Ellison Introduces Financial Regulatory Reform Legislation: Closes Risky Asset Loophole
June 4, 2009, Washington, DC
Congressman Keith Ellison (D-Minneapolis) introduced important legislation today in anticipation of upcoming Congressional action on financial regulatory reform.
The Regulatory Capital Enhancement Act addresses a glaring loophole in existing banking rules.
Under current federal regulations, banks are required to maintain a minimum level of capital based upon the riskiness of the assets that they hold. However, a number of financial institutions have been able to avoid these requirements by creating and using off-balance-sheet vehicles, such as special purpose entities (SPEs), to warehouse risky assets.
The Regulatory Capital Enhancement Act would address this problem by requiring federal banking regulators to issue rules that treat assets held in SPEs in a way that is equivalent with those held on bank’s balance sheets.
“Allowing unregulated segments of the market to build up risk unchecked is bad public policy,” Ellison stated. “This bill would close the loophole by eliminating banks’ incentives to use these vehicles as a means of evading prudent regulation.”
SPEs often used short-term debt called asset-backed commercial paper (ABCP) to finance purchases of securities (backed by mortgages, consumer loans and other assets) from the banks that sponsored them. When markets were stable and flush with liquid funds, these entities had no problems refinancing their ABCP. However, when the crisis hit, the SPEs could no longer roll over their short-term debt. This forced a number of banks to consolidate oftentimes risky, and sometimes distressed, assets on to their balance sheet at the worst possible time. While these SPEs allowed banks to appear better capitalized than they were for a while, the financial crisis ultimately exposed this as fiction.
“Giving regulators the authority to oversee and apply capital standards to these entities is a crucial element of comprehensive regulatory reform. Most importantly, this statutory authority provides regulators the flexibility to address future attempts to arbitrage regulatory requirements,” Ellison concluded.
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