A Conversation about Regulatory Relief and the Community Bank: Remarks by FDIC
Vice Chairman Thomas Hoenig, presented to the 24th Annual Hyman P. Minsky
Conference, National Press Club, Washington, DC
April 15, 2015
Introduction
I have always found it insightful that Senator Richard Shelby, at confirmation hearings for bank
regulatory posts, often asks the nominees if they know of any failed bank that was well
capitalized, well managed, and well supervised. The answer is always wisely “no.”
As the effects of the financial crisis of 2008 are receding, this is a useful question for all
policymakers to contemplate as they consider issues of regulatory burden and relief. Reducing
unnecessary regulatory burden is a legitimate goal. However, such relief can only follow if we
are confident in the durability of the financial industry.
In my remarks this morning I will share my perspective on what led to the regulatory burden
from which the industry is now seeking relief. I will suggest a set of criteria that would
strengthen the industry’s case for such relief, which will emphasize the importance of strong
equity capital and the core commercial banking model. Finally, I will suggest that regulatory
relief for the community bank should not be given as a reason for abandoning the Volcker Rule.
Regulatory Landscape
In addressing the issue of regulatory burden, it is important to recognize that by necessity, the
largest, most systemically important banks have had access to the safety net for decades, as they
conduct intermediation and operate the payments system. However, more recently they have
been permitted to engage in extended activities previously reserved for investment banks,
insurance companies, commercial and industrial firms, and other types of businesses. When
these activities take place inside a bank, they are directly subsidized by the taxpayer. This
situation has shown itself to be unstable, contributing to the financial crisis and leading to the
Dodd-Frank Act.
To be clear, I am not a critic of these activities, all of which are important components of the
financial system. My concern lies with the distortions to the financial system that follow when
these activities are conducted by commercial banks, resulting in creditors becoming protected
and markets no longer disciplining firms’ behavior. The public subsidy allows the commercial
bank that engages in this extended set of activities to obtain funding on favorable terms, operate
with less capital demanded by creditors, and profit from the upside of investments while pushing
the downside onto the taxpayer.
Vice Chairman Thomas Hoenig, presented to the 24th Annual Hyman P. Minsky
Conference, National Press Club, Washington, DC
April 15, 2015
Introduction
I have always found it insightful that Senator Richard Shelby, at confirmation hearings for bank
regulatory posts, often asks the nominees if they know of any failed bank that was well
capitalized, well managed, and well supervised. The answer is always wisely “no.”
As the effects of the financial crisis of 2008 are receding, this is a useful question for all
policymakers to contemplate as they consider issues of regulatory burden and relief. Reducing
unnecessary regulatory burden is a legitimate goal. However, such relief can only follow if we
are confident in the durability of the financial industry.
In my remarks this morning I will share my perspective on what led to the regulatory burden
from which the industry is now seeking relief. I will suggest a set of criteria that would
strengthen the industry’s case for such relief, which will emphasize the importance of strong
equity capital and the core commercial banking model. Finally, I will suggest that regulatory
relief for the community bank should not be given as a reason for abandoning the Volcker Rule.
Regulatory Landscape
In addressing the issue of regulatory burden, it is important to recognize that by necessity, the
largest, most systemically important banks have had access to the safety net for decades, as they
conduct intermediation and operate the payments system. However, more recently they have
been permitted to engage in extended activities previously reserved for investment banks,
insurance companies, commercial and industrial firms, and other types of businesses. When
these activities take place inside a bank, they are directly subsidized by the taxpayer. This
situation has shown itself to be unstable, contributing to the financial crisis and leading to the
Dodd-Frank Act.
To be clear, I am not a critic of these activities, all of which are important components of the
financial system. My concern lies with the distortions to the financial system that follow when
these activities are conducted by commercial banks, resulting in creditors becoming protected
and markets no longer disciplining firms’ behavior. The public subsidy allows the commercial
bank that engages in this extended set of activities to obtain funding on favorable terms, operate
with less capital demanded by creditors, and profit from the upside of investments while pushing
the downside onto the taxpayer.
