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Federal Deposit Insurance Corporation Open Meeting on SA-CCR

Federal Deposit Insurance Corporation

Board of Directors Open Meeting

Tuesday, November 19, 2019

Key Topics & Takeaways

FDIC Board

Summary Agenda

The Federal Deposit Insurance Corporation (FDIC) board unanimously approved the items on the summary agenda (Memorandum and Resolution re: Regulatory Capital Rule: Revisions to the Supplementary Leverage Ratio to Exclude Certain Central Bank Deposits of Banking Organizations Predominantly Engaged in Custody, Safekeeping and Asset Servicing Activities; Memorandum and Resolution re: Regulatory Capital Treatment for High Volatility Commercial Real Estate (“HVCRE”) Exposures; Memorandum and Resolution re: Final Rule Removing Transferred OTS Regulations, Part 390 Subpart M – Deposits; Memorandum and Resolution re: Notice of Final Rulemaking re: The Use and Remittance of Certain Assessment Credits; Memorandum and Resolution re: Establishment of the FDIC Advisory Committee of State Regulators). Gruenberg briefly commented on the final rule that would implement section 402 of S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act to amend the rules for custodial banks to exclude central bank reserves from the supplementary leverage ratio. He noted that he continues to have serious reservations about changes to the supplementary leverage ratio and the possibility of such changes leading to unnecessary financial instability. Before moving to the discussion agenda, McWilliams stated that the FDIC has approved all final rules implementing S. 2155.

Memorandum and Resolution re: Regulatory Capital Rule: Standardized Approach for Calculating the Exposure Amount of Derivative Contracts

FDIC staff provided an overview of the final rule on the standardized approach for counterparty credit risk (SA-CCR) for the purpose of calculating the exposure amount of derivatives contracts. Staff stated that the final rule would replace the current exposure methodology (CEM) and would provide important improvements relative to the CEM. They noted that the SA-CCR capital treatment for derivatives contracts is both more risk-sensitive and model-dependent than the CEM while at the same time being less complex. Staff continued that this final rule is substantially compatible with international standards issued by the Basel Committee on Banking Supervision (BCBS) in terms of regulatory capital treatment for derivatives contracts among international active banking organizations. The final rule requires that Category I and II banking organizations in the interagency tailoring final rule use SA-CCR to calculate their standardized total risk-weighted assets while all other banking organizations (Category III) could elect to use either CEM or SA-CCR for this purpose. It would also require Category I and II banks to use SA-CCR to determine the exposure amount of derivatives contracts for purposes of total leverage exposure. If a Category III bank opts to use CEM to calculate the total-risk-weighted assets, it then must also use CEM to determine the exposure amount of derivative contracts for total leverage exposure. Staff continued that they received approximately 58 comments on the proposed rulemaking and incorporated changes in the final rule to be responsive to these comments. These changes include amending supervisory factors for commodity derivatives contracts to better align with those in the Basel Committee standard, providing relief to commercial end-users by removing the alpha factor for exposures, permitting clearing member banking organizations to recognize client collateral under the supplementary leverage ratio and allowing a banking organization to treat settled-to-market derivatives contracts as subject to a variation margin agreement which allows such contracts to net with collateralize-to-market derivatives contracts of the same netting set. Staff recommended that the FDIC board approve this final rule with an effective date of April 1, 2020 and a mandatory compliance date of January 1, 2022.

Jelena McWilliams, Chair, FDIC

McWilliams noted that while robust capital requirements are a critical element of our regulatory framework, the rules must also be efficient, properly calibrated and appropriately risk sensitive. She stated that this final rule would more accurately reflect risks in the derivatives markets and provide improvements to risk sensitivity and calibration. She continued that the final rule should not raise costs for commercial end users to hedge or mitigate commercial risk and was therefore pleased to see the removal of the alpha factor codified in the final version. While she remains concerned about the risks associated with central counterparties (CCPs), she said that the relevant agencies continue to believe that central clearing through CCPs generally reduces the effective exposure of derivatives. She said that the final rule will not materially change the amount of capital in the banking system and any change in a particular bank’s capital requirements either through an increase or decrease in regulatory capital would reflect the enhanced risk sensitivity of SA-CCR as well as market conditions. She concluded that this rule will improve the overall efficiency of the regulatory framework and signaled her support for approval of this final rule.

Martin Gruenberg, Director, FDIC

Gruenberg stated that this rule would weaken the leverage capital requirement for derivatives exposures for the largest most systematically important banks in the United States. He continued that it would also increase vulnerability to the failure of a central clearing counter party which he believes to be one of the most significant risks to the U.S. and global financial systems. He specifically noted his opposition to a provision within the final rule which would allow for the recognition of collateral and the supplementary leverage ratio of a bank that is a member of the central clearing counter party in connection with a cleared derivatives transaction. He stated that the biggest risk to financial systems today is the expanded footprint of CCPs as a result of the clearing mandate and their interlocking relationships with their largest member organizations, the global systemically important banks (GSIBs). As such, he outlined his opposition to reducing the leverage ratio retirements that large clearing member organizations currently must meet. He concluded that leveraged capital positions should not be weakened and that he will be voting against this rule.

