Should fewer banks be ‘too big to fail’?

Top lawmakers are considering legislation to raise or eliminate the threshold at which banks are considered big enough to pose a threat to the economy if they failed.

Currently, the limit is $50 billion in assets. Changing it, and thereby reducing regulations on some banks, could be the first serious revision of the 2010 Dodd-Frank financial reform law by the new Republican majorities in the Senate and House.

“Five years after this new regulatory framework was conceived, I believe that it is appropriate to revisit its suitability,” said Richard Shelby, chairman of the Senate Banking Committee.

Shelby scheduled a hearing with bank regulators Thursday to discuss the possibility of changing the way banks qualify as systemic threats and get added regulation, and a second hearing next week.

In the House, Rep. Blaine Luetkemeyer of Missouri has introduced a bill that would eliminate automatic thresholds altogether and instead make regulators positively identify each bank they think needs extra regulation.

That bill has Dodd-Frank defenders nervous. But some regulators have expressed openness to revisiting the $50 billion cutoff.

Under Dodd-Frank, there are two ways a financial company can be identified as a “systemically important financial institution,” a label that carries with it extra oversight and that Republicans have said amounts to an explicit acknowledgement that the firm is too big to fail in the eyes of government.

One way is for the super-group of financial regulators known as the Financial Stability Oversight Council to designate a company as systemically important, which it can do for any bank, insurer or other company it sees as a potential threat to the economy.

The other is simply by being a bank with more than $50 billion in assets. The roughly three dozen banks over that size get higher capital requirements and undergo “stress tests” in which the Fed examines whether they could survive a hypothetical financial crisis.

Daniel Tarullo, the Federal Reserve governor in charge of formulating regulatory policy, has floated raising the $50 billion to $100 billion in the past and reiterated that view again Thursday.

“With stress testing in particular, that’s the one area where the administrative flexibility we’ve got seems not to allow us to do something that we think is a win-win on all sides,” he said, noting that stress-testing large regional banks is costly without making the system much safer.

Others have proposed raising the limit even further. The nonprofit Bipartisan Policy Center, for instance, suggested a $250 billion barrier to capture the big Wall Street megabanks without affecting regional banks that are essentially glorified community banks.

Nevertheless, changing the definition will be politically challenging partly because of liberal Democratic opposition to any changes to Dodd-Frank and because of memories of past episodes in which large regional bank failures created bigger problems.

Sen. Elizabeth Warren, D-Mass., said Thursday that exempting large regional banks would be “a recipe for missing the buildup of excessive risk in the financial system, and it reflects the kind of let-the-banks-run-free mindset that created the last financial crisis. I just don’t want to go there again.”

Sherrod Brown of Ohio, another liberal critic of Wall Street practices and the top Democrat on the banking panel, noted that the original too-big-to-fail bank, Continental Illinois, had the equivalent of $90 billion in today’s dollars when it failed and received a bailout in 1984.

More recently, the failure of the large regional California bank IndyMac in 2008 unsettled markets and its bailout could have been prevented, said the Federal Deposit Insurance Corporation’s Martin Gruenberg. “I wouldn’t argue that a stress test for that institution and a risk committee would not have had value for that institution,” he said.

Also, regulators have the ability to tailor their regulations to lighten the burden on regional banks, Treasury Secretary Jack Lew said earlier in the week.

“I’m not of the view that it requires legislation right now until we know that the — the administrative flexibility is inadequate,” Lew told a House panel.

Not only do regulators have the authority to ease regulations for banks just above the $50 billion cut-off, but they can vary rules among the eight megabanks that are considered globally systemic, Tarullo noted. The Fed is working on a rule to raise capital requirements for those eight banks, including Goldman Sachs and JPMorgan Chase, depending on what risks they take on.

“Given the ability to scale the rules that are present…I don’t think we really favor changing the thresholds at all,” said Marcus Stanley, the policy director for Americans for Financial Reform. He noted that GOP lawmakers were considering “much more radical things” than simply raising the limits.

Nevertheless, Shelby did not seem impressed by the idea that regulators can vary some rules. “What this argument fails to take into account is that the law that established this regulatory framework is very prescriptive on how the regulators can tailor their regulations.”