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Lawmakers Considering Bill to Help Private Banks

By on June 2, 2016

A 1991 Puerto Rico law requires financial institutions to put forth securities as collateral for public funds in deposits, in an effort to protect these monies against the depository bank’s inability to have the cash on hand when needed.

Puerto Rico lawmakers are now considering legislation that would ease the costs of this burden by allowing the use of other instruments to satisfy the collateral requirements. This would guarantee the integrity of government resources to provide essential services to residents, particularly in challenging times like these, Senate Bill (SB) 1601 reads.

Yet the measure could be seeking to tackle other difficulties, such as private banks’ recent hurdles in meeting collateral requirements amid the large influx of public funds they have received in deposits during the past few months.

In its written testimony on SB 1601, the Government Development Bank (GDB) notes that private banks have seen a marked increase in their public deposits, while also selling off battered Puerto Rico securities, which are often used as collateral for public funds. The GDB lets on that this combination could have possibly led to a “shortage of collateral” in the local banking sector.TOP STORY

A spokeswoman for the P.R. Treasury Department, which oversees banks’ compliance with public funds’ collateral requirements, told Caribbean Business that as of today, public funds are properly collateralized in private banks.

Sources told this newspaper that Banco Popular, which holds a large chunk of public funds that the Alejandro García Padilla administration has taken out of the GDB, was involved in the bill’s drafting. However, Banco Popular officials could not be reached for comment.

Last week, the upper chamber approved SB 1601 in a 19-1 vote, with Puerto Rican Independence Party Sen. María de Lourdes Santiago saying nay. She warned the bill is “a legislative trick to conceal an alarming financial situation,” while the government could be putting at risk public funds.

For Santiago, considering the measure at this time could mean “deposits made to date have constituted transfers of public funds that do not comply with applicable law.”

Popular Democratic Party Sen. José Nadal Power, chairman of the committee, told Caribbean Business he filed the measure after concerns from the GDB and the local banking sector. He added that flexibility is being sought, while highlighting the credit soundness of the financial instruments being considered.

A low-cost option

The bill specifically calls for allowing the use of municipal letters of credit (Mulocs), an instrument sold by the Federal Home Loan Bank of New York (FHLBNY) to its bank members, which include Popular and other local financial institutions.

The Federal Home Loan Bank is a federal government-sponsored entity that operates under a cooperative framework through which bank members are owners.

Mulocs operate as “a promise, made at the request of a member, to make payments to a third-party beneficiary,” in this case, the government, if the depository bank is unable to meet its obligations. They are backed by FHLBNY’s triple-A credit rating.

According to the entity’s website, the credit instrument provides a cheap option to collateralize deposits of public funds. The bank can prop up its liquidity position by freeing up its securities portfolio for other uses, as well as increase earnings from investmentsLEAD STORY1.

As for the government, it would reduce costs related to monitoring collateral compliance, as Mulocs’ market value remains constant, unlike securities.

In its consideration of SB 1601, the upper chamber’s Treasury committee pointed out some of these benefits, while adding the bill allows for more modern and efficient ways to collateralize public funds. For instance, the committee highlighted how other jurisdictions such as New York, New Jersey and the U.S. Virgin Islands already allow the use of Mulocs as collateral for public funds.

Concerns over the bill

Although no public hearings were conducted, the Senate committee received written statements from the Puerto Rico Bankers Association, Treasury Department, Financial Institutions Commissioner’s Office (OCIF by its Spanish acronym) and the GDB.

According to the committee’s report, the bankers and OCIF fully supported the measure. The GDB and Treasury showed some concerns, although they fell short of opposing the bill. Instead, they recommended some clarifications before signing off on it.

For instance, both Treasury and the GDB asked how quickly these letters of credit could turn into cash if suddenly needed, to which the Bankers Association answered that in the unlikely event this collateral needs to be executed, it would be an expedited process.

In its written statement, Treasury concedes that “in the face of recent movements of [public] funds to private bank accounts, the government should be even more prudent and require a higher collateralization of [public] funds.”

SB 1601 is being considered during times when significant uncertainty remains over the GDB’s future as the government’s depository institution and how long the government could maintain current levels of public funds in local banks. For instance, more than $1 billion was transferred to Popular just in March, a government source told this newspaper.

All things being said, the Senate approved the legislation after introducing amendments to ensure only letters of credit issued by federal government-backed entities would be allowed. The measure now moves to the lower chamber, where it is unclear when it would move forward on the bill. The House reconvenes on June 8.

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