To illustrate this point, a colleague and I at the FDIC have constructed the Global Capital Index
(Index)1, which shows the tangible capital levels for each of the largest global banking firms and
the average levels for different size groups of US banks. The Index shows that the largest global
banks -- those with the broadest range of activities beyond traditional commercial banking --
hold the least amount of capital of any group of banks. In other words, management has chosen
to retain a business model in which the firms engage in expanded trading and related on- and off-
balance sheet activities subsidized by government backstops. For example, Column 8 of the
Index shows that when balance sheet assets and off-balance sheet activities are fully accounted
for under international accounting standards, the largest firms on average hold less than 5 cents
of capital for every dollar of assets held. This is not safe; it invites uncertainty when the system
is under stress and undermines financial stability. It is hard to justify regulatory relief for the
handful of such firms when too little is different today than in 2007.
However, the Index also illustrates that at the more than 6,500 other commercial banks in the
United States, capital levels far exceed those of the largest firms. The average capital positions
held by the remainder of the industry, shown in the last three rows of the Index, are much
stronger. For example, the largest non G-SIBs have tangible capital exceeding 8 percent, a level
similar to other smaller bank groups listed. There is, from a capital perspective, a case to be
made for regulatory relief for the vast majority of commercial banks.
A Proposal for Discussion
With this in mind, I suggest focusing the regulatory relief discussion on activity and complexity,
not strictly size. As such, I suggest defining eligibility for regulatory relief around the following
criteria:
• banks that hold, effectively, zero trading assets or liabilities;
• banks that hold no derivative positions other than interest rate swaps and foreign
exchange derivatives; and
• banks whose total notional value of all their derivatives exposures – including cleared and
non-cleared derivatives – is less than $3 billion.
Such banks are consistently better capitalized than less traditional banks, as the Global Capital
Index shows, and they have a lower rate of failing or requiring government assistance, as shown
in Chart 1.
1 Global Capital Index: https://www.fdic.gov/about/learn/board/hoenig/capitalizationratios4q14.pdf
(Index)1, which shows the tangible capital levels for each of the largest global banking firms and
the average levels for different size groups of US banks. The Index shows that the largest global
banks -- those with the broadest range of activities beyond traditional commercial banking --
hold the least amount of capital of any group of banks. In other words, management has chosen
to retain a business model in which the firms engage in expanded trading and related on- and off-
balance sheet activities subsidized by government backstops. For example, Column 8 of the
Index shows that when balance sheet assets and off-balance sheet activities are fully accounted
for under international accounting standards, the largest firms on average hold less than 5 cents
of capital for every dollar of assets held. This is not safe; it invites uncertainty when the system
is under stress and undermines financial stability. It is hard to justify regulatory relief for the
handful of such firms when too little is different today than in 2007.
However, the Index also illustrates that at the more than 6,500 other commercial banks in the
United States, capital levels far exceed those of the largest firms. The average capital positions
held by the remainder of the industry, shown in the last three rows of the Index, are much
stronger. For example, the largest non G-SIBs have tangible capital exceeding 8 percent, a level
similar to other smaller bank groups listed. There is, from a capital perspective, a case to be
made for regulatory relief for the vast majority of commercial banks.
A Proposal for Discussion
With this in mind, I suggest focusing the regulatory relief discussion on activity and complexity,
not strictly size. As such, I suggest defining eligibility for regulatory relief around the following
criteria:
• banks that hold, effectively, zero trading assets or liabilities;
• banks that hold no derivative positions other than interest rate swaps and foreign
exchange derivatives; and
• banks whose total notional value of all their derivatives exposures – including cleared and
non-cleared derivatives – is less than $3 billion.
Such banks are consistently better capitalized than less traditional banks, as the Global Capital
Index shows, and they have a lower rate of failing or requiring government assistance, as shown
in Chart 1.
1 Global Capital Index: https://www.fdic.gov/about/learn/board/hoenig/capitalizationratios4q14.pdf