[Senate Hearing 112-714]
[From the U.S. Government Publishing Office]
S. Hrg. 112-714
IMPLEMENTING WALL STREET REFORM: ENHANCING BANK SUPERVISION AND
REDUCING SYSTEMIC RISK
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
ON
EXAMINING WALL STREET REFORM
__________
JUNE 6, 2012
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Charles Yi, Chief Counsel
Laura Swanson, Policy Director
Glen Sears, Senior Policy Advisor
Jana Steenholdt, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Beth Zorc, Republican Counsel
Mike Piwowar, Republican Chief Economist
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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WEDNESDAY, JUNE 6, 2012
Page
Opening statement of Chairman Johnson............................ 1
Prepared statement........................................... 41
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 3
WITNESSES
Neal S. Wolin, Deputy Secretary, Department of the Treasury...... 5
Prepared statement........................................... 42
Daniel K. Tarullo, Member, Board of Governors of the Federal
Reserve
System......................................................... 7
Prepared statement........................................... 47
Responses to written questions of:
Senator Brown............................................ 71
Senator Vitter........................................... 72
Thomas J. Curry, Comptroller of the Currency, Office of the
Comptroller of the Currency.................................... 8
Prepared statement........................................... 51
Responses to written questions of:
Senator Johnson.......................................... 75
Senator Shelby........................................... 78
Senator Menendez......................................... 81
Senator Brown............................................ 81
Senator Vitter........................................... 82
Senator Toomey........................................... 84
Martin J. Gruenberg, Acting Chairman, Federal Deposit Insurance
Corporation.................................................... 9
Prepared statement........................................... 62
Responses to written questions of:
Senator Johnson.......................................... 85
Senator Shelby........................................... 86
Senator Brown............................................ 88
Senator Vitter........................................... 90
Senator Toomey........................................... 91
Senator Wicker........................................... 91
Richard Cordray, Director, Consumer Financial Protection Bureau.. 11
Prepared statement........................................... 67
(iii)
IMPLEMENTING WALL STREET REFORM: ENHANCING BANK SUPERVISION AND
REDUCING SYSTEMIC RISK
----------
WEDNESDAY, JUNE 6, 2012
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I call this hearing to order. This
hearing is part of the Committee's continued oversight of the
implementation of the Wall Street Reform Act, and it is also an
opportunity to discuss with our bank regulators the
implications of the massive trading loss recently announced by
JPMorgan Chase, one of our Nation's largest banks. When a bank
with JPMorgan's solid reputation announces that it lost
billions of dollars on a large trade reportedly designed to
reduce the firm's risks, it reminds us that no financial
institution is immune from bad judgment.
While the JPMorgan trading loss does not appear to have
caused systemic problems, it is a clear reminder that Wall
Street continues to need better risk management, vigorous
oversight, and, if the rules are broken, unyielding
enforcement. To repeal or weaken Wall Street reform and defund
the cops enforcing it would take us back to the days before the
financial crisis of 2008.
Wall Street reform was a response to the crisis caused by a
lack of consumer protection, reckless behavior in the financial
sector, and regulators who failed to take action in time. We
now have an agency solely focused on consumer protection, tough
new rules to end negligent and reckless practices by some on
Wall Street, and regulators armed with new powers to ensure the
safety and soundness of the banks they supervise.
The regulators are also in the process of enhancing the
standards for our Nation's largest banks through increased
capital requirements and more judicious liquidity and leverage
standards.
Wall Street reform also requires regulators to sharpen
their focus on the largest and riskiest financial institutions.
All the regulators joining us today are members of the
Financial Stability Oversight Council, a body created to
monitor risks facing our financial system. Most here are also
all working on the Volcker Rule to prohibit proprietary trading
with Government-insured deposits, and the FDIC continues to
work diligently to implement the living wills requirements and
establish the Orderly Liquidation Authority for global, large,
complex financial institutions.
Similarly, while there is a need for strong regulation of
all financial institutions, Wall Street reform recognizes that
small community banks should not be treated the same as the
largest banks. Because large, complex banks take on the most
risk and pose the greatest threat to our economic stability,
they should be required to pay their fair share into the
Deposit Insurance Fund. Likewise, the small banks that did not
cause the crisis should not have to pay for the risks taken on
by their larger competitors, and their assessments have been
lowered accordingly.
A one-size-fits-all approach is not appropriate, and many
parties have raised concerns about challenges faced by small
community banks. I hope to hear from our witnesses today about
the steps they are taking with regard to small banks.
Some have claimed that the Wall Street Reform Act was not
the right set of solutions to the crisis and that it asks our
regulators to micromanage the activities of the firms they
regulate. I disagree. To restore confidence in our financial
system after the crisis, we need more, not less, scrutiny of
Wall Street's activities. The Wall Street Reform Act has built
a stronger oversight framework that closes regulatory gaps,
enhances financial stability, and better protects consumers,
investors, and taxpayers.
And so despite the repeated calls to deregulate and to
defund by those who ignore the costly lessons of the financial
crisis, completing the implementation of the Wall Street Reform
Act must be, and remains, a top priority for this Committee.
In that vein, I look forward to hearing from the witnesses
here today about the progress they have made to complete
implementation of Wall Street reform, as well as the actions
they have taken regarding the JPMorgan trading loss, and their
thoughts on the potential implications of the loss for
supervision and Wall Street reform rulemakings going forward.
I also want to thank Ranking Member Shelby and my
colleagues here on the Banking Committee for all their input
and cooperation over the past several months. At a time when
most of America thinks that Congress is in a gridlock, the
Committee has been very busy getting things done on the Senate
floor. The bipartisan Export-Import Bank reauthorization passed
with broad support and was signed into law by the President
last week. We passed in the Senate this Committee's bipartisan
Iran sanctions bill. Both nominees for the Federal Reserve
Board of Governors received floor votes, and we helped to
secure the passage of their confirmation. We passed the
bipartisan transportation bill in the Senate, and the
Transportation Conference Committee meetings are currently
ongoing with the House. And we passed a 60-day extension of the
National Flood Insurance Program, and we have a commitment from
the Senate's leadership to bring the Banking Committee's
bipartisan NFIP reauthorization bill to the floor in the coming
weeks.
In addition, there is another important legislative matter
facing this Committee: helping responsible homeowners refinance
into lower interest rates at no cost to the taxpayers. We have
already had several full Committee and Subcommittee hearings on
refinancing proposals. I would like to take a bipartisan
approach similar to the other Committee-passed bills of this
Congress where we work together on a bipartisan vehicle with
amendments limited to those related to the underlying bill. I
am hopeful that my colleagues will agree to move forward in
this manner as well so that we can help responsible homeowners
and help the housing market rebound.
With that, I turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. Thank you for
calling this very, very important hearing. And to our panelists
today, welcome again. I think we have spent a lot of time
together, but probably we will spend a lot more in the future
right here.
Today the Committee will hear from the financial regulators
who supervise our Nation's banks. The safety and soundness of
our banking system depends on your efforts. It was not long ago
that our banking system began to collapse, notwithstanding the
presence of a large and vigorous regulatory structure. Hence, I
believe it is critical that this Committee conduct rigorous
oversight to ensure that the financial regulators do not repeat
the mistakes of the past.
As the primary regulator of the national banks, the Office
of the Comptroller of the Currency is responsible for ensuring
the safety and soundness of our largest banks. This means that
the OCC supervises JPMorgan Chase, whose recent $2 billion plus
trading loss has been in the news. And because taxpayers
basically guarantee JPMorgan's deposits, the American public, I
believe, has a right to know whether these trades threatened or
could have threatened the solvency of the bank.
In addition, this Committee, I believe, has an obligation
to determine whether this loss reveals any operational or
regulatory weakness that could cause more serious problems in
the future.
Next week, here in this Committee JPMorgan CEO Jamie Dimon
will appear to explain his bank's actions there. Today I would
like to hear the OCC's views on what happened at JPMorgan. In
particular, the Comptroller, I believe, should give us his
assessment of whether these trades ever threatened, as I said
earlier, the safety and soundness of one of our Nation's
largest banks.
Banks are in the business of taking risks, and losses, as
we all know, are an inescapable part of risk taking. Job
creation and economic growth depend on banks' taking risks. It
is the job, I believe, of regulators to prevent banks from
taking risks that expose taxpayers.
Some people have used JPMorgan's loss as an opportunity to
argue for a stronger implementation of the Volcker Rule. But no
matter where you stand on the Volcker Rule, this argument, I
believe, is a bit premature. Most importantly, was the OCC's
current authority sufficient to prevent these trades from
putting taxpayers at risk, if they did? If so, did the OCC
properly use the authority that it has? I look forward to
hearing the Comptroller's answers to these questions, among
others.
Also with us today is the Acting Chairman of the Federal
Deposit Insurance Corporation, who is no stranger to this
Committee. We have been told that Dodd-Frank will prevent
future taxpayer bailouts and that insolvent financial
institutions will be allowed to fail. Yet under the FDIC's plan
for implementing Dodd-Frank's resolution authority, short-term
creditors would still be bailed out. The lesson we all should
have learned from the TARP bailouts is that creditors of a
failed firm should bear its losses. Today I hope that Acting
Chairman Gruenberg can reassure this Committee that the FDIC's
resolution authority will not institutionalize Government
bailouts.
Regrettably, the FDIC is not the only regulator that has
taken actions that may institutionalize too big to fail. The
Financial Stability Oversight Council, led by Treasury, and the
Federal Reserve Board have recently used the authority granted
by Dodd-Frank to designate several companies as systemically
important and are preparing to designate a larger group soon. I
believe the danger presented by such designations is that the
market will view it as an implicit guarantee that the Federal
Government--the taxpayers--will not allow the designated
institution to fail. This was the same problem that arose with
Fannie and Freddie and ultimately has led to about a $200
billion taxpayer bailout, and more to come. I would like to
hear from the Treasury and the Federal Reserve Board as to how
the designation process will eliminate rather than create too-
big-to-fail companies.
Finally, we will also hear from the Director of the Bureau
of Consumer Financial Protection. The Bureau's regulation and
supervision will impact the safety and soundness of our banking
system, I believe. But unlike other bank regulators, the Bureau
is not required to consider safety and soundness when it writes
rules or takes actions against banks. I think this is becoming
apparent as the Bureau's proposed rule will impose huge costs
on banks and have created serious confusion about what banks
need to do to comply with consumer protection laws.
For example, the Director of the Bureau has unilateral
authority to declare products to be ``abusive.'' However, the
Bureau has said that it will not write a regulation to clarify
what the term ``abusive'' means. Think about it. The refusal to
write a rule stands in stark contrast to the Director's
statements that the Bureau would give banks clear rules of the
road--in other words, certainty in what they could do and what
they could not do.
The refusal of the Bureau, a lot of us believe, to issue
clear rules means that banks will have higher costs, more
exposure to lawsuits, and less effective operations, something
I do not think Congress intended. In the end, it will be
consumers that will pay the price in the form of higher costs,
less access to credit, fewer choices, and more paperwork from
less efficient banks. But this should come as no surprise to
the regulators here. After all, it was not our regulators or
the banks that paid for the poor regulation and practices that
led to the financial crisis. It was the taxpayers and the
consumers.
Thank you, Mr. Chairman.
Chairman Johnson. Thank you, Senator Shelby.
This morning, opening statements will be limited to the
Chairman and the Ranking Member to allow more time for
questions from the Committee Members. I want to remind my
colleagues that the record will be open for the next 7 days for
opening statements and any other materials you would like to
submit. Now I will briefly introduce our witnesses.
Neal S. Wolin is Deputy Secretary of the U.S. Department of
the Treasury.
Dan Tarullo is currently serving as a member of the Board
of Governors of the Federal Reserve System.
Thomas Curry is Comptroller of the Currency. Welcome, Mr.
Curry, to your first hearing before the Banking Committee since
your confirmation as Comptroller.
Marty Gruenberg is the Acting Chair of the Federal Deposit
Insurance Corporation.
And Richard Cordray is Director of the Consumer Financial
Protection Bureau.
I thank all of you again for being here today. I would like
to ask the witnesses to please keep your remarks to 5 minutes.
Your full written statements will be included in the hearing
record.
Secretary Wolin, you may begin your testimony.
