[Federal Register Volume 65, Number 48 (Friday, March 10, 2000)]
[Notices]
[Pages 13077-13078]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-5856]


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DEPARTMENT OF THE TREASURY


Report on the Feasibility and Appropriateness of Mandatory 
Subordinated Debt

AGENCY: Departmental Offices, Treasury.

ACTION: Request for comments.

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SUMMARY: Legislation recently enacted requires the Board of Governors 
of the Federal Reserve System (Board) and the Secretary of the Treasury 
(Secretary) to conduct a study of the use of subordinated debt to bring 
market forces and market discipline to bear on the operation and 
assessment of the viability of large financial institutions. In 
conducting this study, we will consider the views of the general 
public. We invite all interested parties to submit written comments on 
the topics set forth below.

DATE: Comments must be in writing and must be received by May 9, 2000.

ADDRESSES: Send comments to: Subordinated Debt Study, Office of 
Financial Institutions Policy, Department of the Treasury, Room SC 37, 
1500 Pennsylvania Avenue, NW, Washington, D.C. 20220.

FOR FURTHER INFORMATION CONTACT: Joan Affleck-Smith, Director, Office 
of Financial Institutions Policy, U. S. Treasury Department, 202/622-
2470; and Myron Kwast, Associate Director, Division of Research and 
Statistics, Federal Reserve Board, 202-452-2909.

SUPPLEMENTARY INFORMATION: Section 108 of the Gramm-Leach-Bliley Act of 
1999 (Public Law No. 106-102) requires the Board and the Secretary to 
conduct a study of the feasibility and appropriateness of establishing 
a requirement that large insured depository institutions\1\ and 
depository institution holding companies\2\ maintain some portion of 
their capital in the form of subordinated debt\3\ in order to bring 
market forces and market discipline to bear on the operation of, and 
the assessment of the viability of, such institutions and companies and 
to reduce the risk to economic conditions, financial stability, and any 
deposit insurance fund.
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    \1\The term ``insured depository institution'' has the meaning 
given the term in section 3(c) of the Federal Deposit Insurance Act.
    \2\The term ``holding company'' has the meaning given the term 
in section 2 of the Bank Holding Company Act of 1956.
    \3\The term ``subordinated debt'' means unsecured debt that: (a) 
Has an original weighted average maturity of not less than five 
years; (b) is subordinated as to payment of principal and interest 
to all other indebtedness of the bank, including deposits; (c) is 
not supported by any form of credit enhancement, including a 
guarantee or standby letter of credit; and (d) is not held in whole 
or in part by any affiliate or institution-affiliated party of the 
insured depository institution or bank holding company.
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    The Act also requires that, if such a subordinated debt requirement 
is feasible and appropriate, the study address: (1) The appropriate 
amount or percentage of capital that should be subordinated debt, and 
(2) The manner in which any such subordinated debt requirement could be 
incorporated into existing capital standards and other issues relating 
to the transition to such a requirement. The Act requires the Board and 
the Secretary to report to Congress by May 12, 2001 on their findings 
and conclusions in connection with the study together with any 
legislative and administrative proposals that the Board and the 
Secretary may determine to be appropriate.

[[Page 13078]]

Suggested Format of Comments

    In order to assist the Board and the Secretary in preparing the 
subordinated debt study, the two agencies have determined to invite 
interested parties to submit comments and information that would inform 
the study. Comment is invited on all of the issues under study and 
identified below as well as on other issues related to the study that 
have not been included below.

I. Objectives of a Mandatory Subordinated Debt Requirement

    Several changes in the banking industry\4\ have complicated the 
supervision of large banking organizations. These changes include the 
removal of barriers to interstate banking, the blurring of traditional 
boundaries between banking and other types of financial services, and 
the consolidation of bank and nonbank activities in very large 
organizations. Large banks use highly complex methods for taking, 
measuring, and controlling risks. This greatly increases the challenge 
that regulators have in evaluating bank performance and ensuring safety 
and soundness.
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    \4\This and subsequent references to the banking industry refer 
to both commercial banks and savings institutions.
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    Proponents of a requirement for large banking organizations to 
issue subordinated debt (SD) argue that it would enhance market 
discipline exerted on banks, and thus help to promote safety and 
soundness. A mandatory SD policy could provide direct discipline 
through changes in a bank's cost of issuing SD. An SD requirement could 
also enhance indirect discipline, as private market participants and 
government supervisors evaluate bank risk by monitoring SD secondary 
market prices. Expectations of higher SD interest costs and the 
potential imposition of other market or regulatory penalties would 
provide a bank with incentives to manage risk-taking more effectively.
    Some proponents of an SD requirement emphasize its potential in 
limiting supervisory forbearance towards troubled institutions, while 
others argue that it would serve the objective of improving 
transparency and disclosure as SD holders and other market participants 
demand sufficient information to assess the bank's financial condition.
    Finally, an SD requirement is often viewed as a means to increase 
the protection of the deposit insurance funds, since SD could provide 
the FDIC an extra buffer to absorb losses in the event of bank failure.

