Friday, April 15, 2011

Deutsche Bank's Dodd-Frank Gambit: Too Clever by Half

I think Deutsche Bank's latest reorganization may be too clever by half. Deutsche Bank currently has a US bank holding company (BHC) called Taunus, which houses its US banking unit (Deutsche Bank Trust Corp.), its US broker-dealer (Deutsche Bank Securities, Inc.), and various other US nonbank financial firms. Taunus has a combined $373bn in assets, of which only about $18bn come from its US banking unit. In order to avoid being subject to the Collins Amendment, which requires all US bank holding companies to maintain the same capital ratios as US depository institutions (the horror!), Deutsche Bank is planning to move its US banking unit out of Taunus, and then to deregister Taunus as a BHC.

This, Deutsche Bank apparently reasons, will allow Taunus to escape the Collins Amendment (§ 171 of Dodd-Frank). Is Deutsche Bank right? Probably not. The Collins amendment doesn't just apply to US bank holding companies. Read the statute. Section 171(b)(2) provides: (empashsis mine)

(2) MINIMUM RISK-BASED CAPITAL REQUIREMENTS.—The appropriate Federal banking agencies shall establish minimum risk-based capital requirements on a consolidated basis for insured depository institutions, depository institution holding companies, and nonbank financial companies supervised by the Board of Governors. The minimum risk-based capital requirements established under this paragraph shall not be less than the generally applicable risk-based capital requirements, which shall serve as a floor for any capital requirements that the agency may require, nor quantitatively lower than the generally applicable risk-based capital requirements that were in effect for insured depository institutions as of the date of enactment of this Act.
"Nonbank financial companies supervised by the Board of Governors" are nonbank financial companies that the Financial Stability Oversight Council (FSOC) has deemed "systemically important" under § 113 of Dodd-Frank. So Taunus can only escape the Collins Amendment if it's not a BHC or a "systemically important" nonbank financial company.

The problem is that after deregistering as a BHC, Taunus will almost certainly be deemed "systemically important" by the FSOC. To argue that Deutsche Bank's US broker-dealer — one of the biggest, baddest dealers on the Street, and a major player in the derivatives markets — isn't systemically important would be beyond ridiculous. I simply cannot conceive of a scenario in which the FSOC doesn't designate Taunus systemically important. Thus, deregistering Taunus as a BHC will not allow Taunus to avoid the Collins Amendment.

Now, it's true that § 165 allows the Fed to tailor the capital requirements of systemically important nonbanks (bank-like capital requirements might not be appropriate for certain types of nonbank financial companies). The interaction between § 171 and § 165 is unclear, and is subject to some dispute. However, the most natural reading is that § 171 establishes a floor on the capital requirements for systemically important nonbanks — they have to at least be equal to the capital requirements for US depository institutions — and that § 165 allows the Fed to tailor the capital requirements for nonbank financial companies above that floor.

Deutsche Bank seems to be betting that: (a) § 165 trumps § 171 outright; and (b) the Fed will use its discretion in tailoring the enhanced capital requirements under § 165 to permit Taunus to hold significantly less capital. I think that's a bet they're likely to lose. The view that § 165 trumps § 171 outright rests on a very strained interpretation of the law — the language of § 171 is very explicit. If that is indeed what Deutsche Bank is banking on, then I think they're getting very bad advice.

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