STATEMENT OF NEAL S. WOLIN, DEPUTY SECRETARY, DEPARTMENT OF THE
TREASURY
Mr. Wolin. Chairman Johnson, Ranking Member Shelby, and
Members of the Committee, thank you for the opportunity to
appear today to discuss implementation of the Dodd-Frank Act.
The Act's full implementation will help protect Americans from
the excessive risk, fragmented oversight, and poor consumer
protections that played leading roles in bringing about the
recent financial crisis.
That crisis, and the recession that accompanied it, cost
nearly 9 million jobs, erased a quarter of household wealth,
and brought GDP growth to nearly negative 9 percent.
Today our economy has improved substantially, although more
work remains ahead. More than 4.3 million private sector jobs
have been created over the past 27 months and, since mid-2009,
our economy has grown at an average annual rate of 2.4 percent.
As part of our broader efforts to strengthen the economy,
Treasury is focused on implementing the Dodd-Frank Act to build
a more efficient, transparent, and stable financial system.
Core elements of the act include tougher constraints on
risk taking and leverage; a new orderly liquidation authority
to resolve large, interconnected firms facing failure;
comprehensive oversight of derivatives; stronger consumer
financial protections; and new measures to promote transparency
and market integrity.
Substantial progress has been made since the Dodd-Frank Act
was enacted. Regulators have proposed or finalized nearly all
the major rules related to the core elements of reform.
Treasury's implementation responsibilities include the
Secretary's role as Chair of the Financial Stability Oversight
Council and standing up the Office of Financial Research and
the Federal Insurance Office. Excellent progress has been made
setting up each of these entities.
Treasury is also charged with coordinating the Volcker
rulemaking. We are working with the regulatory agencies toward
a final rule that effectively prohibits proprietary trading
activities and limits investments in--and sponsorships of--
hedge funds and private equity funds.
The lessons learned from the recent failures in risk
management at JPMorgan Chase will be an important input into
efforts to design the Dodd-Frank Act reforms, including a
strong Volcker Rule.
The Volcker Rule explicitly exempts from the prohibition on
proprietary trading the ability of firms to engage in ``risk-
mitigating hedging activities in connection with and related to
individual or aggregated positions . . . designed to reduce the
specific risks to the banking entity.''
To that end, the final rule should clearly prohibit
activity that, even if described as hedging, does not reduce
the risks related to specific individual or aggregate positions
held by a firm.
Losses at JPMorgan raised questions that go beyond the
Volcker Rule as well. Among other things, regulators should
require that banks' senior management and directors put in
place effective models to evaluate risk, strengthen reporting
structures to ensure risks are assessed independently and at
appropriately senior levels, and establish clear accountability
for failures in risk management. Regulators should make sure
that they have a clear understanding of exposures and that
banks and their senior management are held accountable for the
thoroughness and reliability of their risk management systems.
Ultimately, the true test of reform is not whether it
prevents firms from taking risk or from making mistakes. It is
whether our financial regulatory system is tough enough and
designed well enough to prevent those mistakes from harming the
economy or costing taxpayers money. We all have an interest in
that outcome.
Our ability to achieve it depends on the authority and the
resources to enforce tougher capital, leverage, and liquidity
requirements on banks and the largest, most complex nonbank
financial companies.
It depends on implementing the full framework of
protections on derivatives, from margin requirements and
central clearing of standardized derivatives to greater
transparency into risks and exposures.
It depends on providing the SEC, the CFTC, the CFPB, and
other enforcement authorities with the resources to police
manipulation, fraud, and abuse.
It depends on our ability to safely unwind a large firm
without the broad collateral damage and risk to the taxpayer
that we experienced in 2008.
And it depends on making sure that no exception built into
the law is allowed to undermine the impact of the tough
safeguards we need.
The challenges our economy has continued to experience
since the financial crisis in 2008 only increase our commitment
to implementing lasting financial reform.
Recent failures in risk management provide an additional
reminder that comprehensive reform must continue to move
forward. The Administration will continue to resist all efforts
to roll back reforms already in place or block progress for
those that remain to be implemented. The lessons of the
financial crisis should not be left unlearned or forgotten, nor
should American workers--or American taxpayers--be left
unprotected from the consequences of future financial
instability.
Thank you.
Chairman Johnson. Thank you.
Governor Tarullo, please proceed.
STATEMENT OF DANIEL K. TARULLO, MEMBER, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you, Mr. Chairman, Senator Shelby, and
Members of the Committee.
You are all probably familiar with the concept of the law
of the instrument, although you may know it instead as the law
of the hammer. If you are holding a hammer, everything looks
like a nail.
Now, that concept itself is supposed to be a warning not to
use reflexively a familiar tool in response to every problem.
But I must confess that the longer I taught and wrote in the
area of financial regulation, the more convinced I became of
the centrality of strong capital standards to a sound financial
system.
My time at the Federal Reserve has not changed my mind. On
the contrary, a series of events, most recently the JPMorgan
loss announced a few weeks ago, has only reinforced my
conclusion.
A bank with a strong capital position can absorb losses
from unexpected sources, whether those be external shocks to
the economy, the insolvency of important counterparties, or
failures of risk management within the firm. Strong capital
buffers ensure that losses are borne by shareholders of the
bank, not by taxpayers, either directly through some form of
bailout or indirectly through a major negative effect on the
economy resulting from a bank's failure.
So I am especially pleased that tomorrow afternoon the
Federal Reserve Board will be considering a final regulation
implementing more rigorous capital requirements for market
risks of banking organizations, as well as proposed rules to
increase the quantity and quality of capital held to satisfy
regulatory requirements.
These regulations are the product of cooperative efforts by
the Federal Reserve, the OCC, and the FDIC over the last few
years to achieve strong international capital arrangements, and
over the last several months to draft joint domestic
regulations. Along with our stress tests, annual capital
reviews, and anticipated systemic risk surcharges, these
regulations will form a complementary set of requirements for
the country's largest institutions.
While capital is central to good financial regulation, it
is not all there is. There is truly more than a hammer in the
regulatory toolbox, which also includes noncapital rules,
market discipline, and supervisory oversight. We continue to
work on rules, notably the enhanced prudential standards for
larger institutions required by sections 165 and 166 of the
Dodd-Frank Act, and the Volcker Rule. The latter, of course,
involves multiple agencies, which have now finished reviewing
the 19,000 comment letters and are considering potential
modifications of the proposed rule.
The enhanced prudential standards elicited considerably
fewer letters but still present a number of important issues
for consideration before final regulations can be implemented,
including how to tailor the application of these standards to
firms of different sizes and complexity.
As to market discipline, one development of note is that
the Federal Reserve and FDIC will in the coming months be
reviewing the resolution plans to be submitted by large firms
in accordance with the joint rule adopted by the two agencies
last year.
Finally, with respect to supervision, the Federal Reserve
continues to build a more centralized, horizontal, and data-
driven approach to supervision of our largest institutions. The
LISCC process, as we call it, has run the stress tests and
other horizontal supervisory exercises since its establishment
in 2010 and is extending its activities to coordinate other
supervisory processes more effectively.
Thank you for your attention, and I would be pleased to
answer any questions you might have.
Chairman Johnson. Thank you.
Comptroller Curry, please proceed.
STATEMENT OF THOMAS J. CURRY, COMPTROLLER OF THE CURRENCY,
OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. Curry. Thank you, Chairman Johnson, Ranking Member
Shelby, and Committee Members. Thank you for the opportunity to
update you on our implementation of the Dodd-Frank Act, its
impact on the supervision of national banks and Federal savings
associations, and our response to JPMorgan Chase's losses
reported in May.
Among the many Dodd-Frank-related rulemakings underway are
rules to remove references to credit ratings from OCC
regulations and a final market risk rule. In addition, I will
soon approve publication of a set of proposals to implement
Basel III. The OCC is also reviewing comments received in
response to proposals regarding the Volcker Rule and stress
tests required by the Dodd-Frank Act. These rules, when final,
will make important contributions to the regulation of
financial institutions in this country.
The Dodd-Frank Act and other reforms have already done much
to strengthen our financial regulatory framework. Translating
these reforms into improved soundness of our banking system and
fair treatment of bank customers requires strong, effective
supervision, which is a theme that flows throughout my
testimony and will mark my tenure as Comptroller.
The OCC has already begun efforts to heighten supervisory
expectations for the largest institutions we oversee. This
process includes increasing our awareness of risks facing banks
and the banking system, ensuring these risks are understood and
well managed, and raising our expectations for management,
capital, reserves, liquidity, risk management, and governance.
It will take time to achieve these objectives, and we must
remain vigilant in maintaining our course. My testimony
provides considerable detail about these efforts.
I want to use the remainder of my time to provide an
overview of what the OCC is doing in response to the JPMC
losses reported in May. We are the primary regulator of JPMC's
national bank where the activity leading to its losses
occurred, and we are responsible for the prudential supervision
of the bank.
Since early April, the OCC has been meeting with bank
management to discuss JPMC's Chief Investment Office positions,
risk management, and controls. As the positions deteriorated,
discussions turned to corrective actions and steps necessary to
mitigate and reduce the risk of the bank's positions. We and
the Federal Reserve are conducting reviews in the bank and are
sharing information with the FDIC and other regulators.
We are also undertaking a two-pronged review of our
supervisory activities. The first component focuses on
evaluating the adequacy of current risk controls at the bank,
informed by their application to the positions at issue. The
second component evaluates the lessons learned from this
episode that could enhance risk management processes at this
and other banks. Consistent with our supervisory policy of
heightened expectations for large banks, we are demanding that
the bank adhere to the highest risk management standards.
We are not limiting our inquiry to the particular
transactions at issue. We are assessing the adequacy of risk
management throughout the bank. We are using these events to
broadly evaluate the effectiveness of the bank's risk
management of its CIO function and to identify ways to improve
our supervision. If corrective action is warranted, we will
pursue appropriate informal or formal remedial measures.
JPMC's national bank has approximately $1.8 trillion in
assets and $101 billion in Tier 1 common capital. Given that
scale, the loss by JPMC affects its earnings but does not
present a solvency issue. JPMC has improved its capital,
reserves, and liquidity since the financial crisis, and those
levels are sufficient to absorb this loss. It is also worth
noting that the events at JPMC do not threaten the broader
financial system, and the bank's effort to manage its positions
is not creating an unusual risk of contagion.
There has been much discussion about whether these JPMC
activities would be permissible under the proposed Volcker
Rule. While it is premature to reach any conclusion before our
review is complete, this episode will certainly help focus our
thinking on those issues.
I appreciate the opportunity to appear before the
Committee, and before closing, I want to stress my commitment
to ensuring that the OCC continues to enhance supervision. I
look forward to updating you throughout my tenure on how we are
achieving strong, effective, fair, and balanced supervision of
national banks and Federal thrifts.
Thank you.
Chairman Johnson. Thank you.
Chairman Gruenberg, please proceed.
STATEMENT OF MARTIN J. GRUENBERG, ACTING CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Mr. Gruenberg. Thank you, Chairman Johnson, Ranking Member
Shelby, and Members of the Committee, for the opportunity to
testify today on the FDIC's efforts to enhance bank supervision
and reduce systemic risk.
The most important new FDIC authorities under the Dodd-
Frank Act are those that provide for the orderly resolution of
systemically important financial institutions. Since passage of
the Dodd-Frank Act, the FDIC has taken a number of steps to
carry out its new responsibilities. First, the FDIC established
a new Office of Complex Financial Institutions to carry out
three core functions: to monitor risk within and across these
large, complex firms from the standpoint of resolutions and
risk to the Deposit Insurance Fund; to conduct resolution
planning and develop strategies to respond to potential crises;
and to coordinate with regulators overseas regarding the
significant challenges associated with cross-border resolution.
For the past year and a half, this office has been
developing internal resolution plans in order to be ready to
resolve a failing systemic financial company.
The FDIC has also completed the basic rulemaking necessary
to carry out its systemic resolution responsibilities. In July
of last year, the FDIC Board of Directors approved a final rule
implementing the Title II Orderly Liquidation Authority. Last
September, the FDIC Board adopted a rule, jointly issued with
the Federal Reserve Board, regarding bank holding companies
with total consolidated assets of $50 billion or more, as well
as certain nonbank financial companies that the Financial
Stability Oversight Council may designate as systemic, to
develop, maintain, and periodically submit resolution plans to
regulators. These are the so-called living wills.
