Regional banks face hit from new debt level requirements

Regional banks face hit from new debt level requirements

Martin Gruenberg, acting chairman of the Federal Deposit Insurance Corp. (FDIC), speaks during an Urban Institute panel discussion in Washington, D.C., on Friday, June 3, 2022.

Ting Shen | Bloomberg | Getty Images

U.S. regulators on Tuesday unveiled plans to force regional banks to issue debt and bolster their so-called living wills, steps meant to protect the public in the event of more failures.

American banks with at least $100 billion in assets would be subject to the new requirements, which makes them hold a layer of long-term debt to absorb losses in the event of a government seizure, according to a joint notice from the Treasury Department, Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp.

The steps are part of regulators’ response to the regional banking crisis that flared up in March, ultimately claiming three institutions and damaging the earnings power of many others. In July, the agencies released the first salvo of expected changes, a sweeping set of proposals meant to heighten capital requirements and standardize risk models for the industry.

In their latest proposal, impacted lenders will have to maintain long-term debt levels equal to 3.5% of average total assets or 6% of risk-weighted assets, whichever is higher, according to a fact sheet released Tuesday by the FDIC. Banks will be discouraged from holding the debt of other lenders to reduce contagion risk, the regulator said.

Higher funding costs

The requirements will create “moderately higher funding costs” for regional banks, the agencies acknowledged. That could add to the industry’s earnings pressure after all three major ratings agencies have downgraded the credit ratings of some lenders this year.

Still, the industry will have three years to conform to the new rule once enacted, and many banks already hold acceptable forms of debt, according to the regulators. They estimated that regional banks already have roughly 75% of the debt they will ultimately need to hold.

The KBW Regional Banking Index, which has suffered deep losses this year, rose less than 1%.

Indeed, industry observers had expected these latest changes: FDIC Chairman Martin Gruenberg telegraphed his intentions earlier this month in a speech at the Brookings Institution.

Medium is the new big

Broadly, the proposal takes measures that apply to the biggest institutions — known in the industry as global systemically important banks, or GSIBs — down to the level of banks with at least $100 billion in assets. The moves were widely expected after the sudden collapse of Silicon Valley Bank in March jolted customers, regulators and executives, alerting them to emerging risks in the banking system.

That includes steps to raise levels of long-term debt held by banks, removing a loophole that allowed midsized banks to avoid the recognition of declines in bond holdings, and forcing banks to come up with more robust living wills, or resolution plans that would take effect in the event of a failure, Gruenberg said this month.

Regulators would also look at updating their own guidance on monitoring risks including high levels of uninsured deposits, as well as changes to deposit insurance pricing to discourage risky behavior, Gruenberg said in the Aug. 14 speech. The three banks seized by authorities this year all had relatively large amounts of uninsured deposits, which were a key factor in their failures.

What’s next for regionals?

Bank groups complain

FDIC to unveil tougher set of guidelines for regional banks

Correction: FDIC Chairman Martin Gruenberg gave a speech in August at the Brookings Institution. An earlier version misstated the month.

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