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Regulators give clues on sweeping bank merger policy revamp

A once-in-a-generation review of bank merger oversight policy is gaining momentum now that the Federal Reserve's new vice chair for supervision has been seated, and senior government officials shed light on their thinking in public appearances last week.

The timing for any formal proposals remains uncertain. However, the rethink, which follows an executive order by President Joe Biden calling for a governmentwide assessment of competition policy, is already believed to have drawn out the approval process for some pending bank deals. Michael Barr, in his debut speech on Sept. 7 as the Fed's top regulator, said he would have more to say on the subject soon.

Like colleagues at other agencies, Barr said revisiting regulators' duties under the Dodd-Frank Act to weigh financial stability risks is critical. He also said the Fed will be looking at potentially tougher standards for the largest regional banks to minimize the risk they pose if they fail. Earlier this year, acting Comptroller of the Currency Michael Hsu raised the idea of extending capital and other requirements that currently apply to just eight of the biggest and most systemically important U.S. banks to large regionals and possibly conditioning merger approvals on the adoption of such standards.

In a separate appearance on Sept. 7, Hsu said he remains concerned about options for handling failures of large regional banks, which have grown substantially in recent years. Hsu said he continues to believe that approaches like total loss-absorbing capacity, or TLAC, requirements for large regionals offer a good way forward because of familiarity with their use at the biggest banks, though he is open to other options.

"I don't have prior, hard-set, set-in-stone views on what the right outcome is," he said. "If there's a better mouse trap, absolutely ... it should be tailored. It should be adjusted so it's appropriate and efficient for the size of the institution."

More scrutiny for big deals

Regulators have shown explicit interest in the question of whether deals above a certain size threshold should be subject to the presumption that they pose systemic risk concerns.

Graham Steele, assistant Treasury secretary for financial institutions, said the tailoring of capital and other requirements for banks grouped by asset size and other characteristics creates "some precedent for at least having some sort of hard number in there."

"I don't know what the right number is for that sort of presumption or that harder look," Steele added, but a bright line would provide "predictability, so the market knows when they're going to be scrutinized more." Steele spoke on Sept. 7 at a conference hosted by The Clearing House and the Bank Policy Institute, the same event at which Hsu delivered his speech.

Regulators have said a major review of merger policy is due since it has been 30 years since the last one. Charles Gray, deputy general counsel at the Fed, said now — 12 years after the Dodd-Frank Act — is the time to clarify the framework for evaluating systemic risk issues.

In recent years, regulators have sometimes provided specific rationale on systemic risk issues in their orders approving deals. The orders "could be analogized to sort of a common law approach that is evolving and developing," Gray said, speaking on the same panel as Steele. "There is in force under the Fed's delegation rules sort of a presumption that proposals that involve an acquisition of less than $10 billion in assets or that result in a firm with less than $100 billion in total assets, generally are not likely to create institutions that pose systemic risks. Beyond that presumption ... there is no threshold that's been articulated at which we would find or presume that an acquisition would necessarily raise financial stability concerns."

Gray added that "there's an appetite out there for greater clarity."

The bank industry has pushed back hard against the need for tougher merger oversight or for changes like extending requirements for TLAC to other banks, arguing that mergers can make banks stronger and that rules implemented since the global financial crisis are sufficient.

Pending deals

Gray declined to comment on how the merger policy review might impact pending transactions. Large acquisitions awaiting regulatory approval include U.S. Bancorp's deal for MUFG Union Bank NA, Toronto-Dominion Bank's deal for First Horizon Corp., and Bank of Montreal's deal for Bank of the West.

TD said in August that any new requirements for TLAC, which consists of Tier 1 capital plus long-term debt, would not impact its transaction since it is already a global systemically important bank and its U.S. intermediate holding company will be compliant at the beginning of next year.

Benjamin McDonough, chief counsel at the Office of the Comptroller of the Currency, or OCC, said regulators would weigh the benefits from a stronger institution taking over a weaker bank.

"In many cases, we can see that is sort of a virtuous transaction to the extent that the acquiring bank would be able to pass on those greater risk management capabilities to the other bank," McDonough said, speaking on the same panel as Steele and Gray. "But we do have to consider financial stability. And so we do this on a case-by-case basis."

MUFG Union Bank entered into a consent order with the OCC over technology and operational risk management issues the day before the deal with U.S. Bancorp was announced. U.S. Bancorp itself returned to bank acquisitions shortly after it was released from a deferred prosecution agreement and a related enforcement action over anti-money laundering compliance.

Twilight for Herfindahl-Hirschman Index?

Regulatory officials also said an update to competition and community impact analysis is needed because of vast changes in the financial services industry, including competition from nonbanks and complexities introduced by partnerships between banks and financial technology companies. The reconsideration could lead to a pivot away from the Herfindahl-Hirschman Index, or HHI, a relatively straightforward algorithm that has been used by regulators to assess competitive implications based on deposit market share.

Steele said the Treasury Department is working on a study on financial technology and nonbank competition that involves "defining these markets and who is a competitor exactly" and whether the current tests used are appropriate. The study is also looking at participation by big tech companies in financial services and the separation of banking and commerce.

"Those are hard things to get at with HHI measurements," Steele said.

Still, McDonough acknowledged that the HHI framework has the virtues of transparency, understandability and predictability. "We'll have to think about that if we try considering some of the other approaches," he said.

He added that "we're still, I think, in the relatively early stages of this" and that "I still expect that we'll want to have more engagement" on the matter.