With the joint rule final, the FDIC and the Federal Reserve
have started the process of engaging with individual companies
on the preparation of their resolution plans. The first plans,
for companies with nonbank assets over $250 billion, are due in
July.
Section 210 of the Dodd-Frank Act also requires the FDIC to
``coordinate, to the maximum extent possible'' with appropriate
foreign regulatory authorities in the event of a resolution of
a covered financial company with cross-border operations.
Although U.S. SIFIs have foreign operations in dozens of
countries around the world, those operations tend to be
concentrated in a relatively small number of key foreign
jurisdictions, particularly the United Kingdom. Our initial
work with foreign authorities has been encouraging. In
particular, the U.S. financial regulatory agencies have made
substantial progress with authorities in the U.K.
In addition to the provisions relevant to systemic risk,
the Dodd-Frank Act also contains a number of other provisions
that may have a more direct effect on community banks. For
example, the Dodd-Frank Act made changes to the FDIC's deposit
insurance program, which were implemented soon after enactment,
that generally work to the benefit of community institutions.
The first of these was the rule to implement the act's
provision to permanently increase the insurance coverage limit
to $250,000. The FDIC has also implemented the Dodd-Frank Act
requirement to redefine the base used for deposit insurance
assessments from deposits to assets. When this provision was
implemented in the second quarter of last year, aggregate
premiums paid by institutions with less than $10 billion in
assets declined by approximately 33 percent.
Many community bankers have expressed concern about the
Dodd-Frank Act rules and other regulatory actions that would
impact their ability to compete in financial markets. In
response, the FDIC is undertaking a series of initiatives
related to the future of community banks. We are holding a
series of roundtables with groups of community bankers in each
of the FDIC's six regions around the country. The FDIC's
Division of Insurance and Research is undertaking a
comprehensive review of the evolution of community banking in
the United States over the past 25 years. Additionally, I have
asked the FDIC's Division of Risk Management Supervision and
the Division of Depositor and Consumer Protection to review the
examination process for both risk management and compliance
supervision, as well as to review how we promulgate and release
rulemakings and guidance, to see if we can improve our
processes and communications in ways that benefit community
banks.
Mr. Chairman, that concludes my oral statement. I would be
glad to respond to questions.
Chairman Johnson. Thank you.
Director Cordray, please proceed.
STATEMENT OF RICHARD CORDRAY, DIRECTOR, CONSUMER FINANCIAL
PROTECTION BUREAU
Mr. Cordray. Chairman Johnson, Ranking Member Shelby, and
Members of the Committee, thank you for the opportunity to
testify today as part of this panel of my colleagues. As the
Director of the Consumer Financial Protection Bureau, I am
committed to being accountable to you for how we carry out the
laws that Congress enacted, and we are always happy to have the
chance to discuss our work with you. This is the 18th time that
the new Bureau has testified before either the House or the
Senate, and I am pleased to be here again today. My testimony
will focus on the areas that you specified in the letter
inviting me to testify at this hearing.
To begin with, you asked about our bank supervision
program. We have been focused on recruiting and hiring the best
team we could find to supervise financial institutions with our
focus on consumer protection. We are blessed with great talent:
Steve Antonakes, the former Commissioner of Banks in
Massachusetts, leads our bank supervision team; Peggy Twohig,
the former Associate Director of the Division of Financial
Practices at the FTC, leads our nonbank supervision team. Our
examiners are working to ensure compliance with Federal
consumer financial laws, and they may seek corrective actions
to redress violations and remediate harm to consumers.
We have met with many supervised institutions to see how
they operate and how they approach compliance. We are engaged
with State banking regulator to establish communication and
share information to reduce compliance burden. To promote
transparency, we published our Examination Manual, along with
other examination procedures covering particular products and
services.
On Monday, the CFPB and the Federal prudential regulators,
as referenced earlier, released a Memorandum of Understanding
that clarifies how we will coordinate our supervisory
activities to minimize unnecessary regulatory burden, avoid
unnecessary duplication of effort, and decrease the risk of
conflicting supervisory directives.
Our responsibility under the law, unique among the Federal
regulators, is to achieve evenhanded and reasonable oversight
of both banks and nonbank firms that compete in the same
consumer finance markets. We take a consistent approach to
examining both, using the same procedures for the same products
and services.
In addition to mortgage lenders, mortgage servicers, payday
lenders, and private student lenders, we will soon finalize a
rule to allow us to examine the larger participants in the debt
collection and credit reporting industries as we develop our
nonbank supervision program further.
The second topic you identified for this hearing is my
statutory role on the Financial Stability Oversight Council. As
you know, Congress designated the CFPB's Director to serve as
one of 10 voting members of the FSOC. The U.S. consumer finance
market represents over $20 trillion in loans and deposits and,
hence, it is central to the stability of domestic and global
capital markets.
Because we share the responsibility of regulating financial
institutions with some of our FSOC colleagues, our mutual
participation furthers our efforts to maintain a collaborative
approach. Participation on the FSOC also provides a broader
vantage point on the kinds of triggers and vulnerabilities that
pose larger risks to the financial system. I have found this to
be valuable as we work toward a sound and vibrant financial
system that protects consumers, supports responsible providers,
and helps safeguard the broader economy against systemic risk.
Third, you asked how our statutory obligations affect our
regulation of community banks. As you know, the Consumer Bureau
does not generally examine any banks with less than $10 billion
in assets and does not enforce the law against any such banks.
We do have the authority to adopt rules that can affect
community banks as well as larger banks.
We will help community banks around the country by our new
oversight of nonbank firms. I have heard from community bankers
who refuse to make an ill-considered mortgage loan, only to see
customers go down the street and get a loan from someone else
who did not uphold the same standards. The other lender often
required no documentation of income and engaged in no
recognizable form of underwriting, but still managed to sell
bad loans into the secondary market. Once bundled into
securities, those loans crashed both the financial system and
the economy.
Consistent application of consumer financial laws will
promote safety and soundness of the financial system. Over the
next year, the Bureau is required to adopt new mortgage rules
that protect consumers. Many of these rules are intended to
return to sound underwriting standards and sound customer
service, practices that are traditional at our good community
banks.
As we develop these regulatory initiatives, we know that
one size does not fit all. When it makes sense to treat smaller
institutions differently from larger institutions, we have
pledged to consider doing so. We are implementing small
business review panels on several of our mortgage rules and
find the input from small providers to be helpful in
calibrating our proposals.
When I became Director of the Consumer Bureau at the
beginning of the year, I barely knew my colleagues on this
panel. Now, 5 months later, from our work together in various
roles on various bodies such as FSOC, I have come to know and
respect them all. Our team is glad to be working with their
teams and with the Members of this Committee to strengthen and
support a sound and vibrant financial system.
I am happy to answer any questions you may have. Thank you.
Chairman Johnson. Thank you. I would like to thank all of
our witnesses for their testimony. As we begin questions, I
will ask the clerk to put 5 minutes on the clock for each
Member.
Mr. Curry, it is clear from your testimony that JPMorgan
lacked the proper controls to mitigate such a large loss. Was
this a failure in risk management? If so, what should the bank
have done differently?
Mr. Curry. Thank you, Mr. Chairman. In essence, we believe
that the issue at JPMorgan Chase is one of inadequate risk
management within the Chief Investment Office. We have been
focusing on potential gaps or deviations from accepted
standards of risk management within that particular office and
looking to see whether similar gaps exist in any other areas of
JPMorgan's risk management architecture.
Chairman Johnson. Mr. Curry, the OCC has dozens and dozens
of examiners at JPMorgan. First, did your agency check the risk
management and internal controls of all aspects of the bank,
including the Chief Investment Office, before this event? Or
did you miss this? And, second, while regulators are not in the
position to review every single trade, what assurances can you
give us that the bank regulators will be able to monitor
situations where large trades, whether done for hedging or
other purposes, could bring down a firm or have a systemic
impact on the broader economy?
Mr. Curry. One of the major focuses of our examination and
supervision activities is risk management. We look at risk
management in the entire organization and within key areas
where there is a substantial risk facing the institution. That
process is intended to go across the entire organization in
those key areas.
In this particular case, we are looking at whether there
were gaps within our assessment of the risks and the risk
controls in place in the CIO office. We are in the process of
evaluating that in our ongoing examination.
The point I would make in terms of our focus on risk
management is that it is one part of the overall approach to
identifying risks within the organization. As Governor Tarullo
mentioned, a key component of how we assess and mitigate risks
in the institutions is the institutions' capital levels, their
level of reserves, and their liquidity.
In the case of JPMorgan Chase, both their capital levels
and liquidity are substantially higher than they were at the
beginning of the financial crisis, and as I mentioned in both
my oral and written comments, they are more than sufficient to
withstand the reported losses in this particular area.
We are continuing to review, as part of one of the two
prongs of our ongoing review, what exactly transpired with the
trading operation within the CIO's office, and we are looking
to make sure that there were appropriate limits and controls on
those activities in that area and how they compared to other
similar areas within the organization.
Chairman Johnson. It is important that Wall Street reform
implementation is completed to enhance financial stability and
reduce systemic risk. Secretary Wolin, just to be clear, it
does not seem to be that the JPMorgan trading loss was
systemic. Do you agree? And what do you believe are the
implications of the recent losses at JPMorgan on the Wall
Street reform rulemakings that have yet to be completed?
Mr. Wolin. Thank you, Mr. Chairman, for that question.
Obviously, the loss at JPMorgan Chase was a big loss and one
that, as Mr. Curry suggested, will affect shareholders. But we
concur in his judgment that it is not about the solvency of the
firm or, for that matter, the stability of the broader
financial system.
I think what is clear is that the lessons that we all
learned from what happened at JPMorgan Chase will serve as
important lessons and insights into the range of Dodd-Frank
implementation work to come, whether it is the Volcker Rule or
questions about risk management or enhanced prudential
standards or, for that matter, capital. I think this incident
underscores the need for us to pay attention to examples like
this in order to learn those lessons, both with respect to
Dodd-Frank implementation and, as I suggested earlier, the
broader efforts of supervision that are ongoing.
Chairman Johnson. Secretary Wolin, are regulators better
coordinated and prepared after Wall Street reform to deal with
external threats to our financial stability and economic growth
like the euro zone crisis? What steps are you taking in
response to this crisis?
Mr. Wolin. I think there is no question, Mr. Chairman, that
the existence of the Financial Stability Oversight Council has
given Treasury and the various banking and market regulators of
the U.S. Government an opportunity to constantly monitor
financial markets and the exposures of our banks and our
broader financial system to what is going on in Europe. The
Financial Stability Oversight Council has spent a lot of time
on Europe and thinking through what its implications are and
might be to our financial system. That work, of course, is
ongoing. For the first time, this Council really gives the
range of relevant entities of the U.S. Government the capacity
to share perspectives, to work together in engaging
counterparts in Europe to make sure that we are as well
prepared and have thought through the various contingencies
that might be necessary.
Chairman Johnson. Governor Tarullo, do you have anything to
add to this?
Mr. Tarullo. Mr. Chairman, with respect to European
preparation, I would just say that one thing about the euro
zone problems is they have been with us for some time, as a
result of which we have been able to regularize a system of
oversight of U.S. financial institution exposures and
activities in Europe. Right after the first Greek problems
arose in May of 2010, on an ad hoc basis we began looking at
them. Over time we have been able to put in place a system that
allows us to check the positions and exposures of individual
firms against aggregated data, whether from market sources or
from supervisory sources, just to make sure that both we and
the firms have a handle on what is going on. Other than that, I
would concur with what Secretary Wolin said.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you.
I think it is kind of a given here--from what I read and
what I know, the stress test JPMorgan went through and so
forth--that they have more than adequate capital. I have been
told that they would have to sustain losses 40 times, in other
words, $70, $80 billion, and they would still be standing. Is
that about right, Governor Tarullo?
Mr. Tarullo. Senator, in the stress test, what we did with
the trading book was to assume an instantaneous shock based on
a very adverse scenario, which entailed trading losses of $28
billion. We also assumed over the period of the stress test
credit losses of $56 billion. The sum of those gives
approximately the number you indicated.
