The U.S. Congress is scheduled to consider a proposal to allow banks to keep swaps trading units.
The congressional vote on the proposal, which is included in the government funding bill (H.R. 83), will take place soon.
Regarding the bill, FDIC Vice Chair Hoenig stated that “[i]t is illogical to repeal the 716 push out requirement,” and explained that most derivatives would not even be pushed out of the bank because “interest rate swaps, foreign exchange and cleared credit derivatives can remain within the bank.”
According to Vice Chair Hoenig, the main items that must be pushed out under Dodd-Frank Section 716 are uncleared credit default swaps, equity derivatives and commodities derivatives, which are “much smaller and where the greater risks and capital subsidy is most useful to these banking firms.” Additionally, he stated, the derivatives that are pushed out are “only removed from the taxpayer support and the accompanying subsidy of insured deposit funding – they will continue to exist and to serve end users.”
Lofchie Comment: There are good reasons to repeal Section 716. It is wasteful and expensive for banking organizations to have to build an infrastructure to support swaps-dealing activity in more than one legal entity. This requires a duplication of regulatory expenses, a substantial duplication of technology infrastructure and a significant increase in necessary personnel. Additionally, banking organizations face the same customers in both types of transactions. By forcing banking organizations to split their transactions between two legal entities, the regulations diminish the ability of the banks to reduce credit exposure by netting off transactions with a single customer. Similarly, banking organizations face more operational burdens when moving margin payments back and forth between entities as a customer’s positions change in value at separate entities. Contrary to Vice Chair Hoenig’s view that banks will continue to provide these services to end users, it follows that banks will provide fewer of the services at a higher cost. (These requirements are not cost-free, nor are they internalized by the banking system; they have to be passed on to users, such as the commercial firms that trade in commodities.)
Banks are well suited to engage in these activities. Lending money with respect to debt obligations or commodities, whether the exposure is documented as a loan or as a derivative, is inherently a credit function and, thus, an activity appropriate for banks.