Regulatory Watch August Update: Debt Changes for Regional Banks

In July, our Regulatory Watch update shared sweeping capital requirement changes that would impact approximately 30 of the largest banks, including regional banks. The newest proposal dominating the news in August is increased debt requirements for large regional banks.

$70 Billion in New Debt Requirements 

Proposed during the August 29th FDIC meeting, the new regulations would require banks with over $100 billion in assets to hold more long-term, loss-absorbing debt to minimize the stress on deposit funding. Debt financing will be more expensive than deposit funding, but regulators believe it will be more stable and ease pressure on FDIC-insured deposits.

These changes mean large regional banks would have to increase debt by about $70 billion. Regional banks with assets over $100 billion will now have debt requirements that align with the debt requirements imposed on $250 billion+ banks. FDIC Chairman Martin Gruenberg advocated for the changes to add protection and reassurance for depositors and thus bring more financial stability.

The FDIC proposal elaborates, “Considering its long maturity, [long-term debt] would be a stable source of funding and in contrast to other forms of funding like uninsured deposits, may serve as a source of market discipline through pricing.”

Living Will Rule

Yet another change with a disproportionate impact on regional banks is the proposed living will changes.  Banks over $50 billion will need to submit living wills to regulators which outline plans for bank dissolution in the event of a failure. When the FDIC struggled to find a quick buyer for Silicon Valley Bank, it increased anxiety across the banking sector. The rationale for living wills is that a planned sales process will be less rushed and could decrease the likelihood of subsequent bank failures due to investor fears.

Pressure for Bank Consolidation

Increasing regulation, including more liquidity, capital, and debt rules, will put pressure on regional banks to be more careful about what they add to their balance sheets. According to Christopher McGratty, Head of U.S. Bank Research at KBW, this can slow loan growth, limit buybacks, and increase M&A activity.  “Near-term, there are pressures on earnings, there are pressures on returns ... There are 80 banks between 10 and 40 billion in assets. As the banks need to build more scale beyond the 100 billion, [consolidation] is one of the effects of regulation.”

Regional Banks Need to be Prepared

For the last few months, our Regulatory Watch message to regional banks has been to be prepared. The new rules impacting regional banks keep coming as regulators take a “carpet-bombing” approach to ensure they won’t miss potential risks in the industry.

Even with long phase-in periods, regional banks need to be proactive about risk management. A great place for many banks to start is identifying business-critical processes that aren’t meeting current compliance standards, likely because they are in error-prone, uncontrolled spreadsheets.  Solutions like Coherent Spark can help banks add robust governance, control, and audibility to their existing processes.

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