Senator Shelby. Comptroller Curry, tell us, just walk us
through from what you know, what was going on at JPMorgan. You
know, were they managing risk? Were they making money? Were
they doing a combination? Everybody has got to measure risk,
but, in other words, what was really going on? You had people
on-site, right?
Mr. Curry. That is correct.
Senator Shelby. So they took a position. Was that a
position to manage something they had already done? Could you
explain that to us?
Mr. Curry. That is actually the key question that we are
trying to address, Senator, what actually happened in this
particular investment strategy, and it is a very complicated
investment strategy both in terms of its size as well as
complexity.
We are looking to determine what the actual strategy behind
that investment scheme was and also if there were any other
factors that were driving that strategy other than attempting
to mitigate known risks in the bank's portfolio.
Senator Shelby. But whether it is the banking arena or some
other arena, but especially in the area of derivatives and so
forth, you take a position, somebody else has another position,
right?
Mr. Curry. Yes.
Senator Shelby. So if you win, you are looking great, you
are looking smart. If you lose, you are maybe having a bad day.
But you are not trying to take risk out of the market, are you?
Mr. Curry. Not necessarily.
Senator Shelby. What are you really trying to do? From my
perspective, I think banks ought to be able to take risk. They
ought to manage those risks. The regulators ought to make sure
that they know what is going on from your perspective and the
Fed's perspective of any huge risk they take, that it might
endanger the taxpayer. A lot of us--maybe not everybody, but a
lot of us are worried about the taxpayer and bailouts and
future bailouts. JPMorgan, as strong as they are, it seems from
your testimony and others' and what we know, was never in any
danger if they lost $2 billion or $4 billion or what. That is a
lot of money to me, and I guess it is a lot of money to them.
But what did the Comptroller's office know? And were you on top
of things? How many people did you have at JPMorgan kind of
supervising or watching this?
Mr. Curry. Let me address the issue of the supervisory
strategy with respect to risk management, first, Senator.
Senator Shelby. OK.
Mr. Curry. Number one, we are looking for the institution
to identify and address the potential for a serious risk within
the organization. We are really not looking to eliminate all
risk. If you did so, you would not have a bank. The nature of a
bank is to manage risk and to be profitable.
The role of capital is really to absorb those areas where
risk is either unavoidable or occurs just because of the nature
of the business. And in the case of JPMorgan's national bank,
which we supervise, there is ample capital. There is over $101
billion worth of capital backing just the national bank, not
the holding company.
With respect to the actual supervision of JPMorgan Chase,
we have 65 individuals who are our core team of examiners who
are resident at the institution. On top of that, we are able to
draw upon a considerable reservoir of skilled individuals with
expertise in a variety of credit market--capital markets and
other areas that are brought in as targeted exams on an as-
needed basis. We also work in connection and cooperation with
the Federal Reserve System, which also supervises the holding
company.
In terms of this particular investment situation at the
CIO's office, we did begin to examine this early in April. Our
interest and concern intensified during the month as losses
increased within the portfolio up to the point that the
institution itself announced the significance of the losses
that were incurred.
Since that point in time, our focus has been on managing
and monitoring the bank's efforts to mitigate or de-risk that
particular portfolio with the objective of ensuring that there
is a soft landing of that particular position, to minimize both
risk to the institution and ultimately to the Deposit Insurance
Fund.
Senator Shelby. When do you think you will finish your
analysis of what really happened in all this?
Mr. Curry. We hope to do that as quickly as possible, and
we also hope to use our findings to inform us as to what
potential implications there are for the other institutions
that we supervise in our large bank cadre of institutions.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you very much.
Mr. Curry, you have 65 personnel devoted to supervision.
How many are in London?
Mr. Curry. We have five individuals who reside or are
housed in our London office.
Senator Reed. And they are responsible for how many
institutions in London?
Mr. Curry. They are responsible for any national bank that
has a global operation, especially with the presence in London,
like a London branch office.
Senator Reed. So how many would that be, roughly?
Mr. Curry. That would be--I will give you the exact number,
but it would be roughly a half dozen institutions.
Senator Reed. A half dozen. How common is it to have the
risk office of a national bank located outside of the United
States?
Mr. Curry. In this particular case, the risk office is
actually housed in New York where the global operations of the
CIO office are housed. So from a supervisory standpoint, our
focus in supervising that and other global issues is really
directed from our resident team in New York.
Senator Reed. One of the impressions you get from reading
the press, though, is that the CIO office in London actually
had significant responsibilities with respect to the overall
risks to the bank. In fact, the justification that has publicly
been made is that they were taking these hedged positions,
taking these investment positions to protect the bank from the
overall portfolio of the bank, which is an essential risk
operation. Can you explain?
Mr. Curry. The individuals who are responsible for managing
the risk and establishing the parameters for the activities
that may occur in the London office are housed in New York, and
that is where the physical focus of our activity has been.
Senator Reed. And they reported directly to the chief
management or----
Mr. Curry. The chief executive officer, yes.
Senator Reed. And you are confident from your review that
they had complete authority to countermand or contradict or
direct the operations in London?
Mr. Curry. One of the focuses of our review is to determine
the accountability, the involvement of management in
supervising the design of the risk management controls and
their monitoring of it.
Senator Reed. When the model for risk was changed, were you
aware of that change? Did you evaluate the new model? It took
place prior to your assuming these duties, I understand that.
You came on board about April----
Mr. Curry. Nineth.
Senator Reed. The 9th, and April 6th was the first
indication of difficulty. But was that--I think VaR is the
term--model evaluated by OCC?
Mr. Curry. There are hundreds, if not thousands, of models
that are employed by large financial institutions to measure
and monitor a variety of risks or other functions in the
institution. But under the authority of the applicable capital
regulations, Basel regulations, we are required to approve
their capital-related models. There are other models that may
be at issue here, management-related models or other models
that would have been involved in this particular situation. We
would not have had an express approval requirement of those
models, but we would likely have been aware of them, and we are
looking at our procedures for evaluating other types of models
that are used by an institution such as JPMorgan Chase.
I would point out that a year ago last April, the OCC did
publish written formal guidance on the use of models by OCC-
supervised institutions, and that guidance does outline the
pitfalls and areas in which banks and bank management must
assess in the use of models in measuring risk throughout their
organization.
Senator Reed. Thank you.
Mr. Wolin, right now we face a serious challenge in Europe
with European banks who seem to be in a much more adverse
condition than the United States banking industry based on
capital and many other measures, as in Governor Tarullo's
testimony. To what extent has Dodd-Frank improved our banking
situation vis-a-vis the Europeans and put us in a better,
stronger position?
Mr. Wolin. Senator, I think that both Dodd-Frank and the
ability of the Financial Stability Oversight Council to come
together and discuss and understand these things, but also the
work of the Fed and other regulators sitting at this table to
undergo the stress tests that have been at the core of making
sure that our banking system is well-capitalized and well-
cushioned from the kinds of exposures it might otherwise have,
have been important aspects of our being in a much better
position than we were before Dodd-Frank and, frankly, in a much
better position than our counterparts in Europe.
Senator Reed. Is that your view, Governor Tarullo?
Mr. Tarullo. Yes, Senator. Beginning in 2008 and with the
hearings on reform that were conducted by this Committee and
your counterparts in the House in 2009 there was a sea change
in attitudes and orientation both with respect to existing
authorities and the use of new authorities. As Secretary Wolin
indicated, particularly with stress testing and capital
requirements, which of course are embedded now in Section 165
of the Dodd-Frank Act, we all have a much better handle on the
positions that our banks will have in the case of a tail event,
which is to say the very bad ``if'' low probability outcome.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Corker.
Senator Corker. Mr. Chairman, thank you, and thanks for the
hearing. And I do hope we are successful in having a markup on
the Menendez-Boxer bill and that it is a real markup, and
hopefully it will happen soon.
I know that in any big piece of legislation, 2,400 pages,
there are going to be some good attributes. I know that from my
perspective, as we get further and further in the rearview
mirror, it is more evident to me that in many ways Dodd-Frank
was a political response to a--instead of real reform in so
many ways, and I do hope that when this season is over, with
everybody talking about it being the best thing since sliced
bread, we will actually move on to exploring some real reforms
down the road.
Mr. Tarullo, I do thank you for talking about capital. I do
think that that is our best buffer against financial
institutions having trouble, and I think that has been a
contribution.
Mr. Gruenberg, I appreciate you coming in and talking the
other day about orderly liquidation.
I do think, Mr. Chairman--I do not know how many people
have gone through the FDIC proposed rules on resolution, but
the word ``liquidation'' is throughout Title II. I know Senator
Warner knows that well. And I think we have found that it is
anything but liquidation, and it really is only dealing with
the holding company these institutions will continue. And,
again, I just think it would be great for us to understand that
and maybe think about whether there should be a Chapter 2 to
Title II.
But let me move on to the issue at hand. I think it is a
fool's errand to think that regulators are going to be ahead
of, you know, bankers, especially in these highly complex
organizations, and the notion of having a regulator beside
every banker is, again, a fool's errand. And I really think we
have charged you all with a lot of things we should not have
charged you with in the first place.
But the real question to me--I know that, look, JPMorgan
lost $2 billion. I think over a 2-year period they could lose
like $80 billion and still be OK. And yet we still have not
deal with the $200 billion that taxpayers really lost with the
GSEs. I know people may be looking at this hearing and
wondering why we are having it. The reason I think it is
important is this is a real live example of what Volcker may or
may not be. And I know that determinations are being made about
Volcker, and since we have all the regulators here--and I will
start with you, Mr. Wolin, and actually ask each of you, what
does this mean, ``risk-mitigating hedging activities in
connection with and related to individual or aggregated
positions or contracts''? You all know what the rest of it
says. But what does that mean? Does an institution rightfully,
once Volcker is in place--by the way, we all understand Volcker
is not in place today, so it has no relevance whatsoever as it
relates to what happened to JPMorgan. But what does that mean?
If an institution has tremendous exposure in Europe through
whole loans, just normal loan-making activity, does it or does
it not have the opportunity, once Volcker is put in place, to
hedge against a downturn in economic activity or just
activities there that may be adverse to the bank? I would just
like for you all to go across and tell me what this means. And
is portfolio hedging something that you envision to be
something that can happen or cannot happen after Volcker is
fully implemented? We will start with you, Neal.
Mr. Wolin. Senator, I think as the statute says and you
quoted it, the right question to ask is: Is it related to
individual or aggregate positions? If you are hedging something
that is related to that, then it is permitted. If it is
something other than that, then it is not.
I think, the question of portfolio hedging depends a lot on
what you mean by portfolio hedging. If you are, quote-unquote,
hedging some macro risk that is not related, as the statute
requires it to be, to individual or aggregated positions and
the risks that come from those, then it is not permissible, our
read under the statute. But, of course, in the end the
regulators, with our coordination, will have to work through
exactly the technical issues of what that means. They put out a
proposed rule and 18,000 or so comments came in. They are
working through that right now. But I think the question is not
really whether it is portfolio hedging or not because the
statute does not talk about portfolio hedging. It talks about
whether it is associated with individual or aggregate positions
that the firm has actually taken and put on their books.
Senator Corker. And if you would, as you go through, I
assume that in order to have a political response to what has
just happened during this political season, we could end up
making regulations on hedging that make some of the highly
complex organizations, if we are going to keep them like they
are, even more risky. Is that correct?
Mr. Wolin. Well, the goal here is to allow hedging that
relates to risks that are associated with the positions of the
firm, and in that respect, it is risk reducing. What we do not
want to have done and what the Volcker Rule is about, of
course, at its core is to not allow activity, proprietary
trading activity, with the firm's money that the rest of us,
the taxpayers, are ultimately potentially on the hook for
making whole.
Senator Corker. That is what I thought you would say. Thank
you.
Mr. Tarullo. Senator, at the last hearing, we had a
discussion of the distinction between proprietary trading and
market making, and I think what we are facing now is the
distinction between proprietary trading and a hedging trade.
When you asked what does that provision, which is basically
taken from the statutory language and put in the regulation,
mean, at least with respect to hedging, what the proposed rule
would do would be to put in place both some substantive
guidelines for trying to distinguish between hedging of
individual or aggregated positions on the one hand, or
proprietary trading on the other. And perhaps as importantly,
put in place a set of risk management reporting and
documentation requirements.