II. Is a Mandatory SD Requirement on Large Banking Organizations 
Feasible and Appropriate?

    Current Market: An understanding of the current market for banking 
organization SD is necessary to evaluate the feasibility of instituting 
an SD requirement. Important features of the current market to consider 
include: Its liquidity; the typical size and frequency of debt 
issuance; fixed and variable issuance costs; the degree of homogeneity 
of the debt instruments; the quality of price and volume data; and the 
size and other characteristics of the issuing organizations. It is also 
important to assess the effectiveness of the current SD market with 
respect to: creating market discipline; protecting the FDIC; and 
providing useful information to government supervisors.
    Benefits of Mandatory SD: Proponents of a mandatory SD policy argue 
that, if structured in certain ways, the policy would provide greater 
market discipline than that provided by the existing SD market. Some 
also have argued that: SD compares favorably to other debt instruments 
and to equity in providing accurate and timely signals about bank risk; 
mandatory SD could improve bank supervision; and mandatory SD would 
provide additional protection from losses to the deposit insurance 
funds.
    Costs and Risks of Mandatory SD: Critics of mandatory SD argue that 
such a requirement may impose additional costs on banking 
organizations, including the greater underwriting and related costs 
arising from required periodic issuance. A mandatory policy may alter 
market liquidity in ways that raise banks' funding costs. There are 
concerns that a mandatory SD policy might lead to a substitution of 
debt for equity. Some have cautioned about risks to economic stability, 
including the possibility that such a policy could exacerbate a 
business cycle downturn. These critics also say that SD may not be 
necessary because the deposit insurance reforms enacted early in the 
1990s may provide a sufficient amount of market discipline in a 
downturn. Furthermore, an SD policy structured in certain ways (e.g., 
capping spreads on the debt or requiring put options) could unduly 
constrict supervisory flexibility and destabilize financial 
institutions or debt markets.

III. If an SD Requirement Is Feasible and Appropriate, How Should 
It Be Structured and to Which Organizations Should It Apply?

    Most mandatory SD proposals have called for debt to be issued at 
the bank level, while the existing market for the publicly traded SD of 
large banking organizations is primarily at the holding company level. 
The minimum institution size to which an SD requirement would apply, 
the amount of SD required, the minimum frequency of issuance and 
maturity, and other features of the debt all would affect the degree to 
which the policy meets its desired objectives while avoiding undue 
costs and risks.

IV. If an SD Requirement is Feasible and Appropriate, How Should It 
Be Incorporated Into Existing Capital Standards and Supervisory 
Policies?

    Some mandatory SD proposals would allow SD to count towards 
existing capital requirements while others call for SD over and above 
capital levels currently required. Application of mandatory SD only to 
U.S. banks could have implications for international competitiveness. 
Some argue that using interest rate spreads or SD as supervisory 
triggers (e.g., in prompt corrective action and in setting risk-based 
deposit insurance premiums) would be critical to its effectiveness, 
while others argue that the augmented market discipline and additional 
information it would provide to supervisors would be worthwhile on 
their own.

V. If an SD Requirement Is Feasible and Appropriate, What Are the 
Transition Issues?

    Imposing an SD requirement would raise various transition issues, 
including the treatment of existing SD outstanding (e.g., 
grandfathering) and the length of a transition period to full 
implementation of the requirement.

    Dated: February 25, 2000.
Gregory A. Baer,
Assistant Secretary for Financial Institutions, Department of the 
Treasury.
[FR Doc. 00-5856 Filed 3-9-00; 8:45 am]
BILLING CODE 4810-25-P