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CBAI Responds to FASB’s Misguided Comments About Community Banks and the Proposed Current Expected Credit Loss (CECL) Model

CBAI responded to disturbing comments by FASB’s Chairman Russell Golden about the role community banks played in the financial crisis and presented an alternate approach to the Current Expected Loss (CECL) model. In his remarks, Golden enumerated “troubling misconceptions” including “The credit crisis involved only large banks.” He cited community bank bank failure statistics followed by his conclusion that “Clearly community banks have been a major part of the problem” and that this is the reason why “all lending institutions should be included in the new guidance.” This flawed reasoning is comparable to citing elder financial abuse statistics and then concluding that senior citizens have been a major part of the problem.

What is not needed in FASB’s response to the financial crisis is a one-size-fits-all CECL model being imposed on community banks. What is needed is an exemption from CECL for banks under $10 billion in assets. An exemption would alleviate the concerns of community banks regarding inappropriate and expensive provisioning that does not fairly present the risk profile of their assets. Read CBAI Letter to Golden.

December 21, 2015

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Your Voice Matters - Here’s How

Your response to CBAI’s Action Alerts is an important part of our governmental relations efforts which support your bank’s performance and shareholder value. These Alerts are delivered to you via e-mail, are simultaneously posted on our website, and are prominently featured in our bi-monthly E-Newsletter. These Alerts communicate your position on critical community bank issues to legislators and regulators.

We make it easy to identify your elected representatives and deliver your message to the appropriate office(s) electronically with a simple click of the “send” button. We are respectful of your limited time, so your response to an Alert will take no more than 30 seconds to complete. Not only are Alerts sparingly requested, but they are sent at the most critical time in the consideration of proposed bills and regulations. As a result, your prompt reply will be most impactful.

Some bankers question the real impact of an electronically delivered form letter or petitions in influencing the legislative and regulatory process. We can say with absolute certainty that every time community bankers rise together and respond in large numbers, the significant industry response is noticed by legislators and regulators and in the financial services industry press. Your overwhelming response becomes an important part of the discussion.

What we can also say with absolute certainty is that a lack of response clearly communicates to legislators and regulators that the issue is just not important enough for community bankers to spend 30 seconds of their time to act. From their perspective, your silence is your consent to their proposal. In most cases this is not the message that we need to be communicating as it seriously undermines important advocacy efforts by CBAI and the ICBA on your behalf. Click Here for numerous examples of how your voice has made a difference with regulators and legislators.

December 15, 2015

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CBAI Calls on Regulators to Advocate for Community Banks with the NCUA and the FCA

Community banks are confronted with blatant discrimination and disadvantages when competing against credit unions and Farm Credit System (FCS) banks. The Community Bankers Association of Illinois (CBAI) has urged the Federal Reserve Board (Fed), the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) (collectively, Regulators), to aggressively and publicly advocate for community banks and to emphasize to the National Credit Union Administration (NCUA) and the Farm Credit Administration (FCA) that there needs to be a level playing field.

Regulators, however, have stated that these are “political” and not “regulatory” matters and they should not get involved, particularly with other agencies. CBAI strongly disagrees with this very narrow interpretation of Regulators’ responsibilities.

The loss of customers to credit unions and Farm Credit System lenders hurts community bank deposit and loan growth, earnings, and credit risk, which negatively affects their safety and soundness and the health of the banking profession. CBAI has emphasized that the Regulators’ stated mission is to ensure the safety and soundness of the financial institutions they regulate. Therefore, it is entirely and rightfully within the responsibility of the Federal Reserve, FDIC and OCC to advocate, in the strongest possible terms, against the NCUA’s and the FCA’s harmful discrimination against community banks. CBAI recommends that the Regulators embrace this responsibility and immediately begin an aggressive and public advocacy effort. Read Letter to Regulators.

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CBAI Urges Consideration of Wilmarth’s TBTF Resolution Reforms

Arthur Wilmarth, George Washington University (GWU) Law School professor, is a nationally-recognized authority on bank regulation. Professor Wilmarth is the author of more than thirty articles and books in the field of banking and has testified before committees of the U.S. Congress on bank regulatory issues.