So, in essence, if a firm said we are doing this because it
is a hedge, they would be required to explain to themselves,
importantly, as well as to the primary supervisor, what the
hedging strategy was, how it was reasonably correlated with the
positions that they were hedging, and how they would make sure
that they did not give rise to new kinds of exposures.
So I think you ask absolutely the right question. What does
that mean? And that is the reason why in the proposed
regulation there is an elaboration of both some substantive
guidelines but also some risk management and documentation
requirements.
Mr. Curry. I would simply state that from a strictly
supervisory standpoint, I think we expect all banks, large or
small, to have robust and comprehensive assets liability
management policies and practices in place.
Senator Corker. And that includes portfolio hedging.
Mr. Curry. It would depend on the risks in that particular
institution that they are facing, and it could include that.
But the issue, I think, as Governor Tarullo mentioned, is
really, is there robust risk management in place with controls
and limits that allows these risks to be addressed and
mitigated without introducing additional risk? And I think that
is the concern or the issues that the NPR is trying to address.
Mr. Gruenberg. Senator, I think the central issue here is
that hedging is a risk management activity to reduce risk to
the institution as opposed to the activity that would get into
a speculative nature where you are really trying to generate
income. And I think the whole goal would be--and I think this
has been the point that has been made--creating a set of
controls in which you can monitor the activity so that the
important legitimate hedging activity goes forward. If you are
getting into riskier speculative activity, you want to be able
to identify that. I think that is important for the institution
to be able to recognize and important for the regulators to
recognize.
Senator Corker. Mr. Chairman, I know my time is up, and I
realize that the consumer agency is not particularly involved
in that aspect, but I thank you all. And I do hope that the
political pressures of what has happened do not cause
regulators to end up doing something different than what they
think is good for our banking system. And I do hope down the
road we will look at some real reforms that may work for us a
little bit better and not put all the onus on having a
regulator beside every banker.
Thank you.
Chairman Johnson. Thank you.
Senator Warner.
Senator Warner. Thank you, Mr. Chairman. I want to pick up
a little bit where my friend Senator Corker left off.
Mr. Curry, one of the things you had said was that you are
still here months after at least looking into some of these
JPMorgan activities, trying to determine their strategy. And I
believe Governor Tarullo said that one of the results of what
you envision a Volcker Rule being implemented might be is that
determining this assessment of whether your hedging strategy
would have to be laid out, in effect, ahead of time to make a
determination of whether it fit within the boundaries of
appropriate hedging or bled into proprietary trading. So do you
think whether this particular Morgan transactions fell in or
out of the Volcker restrictions or not, would the very nature
of having this, in effect, sharing of strategy beforehand have
perhaps given your office some more guidance? And, Governor
Tarullo, if you want to comment on that as well.
Mr. Curry. I think the point I would like to make in
regards to the discussion on the Volcker Rule and JPMorgan
Chase, we do not know all the facts. I think that is important
before you make any judgments as to whether or not the rule, if
it were in effect, would have been applicable in this
particular instance. I would like to emphasize this was a risk
management issue, regardless of whether or not the Volcker Rule
was in play. And the issues really are similar in the sense
that, were there appropriate management controls in place in
advance of the strategy, were there procedures and reports that
enabled management to assess the risks initially and as they
may have developed in the course of the execution of that
particular strategy.
So I believe that in any event, it is still a risk
management issue, regardless of the Volcker Rule.
Mr. Tarullo. Senator, I think the Comptroller has been
addressing the question of whether this is a proprietary trade,
and I think he is saying he does not have information right now
that would allow him to say whether, if Volcker were in effect,
it would have been a proprietary trade.
My point, though, is regardless of what we conclude about
the actual nature of this particular set of transactions, if
this proposed rule had been in place, if the hedging exception
were to be invoked by a firm, they would have had to ensure
that the kinds of risk management that Comptroller Curry speaks
of would have been in place, and they would have been required
to document it. And I suspect we are going to find in this case
that there was an absence of documentation both within the firm
and in reporting to----
Senator Warner. You would have perhaps a little more
guidance on aggregate hedging. I mean, clearly I think there is
a value in aggregate hedging in terms of your portfolio,
instead of hedging each individual trade, but you would have
had at least perhaps a little clearer guidance.
Mr. Tarullo. I think that that is the intention of these
additional provisions in the regulation, and then, of course,
the ongoing supervisory challenges to make sure that the
information that is received is scanned and reviewed properly.
Senator Warner. Let me move to a different subject because
my time is running out. Again, to Governor Tarullo and Mr.
Gruenberg, one of the new tools that we have tried to put in
place--actually that Senator Corker and I worked on--is these
living wills. And as we move down that path, I would like both
your comments in terms of have you had the tools you need to
kind of evaluate the back and forth on creation of living
wills. And to what standard are you going to hold the
institutions? In a sense, this living will will demonstrate how
they would unwind themselves? Are you looking at that in kind
of a blue skies environment? Are you looking at it in the
potential real environment we may have with the breakup of the
euro? I would like to just get some comments on that.
Mr. Gruenberg. Senator, the statute itself establishes a
standard for evaluating the plans, and that standard is the
Bankruptcy Code. And the requirement is that you have to make a
judgment as to whether the plan could credibly result in an
unwinding of the institutions under the standards of the
Bankruptcy Code, and that is sort of the operating premise for
the development of the resolution plans.
As I indicated previously, the Fed and the FDIC issued a
joint rule last year establishing the criteria for the plans.
We have been working with the institutions on their
development. Under the rule, the first round of plans--and
those will be for the largest institutions, those with assets
of over $250 billion--will be due in July. So we have been
engaged in a process with those companies in the initial
development of those plans. We are going to get the initial
submissions in July. Then there will be an extensive process of
review of those plans following the submissions.
Mr. Tarullo. The only thing I would add to that, Senator,
is that obviously it is not possible to tailor a lot of
different resolution plans to a lot of different potential
adverse scenarios. That is why our review of the plans that are
submitted is going to need to include basic questions about the
ongoing structure of the firm; that is, we are not just going
to be able to say, if something bad happens on Thursday, will
they be able to resolve by Monday morning? We are going to need
to ask ourselves whether the drafting and review of the
resolution plans shows us that there are structural elements or
features of the organization that could be an impediment to
achieving that end and, thus, as a matter of current
supervisory policy, we need to adjust. That kind of exercise
should help provide some more suppleness in response to
whatever the risk is that could eventually lead to the firm's
problems.
Senator Warner. Thank you, Mr. Chairman.
Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman. I want to first
indicate that I strongly agree with the tenor of the questions
that we heard from Senator Corker and Senator Warner with
regard to the Volcker Rule and those aspects. I think we have
covered that thoroughly, so I am not going to go into that
further myself, but I did want to indicate that that is a
direction I would have gone into had we not already had a full
discussion of that. And I encourage you to take their comments
to heart as we move forward. I am very concerned about how we
are moving forward in the regulatory climate right now with
regard to the response to things like the JPMorgan issues and
others.
I want to just shift the focus for a minute, and, Mr.
Cordray, I want to talk to you first. The housing credit market
continues to be very tight, and I am hearing a lot of concern
about how Dodd-Frank will reduce credit availability through
the proposed rules for qualified mortgage that increases
liability and qualified residential mortgage that requires a 20
percent downpayment.
I know that last week the CFPB reopened the comment period
for the qualified mortgage proposal until July 9th, seeking
comments about data that can be used to model the relationship
between the borrower's ability to repay and variables such as
the consumer's ratio of debt to income.
Is it your intention to also convene a small business panel
to discuss the impact of this proposed rule?
Mr. Cordray. So thank you, Senator, for the question about
the qualified mortgage or ability to repay rule. One of the
reasons we did reopen the comment period is that we have
recently been able to obtain a significant amount of data from
FHFA that gives us a better window into the mortgage market. We
are all, I think, quite concerned--and I know all of you are as
well--about the direction and trajectory of that market, and
this is an important rule in helping shape the future of that
market. We want to be clear that we craft a rule that is based
on sound data and that does not unduly restrict access to
credit, which I think is something we have been hearing
consistently from small banks, large banks, community and
consumer groups across the country.
Even after the Fed's comment period had closed on this
proposed rule, we continued to get immense amounts of comment
from different groups, and we thought that we would open up a
comment period again to make sure everybody had an even chance
at commenting on those issues, including data issues that we
have identified in the re-comment proposal. Because this rule
was originally proposed by the Fed, the small business panel is
not implicated, and if we were to try to convene a whole
process, we would miss the statutory deadline Congress has set
for us, which is January of 2013, which we fully intend to
comply with.
So that is our approach at the moment. We encourage any
small provider that wants to take advantage of the renewed
comment period--and this is part of the reason why we did it.
Those outside the Beltway often do not understand the ways that
they can access the agency, and we want them to have full
access and full voice in our rulemaking to make sure we are
reflecting the entire market.
Senator Crapo. Well, thank you, and to Mr. Gruenberg, Mr.
Curry, and Mr. Tarullo, it would seem to me that because of the
qualified residential mortgage is supposed to be more broadly
defined than the qualified mortgage, would it be correct to say
that the banking regulators should wait for the CFPB to finish
its rules before they move ahead with their risk retention
rules?
Mr. Gruenberg. Senator, I do not know that a judgment has
been made on that. I think as a general matter we thought there
was a logic in having the QRM follow the QM. So we will have to
see. But there is a logic to that.
Senator Crapo. Mr. Curry, do you agree?
Mr. Curry. I think that that is a necessary component to
the entire package of rulemaking, the QRM and the QM.
Senator Crapo. Mr. Tarullo.
Mr. Tarullo. It is an interagency process, Senator. If
people want to wait, we will wait, too.
Senator Crapo. All right. I would encourage you to do that.
Mr. Tarullo, recent events have highlighted the difficulty
in modeling risk. My understanding is that the Federal Reserve
is following or utilizing the current exposure method and that
there has been quite a bit of concern about whether that is an
accurate method of risk modeling.
Are you considering other models or are you focused on
simply staying with the current exposure method?
Mr. Tarullo. I am sorry, Senator. In what context? In the
stress test context or in the----
Senator Crapo. That is my understanding, yes.
Mr. Tarullo. With respect to the stress testing, what we
are trying to do in stress tests is make our best judgment as
to what kinds of losses would be entailed across the industry.
Senator Crapo. Let me interrupt.
Mr. Tarullo. I am sorry.
Senator Crapo. I was mistaken. I was more focused on the
single counterparty.
Mr. Tarullo. Oh, yes. OK. That is a different issue, right.
That is a calibration issue with respect to the determination
of the exposure of a large institution to another institution
for purposes of the limits that we will be promulgating. That
is one of the topics that is being commented on in the
consideration of changes to or potential modifications to the
proposed rule on sections 165 and 166. There have been a number
of alternatives suggested. The challenge, without trying to
signal where we would go because we have not seen all the
comments yet, and I certainly have not had a briefing on it.
The challenge is going to be on the one hand wanting to have a
methodology that tries genuinely to track actual risk exposure
while on the other not becoming dependent on modeling within
firms, because as we have seen in a number of other contexts,
dependence solely upon the modeling and firms can lead you
astray, particularly because firms in our observation tend to
be much better at modeling VaR and associated kinds of risk
assessments for more or less normal times, as opposed to the
tail events that we are trying to guard against.
So in thinking about the comments on the proposed rule, we
will have to keep both those issues in mind, trying to hew
toward what really are the risks associated with the positions
on the one hand and on the other hand wanting to make sure that
we are not totally dependent on some internal model.
Senator Crapo. Well, it is another example of where if we
model too aggressively one way or the other, we will get it
wrong and create unintended consequences, so I encourage you to
get it right and focus on these concerns about the accuracy of
the current exposure method.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair.
Does anyone on this panel think that Bruno Iksil, the
``London Whale,'' who ran JPMC's European strategic investment
unit, woke up each day trying to mitigate the risk from excess
deposits invested between loans and bonds?
Mr. Curry. That is a related area of inquiry at the OCC.
Senator Merkley. So you are inquiring, but you would not
argue that case?
Mr. Curry. Not necessarily.
Senator Merkley. No, I would not think anyone would,
because he woke up each day as head of the strategic investment
unit trying to make money for the bank. And so it is kind of a
basic observation.
