U.S. banks including Goldman Sachs Group Inc. (GS) should be banned from owning commodities businesses because they could threaten the institutions and global supply chains, Senators Sherrod Brown and Elizabeth Warren told the Federal Reserve.
Financial holding companies “should be prohibited from owning physical assets like warehouses, pipelines and tankers,” Democrats Brown of Ohio and Warren of Massachusetts said in a letter to the Fed yesterday. “These activities pose significant safety and soundness, legal and reputational risks to the institutions.”
The Fed yesterday concluded a comment period on risks posed by bank ownership and trading of commodities such as oil, gas and aluminum, and the possible benefits of imposing additional capital standards on such activities. The Fed announced on January 14 that it was seeking comment on curtailing banks’ involvement in the physical commodities business and other non banking activity.
The Fed’s review of commodities activities at about a dozen large banks followed congressional hearings last year led by Brown. Senator Carl Levin, a Democrat from Michigan, is also investigating possible conflicts of interest and manipulation in those markets. Levin leads the Senate Permanent Subcommittee on Investigations.
The lawmakers have warned that a catastrophe involving a bank-owned supertanker or power plant could jeopardize a lender’s health and leave taxpayers on the hook for a bailout. Bankers say liability from an oil spill or similar accident wouldn’t fall onto them or their depositors.
Levin also said in a letter that the Fed should further restrict banks’ involvement in physical activities, stopping short of an outright ban. He said the cost of a commodities accident could “spread beyond the financial holding company to its banking and non-banking commercial enterprises,” and other institutions.
“If the financial holding company were large enough and the catastrophe severe enough, it could even affect the U.S. financial system,” Levin said in his letter to the Fed.
Levin suggested the Fed tighten the criteria for banks’ allowable commodity-business holdings, limit the value of those investments and require “adequate insurance” and additional capital to protect against an industrial accident.
“Commodities activities present risks that are different from financial-market risks, are idiosyncratic, and have the potential to disrupt more than just the financial system,” Brown and Warren wrote in their letter. “Global supply chain disruptions can affect industries in the broader economy that rely upon raw materials.”
The U.S. Chamber of Commerce said that forcing banks from the physical commodities market could result in an “immediate liquidity drain.”
“These results could lead to serious, unintended consequences for commercial market participants, giving them fewer and more expensive options for hedging and mitigating commercial risk,” the Chamber said in an April 3 comment letter.
Fed restrictions were also opposed by energy-industry groups.
“Our ability to serve our customers will be hampered if the Board places new restrictions on the commodity activities of financial holding companies,” according to a March 31 letter from a group that includes the American Gas Association. A tough rule could “artificially restrict competition” in the commodities markets their members rely on, they told the Fed.
The Fed’s notice cited a list of recent accidents and natural disasters, including the 2010 Deepwater Horizon drilling rig explosion that cost BP Plc more than $42 billion through the end of 2012, as examples of catastrophic events posing risk to exposed institutions.
Fed Chair Janet Yellen said in a February House hearing that the central bank would review the industry comments and pledged to make changes in its oversight of banks’ role in commodities.
JPMorgan Chase & Co. (JPM), Morgan Stanley and Bank of America Corp. have announced plans to sell portions of their commodities business. The Fed’s action could increase pressure on Goldman Sachs to exit the physical commodities business.
Goldman Sachs Chief Executive Officer Lloyd C. Blankfein said in September that the bank’s physical commodities unit is a “core” business that provides crucial service to clients.
Federal law restricts banks from owning a non-financial business unless they get special exemptions. Goldman and Morgan Stanley, the biggest U.S. securities firms until they became bank holding companies during the 2008 credit crisis, were granted grandfathered exemptions for commodities operations under a 1999 law.