Proposed Reg Might Curtail Banks' Muni Demand

Banks have been increasing holdings of municipal bonds in recent years, but a proposal by the Fed, OCC, and FDIC would make munis less attractive.

U.S. banks poured more than $200 billion into state and local-government debt since the onset of the financial crisis six years ago, boosting their share of the $3.7 trillion market to a two-decade high.

Now, if federal regulators have their way, California Treasurer Bill Lockyer says banks next year will have more incentive to buy debt sold by Saudi Arabia or Botswana than by U.S. municipalities. The result, he says: higher costs for taxpayers.

Such assets would include Treasuries, bonds of foreign governments, and other securities, including some stocks and corporate bonds. Municipal obligations wouldn’t count because regulators said they didn’t consider them easy enough to sell.

That exclusion may cause banks to reduce munis in favor of securities that meet the requirements, Fitch Ratings said on Jan. 30. The New York-based company said banks that operate as dealers, the market’s middlemen, may hesitate to commit money to trading of local debt, potentially making it harder for investors to transact in the securities.

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