A rule proposed by the Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Comptroller of the Currency would broadly tighten access to credit and pose economy-wide increases to borrowing costs, the American Public Power Association and state and local associations said in Jan. 16 said.
At issue is a Notice of Proposed Rulemaking on Regulatory Capital Rule: Large Banking Organizations and Banking Organizations with Significant Trading Activity issued by the Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Comptroller of the Currency.
The proposed rule was drafted to comply with “Basel III” -- an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-09.
Basel III measures aim to strengthen the regulation, supervision, and risk management of banks.
The proposed rule would reduce liquidity ratio for municipal debt and increase capital requirements for certain transactions, including hedging transactions with non-registered entities, including public power utilities and rural electric cooperatives.
“Our organizations are composed of thousands of state and local government issuers of municipal debt, nonprofit borrowers, lenders, underwriters, investors, counsel, and other participants across the municipal debt market,” the groups said in their comments.
The proposed rule “would increase the costs to financial institutions that make loans to issuers of municipal debt, and those that underwrite and hold municipal debt in inventory and will disincentivize market makers, resulting in increased borrowing costs and reduced liquidity and stability in the municipal debt market,” APPA and the other groups said.
“This anticipated outcome is the opposite of the stated goals of the proposal. We share the concerns of many stakeholders that the increased banking requirements, as proposed, would broadly tighten access to credit and pose economy-wide increases to borrowing costs,” they said.
These concerns are elevated by the proposal’s release during a time of 30-year-high borrowing costs, the groups said.
APPA and the other groups asked that the Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Comptroller of the Currency pause the rulemaking process until the proposing agencies and other stakeholders can:
- Further evaluate the effect of these rules on the economy generally;
- Specifically evaluate the impact to the municipal debt market and state and local issuers of debt; and
- Reassess the treatment of municipal securities in light of their tax-exempt status and reduce the risk weights and loss-given-default rates in both the sensitivities-based method and default risk charge “which we believe would lead to a significant risk weighted asset reduction, especially considering the materially lower instance of default in the municipal market.”
“If these key details are not assessed, all these issues will make the financing of U.S. state and local government and non-profit borrowers’ capital projects more expensive,” the groups said.
“Our U.S. State and local government issuers and conduit nonprofit borrowers rely on access to affordable credit, primarily through the issuance of municipal bonds and direct loans from financial institutions, to finance our nation’s infrastructure assets and critical public services,” they pointed out.
These borrowing opportunities are often made more affordable by the tax-advantaged treatment of qualified bonds and relationships built between local lenders and borrowers.
“Increases in debt service costs for municipal issuers and conduit borrowers will result in declined investment in infrastructure, public safety, education, and numerous other social services,” the groups said.
Governmental entities also rely on banks as counterparties to derivatives contracts that are used to hedge prices and supply risks related to energy commodities.
“Whether these commodities are for power generation, for institutional use, or for transportation, we do not believe that increasing the capital requirements for these contracts will increase financial system stability, but we are certain that it will increase the cost of managing these risks -- costs that will ultimately be passed on to communities though higher charges for services,” the groups went on to say.
“Further exacerbating this problem is that the portion of the proposal related to derivatives provides a favorable rule for entities that issue investment grade securities that are publicly traded on an exchange, which effectively excludes State and local governments from this favorable treatment.”
In addition to direct costs from higher interest rates and charges for commodity hedges, “overly punitive changes to the capital rules, without regard to the unique nature of the municipal debt markets may result in reduced willingness by financial institutions to hold inventory and could lead to less liquidity, higher yields and lower market making activity in municipal bonds. Major market players have already taken steps to analyze whether to deploy their capital elsewhere and several firms have exited the municipal market because of many factors including regulatory burdens.”
Along with APPA, the other groups signing on to the comments were the Government Finance Officers Association, the National Association of Health and Educational Facilities Finance Authority, the National Association of State Treasurers, the Large Public Power Counsel, the Securities Industry and Financial Markets Association and the Bond Dealers of America.
In related news, APPA and the National Rural Electric Cooperative Association said in Jan. 3 comments that the proposed rule will have serious consequences for the ability of public power utilities and rural cooperatives to find regulated counterparties for the forward contracts, commodity trade options, and energy commodity swaps needed to hedge price and supply risks.