Financial Reforms Mostly Good for Big Bank Creditors
The regulatory framework proposed by the Obama Administration should, if enacted, be “an overall positive development for the majority of creditors of the U.S. regulated financial sector,” according to Moody’s. “Banks, insurers, their counterparties, and their current unregulated competitors would be subject to more uniform and more prudent regulatory requirements on a consolidated basis.”
However, there would also be implications that Moody’s perceives as potentially raising some credit risks or, at least, some questions at this early stage:
- …it may be more difficult for large, systemically important firms that fall into the new category of Tier 1 Financial Holding Companies (subject to more stringent regulation by the Federal Reserve) to generate returns at pre-crisis levels. On the other hand, these higher prudential standards would likely make these firms safer institutions, which in theory should help them obtain lower cost funding. At the same time, we see the Tier 1 FHC category as a soft form of restriction on “too-big-to– fail” institutions. While this would likely also be beneficial to creditors, we believe this could make government support less likely in the future.
As we have mentioned previously, the new resolution powers, if enacted into law, may be detrimental to more junior classes of creditors, including holding company creditors, as it would grant the FDIC expanded authority to impose losses on debtholders.
- … the reforms to the securitization process, and more particularly the requirement for originators and sponsors to retain an unhedged slice, should act as an incentive for prudent underwriting and help revitalize investor confidence. While we would not anticipate negative credit implications from this requirement, the impact of this retention measure might be particularly felt by investment banks that typically bought loans for the sole purpose of repackaging and securitizing. This business’s return on capital would likely become far less attractive for these firms.
- More stringent and uniform capital and initial margin requirements for all OTC derivatives would likely impose economic limits on excessive risk-taking. Moving OTC contracts to exchanges produces negligible systemic benefits, but if done, would disadvantage large dealers, and would benefit exchanges.
- The new Financial Protection Agency for Consumers would regulate and provide consumer education on products that have, at times, generated significant risk-adjusted returns for banks, while also being a source of volatility during economic downturns. Restrained risk-taking with less creditworthy consumers may hurt earnings in the short run, but help stabilize them in the long run, and thus would be construed as a credit positive.
For details see: Preliminary Assessment of the Obama Administration’s Regulatory Reform Proposal.
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