Wilmarth is highly critical of the lack of meaningful reform of the financial system to successfully address and resolve the problem of large financial conglomerates (i.e., too-big-to-fail (TBTF) banks). CBAI believes Wilmarth’s observations and recommendations in his 2015 GWU publication, “The Financial Industry’s Plan for Resolving Megabanks Will Ensure Future Bailouts for Wall Street,” have considerable merit and warrant serious consideration by lawmakers and banking regulators. If implemented, Wilmarth’s recommendations would compel mega banks and their insiders to internalize at least some of the systemic risks that they impose on society, encourage them to follow more sustainable long-term business policies, and also support current efforts by regulators to persuade mega banks to reduce their size and complexity.

OBSERVATIONS

In this research paper and subsequent correspondence with CBAI, Professor Wilmarth states,

“The high-risk business model of large financial conglomerates (frequently called “universal banks”) was an important cause of the financial crisis. Universal banks rely on cheap funding from deposits and shadow banking liabilities to finance their speculative activities in the capital markets. By combining deposit-taking and short-term borrowing with underwriting, market making, and trading in securities and derivatives, the universal banking model creates a strong likelihood that serious problems occurring in one sector of the financial industry will spread to other sectors.

To prevent such contagion, federal regulators have powerful incentives to bail out universal banks and protect all of their depositors and shadow banking creditors. That is precisely what happened during the financial crisis.

Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 seeks to end bailouts by requiring the Federal Deposit Insurance Corporation (FDIC) to liquidate failed systemically important financial institutions (SIFIs) while imposing losses on their shareholders and creditors. Title II's liquidation-only mandate threatens the TBTF subsidy for SIFIs and their Wall Street creditors, and it therefore presents a direct challenge to the universal banking model.

To meet that challenge, Wall Street developed its "single point of entry" (SPOE) plan for resolving failed SIFIs. Wall Street's SPOE plan would ensure future bailouts for SIFIs and their favored creditors while imposing the costs of those bailouts on ordinary investors and taxpayers.

Under SPOE, only the parent holding company of a failed SIFI would be placed in receivership, and its operating subsidiaries would be maintained as going concerns. All creditors of the operating subsidiaries would be fully protected. Those protected creditors would include uninsured depositors and shadow banking creditors with close connections to Wall Street, such as holders of commercial paper and securities repurchase agreements.

The financial industry's SPOE plan relies on a two-part funding strategy to guarantee continued protection for Wall Street creditors. First, each SIFI's holding company would issue long-term "bail-in" bonds. The FDIC would convert bail-in bonds into equity when a SIFI fails, thereby imposing losses on bail-in bondholders as well as shareholders. To avoid the risk of contagion, SIFIs would not sell bail-in bonds to other financial institutions. Instead, SIFIs would sell bail-in bonds to non-systemic investors, including retail mutual funds and pension funds that invest the savings of ordinary individuals. Thus, ordinary investors would be the primary losers when bail-in bonds are converted into equity.

Second, if write-offs of bail-in bonds are not sufficient to recapitalize a failed SIFI and its operating subsidiaries, the FDIC would borrow the rest of the needed funds from the Treasury Department through the Orderly Liquidation Fund (OLF). Because the OLF currently has a zero balance, OLF loans would be backstopped by taxpayers. Wall Street's SPOE plan would use OLF loans to ensure full protection for short-term creditors of a failed SIFI's holding company and all creditors of its operating subsidiaries.

At the end of the resolution process, a new SIFI would emerge with a minimum of structural changes. Thus, contrary to Title II's liquidation-only mandate, the financial industry's SPOE plan would reorganize failed SIFIs and guarantee bailouts for Wall Street creditors. Ordinary citizens – whether as bail-in bondholders or taxpayers – would be left holding the bag once again.

The Federal Reserve Board and the Financial Stability Board have recently issued proposals that require SIFIs to issue long-term bonds, bail-in debt that would qualify for “total loss absorbing capacity” (TLAC) treatment. The TLAC proposals are closely aligned with the financial industry’s SPOE resolution strategy. It therefore seems highly likely that the U.S. and foreign regulators will adopt the industry’s SPOE plan.

RECOMMENDATIONS

Given that reality, policymakers must adopt three major reforms to reduce the TBTF subsidy inherent in SPOE. First, SIFIs should be prohibited from selling bail-in bonds to ordinary individuals, retail mutual funds, or pension funds unless those bonds are expressly designated and marketed as subordinated debt that is junior to the claims of all general creditors. The foregoing prohibition would prevent megabanks from misleading ordinary investors by selling bail-in bonds that are described as "senior" to subordinated debt (and therefore pay lower interest rates) but in fact have complex, high-risk "triggers" terms.