Small businesses across America--and, Comptroller Curry, I
will address these to you, and I will try to ask you to keep
your responses crisp so I can try to get through a series of
questions. But across America, small businesses are trying to
get access to credit. They are highly frustrated. The ability
of them to access credit is essential to the recovery of our
economy. Does it do damage to our economy to have banks
diverting taxpayer-insured deposits into hedge fund investments
rather than making loans to families and small businesses?
Mr. Curry. We at the OCC, Senator, are very supportive of
small business lending by the entire spectrum of national banks
and Federal thrifts that we supervise, both from the largest--
--
Senator Merkley. Right, but that was not the question. The
question is: Is diverting deposits into hedge fund investing
rather than making loans damaging to our economy?
Mr. Curry. I would hope not. I hope that was not the case,
would not be the case.
Senator Merkley. But it would be if deposits were diverted
into hedge fund investing rather than making loans to small
businesses. You are hoping it was not the case, but you are
saying it would be if that is what happened?
Mr. Curry. We expect national banks and Federal thrifts to
meet the credit needs of their communities, including small
business lending. We do not direct exactly how they do that. We
assess it from the CRA.
Senator Merkley. OK. I will continue then. Thank you. Does
it increase systemic risk to have banks diverting taxpayer-
insured deposits into hedge fund investments?
Mr. Curry. I believe that is the intent of the Volcker
provisions of the Dodd-Frank Act, and----
Senator Merkley. Well, certainly it is the intent, but in
your opinion, does it increase systemic risk?
Mr. Curry. Unrestrained financial risk taking outside a
legitimate risk framework is something that we would be very
concerned about as a supervisor at the OCC.
Senator Merkley. From a common citizen's point of view,
when they look at the fate of Long-Term Capital Management, MF
Global, AIG, Lehman Brothers, Merrill Lynch, and a host of
institutions that survived only because we bailed them out, I
think the case is fairly clear that if you are in the hedge
fund business, you increase systemic risk; and if you are in
the banking world doing hedge funds, you would increase
systemic risk. Am I way off base here?
Mr. Curry. Again, Senator, we would look to the banks
engaging in safe and sound lending within the context of
banking. To the extent that it was undue risk taking that
occurred, we would hope to either have a statutory or
regulatory restraint.
Senator Merkley. OK. Let me explore it from this angle. Do
bank-hosted hedge fund investment units have a competitive
advantage over nonbank hedge funds? Because the bank-hosted
funds have access to the discount window and they have access
to insured deposits. Do they have a competitive advantage over
nonbank hedge funds?
Mr. Curry. I would have to look at the available research
to come to a conclusion.
Senator Merkley. I would say of course they have an
advantage. They have taxpayer-insured deposits and access to
the discount window. Is that an observation that is way off
mainstream common sense?
Mr. Curry. I would like to be able to research that subject
further.
Senator Merkley. OK. In terms of proprietary trading being
disguised as risk mitigation, it seems like there are basic
things that kind of create red flags. If a company says it is
mitigating risk on a long position that is investment in
corporate bonds by essentially taking a long position by
selling insurance, is that a red flag that maybe this is not
risk mitigation after all?
Mr. Curry. That is something that we would raise red flags
and would have to look at.
Senator Merkley. How about if a so-called risk mitigation
operation is investing in hedge funds, private equity funds?
Would that be a red flag that this is not risk mitigation, this
is an investment operation, a proprietary trading operation?
Mr. Curry. That would be another area under general risk
management at a minimum that we would be looking at.
Senator Merkley. So a potential red flag, it would draw
attention.
If a risk mitigation operation is making massive trades
that are not identified with specific risks from specific
assets, whether individual or aggregated, would that be a red
flag?
Mr. Curry. We would look at that and the other examples you
have given very closely.
Senator Merkley. OK. So if they are not tightly correlated,
something--red flag.
Are you going to support closing the loopholes that the
Wall Street banks have been arguing for so they can continue
hedge fund-style operations? Are you going to support closing
those loopholes or keeping those loopholes?
Mr. Curry. That is one of the issues that all the agencies,
the banking agencies and the other agencies, are looking at,
the proposed NPR on the Volcker Rule. I would add that I think
our experience here, as it unfolds with JPMorgan, would help
inform our views in the final rulemaking.
Senator Merkley. Thank you very much.
Mr. Curry. Thank you.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman.
I would like to start by also acknowledging Mr. Tarullo's
comments about the importance of capital, and I know you have
given a great deal of thought to this for a very long period of
time and have considered this in a very sophisticated way. And
there may be many things you and I may or may not agree on, but
I think the emphasis on capital as a general matter is exactly
the right direction that we ought to be heading in. And I fear
that Dodd-Frank is a profoundly misguided effort to do many,
many other things. I have to respectfully disagree with our
Chairman, who in his opening comments I think tends to disagree
with the characterization of Dodd-Frank, as I have
characterized it, as a very explicit attempt to require that
regulators micromanage banks. I do believe very much that it is
exactly that and that it is guaranteed to fail in that respect.
But I want to touch on another topic, if I could.
Mr. Gruenberg, I observed in a recent speech that you
stated, among other things, that--and I think this is within
context--``the typical path toward the failure of an insured
bank starts with bad loans.'' My understanding is, according to
the FDIC's Web site, over the course of 2009 and 2010, there
were almost 300 banks that failed--about 297. That is actually
quite a high rate of failure, the highest since the early
1990s. Ninety-five percent of these failures were banks with
assets of less than $1 billion. And I would just ask you, to
your knowledge, how many of them failed because of their
proprietary trading activities?
Mr. Gruenberg. To my knowledge, Senator, none of them.
Senator Toomey. None. Not one. Did they fail because they
made loans that went bad?
Mr. Gruenberg. As a general characterization, I would say
yes.
Senator Toomey. Like virtually 100 percent of the cases, it
was because they had bad loans. So would it be fair to say that
historically, including to the present day, the biggest risk of
banking is the lending activity that is inherent to the banking
process?
Mr. Gruenberg. Yes.
Senator Toomey. Do you regulate that at all? Does the FDIC
and does the OCC have any regulatory oversight whatsoever over
the lending process?
Mr. Curry. Yes, that is a considerable focus of our
examination and supervision.
Senator Toomey. Yes, that is what I thought. Lots of
regulation, right? Documentation----
Mr. Curry. And on-site examination.
Senator Toomey. Concentration requirements, supervision of
the activities. And yet, despite that, 100 percent of the
failures of banks in America in the last 2 years are attributed
to bad loans. I am not criticizing the regulatory process. It
seems to me that if we have a banking activity, the very nature
of which is to take risk in extending credit, some of those
banks, especially during tough economic times, are going to
fail. And that is unfortunate, but it is acceptable. It is
unavoidable. And the real goal of the regulatory regime, it
seems to me, ought to be to just ensure that you do not have
systemic risk, you do not have the failure of one or more
institutions taking down the rest. And this is why I go back to
Mr. Tarullo's observation. It seems to me that capital is the
greatest assurance that you have less leverage if you have more
capital and less systemic--greater ability, of course, to
absorb whatever losses might occur. But instead we are going
down the direction--and, again, you are forced to implement a
law that has been passed, but Dodd-Frank--to the Chairman's
point about micromanaging, my understanding is there are 398
rulemaking requirements, 110 of them have been met with
finalized rules, another 144 rules have been proposed, yet
another 144 have yet to be proposed. And as we all know, but
maybe all of our constituents may not be fully aware of, we are
talking about rules; we are not talking about an admonition not
to play in traffic. We are talking about many, many pages of
very dense and complex matters that are associated with each
individual rule. The Volcker Rule alone is staggering in its
length and complexity. I think it is an impossibility.
Take one little aspect of the Volcker Rule, the exception
that is applied to market-making activities. Just in
formulating that exception, we have all kinds of metrics that
we are going to impose, that regulators are going to decide.
They are going to invent limits, for instance, on how much
money can be earned from the bid-offer spread versus a
subsequent market rule; how much business a market maker must
do with end users versus interbank dealers; what kind of asset
classes are permitted to trade what kind of risks and under
what kind of circumstances. We have to decide whether these
limits apply to an individual trader or whether we aggregate
trades. It is staggering.
I am concerned that it is going to limit the ability of
banks to manage risk. It is going to have a huge cost. It is
going to reduce liquidity in the market. And we are doing this
while no banks have failed because of proprietary trading.
Oh, and by the way, we create these arbitrary exceptions.
It is perfectly OK if you do all the risk taking you like, as
long as it is in Treasurys. As someone who once traded fixed-
income instruments, I can assure you, you can lose your shirt
trading Treasurys just as readily as you can lose your shirt
trading corporates, for instance.
So I guess I do not have a specific question about this. I
am just very, very concerned that we have created a monster
that at my last count, between the Comptroller of the Currency
and the Fed, we have over 100 examiners on the ground I guess
pretty much full-time at JPMorgan alone. That is before we
implement all of these rules.
Mr. Chairman, I have to say I think we have very much taken
the wrong direction here, and I hope we will reconsider when we
are in a political environment where it is possible and will
consider capital as the essential tool to reduce systemic risk.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Mr. Curry, I want to ask you about JPMorgan losing $2
billion, and possibly more, since the OCC was the primary
regulator was JPMorgan, and the OCC has a well-deserved
reputation for being too cozy with the banks that it regulates.
And I know you just got to your new position, so you have an
opportunity here to decide what the OCC does in the future.
I find it interesting. You know, what I do not want to see
is a repeat of 2008. I know that a free market is essential to
our very economic vitality, but there is a difference between a
free market and a free-for-all market. And in 2008, what we
obviously came to the conclusion of is the consequences of a
free-for-all market where the decisions of large financial
institutions became the collective risk of an entire country,
even though they were not part of making those investment and
other decisions, and then all of us had to pay.
And so, you know, I wish we had insisted on capitalization
then. I wish we had insisted on a whole host of things that
would have avoided 2008 because I will never forget that
meeting with Chairman Bernanke and Secretary Paulson where they
described largely a series of financial institutions on the
verge of collapse and suggested that if they collapsed, not
only would they create systemic risk to the entire country, but
failure to act would lead us to a new Depression. I do not want
to revisit that.
Now, I do not know whether people can forget such quick
history because it is recent history, but I do not.
So I know you just got to this position, and I am certainly
not blaming you personally for this. But I just have a yes-or-
no question. Did the OCC screw up in allowing these JPMorgan
trades to happen?
Mr. Curry. Senator, we are going to critically look at that
question. Part of my goal in reviewing what happened at
JPMorgan Chase is not just to see what the bank itself did or
did wrong, but also how we can improve our supervisory
processes at the OCC. So it will be a critical self-review as
part of this process.
Senator Menendez. How long is that self-review going to
take you to come to a conclusion?
Mr. Curry. I hope to have it done as quickly as possible,
Senator.
Senator Menendez. What does that mean?
Mr. Curry. I would hope within the next several weeks and
no more than a few months. But I do want to reiterate that my
goal as Comptroller is to have a strong, effective, and fair
supervision at the Comptroller's office, and it is imperative,
and the lessons learned from the 2008 crisis are clear to me
and to my colleagues at the OCC. We do need stronger capital,
which we are getting through Basel III and other rulemakings.
We also need heightened expectations, and we are requiring that
of the largest institutions we supervise in terms of the banks'
management, its awareness of risks, raising their expectations
with what we require for minimum reserves, liquidity, and risk
management, and also corporate governance, which is critical as
a----
Senator Menendez. I know you say you are going to reserve
it, but should not the sheer size of these trades have been a
huge red flag for the OCC?
Mr. Curry. That is an issue; the concentrated nature of the
trading and the illiquidity of it are red flags that are
clearly apparent now.
Senator Menendez. Well, I just think that for those of us
who supported Wall Street reform and do not want to relive
2008, I think every regulator here responsible for implementing
the law should know if huge trading losses like this happened
at banks after we established the Volcker Rule and capital
rules have been written and implemented, then I think the blood
will be on all of your hands if the London Whale ultimately
goes belly up next time, because in this case I know that the
comment is, ``Well, they can absorb the $2 or $4 billion,''
whatever it ends up being. But what if you had through these
trades--what is to stop them from losing multiples of that,
billions more the next time, or even more significantly, a less
well capitalized bank from losses that could bring it down? I
just do not see where the circuit breakers are here. I do not
see where the ability to ensure that, in fact, that type of
decision making does not become the collective risk of all of
us again in this country. And I do not think the American
people, and certainly this Senator, are willing to go down that
road again. I do not know what it takes to get everybody to
understand that we are serious of purpose here to ensure that
the law is fully implemented.
