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FRB Governor Raskin Urges Banks to Take Proactive Role in Dealing with Reputational Risk
[Editor’s Note: The following post is from Goodwin Proctor’s recent Financial Services Alert by Eric R. Fischer, Jackson B. R. Galloway, and Elizabeth Shea Fries. This and other updates from Goodwin Proctor are available here.]
On February 28, 2013, FRB Governor Sarah Bloom Raskin made a presentation entitled “Reflections on Reputation and its Consequences” to the 2013 Banking Outlook Conference at the Federal Reserve Bank of Atlanta. Governor Raskin noted that, in the aftermath of the 2007-2009 financial crisis, financial institutions of all sizes have seen a decline in the public’s perception of their reputation and trustworthiness (and she added that the quality of their reputation is of particular importance to financial institutions). Governor Raskin stated that the decline in public trust of, and confidence in, financial institutions has been increased recently by, among other things, “the Occupy Wall Street movement, payday loans, overdraft fees, rate-rigging settlements in London Interbank Offered Rate [LIBOR] cases, executive compensation and bonuses that seem to bear no relationship to performance or risk, failures in the foreclosure process, and a drumbeat of civil litigation.”
Please click here to read the rest of this entry.
Mortgage Closing Costs May Rise Under the New Rules to Prevent Illegal House “Flipping”
In August 2012, six federal financial regulatory agencies issued a proposed rule to implement Section 1471 of the Dodd-Frank Act which sets forth appraisal requirements for “higher-risk” mortgage loans.
The intended purpose of the proposed rule is to tighten valuation standards for homes in order to reduce the risk of appraisal fraud, a move meant to reassure creditors, borrowers, and investors alike. Section 1471 was created as part of Congress’ intention to prevent the use of false or inflated appraisals in obtaining mortgages. If the proposed rule is finalized without amendment, lenders seeking to issue high-risk mortgage loans will be “unable to value properties on the basis of broker-price opinions, automated valuations, or drive-by appraisals”. The proposed rule would affect mortgages with annual percentage rates (APRs) at designated levels above the Average Prime Offering Rate (APOR). First-lien loans (such as standard mortgages) with an APR 1.5 percentage points above the APOR would be classified as a higher risk mortgage under the proposed rule, while first-lien jumbo loans with APRs 2.5 percentage points above, and subordinate-lien loans with an APR 3.5 percentage points above the APOR would similarly be considered higher-risk.
Banking Supervision: Capital Conservatism
The broad supervisory standards and guidelines issued by the Basel Committee on Banking Supervision (‘the Committee’) have greatly influenced the manner in which Banks are organized in various jurisdictions. The Committee claims that the main culprit behind the current financial crisis is excessive leverage assumed by banks both on and off the balance sheet. The latest in the series of proposed changes propounded by the Committee is Basel III, which seeks to restructure banks like shock absorbers rather than transmitters of financial risk.
The Federal Reserve Bank (‘Federal Reserve’) has responded to Basel III by asking bank holding companies (‘BHCs’) to submit comprehensive capital plans over the next 24 months. It is noteworthy that BHCs are required to notify the Federal Reserve of any change in their capital structure under Section 224.5(b) of Regulation Y issued under section 5(b) of the Bank Holding Company Act of 1956. Basel III, which has been designed conservatively, creates a framework whereby banking companies are to maintain higher common equity ratios, institute tougher stress tests for liquidity, and enhance market discipline and disclosure, among other things. Furthermore, trading positions will be subject to more stringent review, as the Federal Reserve believes that such changes are in the spirit of financial reform initiated by the Dodd-Frank Act.
Volcker Rule Update #2: Comment Period Extended; Analysis of the Hedging Exemption
The deadline for submitting comments regarding the proposed regulations implementing the Volcker Rule has been extended from January 13 to February 13. As we noted in our previous update on the Volcker Rule, the timeline was already very tight if regulators intended to meet the implementation deadline of July 2012, and this postponement only makes that timeline even tighter and less feasible.
Putting this logistical problem to a side, one major provision in the proposal we have yet to discuss in-depth is the exemption provided in the Volcker Rule for risk-mitigating hedging transactions. The current proposal would allow banks to maintain, purchase, or sell hedging positions with commercial deposits provided that these positions arise from and are related to specific risks involved in the bank’s other legitimate positions, contracts, or holdings. These other risks include market risk, counterparty/credit risk, currency/foreign exchange risk, and interest rate risk (among others). Additionally, the hedged positions taken by the bank must be “reasonably correlated” (or, to be more precise, reasonably negatively correlated) with the risks purportedly being mitigated.
