Swaps Push-Out: Keeping Risk Out of Insured Banks

Key Takeaways

• The broker-dealer bank push-out rules required insured banks to move risky swap dealing into non-insured affiliates.
• The provision, Section 716 of Dodd-Frank, was nicknamed the Lincoln Amendment after its sponsor.
• Congress narrowed it in 2014, leaving only certain asset-backed swaps subject to the push-out.
• The debate centers on whether taxpayer-backed deposit insurance should subsidize derivatives trading.

What It Is

The push-out rules came from Section 716 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, often called the Lincoln Amendment after Senator Blanche Lincoln. A swap is a derivative contract in which two parties exchange cash flows, such as a fixed interest rate for a floating one, or payments tied to a company's default.

As originally written, Section 716 barred an FDIC-insured bank, or a firm with access to Federal Reserve credit, from acting as a swap dealer except in limited cases. To keep dealing in those products, the bank had to "push out" the activity into a separately capitalized affiliate that does not carry deposit insurance.

The Intuition

Deposit insurance and the Federal Reserve's lending facilities exist to protect ordinary savers and keep the payment system running. They are a public backstop. When a bank uses that backstop while also running a large derivatives trading book, taxpayers are indirectly standing behind speculative bets.

The push-out idea was to draw a line. Plain banking that the public supports stays inside the insured bank. Riskier swap dealing moves to an affiliate that can fail without triggering a deposit bailout. Supporters argued this protects taxpayers. Opponents argued that splitting the activity is costly, pushes trading to less-regulated corners, and may not make the system safer. Both views shaped how the rule ended up.

How the Broker-Dealer Bank Push-Out Rules Work

Under the original Section 716, an insured bank that wanted to keep dealing the covered swaps had two broad choices. It could stop dealing those products, or it could set up a non-bank affiliate, fund it with its own capital, and run the dealing there. The affiliate would not have access to deposit insurance or routine Fed credit, so its losses would not fall on the public safety net.

The rule never covered all swaps. Banks were generally allowed to keep hedging their own risk and dealing in swaps tied to assets a bank may invest in, such as interest-rate and many investment-grade products. The push-out bit hardest on riskier categories.

In December 2014, Congress amended Section 716 through a provision attached to a large spending bill. The amendment sharply narrowed the rule so that only swaps based on certain asset-backed securities remained subject to push-out. After that change, banks could keep the large majority of their swap dealing inside the insured entity rather than moving it to an affiliate.

Worked Example

Imagine a large insured bank that, before the rules took effect, ran a single swaps desk inside the bank itself, dealing interest-rate swaps, credit default swaps, and structured products to clients.

Under the original Section 716, the bank would have faced a decision on its riskiest lines. It could move credit default swap dealing on lower-quality names into a newly capitalized affiliate, "Bank Swaps LLC," funded with the bank's own equity and standing outside deposit insurance. After the 2014 amendment, however, most of that dealing could stay inside the bank, with only certain asset-backed swaps still required to move. The practical result was that far less activity actually got pushed out than the 2010 law first envisioned.

Common Mistakes

1. Thinking the rule banned bank swap dealing. It never did. It pushed certain categories into affiliates and exempted hedging and many common products from the start.

2. Assuming the original 2010 version is still in force. Congress narrowed it in 2014. Today only certain asset-backed swaps fall under the push-out requirement.

3. Confusing it with the Volcker Rule. The Volcker Rule limits banks' own proprietary trading. The push-out rules address swap dealing for clients and where it must be housed.

4. Believing an affiliate makes the trades risk-free. Pushing risk to an affiliate changes who bears losses, not whether losses can happen. The affiliate can still fail.

5. Treating the topic as settled policy. The repeal was contested, and the underlying question of whether insured banks should deal swaps remains debated by economists and lawmakers.

Frequently Asked Questions

What are the broker-dealer bank push-out rules in simple terms? They were a Dodd-Frank requirement that insured banks move their riskier swap dealing into separate affiliates. The goal was to keep taxpayer-backed deposit insurance from supporting derivatives speculation.

How do the push-out rules affect investment decisions? They shape where a bank houses its derivatives risk, which affects how regulators view the bank's safety. Investors analyzing bank stocks consider where swap exposure sits and how it is capitalized.

What is a real-world example of the push-out rules? A bank dealing credit default swaps inside its insured entity would, under the original rule, have moved that dealing to a separately funded affiliate. The 2014 amendment let most such dealing stay inside the bank.

How can investors think about the push-out rules effectively? Read them as part of the broader question of how much risk sits behind the public safety net. When studying a bank, look at its derivatives footprint and how regulators treat it rather than the label alone.

How are the push-out rules different from the Volcker Rule? The push-out rules address client swap dealing and where it must be housed. The Volcker Rule restricts a bank trading for its own account.

Sources

1. U.S. Government Accountability Office. "Financial Regulation: Perspectives on the Swaps Push-Out Rule." https://www.gao.gov/products/gao-17-607
2. Cadwalader, Wickersham & Taft LLP. "The Lincoln Amendment: Banks, Swap Dealers, National Treatment and the Future of the Amendment." https://www.cadwalader.com/resources/clients-friends-memos/the-lincoln-amendment_banks_swap-dealers_national-treatment-and-the-future-of-the-amendment
3. Peterson Institute for International Economics. "Don't Repeal Swaps Push-Out Requirements (Section 716 of Dodd-Frank)." https://www.piie.com/blogs/realtime-economic-issues-watch/dont-repeal-swaps-push-out-requirements-section-716-dodd-frank
4. Lexology. "The Lincoln Amendment: banks, swap dealers, national treatment and the future of the amendment." https://www.lexology.com/library/detail.aspx?g=6d4652ef-84ac-4750-ab3a-3f22727ccbb6

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.