Large Banks Plan to Use the
Administrative Procedure Act to Run Out the Clock on
the Present Administration's Proposal to Raise Capital Ratios
The history of bank regulation is that unless there is a banking crisis the status quo reigns. For example, the Great Depression led to the enactment of the Banking Act of 1933 and the creation of FDIC insurance. The savings and loan crisis of the 1980s led to the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and the Federal Deposit Insurance Corporation Improvement Act 1991. The Great Recession led to the enactment of the Dodd Frank Act of 2010. The history also shows that as the most recent crisis wanes the banks begin advocating for the loosening of regulation, arguing that they are unnecessary and restrict access to credit.
Since Dodd Frank was enacted in 2010, the banks have been remarkably stable. Not surprisingly, therefore, the banks are pushing back hard against the proposal by the federal regulators (FED, OCC, and FDIC) to increase capital requirements for the largest banks by adopting the so-called Basel III Endgame.
The pushback is intense even though the Basel III Endgame is intended to complete the goals of the Dodd Frank Act—passed thirteen years ago. The collapse of the financial system in 2008 was caused by poorly underwritten mortgages that were securitized and sold worldwide. Ironically, the largest banks, that were the most culpable for creating the crisis, grew bigger while the smaller banks, which participated in the unsafe and unsound mortgage securitization regime created by the largest banks, failed by the hundreds.
One of the most controversial of the Basel III Endgame provisions is to change the way large banks calculate their risk-weighted-assets-to-capital ratio. The present approach allows banks to use internal models to assess the riskiness of their assets. The use of a bank's internal modeling has been criticized for allowing the “gaming” of the calculation to lower the bank's capital requirements. The proposed rule would require large banks to apply a “dual-requirement framework.” Under this approach, banks would calculate their risk-weighted asset amounts under the current approach using internal modeling and an expanded risk-based approach which does not rely on internal models. The bank must use the approach that requires the most capital. Unsurprisingly, the banks are upset because the new approach will require them to hold more capital than their “home cooking” models require.
Substantively, the banks argue that this new approach will greatly increase the amount of capital it must hold and will result in a restriction of credit. The banks, however, never seem to be able to show how past regulatory actions that increased capital requirements did any such thing.
Procedurally, the banks argue aggressively that the proposal violates the Administrative Procedure Act. The APA establishes rules agencies are required to follow when they promulgate regulations that will have the same force and effect as a statute. The banks contend that the APA prohibits an agency from substituting its considered judgment with the judgment of some third party, here the Basel Committee. The banks also argue that the regulators have failed to conduct a meaningful cost-benefit analysis of the effects of the proposed rule. These are facially sound arguments that could slow, but eventually not stop, the finalization of the proposed rule. That may be all that the banks need if the next administration abandons the proposed rule while the rule challenges languish in the courts. Look at it as the old four-corners offense used by North Carolina's Coach Dean Smith (before the shot clock) to hold the ball to run out the clock.
The plain fact is that assessing the amount of capital a bank needs relative to the riskiness of its assets is an inherently subjective process. Because bank capital requirements are typically designed to “fight the last war” and crises are invariably caused by a series of unforeseen circumstances, there is no way to predict with confidence how much capital is needed to protect the American banking system. Regulators who are charged with protecting the safety and soundness of the system will typically advocate for banks to hold more capital. Banks, on the other hand, typically will argue increasing capital will hinder economic growth. This tug of war is a constant. Only when a bank crisis occurs will the adequacy of capital requirements be revealed and, if insufficient, cause Congress to act.
Simply put, the problem the regulators face is that there is no banking crisis and therefore a lack of political support for promulgating a rule that Dodd Frank identified as necessary to protect the banking system. The banks are willing to roll the dice but should the taxpayers?
 The Basel Committee on Bank Supervision is an informal organization of the world's leading central banks which attempts to set uniform capital standards for banks across the leading economies. It cannot bind the U.S. bank regulators but the U.S. and other countries have stated their commitment to adopt all elements of the new 2017 Basel capital framework.