Federal Deposit Insurance Corp. Director Jonathan McKernan shared his top-of-mind thoughts Friday at the annual meeting of the Association of American Law Schools — particularly spotlighting the influence asset managers have on publicly traded banks, along with his agency’s not-so-tight timeline for bank merger applications.
The key takeaways:
1. Beware (maybe) of the Big Three. Vanguard, BlackRock and State Street, the three largest asset managers, have a potentially outsized influence on publicly traded banks, McKernan said Friday.
“At least with respect to their index funds, the Big Three purport to be merely passive investors, but a growing body of evidence suggests that’s not always the case,” he said.
“Due to the popularity of their index funds, each of the Big Three has large equity stakes in many publicly traded banking organizations, and some have speculated that that voting power could grow to perhaps 40 percent of shareholder votes,” McKernan added, citing a paper from Harvard and Boston University economists.
Control is a fundamental concept in banking laws — if a company is found to have indirect of direct control of a bank, it’s subject to certain regulatory requirements — and the Big Three are “quite focused on avoiding a finding of control,” McKernan said, adding that the FDIC has provided “regulatory comfort,” on occasion, that that won’t happen with their current equity interests in banks.
Recently, however, “some of the Big Three have proposed increasing their equity interests in some banking organizations well above the thresholds contemplated by this regulatory comfort, even to as much as 24.99 percent of a class of voting stock,” McKernan said. “Some have even contemplated the right to appoint up to two directors to the boards of these banking organizations.”
This has caught the attention of FDIC staff, McKernan said, adding, “we should do more.”
“We should consider taking a close look at the Big Three themselves — in particular, the activities of their investment stewardship teams and their interactions with management of publicly traded banking organizations,” he said.
2. Waiting on approval. “In my first year at the FDIC, I have been struck by the amount of time some applications have been under consideration. We have merger applications that have been with the FDIC for more than a year,” McKernan said. “We have deposit insurance applications by proposed industrial loan companies that have been pending with the FDIC for two or three years.”
Perhaps, he indicated, it doesn’t have to be that way. Banks that have had to extend their merger agreements likely think so. Revising and policy framework around new applications could help the regulator move forward on the applications in queue, McKernan said, adding that the public is owed timely considerations of applications.
3. Bank failures are inevitable. The turmoil of last March yielded lessons, including that “considerable work remains to be done to avoid future bailouts,” McKernan said.
To do that, it must be accepted that failures are inevitable and, in preparation, the regulators should focus on “strong capital requirements and an effective resolution framework as our best hope for eventually ending this practiced habit we’ve developed of privatizing gains while socializing losses.”