Now, I know there are those who disagree with the law, but
as has been said in the past, Americans are free to disagree
with the law, they are not free to disobey it. They are not
free to disobey it. And this Senator for one is going to
continuously pursue to make sure that we do not relive 2008.
And I hope that all the regulators but certainly the OCC
understands that.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Moran.
Senator Moran. Mr. Chairman, thank you very much.
This is one of many hearings that I have participated in
that this Committee has held in regard to oversight of the
implementation of Dodd-Frank. When I asked for Committee
assignments a year and a half ago, I asked for the Banking
Committee, was told by some, ``Well, you do not want to be on
the Banking Committee. Its work is done. They have already
passed Dodd-Frank. Its heyday has come and gone.'' And in my
view, oversight, implementation, modification, and alteration
of Dodd-Frank is a very important task for this Congress and
one that I wanted to fully engage in because the questions of
Dodd-Frank are tremendous, certainly directly to financial
institutions but, more importantly, to the customers,
borrowers, and depositors that we care a lot about.
It is concerning to me that while we continue to have these
hearings, my concern is that there is no legislation that then
follows the series of ideas that are presented, and certainly I
would guess almost every Member of this Committee has
expressed, either here in a Committee hearing or in a letter to
the regulators, a desire for a different outcome than what has
occurred with Dodd-Frank.
And so I think there is a general belief among most
everyone on the Committee that there needs to be some
alterations in Dodd-Frank, and my hope, Mr. Chairman, is that
we will take the opportunity to modify through the legislative
process provisions of Dodd-Frank that we think are
objectionable or improperly worded or in need of alteration
based upon the hearings over a long period of time that we have
had on this topic. And I have always been concerned that
anytime legislation is proposed that alters the provisions of
Dodd-Frank, the allegation is that the person, the Senator, the
legislator who wants to make changes is defending big banks,
does not care about the consumer. But I cannot imagine a
circumstance in which there is not legitimate needs that need
to be addressed that are concerns for everyone on this
Committee in different areas, different issues. But I think
just we need to make certain that the oversight hearings become
something more than an oversight hearing, that there actually
is a legislative response in which we treat each other with
great respect and not with political allegations that we are
carrying water for some particular financial institution or
segment of the financial industry.
I would encourage, for example, us to mark up the Menendez
legislation. Let us go to work and pursue some of the things
that we think need to be done in regard to improving the
financial regulation, even though we have passed Dodd-Frank,
and to prove me right that the glory days of the Banking
Committee are not over, that they are ahead of us and we have
lots of work to do.
I wanted to ask, I guess a series of you have indicated
that as a result of the loss announced at JPMorgan that your
position in regard to the Volcker Rule has been ``informed.''
And I am interested in knowing how the loss as reported, how it
has ``informed'' your view in regard to the Volcker Rule, and
in particular, what do you think needs to occur in regard to
Dodd-Frank now that you have become informed?
Mr. Curry. Since I believe I used that term, I will be the
first to go. I think by ``informed'' I mean that our experience
with the level of risk management that was present at the CIO's
office that was engaged in activity that, arguably, may fall
under Dodd-Frank's Volcker Rule provision in the proprietary
trading and possibly the risk mitigation hedging exception. It
really is, I think, illustrating in terms of the types and
kinds of oversight structures and mechanisms that would be
needed under that particular provision.
Senator Moran. Has anyone else become informed?
Mr. Tarullo. I did not use the term, Senator, but I will
answer you anyway. It seems to me what someone will do--we need
people to run through this--is to say, OK, you have got a
situation in which the firm has publicly said they did not
think this was a well-managed risk, it was supposed to be a
hedge. So somebody should align the rule with the practice and
say if the rule had been in effect, would it have precipitated
the kinds of risk management, identification of strategy, and
documentation that would have been adequate to being the
attention of both the firm and the supervisors to a potentially
risky strategy.
As I sit here today, I think that is the case, but I would
certainly want someone to go through it more carefully.
Senator Moran. Mr. Chairman, thank you. I would like to
associate--at least compliment my colleague from Pennsylvania,
Mr. Toomey, on what I thought was a very logical presentation
and, in my view, enlightening. Thank you, Mr. Chairman.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman, and thank you for
holding this hearing.
This was not something I was going to talk about, but I
appreciate Senator Moran's comments. I would say that I think
all of us believe we want to have as efficient a capital market
as possible, a profitable capital market, a secure capital
market in this country. But I just want to be clear because I
sat here 3 years ago and heard the testimony on the credit
default swaps that brought down these large financial
institutions and put my family and your families through
enormous economic turmoil, that it was very clear to me that
the testimony we were hearing was that no one was watching
that, that no one had a view of the systemic risk that was
produced by those transactions, and to think of those as merely
bad loans rather than securitized instruments that nobody was
watching I think is not an accurate reflection--and this is not
anything you said, Senator, but this is not an accurate
reflection of the history of what we heard. I am not for any
more regulation than is needed, and I share some of the
skepticism on the other side about the ability of the
regulators to keep up with what is going on in the capital
markets, which raises the importance of capital as you
described earlier. But I do want people to remember why we are
here to begin with and the gaps that we saw in the regulation
that had a profound effect on this economy, on the people that
I represent.
So having said that for the record, I want to go back to
actually the Ranking Member's very first question, or one of
them, which was what was the nature of this transaction. Was it
proprietary or was it a hedge? And we know through the
testimony today that we do not have an answer to that yet. But
here is how I would like to ask that question to Mr. Curry and
to Mr. Tarullo, which is this:
Explain to us what that examination is going to look like.
What will you consider as you think about defining that?
Because I think you are quite right, we can learn something
from that. Those of us that are cautious about those
definitions would like to know what you are actually going to
be looking at.
Mr. Curry. At the OCC, we have a two-pronged approach to
this particular issue. Number one, we want to fully understand
the nature of the hedge or trading activity at issue. We also
want to get an assessment and a full understanding of how the
bank intends to reduce its exposure or de-risk from that
position.
Part of that process and as part of our secondary prong,
which is to----
Senator Bennet. Can I just--I am sorry to interrupt, but
the first step is to determine the nature, but the second step
is to determine the risk--the attention to risk in the
institution. Is that second determination dependent on the
nature of the transaction?
Mr. Curry. No, the first prong is really to assess what is
the financial risk to the institution, and that is really a
priority, particularly immediately after this issue surfaced.
But we are also looking at it almost from a postmortem
standpoint of what happened, where were the deficiencies, what
needs to be corrected, are there additional risk management
gaps elsewhere in the organization, and is there an opportunity
to learn from this experience in terms of the risk management
practices at the other large institutions that we supervise.
That is the general scope of our review.
Senator Bennet. Governor, do you have anything you would
like to add? Then I have got one question for you.
Mr. Tarullo. Then I think, Senator, you should--why don't
you go ahead and give me the question, because I think----
Senator Bennet. I was going to shift to your--well, you
made an observation earlier that I thought I heard you say the
low likelihood of a tail experience with Europe, and I just
wanted--I want to know why you think that is a low likelihood
or if I misunderstood what you----
Mr. Tarullo. No, I was referring more generally, Senator,
to the fact that, at least in my observation, the modeling that
financial firms do, VaR modeling and associated kinds of
modeling, to try to understand what their risk of losses are
from any number of contingencies tend not to be as oriented
toward tail risks, which means events that, while appearing at
that moment to be low probability, would, if they transpired,
have enormous loss. I was not commenting----
Senator Bennet. So in that spirit, since we are about to--I
do not know, Secretary Wolin, if you would like to talk about
this at all. How do you view that risk right now as you are
sitting here? I understand that the balance sheets here are in
better shape than the balance sheets are in Europe, but the
risk of collapse there?
Mr. Wolin. Well, I think, Senator, a couple things. First
of all, I think that European leaders appear to be moving with
a heightened sense of urgency. I think the run-up to the G20
meetings is Los Cabos will be an important opportunity for them
to make further progress with respect to their banks, the
capitalization of their banks and the restructuring of their
banks. And as you have seen, they are considering those things
really now on a European-wide basis.
The Europeans have the will and they certainly have the
capacity to keep this thing together. The President, the
Secretary of the Treasury, and others throughout the
Administration are very much engaged; I think that we will see
as developments move forward. I think it is not useful for me
to hazard a guess, but I think what is clear is they have the
will, they have the capacity, and I think they understand more
than ever before the urgency to start taking the actions that
are consistent with avoiding some of the most unpleasant
outcomes.
Senator Bennet. Thank you, Mr. Chairman.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, Mr. Chairman. Thank you all for
joining us.
I am glad to hear my colleagues on both sides of the aisle
talk about the importance of capital requirements. They seemed
less convinced of that during the drawing up of Dodd-Frank, but
if there are changes to Dodd-Frank, that may be somewhere where
we want to look, and especially the discussion from Mr. Toomey
and Mr. Moran on the importance of higher capital requirements.
Mr. Curry, my questions will be to you, if I could. I have
sent you a number of written questions. I look forward to your
prompt and substantive response, and I would appreciate those
answers prior to Mr. Dimon appearing in front of this Committee
next week. I really hope you are able to do that.
Last June, about a year, my Subcommittee held a hearing on
bank examination and supervision at which the OCC testified.
You were not here then, of course. I appreciate your taking the
responsibility of this job. It is difficult in these
circumstances, especially with the reputation of the history of
your agency.
I want to share some of that testimony, and I appreciate--I
would insist on brief answers because I have several questions
and limited time, as you know how this works. And I
particularly would appreciate a yes or no response.
David Wilson, OCC's head of credit and risk, testified,
``Given the importance in the role that these large
institutions play in the overall financial stability of the
United States, we have instructed our examiners that these
organizations should not operate with anything less than strong
risk management and audit functions. Anything less will no
longer be sufficient.''
Jamie Dimon himself said JPMorgan's trades were flawed and
complex and poorly reviewed, poorly executed, and poorly
monitored. I would like a yes or no on this question. Did OCC
meet the standard prior to your being there, did it meet the
standard that it set for itself in this case?
Mr. Curry. Before I answer that, I do want to acknowledge
that we are working on responses to your written letter and
will endeavor to get it to you prior to Mr. Dimon's testimony.
Senator Brown. Thank you for that.
Mr. Curry. In this answer, I think the answer is no, not in
the particular case of the CIO's office, it does not appear
that they met the heightened expectation----
Senator Brown. Thank you for that answer.
Mr. Curry. ----to meet demand.
Senator Brown. Mr. Wilson also said at that hearing that
every report of examination is reviewed and approved by the
responsible ADC or Deputy Controller before it is finalized.
Both units have formal quality assurance processes that assess
the effectiveness of our supervision and compliance with OCC
policies. Again, I know you were not there, but did they just
not--did the Deputy Comptroller and the Assistant Deputy
Comptroller simply not know about them?
Mr. Curry. This is part of the inquiry that we are
conducting to determine how we can improve our processes.
Senator Brown. Thank you for that. Your written testimony
suggests that the examiners and the supervisors were unaware of
the activities occurring at JPMorgan's Chief Investment Office
until April of this year. And what is intriguing about that is
this: This office was making $360 billion in trades. This is
larger than the assets of 7,299 banks in the United States. If
there were a stand-alone bank, it would be the eighth largest
bank in the United States. It was making a trade that you say
is the biggest, most complex trade in the entire banking
system, and the question then is this: Should the eighth
largest bank in the Nation be allowed to make the biggest, most
complex trade--your words--in the entire banking system without
the OCC's knowledge?
Mr. Curry. We would expect to be aware of significant
risks, to have the bank identify them and for us to have
adequate reporting about those risks.
I just want to clarify that the CIO's office invests a pool
of approximately $350 billion, but that this particular area
was a discrete portion of it, and that may be part of the
reason why it was not identified as quickly as we would like.
Senator Brown. It still should have been identified, and
that is an issue of the structure of OCC--again, under
different management than when you were there--than you are
there now, of course.