Joseph Otting, Comptroller of the Currency

Otting declined to make a statement.

Kathleen Laura Kraninger, Director, Consumer Financial Protection Bureau (CFPB)

Kraninger declined to make a statement.

Final Vote

The FDIC Board approved the final rule in a 3-1 vote, with Gruenberg opposing.

Memorandum and resolution re: Notice of Proposed Rulemaking on Conversion of the Statement of Policy for Section 19 of the Federal Deposit Insurance Act to a Regulation 

FDIC staff provided an overview of the proposed rulemaking which would convert the statement of policy for Section 19 of the FDIC Act to a regulation. Staff summarized Section 19, which prohibits without the prior written consent of the FDIC, a person convicted of any criminal offense involving dishonesty, breach of trust, money laundering or who has entered into a pretrial diversion or similar program in connection with a prosecution for such an offense from becoming or continuing as an institution-affiliated party, owning or controlling an insured institution and participating in the conduct of an insured institutions. Staff noted that since the Statement of Policy (SOP) for Section 19 was promulgated in 1998, it has been amended on four occasions, most recently in July 2019. Staff continued that by incorporating the current SOP into the FDIC’s regulations, the FDIC will be able to provide greater transparency and clarity to the banking industry and public regarding the Section 19 process while not impairing the integrity of the SOP. They encouraged the submission of comments from industry and other interested parties about the functionality of the proposed regulation.

Jelena McWilliams, Chair, FDIC

McWilliams stated that the application of Section 19 should not be a barrier to entry for individuals who have committed minor crimes in the past, paid their debt to society, reformed their conduct and are now seeking to gain employment with a financial institution. She noted that this rulemaking will not undermine the intent of the SOP and that it is sound policy to codify this SOP through a final rulemaking. She said that she is particularly interested in comments on whether and how the FDIC should expand the criteria for what constitutes a de minimus offense. McWilliams concluded by signaling her support for the proposed rulemaking.

Martin Gruenberg, Director, FDIC

Gruenberg stated his support for the proposed rulemaking.

Joseph Otting, Comptroller of the Currency

Otting declined to make a statement.

Kathleen Laura Kraninger, Director, CFPB

Kraninger noted her support for the proposed rulemaking.

Final Vote

The FDIC Board approved the proposed rulemaking unanimously.

Memorandum and resolution re: Notice of Proposed Rulemaking on Federal Interest Rate Authority

FDIC staff outlined the proposed rulemaking which proposes regulations implementing Sections 27 and 24(j) of the Federal Deposit Insurance Act (FDI Act). These regulations would codify guidance set forth in FDIC General Counsel’s Opinion No. 11, which was adopted by the Board and published in 1998. Further, these regulations would clarify the law governing the interest rates that state-chartered banks and insured branches of foreign banks may charge, address legal uncertainty resulting from the Second Circuit Court’s decision in Madden v. Midland Funding, LLC., which called into question the enforceability of the interest rate terms of a loan agreement following the assignment of the loan, and continue to promote parity between state banks and national banks. Staff noted that this case concerned a loan made by a national bank and that the court concluded that the National Bank Act did not permit the assignee to charge interest at the contractual rate, contrary to long standing legal principles and market practices. Staff continued that the proposed rulemaking would provide that the permissibility of interest for purposes of Section 27 would be determined when a loan is made and would not be affected by later events, thereby protecting the parties’ expectations and reliance interests while at the same time providing a rule that is ‘simple, logical and fair.’ Staff concluded that the proposed rulemaking would address the legal uncertainty created by this case while promoting the marketability of state bank loans, which would have important safety and soundness benefits.

Jelena McWilliams, Chair, FDIC

McWilliams stated that the Madden v. Midland Funding, LLC decision injected significant uncertainty in the market for loan sales and that it was an unnecessary deviation from long standing notions of contract law. She noted that the proposed rule would correct this anomaly by establishing in regulations Section 27 of the FDI Act that the permissibility of interest would be determined when a loan is made and is not impacted by subsequent assignment, sale or transfer. She continued that in reaffirming and codifying in regulation the valid doctrine, the proposed rule does not address the question of whether a state bank or insured branch of a foreign bank is a real party in interest with respect to a loan or whether it has an economic interest in the loan under state law. She concluded by stating her support for the proposed rule and noting that the FDIC views unfavorably the arrangements in which an entity partners with a state bank for the sole purpose of evading a lower interest rate established under the law of the entity’s licensing state.

Martin Gruenberg, Director, FDIC

Gruenberg stated that he intends to vote against this notice of proposed rulemaking as he believes that it could unnecessarily undermine the application of state consumer protections laws to enter into charter relationships.

Joseph Otting, Comptroller of the Currency

Otting declined to make a statement.

Kathleen Laura Kraninger, Director, CFPB

Kraninger declined to make a statement.

Final Vote

The FDIC Board approved the proposed rulemaking in a 3-1 vote, with Gruenberg opposing.

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