Requiring SIFIs to designate bail-in bonds as subordinate debt would ensure that SIFIs pay higher interest rates that are more commensurate with the risks inherent in those bonds. If SIFIs decide to avoid higher interest costs by issuing common stock and perpetual preferred stock instead of bail-in bonds, that would be a highly desirable outcome.

Second, SIFIs should pay risk-adjusted premiums to prefund the OLF at a level of $300 billion or more. The prefunded OLF should be used to cover the costs of resolving failed megabanks after the FDIC has written off investments by their shareholders and bail-in debt. Prefunding the OLF would help to protect taxpayers from bearing the costs of resolving failed megabanks.

In addition, a well-designed, risk-based schedule for OLF premiums would encourage SIFIs to follow more prudent operating strategies and adopt less complex business structures. As part of their OLF premiums, SIFIs should pay fees on their uninsured deposits and shadow banking liabilities. Under SPOE, those deposits and liabilities would receive full protection and would enjoy a status similar to insured deposits. The required fees should be comparable to risk-based deposit insurance premiums and should encourage megabanks to establish more stable, longer-term funding structures.

Third, federal regulators should adopt long-delayed incentive compensation rules under Section 956 of the Dodd-Frank Act. Those rules should require SIFIs to pay at least half of their total compensation to senior executives and other key employees (including risk managers and traders) in the form of contingent convertible bonds (CoCos). Insiders should be required to hold their CoCos, without any hedging, for several years after their employment ends. CoCos would expose insiders to immediate losses – without any need for clawbacks – if their SIFI fails during their employment or during their post-employment holding period. CoCos would therefore encourage insiders to adopt sustainable, long-term business strategies that are more closely aligned with the interests of long-term creditors, the FDIC, and taxpayers.”

Wilmarth concludes that the reforms would not eliminate the TBTF subsidy for mega banks, but they would compel mega banks and their insiders to internalize at least some of the systemic risks that they impose on society. He emphasized that by requiring SIFIs and their insiders to bear those risks, that would encourage them to follow more sustainable, long-term business policies, and would also support current efforts by regulators to persuade SIFIs to reduce their size and complexity.

Wilmarth, Arthur E., The Financial Industry's Plan for Resolving Failed Megabanks Will Ensure Future Bailouts for Wall Street (2015). GWU Law School Public Law Research Paper No. 2015-36; GWU Legal Studies Research Paper No. 2015-36. Available at http://ssrn.com/abstract=2648572.

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Highway Funding Bill Includes Community Bank Regulatory Relief

Congress passed and President Obama signed into law a highway and transportation funding bill that included community bank regulatory relief. Three bills detailed below were included in an amendment to the funding bill. All had previously passed the House as stand-alone measures with very strong bi-partisan support.

H.R. 601, the Eliminate Privacy Notice Confusion Act

Summary: This legislation will reduce confusion among consumers by clarifying that they will receive privacy notices after opening a new account (only) when their financial institution’s privacy policies change rather than on an annual basis. The bill passed the House by voice vote on April 13th.

H.R. 1553, the Small Bank Exam Cycle Reform Act of 2015

Summary: This legislation will provide regulatory relief for community banks by allowing well-managed institutions to qualify for longer exam cycles. The bill passed the House 411-0 on Oct. 6th.

H.R. 1334, the Holding Company Registration Threshold Equalization Act of 2015

Summary: This legislation increases the shareholder registration and deregistration thresholds contained in the JOBS Act (passed a few years ago) to savings and loan holding companies. The bill passed the House by voice vote on July 14th.

The highway and transportation funding legislation also exempts community banks $10 billion and under from cuts to Federal Reserve Bank stock dividends which will save approximately $200 million per year (ICBA estimate). In addition to the exemption, the law also contains CBAI/ICBA advocated measures which will: restore funds cut from the federal crop insurance program; drop language that would have extended higher Fannie Mae and Freddie Mac guarantee fees; remove language that a bank must operate “predominantly” in rural or underserved areas to qualify for a QM mortgage underwriting exemption; and establish a process for appealing the CFPB's rural area designation.

CBAI thanks members of the Illinois Congressional delegation for their overwhelmingly bi-partisan support for this important legislation.

December 7, 2015