and benefits of this calibration framework, I will be particularly eager to better understand the extent to which certain firms might face different costs in maintaining the required amounts of long-term debt.
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Long-term debt can be used to replenish a banking organization’s equity in the event it has significant losses that deplete its equity capital. By ensuring that the losses incurred by a failed banking organization are borne by shareholders and creditors, long-term debt also could enhance market discipline over excessive risk-taking and decrease the likelihood that the banking organization fails. Similarly, to the extent the debt has been issued by an insured depository institution, long-term debt absorbs losses before deposits and thereby gives the FDIC more options to resolve the insured depository institution.