Academic journal article Fordham Journal of Corporate & Financial Law

The Inadequacy of Regulation F in Effectively Reducing Systemic Risk Post Fdicia

Academic journal article Fordham Journal of Corporate & Financial Law

The Inadequacy of Regulation F in Effectively Reducing Systemic Risk Post Fdicia

Article excerpt

Abstract

This Note discusses the role interbank liabilities play in the decision made by banking regulators to invoke too big to fail treatment for a commercial bank. In 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act which sought to reduce the use of Too Big To Fail treatment through a number of measures, including placing limitations on interbank liabilities. Congress did this by giving the Federal Reserve Board of Governors the power to promulgate regulations, which resulted in Regulation F. This Note analyzes how Regulation F does not effectively limit interbank liabilities, and, therefore, is inadequate to fulfill congressional intent under the Act.

Introduction

Even as the 2008 financial crisis brought banking regulation to the forefront of the national agenda, and the Dodd-Frank Act strengthened consumer protection and limited the activities of investment banks,1 an issue of enormous importance to the security of U.S. financial institutions escaped public attention. That issue is interbank liabilities. Federally insured commercial banks are not only growing in size, but they are interconnected through a variety of direct and indirect liabilities, causing them to be increasingly dependent on each other's success.2 Interbank liabilities have the potential to cause exponential harm to consumers, and the financial sector as a whole. When an interconnected firm fails, it can cause those other institutions with substantial deposits in them to fail as well.3

The issue of interbank liabilities has become indistinguishable from Too Big to Fail treatment, a notorious decision by banking regulators to bail out failing financial institutions at the expense of the Federal Deposit Insurance fund ("FDIC fund") and taxpayers.4 A variety of factors contribute to the likelihood that regulators will bail out an institution, including the primary concern that the failure of the institution would cause financial instability to the banking sector as a whole.5 Interbank liabilities play a substantial role in this determination because the interconnectedness of a failing firm directly impacts surviving firms.6

Interbank liabilities have not entirely escaped the attention of Congress or banking regulators. In 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), which directly addressed the issue of interbank liabilities while attempting to reduce the likelihood of bank failure and subsequent too big to fail treatment.7 However, the statute left regulation almost entirely to the Federal Reserve Board of Governors ("Fed") who responded by promulgating Regulation F, which did little to address the issue.8 9 Since the promulgation of Regulation F, the Federal Government has done nothing else to impose limits on interbank liabilities or to reduce the risks interbank liabilities impose on systemic risk.4

This Note will address the inadequacy of Regulation F in limiting interbank liabilities to minimize too big to fail treatment. Part I of this Note will discuss the factors that contribute to systemic risk in the banking system and those events leading up to the enactment of the FDICIA, including the bailout of Continental Illinois National Bank and Trust Company ("Continental Illinois") in 1984. Next, Part I will discuss the details of Regulation F and subsequent legislative action in the area of banking regulation. Part II of this Note will address why Regulation F is inadequate to accomplish the intent of Congress. Part II goes on to discuss Regulation F's failure to meaningfully contribute to the reduction of interbank liabilities or solving the problem of too big to fail treatment. Lastly, in Part III, this Note will explore the impact of interbank liabilities in contrast to the size of financial institutions and will propose that the Federal Reserve Board readdress the issue of interbank liabilities by promulgating a new regulation more in line with the original language of the FDICIA. …

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