Federal Reserve seeks to reverse law on merchant banking

America’s most powerful banking regulator has recommended that the US Congress reverse a 17-year-old law allowing banks to take big equity stakes in non-financial companies, as it seeks to put new curbs on activities which it says could pose a threat to the broader financial system.

In a report to Congress published, the US Federal Reserve recommended an end to the practice of banks buying stakes above 25 per cent in a wide range of businesses. Banks were granted permission to hold such stakes for up to 10 years in 1999, when Congress passed an Act that gave them much freer rein to provide capital to companies in the form of equity rather than debt.

Within hours of the release of Thursday’s 107-page report, the top five banking lobby groups produced a joint statement denouncing it as “unfortunate” and “ill-considered”, claiming that the Fed had offered no evidence that such activities – known broadly as merchant banking – were a menace to the system.

“For the last 15 years bank holding companies have successfully used the merchant banking authority granted to them by law to finance start-ups and growing companies, fuelling jobs and economic growth,” the lobby groups said.

“And they have done so without any threat whatsoever to the safety and soundness of their affiliated banks or to the financial system at large.”

Reforms

The report was mandated under the Dodd-Frank Act of 2010, the main batch of reforms after the 2008-09 crisis, which required the Fed, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency to advise Congress on the types of banking activities that could unsettle the broader financial system.

The Fed, which produced the toughest and most sweeping proposals of the trio of regulators, also recommended that lawmakers repeal an exemption that gave Goldman Sachs and Morgan Stanley unique permission to own pieces of commodities infrastructure such as power plants and oil terminals.

Under the 1999 Act, known as the Gramm-Leach-Bliley Financial Services Modernisation Act, companies that owned such properties before September 1997 could keep them even if they converted to financial holding companies, as Goldman and Morgan Stanley did in 2008.

Goldman has since disposed of all of its commodities infrastructure, while Morgan Stanley has vastly scaled down its holdings, including selling TransMontaigne, a fuel distributor.

The Fed said the carve-out for the two banks “may create an un-level playing field between these firms and most other banking organisations”.

In January 2014 the Fed issued a proposal on limiting physical commodities trading by a broader group of banks, but has not followed through with new rules. That rulemaking process was ongoing, the Fed said.

Goldman and Morgan Stanley declined to comment on the proposal.

Presidential election

Doug Landy, a former Fed official now at the New York office of Milbank, a law firm, noted that Congressional approval of the merchant-banking ban is uncertain, in view of November’s presidential election.

But he said that lawmakers were now on notice of the “Fed’s view of the world” – which is that “merchant banking is an unsafe and unsound practice”.

Randy Guynn, a partner at Davis Polk in New York, described the proposed ban as “a solution in search of a problem. It seems like they want to turn back the clock.”

The big five lobby groups for the US banks, all based in Washington, are The Clearing House, the American Bankers’ Association, the Securities Industry and Financial Markets Association, the Financial Services Roundtable and the Financial Services Forum.

– (Copyright The Financial Times Limited 2016)