WASHINGTON (CN) - The American Bankers Association sued the Federal Reserve Board, claiming a final rule finally written for the Dodd-Frank Wall Street Reform and Consumer Protection Act will shut down as many as 37 community banks and drain $600 million from banks overnight.
The American Bankers Association and two banks sued the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System in Federal Court to stop the rule, citing Administrative Procedure Act violations.
Plaintiffs include CB&T Bancshares / Citizens Bank & Trust Co., of Marks, Minn., and MBT Financial Corp. / Monroe Bank & Trust, of Monroe, Mich.
More than 3 years after passage of Dodd-Frank, the government adopted the "Volcker Rule" on Dec. 10 this year.
"To the shock of community banks, the Final Rule unexpectedly requires banks to divest their holdings in a commonly held debt instrument known as a 'TruPS-backed CDO' by 2015 and, under Generally Accepted Accounting Principles ... to take an immediate and irrevocable hit to earnings and capital as a result," the complaint states.
TruPS-backed CDOs are trust-preferred securities banks bought to create a steady stream of long-term income. Banks like them because they can survive market fluctuations.
"The Final Rule will impact over 275 banks and cause an estimated $600 million in capital to vanish overnight," the bankers claim. "These capital losses will immediately subject small banks to increased regulatory scrutiny, increase the cost of acquiring funds, and adversely affect the banks' ability to make loans and to provide other services to members of their communities."
The bankers claim that small banks that lose income from having to sell these securities will face a sudden drop in capital that will strangle their ability to loan money and force them to pay higher interest rates to attract investors, creating a ripple effect that could reach small businesses.
"The actual loss to these institutions may ultimately be even greater," the complaint states. "The Final Rule requires all banks (including several large banks with substantial TruPS investments) to sell their holdings in these debt instruments within 19 months. The flood of TruPS-backed CDOs into the market, while dramatically reducing the number of typical investors in these instruments will depress the market value of these investments, effectively requiring the banks to sell their TruPS-backed CDOs at fire-sale prices."
The complaint adds: "Accordingly, it is likely that banks will face additional earnings and capital losses in 2014 as the market value for these debt instruments falls."
Though the lawsuit predicts damages the rule will have on small banks, the predicted damage to the plaintiffs' own operations is under seal and has been redacted from the complaint.
The groups say the government violated the Administrative Procedure Act.
"First, [the rule] is contrary to law, impermissibly treating a debt instrument with no participation in profits and losses as a prohibited, equity-like 'ownership interest.' Second, its sweeping expansion of the term 'ownership interest' is not a logical outgrowth of the Proposed Rule and therefore violates the notice-and-comment requirements of the Administrative Procedure Act. ... And third, the Agencies' utter disregard of the great costs imposed on community banks, despite a statutory obligation to consider these costs and their avowed objective of minimizing the burden on these small institutions, was arbitrary and capricious," the complaint states.
The bankers warn that "the consequences of these errors will be grave."
They seek declaratory judgment that the government's expansion of "ownership interest" in the rule violates federal law, and an injunction remanding the rule to the Federal Reserve for further notice and comment.
The bankers are represented by Anthony Herman with Covington Burling.
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