Shelby’s Bill Could Free 25 Midsize U.S. Banks From Stress Test

How big is too big?

A bill introduced this week by Senate Banking Committee Chairman Richard Shelby, which would raise the minimum amount of assets for a bank to be designated systemically important to $500 billion from $50 billion, has touched off a debate about the answer to that question.

The Alabama Republican’s bill could spare 25 mid-size lenders from annual stress tests and having to prepare living wills, exercises that cost banks millions of dollars a year. Among firms that could get relief are U.S. Bancorp, Bank of New York Mellon Corp. and Capital One Financial Corp. Only the six largest U.S. banks have more than $500 billion in assets.

The proposed change is part of a bill that would mark the biggest revision of the 2010 Dodd-Frank Act. Some Democrats have said they’re open to raising the threshold, though not as high as Shelby proposed, which could lead to a compromise. If it’s set at $250 billion, as some analysts expect, regional banks such as SunTrust Banks Inc., BB&T Corp. and Fifth Third Bancorp would get a reprieve.

Wherever the bar is set, the bill would allow regulators to designate banks below that level as systemically important after an elaborate process that gives firms a right to appeal. A committee vote is scheduled next week.

The 31 banks considered systemically important are subject to two stress tests a year, both conducted by the Federal Reserve. One, mandated by Dodd-Frank, measures how much a firm would lose in a hypothetical economic downturn. The other uses those results to determine if a bank can distribute cash to shareholders in the form of dividends or share buybacks. Each year, several firms fail the second test and have to reduce their payouts to comply.

Living Wills

While both tests use the $50 billion cutoff to determine whether a bank is systemically important, only the one mandated by Dodd-Frank is required to do so. There’s nothing preventing the Fed from raising or lowering the bar for the second test. As a matter of convenience, it would probably use the same standard for both.

Living wills are blueprints designed to show regulators how they could be wound down if they fail. They were introduced by Dodd-Frank after the collapse of Lehman Brothers Holdings Inc. showed that having thousands of subsidiaries around the world made the process more cumbersome than a typical bankruptcy.

Moving the threshold won’t necessarily mean all banks that fall under it will get relief, according to Brian Gardner, an analyst at Keefe, Bruyette & Woods.

“Those under $100 billion are simple enough for the regulators not to worry about,” Gardner said. “But north of $100 billion, it gets more complex. Regulators would use their discretion to designate some of those as systemically significant.”