Tarullo sees biggest banks with new Fed rule protecting taxpayer

, Bloomberg

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Daniel Tarullo
Daniel Tarullo

Federal Reserve Governor Daniel Tarullo is pushing an agenda to regulate banks beyond the restraints in the Dodd-Frank Act, including making them fund more of their assets using long-term borrowing.

The Fed and the Federal Deposit Insurance Corp. are holding preliminary discussions on a rule that would require holding companies for the largest U.S. banks to maintain a minimum amount of long-term debt that would aid in winding them down in case they fail, FDIC spokesman Andrew Gray said.

As the Fed governor in charge of bank supervision, Tarullo leads the central bank's effort to implement the 2010 Dodd-Frank Act and is now pressing beyond it to limit the kind of systemic risks that required taxpayer-funded bailouts in the 2008-2009 financial crisis. Tarullo, 60, became President Barack Obama's first appointee to the Fed in January 2009 after previously serving as an aide to President Bill Clinton.

"Tarullo is very intent on fixing what in his views are flaws in the supervisory process," said Deborah Bailey, managing director at Deloitte LLP in New York and a former deputy director in the supervision and regulation division at the Fed. "The Fed was given more explicit authority under Dodd- Frank to oversee financially systemic institutions, and, as a result, they are on the hook" if another large bank fails.

Tarullo's agenda for reducing risk also includes strengthening supervision of so-called shadow banking that falls outside traditional regulation and limiting the risk that the biggest banks once again become too big to fail through mergers and more complexity.

Long-Term Borrowing

The push to get banks to use more long-term borrowing is aimed at creating a class of stakeholders that could step in to shoulder losses in case of a failure and reduce the need for taxpayer funding.

Banks typically fund their longer-term assets with short- term debt, making a profit on the interest-rate difference between the two. In a bank failure, stockholders are typically wiped out, and short-term debt can evaporate quickly as creditors refuse to renew commercial paper and short-term notes.

Requiring banks to rely more on long-term debt means the issuers of such debt would become stakeholders at the holding company level, whose bonds regulators could convert into equity in a failure. That might reduce or eliminate the need for taxpayer funding, which Dodd-Frank prohibits. Yields on long- term bank bonds would also provide regulators with a market gauge of bank stress.

Risk Awareness

"It eliminates the government as the backup and makes everybody in the capital line a little more cognizant of risk because you could be wiped out or moved down the capital structure in a pinch," said R. Scott Siefers, managing director at Sandler O'Neill & Partners LP in New York.

Regulators have rarely determined the capital structure for private banks, he said. "We are living in a completely new world."

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