FDIC’s Bair Says Keep Derivatives Trading Within Banks
On Friday, Sheila Bair — the head of the Federal Deposit Insurance Corporation, which performs banking oversight and consumer protection as well as guaranteeing most bank deposits — wrote a letter to Sen. Chris Dodd (D-Conn.) and Sen. Blanche Lincoln (D-Ark.) urging them not to force banks to spin off their derivatives business. Last week, Dodd merged Lincoln’s derivatives language into the financial regulatory reform bill currently under consideration by the Senate, including the controversial spin-off provision.
Bair, known as a tireless consumer advocate, argues that pushing derivatives trading outside of banks will make the system riskier:
I urge you to carefully consider the underlying premise of this provision — that the best way to protect the deposit insurance fund is to push higher risk activities into the so-called shadow sector….
Banks are not perfect, but we do believe that insured banks as a whole performed better during this crisis because they are subject to higher capital requirements in both the amount and quality of capital…. If all derivatives market-making activities were moved outside of bank holding companies, most of the activity would no doubt continue, but in less regulated and more highly leveraged venues. Even pushing the activity into a bank holding company affliate would reduce the amount and quality of capital required to be held against this activity…. By concentrating the activity in an affiliate of the insured bank, we could end up with less and lower quality capital, less information and oversight for the FDIC, and potentially less support for the insured bank in a time of crisis. Thus, one unintended outcome of this provision would be weakened, not strengthened, protection of the insured bank and the Deposit Insurance Fund, which I know is not the result any of us want.
Thus, opposition to the spin-off provision comes both from the consumer advocacy and the investment banking sides. Banks do not want to spin off the derivatives business because it is lucrative. Regulators do not want banks to spin off the derivatives business because it is dangerous, and better held within institutions with more government oversight and higher capital requirements.