Update: 298 Page Volcker Rule Proposal Leaves Much To Be Desired (And Decided); Issue #1: Market Making
On October 12th the Federal Reserve, FDIC, Office of the Comptroller of the Currency, and SEC submitted the long-awaited proposal for implementation of Section 619 of the Dodd-Frank Act, widely referred to as the “Volcker Rule.” Legislators included this section in the Dodd-Frank Act in order to divide commercial banking and depository functions, which are federally insured, from banks’ investment activities (commonly referred to as “proprietary trading”). Given the fact that many large commercial banks, such as Bank of America and JP Morgan Chase, derive a significant portion of their revenue (8% and 9%, respectively) from their trading desk, the details of the rule could have enormous implications for the future financial strength and stability of depository institutions.
The proposal has several large exceptions to its prohibition on proprietary trading in order to allow banks to continue to provide important financial services to their customers. One of the largest exceptions is for market making. Market making can involve a number of activities, but at its core it consists of financial institutions accepting client requests to purchase (or sell) any given security without that financial institution immediately going out into the market and finding a seller (or buyer). In order to facilitate this process, financial institutions involved in market making may maintain a stock of various securities that they buy and sell to clients as needed to meet client demand. Under the new proposal, banks would be allowed to purchase and sell securities under the premise of market making so long as: a.) the bank “holds itself out” as being willing to buy and sell those securities to and/or from clients, b.) the purchases or sales do not exceed “reasonably expected near term demands” of clients, c.) the activities are primarily intended to generate income from fees, commissions, and bid-ask spreads (as opposed to appreciation or depreciation in the securities themselves), and d.) the compensation arrangements of employees engaged in market making is not designed to reward large returns that may result from the appreciation or depreciation of the securities themselves.
Yield-Spread Premiums Prohibited Under New Loan Origination Compensation and Steering Rules
Under Loan Originator Compensation and Steering rules issued by the Federal Reserve, new restrictions on loan originator compensation and steering practices will go into effect on April 1, 2011. The new rules amend Regulation Z, Federal Reserve rules for implementing provisions of the Truth in Lending Act (TILA), and are consistent with the § 129 TILA provisions in the Dodd-Frank Act (15 U.S.C. 1639(l)(2)). In particular, the new rules have three major prohibitions:
- Loan originators compensation must be based on the principal loan amount and cannot be based on any other loan terms or condition, such APR or interest rate. These new restrictions effectively end the practice of loan originators receiving yield-spread premium compensation from lenders. Read the rest of this entry »
Fed Proposes Definitions for Systemically Important Nonbank Financial Institutions
On February 8th the Fed published a proposed rule that would govern when a company is “predominantly engaged in financial activities” and when it would be considered “systemically important.” Various provisions of the Dodd Frank Act require regulations to be implemented for systemically important financial institutions, including general regulation on activity, as well as reporting and disclosure requirements.
Under the proposed rule, an institution could be considered “financial” if, in either of the past two years, 85% or more of its revenue is related to activities determined to be financial in nature (according to the Bank Holding Company Act). This calculation would include income from equity investments in other institutions that are primarily engaged in financial activities.
Fed Approves Final Rule to Implement Volcker Rule
On February 9th the Fed approved of the final version of the Volcker Rule, part of the Dodd-Frank Act, which is now scheduled to go into effect on April 1, 2011, though there is a 2 year window in which governed entities will be given to conform their behavior to its regulations. The Volcker Rule prohibits insured depository institutions (hereafter referred to as “banks”) from proprietary trading in securities and financial derivatives, as well as from acquiring a financial or governing interest in hedge funds. Activities by U.S. banks would be governed by the rule, regardless of where their activities take place, however activities by non-U.S. banks would only be governed if they occurred, at least in part, within the U.S.
The definition of activities that constitute proprietary trading is taking positions with the primary purpose of selling shortly thereafter. The ambiguity inherent in this definition is supplemented by the provision that allows government agencies, such as the SEC and CFTC, to implement rules that extend activities governed by the rule to any security or financial instrument that is deemed appropriate.
Bernanke Testifies on Fed’s Commitment to Implementing Dodd-Frank
In a statement before the Committee on Banking, Housing, and Urban Affairs, Ben Bernanke reaffirmed the Federal Reserve’s commitment to working with financial regulatory agencies to implement Dodd-Frank – more than 50 rulemakings and formal guidelines. According to Bernanke’s statement, the Fed has more than 300 staff members working on implementation projects, and the transfer of the Federal Reserve’s consumer protection responsibilities to the new Bureau of Consumer Financial Protection is well under way. After delving into a list of ongoing implementation projects, Bernanke concluded his statement by expressing the Fed’s commitment to its “long-standing practice of ensuring that all of its rulemakings are conducted in a fair, open, and transparent manner.”
Click here to read his entire testimony.
