The Federal Reserve Reviews Bank Investment Rules

Filed Under Board of Governors, Federal Reserve, Mortgage News, Mortgage Video
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The Federal Reserve is currently reviewing regulations that impose limits on how much investment firms can invest in banks, looking to see if they can make it easier for banks to raise capital.

Is this necessary? Rules were put in place to avoid large Industrial Loan Corporations from controlling banks and the availability of credit. Why would a private equity firms be different?

The concern we have with the Industrial Loan Companies is that commercial firms can go in and gain control of banks. What private equity firms are interested in is not a controlled investment, but they are more interest in trying to get a good return for their money by picking up shares of banks.

Do banks need these changes? Are they finding it hard to raise capital?

As the chairman of the FDIC testified a few days ago, almost 99 percent of banks are well capitalized in the United States and they control over 99% of assets in the country. As a whole, the interest industry is well capitalized. There are some individual banks that could use more capital. but it is safe to say you cannot find examples of bank examiners saying that they have too much.

Obviously congress writes the laws but the Federal Reserve interprets them and given the powers they have, what changes could the Feds possibly make?

Our Congress does established the rules about how much a company can invest in before it becomes a bank holding company, however, the Fed has quite a bit of latitude below the 25% ownership threshold. When you get an investment below 25%, you start to run into fairly complicated questions as to whether a company will be presumed to control a bank or a bank holding company. That is where the Fed has discretion.

So what kind of safeguards could be left in place for both investors and for the banks?

There are a couple of safeguards. First of all, if a company were to acquire 25% of a voting class of shares of a bank, it would become a bank holding company subject to the jurisdiction of a Federal Reserve board, subject to the minimum capital rules, and subject to the investment limitations and so on. So it is likely that a private equity firm would do what ever it needs to do in order to stay clear of the 25% threshold. Even below 25%, in order to assure there is not control being exercised by a private equity firm over a bank, the equity firm will likely have to enter into passivity commitments, which in essence mean that the investor agrees not to exercise a controlling influence over the bank.

One of the key provisions of the law, is the Source of Strength Doctrine. Large investors must be willing to stand behind the institution they invest in. It is a large liability on how they handle that.

The investment companies would not become bank holding companies and a Source of Strength Doctrine only applies only if the bank holding company exceeds that level. So the companies will usually do what they need to do to steer clear of being found bank as a bank holding company. For any company that controls a bank, they will be bank holding companies and it will be subject to the Source of Strength Doctrine, which is a principle that has serve our country well. The Federal Reserve must make sure, as it will, no doubt, that the Source of Strength Doctrine stays in place.

Is this something that should be done even if the times when not as bad as they are now?

What you have going on are two things. The Federal Reserve Board is taking a look at the regulations with an eye toward whether they can improve regulations either by deleting outdated provisions or improving the clarity of the provisions or incorporating new precedents, as they have been doing for the last two years. It is good for the Federal Reserve to look at whether there are artificial barriers to new capital coming into the banking system.

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