Alert May 20, 2014

FRB Issues Proposed Rule Implementing Dodd-Frank Act’s Concentration Limit on Large Financial Companies

The FRB issued a notice of proposed rulemaking (the “Proposed Rule”) that would implement section 622 (“section 622”) of the Dodd-Frank Act, which established a financial sector concentration limit (the “Concentration Limit”) “that generally prohibits a financial company from merging or consolidating with, or acquiring, another company if the resulting company’s liabilities upon consummation would exceed 10 percent of the aggregate liabilities of all financial companies…”  The Proposed Rule would be designated “Regulation XX” of the FRB.  The Concentration Limit supplements the nationwide deposit cap of 10 percent of total deposits at U.S. insured depository institutions imposed by current Federal banking law.  Unlike the deposit cap, the Concentration Limit takes into account nondeposit liabilities and off-balance sheet exposures.  The Concentration Limit does not constrain organic growth by a financial company, i.e., internal growth that does not involve an acquisition or merger.

Under the Proposed Rule, exemptions from the Concentration Limit are provided for liabilities acquired in connection with: (1) the acquisition of a failing bank; (2) (with the prior written consent of the FRB) a de minimis transaction that increases liabilities by less than $2 billion; and (3) ordinary business transactions that may increase total liabilities of the financial company, e.g., acquiring shares in the ordinary course of collecting a bad debt, in a fiduciary capacity or as part of merchant or investment banking activities.

The FRB estimated that the financial sector’s current aggregate liabilities are approximately $18 trillion, leading to a current Concentration Limit of approximately $1.8 trillion.  As pointed out in the financial press, because of other Dodd-Frank Act provisions that focus on addressing matters and transactions that could pose systemic risk, bank regulatory agencies may well deny applications seeking approvals of mergers and acquisitions where the resulting organization would have aggregate liabilities of significantly less than $1.8 trillion.

Section 622 and the Proposed Rule define a “financial company” as a U.S. insured depository institution, a bank holding company, or savings and loan holding company, a foreign banking organization that is treated as a bank holding company for purposes of the Bank Holding Company Act, any company that controls an insured depository institution and a nonbank financial company that is designated by the Financial Stability Oversight Council (FSOC) for supervision by the FRB.

The Proposed Rule generally defines the liabilities of a financial institution as the “difference between its risk-weighted assets, adjusted to reflect exposures deducted from regulatory capital, and its total regulatory capital.”  Those financial companies that are not subject to consolidated, risk-based capital rules would, under the Proposed Rule, use generally accepted accounting standards.  In the FRB’s proposal, a financial company’s aggregate liabilities would be disclosed annually, but would be calculated as a two-year average.

Comments on the Proposed Rule are due to the FRB by July 8, 2014.  In the Proposed Rule, the FRB poses 14 specific questions as to which it is seeking comments, but it invites comments on all aspects of the Proposed Rule.