Rep. Rose Leads Letter to Federal Reserve Chair Powell

Washington, D.C.- Today, U.S. Representative John Rose (TN-06) led a letter to Federal Reserve Chair Jerome Powell urging the Board to efficiently review financial institutions' applications for risk-adjusted capital treatment from the direct issuance of credit-linked notes to help reduce the backlog of applications as financial institutions prepare for the damaging Basel III Endgame finalization.

As some have called for more scrutiny of risk transfers, market participants have reported banking regulators implementing quasi-shadow bans by delaying routine approvals of these transactions. This comes despite Chair Powell's remarks before the House Financial Services Committee earlier this year saying, "if something works to reduce the risk on a bank's balance sheet, that's something we should be okay with."

U.S. Rep. Rose released the following statement:

"Credit-linked notes are an effective tool used by regional banks to become more efficient," said Rep. Rose. "The Federal Reserve Board should follow the Chair's words and stop stonewalling this effective tool to reduce risk and make markets more efficient, especially as they prepare for the damaging impacts of Basel III Endgame's finalization."

Read the full letter here:

"We write to encourage the Federal Reserve Board ("the Board") to efficiently, yet thoroughly, review regulated entities' applications for risk-adjusted capital treatment from the direct issuance of credit-linked notes. Credit-linked notes are a contract between the banks and a sophisticated institutional investor. The direct issuance of credit-linked notes can diversify bank balance sheets and improve financial resiliency.

"Financial institutions have long sought to diversify their credit risk concentration from lending activities - including home mortgages, credit card debt, or auto receivables - through various means, such as the direct sale of loan pools or securitizations. By directly issuing credit-linked notes banks may diversify their risk profile without the need to sell the actual assets, which allows them to retain customer relationships. An efficient review and approval process by the Board is particularly important considering the banking agencies' recent proposal to increase capital requirements on regulated banks.

"Credit-linked note transactions can also lead to a more efficient allocation of capital and allow financial institutions to redeploy capital for additional lending or investing activities that the bank otherwise would be required to maintain to meet regulatory capital requirements. This directly benefits consumers, small businesses, and corporations who rely on bank financing by freeing up more capital that can be allocated for their lending needs.

"As you are aware, the Board must approve directly issued credit-linked note transactions. Under Subpart D of Regulation Q, this review ensures that the proposed transactions legitimately transfer risk to evaluate a bank's capital adequacy. This review plays an important part in the Board's mandate to promote safety and soundness in the banking sector. An efficient review and approval process by the Board is particularly important considering the banking agencies' recent proposal to increase capital requirements on regulated banks and to keep capital moving to where it is needed most.

"As indicated in past communications, we have concerns with the federal banking agencies' recent proposal to implement the Basel III Endgame agreement in the U.S. and significantly increase capital requirements for banks. While your recent testimony that the Board will re-propose portions of this proposal has been well received, market participants are already beginning to manage their balance sheets for forthcoming restrictive regulations. The direct issuance of credit-linked notes is a key tool banks have begun to utilize that will improve the overall resilience of the financial system by reducing risk concentration within specific institutions, and better aligning assets with funding sources that best match their duration and liquidity profiles. Already, in the fall of 2023, there was a record amount of credit-linked note transactions issued due to fears regarding strict capital regulation, and as we get closer to the finalization of the Basel III Endgame proposal applications received by the Board should only continue to grow.

"However, we are concerned that backlogs may form in the review process at a time when banks are preparing for increased capital requirements arising from the Basel III Endgame standards. We encourage the Board to dedicate sufficient attention and resources to reviews of proposed directly issued credit-linked note transactions to ensure they are conducted as efficiently as possible. Specifically, we would ask the Board to create a clear and transparent timeline for reviewing these applications and reaching final decisions."

The letter was signed by Reps. Sessions (TX-17), Posey (FL-08), Wagner (MO-02), Williams (TX-25), Emmer (MN-06), Mooney (WV-02), Steil (WI-01), Timmons (SC-04), Meuser (PA-09), Fitzgerald (WI-05), Garbarino (NY-02), Kim (CA-40), Donalds (FL-19), Lawler (NY-17), Nunn (IA-03), De La Cruz (TX-15).

Read the full letter here.

Background:

Credit-linked notes are a common, long-standing risk management tool used by financial institutions to reduce credit risk from lending activities - including home mortgages, credit card debt, or auto loans. They combine a bond with a credit derivative. CLNs allow banks to transfer credit risk to investors, reducing their exposure to potential losses. They can also provide investors with a new way to gain exposure to specific credit assets, potentially earning higher returns.

Risk-adjusted capital treatment refers to the regulatory approach of adjusting a financial institution's capital requirements based on the level of risk associated with its assets and activities. The goal is to ensure that the institution holds sufficient capital to cover potential losses, while also allowing for more efficient allocation of capital.

U.S. Representative John Rose is currently serving his third term representing Tennessee's Sixth Congressional District and resides in Cookeville with his wife, Chelsea, and their two sons, Guy and Sam. The Sixth District includes Cannon, Clay, Cumberland, DeKalb, Fentress, Jackson, Macon, Overton, Pickett, Putnam, Smith, Sumner, Trousdale, Van Buren, and White counties as well as portions of Davidson, Scott, Warren, and Wilson counties. Representative Rose is an eighth-generation farmer, small business owner, and attorney, and currently serves on the House Financial Services Committee and House Agriculture Committee.

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