This is not about--I hear that--and this will be a
discussion for next week, but I hear about the $2 billion or $4
billion lost at the Chief Investment Office. That is serious,
but it is obviously more than that. JPMorgan took a $25 billion
hit to their stock. That is 401(k)s, that is pension funds,
that is a loss of wealth to a large number of people. We went
through that in multiples higher than that, of course, 2 and 3
years ago. And they are a signal that the market believes that
this event demonstrates bigger problems in the management and
oversight at JPMorgan.
This begs the issue that these trillion dollar--$2 trillion
in that case--mega banks are not just too big to fail; they are
too big to manage and they are too big to regulate. But the
OCC's position has been that, ``They do not subscribe to the
view that big in and of itself is bad.''
As long as OCC continues to insist that big, complex banks
are actually essential to our economy, they are responsible for
their inability to properly examine and supervise these mega,
mega banks.
I appreciate you are working to improve your oversight, but
I heard the same promise last year--again, under different
management. For the OCC to, in your words, ``determine what in
retrospect the OCC could have done differently, you need to''--
and I know you want to look forward. That is your job. But you
need to identify what mistakes were made, by whom those
mistakes were made, and if JPMorgan can hold its senior
executives accountable, which they appear, at least in part, to
be doing, we should expect nothing less than you, Mr. Curry,
and the people who work for you, whether they are the people
that are there now or the people whom you replace them with.
Thank you.
Chairman Johnson. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and I thank the
witnesses.
One of the obvious issues raised by JPMorgan trading losses
is the role of risk management at the banks, especially large
banks. As some of you know, I fought to have included in Dodd-
Frank a provision, Section 165(h), requiring all banks with
over $10 billion in assets and all nonbank financial firms
supervised by the Fed to have a separate risk committee that
includes at least one ``risk management expert having
experience in identifying, assessing, and managing risk
exposures of large, complex firms.''
Now, Mr. Curry, in your testimony, you say you ``will
require the bank to adhere to the highest risk management
standards.'' In your assessment, did the JPMorgan risk policy
committee have sufficient expertise in risk management to carry
out its duties? Also, it has been reported JPMorgan is changing
the composition of its risk policy committee. Can you provide
the Committee with an update on those changes and discuss
whether you think the new Members of the Committee have
sufficient expertise?
Mr. Curry. Thank you, Senator. The introduction of the risk
committees through Dodd-Frank is a welcome improvement to the
overall corporate governance of financial institutions,
particularly large institutions, and we view the role of the
board in terms of corporate governance as a mitigant to
excessive risk as being a critical feature of sound risk
management.
In this particular case, there appears to have been a
breakdown at the CIO level's risk management architecture and
system and controls. That is a matter of significant concern to
us at the OCC, and it is also one in which we have endeavored
to make sure is not endemic throughout the entire organization.
We hope that the reconstituted risk committee members of the
board will be experts in----
Senator Schumer. Have you reviewed the risk committees of
other banks with over $10 billion to determine whether they
have the necessary expertise? And that is for Mr. Tarullo as
well.
Mr. Tarullo. Senator, one of the virtues of the provision
that you referred to is that, as one of the enhanced prudential
standards, it will now precipitate what we call a horizontal
comparison and review, meaning that for those largest
institutions, our large institution supervision committee will
look at each and compare them. And I think it is that process
which is actually going to give the individual supervisory
teams on the ground more guidance and more insight as to what
they should expect.
Senator Schumer. Right. And I suppose there is some
difference. There are some banks that are over $10 billion that
are pretty plain vanilla banks and other banks over $10
billion----
Mr. Tarullo. That is absolutely correct.
Senator Schumer. ----that are doing all these fancy,
sometimes unfathomable things.
Mr. Tarullo. That is correct.
Senator Schumer. You did not correct the word
``unfathomable.''
Mr. Curry, are you reviewing other banks as well?
Mr. Curry. That is a critical component of our assessment
of corporate governance and the overall risk management
policies.
Senator Schumer. So you are.
Mr. Curry. Yes.
Senator Schumer. OK. Second question, and this is for you,
Mr. Curry. JPMorgan's credit derivative trades were made by a
group that is part of the U.S. bank, but apparently all booked
in London. Do you as the U.S. regulator have full access to the
information you need about trading activity conducted in London
if it is carried out by a U.S. bank? And what more needs to be
done to improve coordination with international regulators to
prevent these kinds of cross-border losses?
Mr. Curry. The London operations at JPMorgan are conducted
through a branch of the national bank. So in terms of
jurisdiction, we have clear jurisdiction over the activities of
that branch.
In the case of JPMorgan Chase, those activities are managed
on a global basis through the New York office where we have the
majority of our core staff.
Senator Schumer. OK, good. All right. Third question, and
it is about early warning systems. Traders at several hedge
funds, we have read in the newspapers, have been able to spot
the JPMorgan trade through its irregular impact on the market
for credit derivatives. So it begs the obvious question. Why
didn't the regulators know? Obviously, regulators cannot
micromanage every trading position at every bank. That would be
impossible for you to do. But is it possible to build an early
warning system that could warn us if, say, a single company
accumulates unusually large positions in any single product, as
it appears with the JPMorgan case? Last month, I asked the SEC
and CFTC Chairmen if it would be possible. They both said that
with the new information to be reported under Dodd-Frank, we
will be able to set up early warning systems that could
identify risky positions before they blow up.
So my question goes to both you, Mr. Tarullo, and any
others who care to add their opinions. What can and should
regulators do to improve their ability to identify potentially
risky trading activity ahead of time. And I realize foresight
is a gift and it is not easy, but at least when you are getting
above a certain level of money, a little bell could go off, and
maybe it is a perfectly plain vanilla safe trade and maybe it
is not, but it would not ask you to get involved in every
single thing that the banks are doing.
I will first go to Mr. Tarullo, Mr. Curry, and anybody
else.
Mr. Tarullo. So, first, obviously, is the risk management
of the firm as overseen by the supervisors, which should
include and generally does include things like position limits,
and that should be a first early warning.
Second, Senator, we do already within our supervisory
process look at market indicators, including aggregated market
information, to try to identify trends that might be relevant
to the particular institution. But our ability to do that
obviously depends on the relative granularity or specificity of
the information, and in this case, for example, I believe there
were products which, although they could be a big part of a
market, JPMorgan could be a big part of a market, for the
overall financial markets are still relatively small. So unless
there is reporting on more specific products like that, our
normal look at market information would not have revealed this.
So it has to come internally.
Senator Schumer. And what about after Dodd-Frank is fully
implemented where you will get more significant information?
Mr. Tarullo. Yes, there I think what is most important is
when a firm is taking a hedging position, it will be required
to specify what its strategy is and what its risk management
and what the monitoring of that strategy will be, and the
supervisors will have ex ante, or beforehand, access to that
information rather than have to rely on us going in afterwards.
Senator Schumer. OK. So you think it will improve with
Dodd-Frank being implemented?
Mr. Tarullo. I think it will improve.
Senator Schumer. Mr. Curry.
Mr. Curry. Yes, as Governor Tarullo mentioned, this was a
highly complex, illiquid, and concentrated investment. It would
have been very helpful if there were market or other data
available that would highlight this concentration to us as a
regulator. So to the extent that the Dodd-Frank Act does
provide that or that there is other readily market information
that we could utilize, it would be very helpful.
Senator Schumer. And the fact that they have to report and
justify this, does that tend to be prophylactic, or do they
still have to do that within the bank anyway so it does not
make a difference if they send the report to you?
Mr. Curry. The reporting would be very helpful, and that is
one of the issues here, whether there was adequacy of reporting
and whether that reporting was available to the OCC and the
Federal Reserve examiners.
Senator Schumer. My time has expired. Anyone else care to
comment?
[No response.]
Senator Schumer. OK. Thank you, Mr. Chairman.
Chairman Johnson. Thank you.
Senator Shelby has an additional question.
Senator Shelby. Thank you.
Governor Tarullo, in your testimony you state, and I will
quote--and I want to be like Senator Toomey and agree with you
on this. You said, ``Recent events serve to remind us that the
presence of substantial amounts of high-quality capital is the
best way to ensure that significant losses at individual
firms''--meaning financial institutions--``are borne by their
shareholders and not depositors or taxpayers.''
What percentage of capital under Basel III will large banks
likely hold under the new enhanced capital standards? And will
this amount, in your judgment, be sufficient? I think it is a
given here that there is no substitute for capital. You can
regulate everything in the world, but if they have inadequate
capital, you know what is going to happen sooner or later.
Mr. Tarullo. Senator, as you know, because you quoted from
me, I do believe in the centrality of capital. I do not think
it is the only way----
Senator Shelby. Oh, no.
Mr. Tarullo. But it is a central way.
Senator Shelby. But it is number one, is it not?
Mr. Tarullo. In my judgment, yes.
The Basel requirements are for a 7-percent common equity
ratio, which is a substantial increase over the pre-crisis
level.
Senator Shelby. Tell the public what you mean by common
equity, 7 percent.
Mr. Tarullo. Traditionally, measures of capital, the
measure of capital, so-called Tier 1 capital, which could
include common equity, which people generally think of as
shareholdings, shareholder earnings, retained earnings, and
what they have put into the company; but it also included some
other kinds of hybrid instruments, the loss absorption capacity
of which for an ongoing firm is not as strong as for common
equity. So basically pre-crisis, if you went down, dug down
into the requirements, it was only really a 2-percent common
equity ratio requirement, meaning you had to have common equity
which was at least 2 percent of your risk-weighted assets;
Basel III takes that up to 7 percent for banks generally. And
then as you referenced, with respect to very large
institutions, there will be, once we have implemented our
additional authority, a surcharge, which at present we think
will be between another 1 percentage point and 2.5 percentage
points.
Now, is that enough? Well, as I have said publicly before,
my preference would have been to have both somewhat higher, but
these were negotiated internationally. We did set them with an
eye to those other regulatory tools that you talked about. So
there are some restraints on activities. There is some market
discipline. There is some supervisory capacity. And it is
always going to be a balance as to how much capital is enough
given what other tools you have.
Senator Shelby. Do you believe that our banks are overall
in much better shape than they were 3 years ago?
Mr. Tarullo. Yes, Senator.
Senator Shelby. Do you agree with that, Mr. Secretary?
Mr. Wolin. I do, Senator. Yes, absolutely.
Senator Shelby. Mr. Curry.
Mr. Curry. Yes, definitely, with respect to national banks
and Federal thrifts.
Mr. Gruenberg. Yes, Senator.
Senator Shelby. OK. And do you believe that a lot of it is
because of required capital and the buildup of capital--not
everything, but do you believe that that is central to that?
Governor Tarullo.
Mr. Tarullo. I do believe it is central, but I do also
think that there has been a good bit of de-risking during that
period.
Senator Shelby. Is there some risk to the economy if people
try to take most risk out of the banking system? In other
words, you make a loan, that is a risk. You hedge something,
that is a risk. Or you are trying to manage risk. You cannot
take real risk out of the financial system, can you? Mr.
Secretary.
Mr. Wolin. No, you cannot, Senator.
Senator Shelby. We would not want to, would we?
Mr. Wolin. You would not want to.
Senator Shelby. Governor.
Mr. Tarullo. That is correct. It is always a question of,
one, properly understood and managed risk; and, two, of course,
a capital buffer when things happen that you do not anticipate.
Senator Shelby. Any comment?
Mr. Curry. I would agree with the Governor.
Mr. Gruenberg. I agree also, Senator.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Thank you all for your testimony and for
being here with us today.
Now with the continued threat from Europe and the recent
reminder that risks in the financial system must be
appropriately managed, we must remain vigilant and complete the
implementation of Wall Street reform to enhance financial
stability and reduce systemic risk.
This hearing is adjourned.
[Whereupon, at 12:20 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
I call this hearing to order. This hearing is part of the
Committee's continued oversight of the implementation of the Wall
Street Reform Act, and it is also an opportunity to discuss with our
bank regulators the implications of the massive trading loss recently
announced by JPMorgan Chase, one of our Nation's largest banks. When a
bank with JPMorgan's solid reputation announces that it lost billions
of dollars on a large trade reportedly designed to reduce the firm's
risks, it reminds us that no financial institution is immune from bad
judgment.
While the JPMorgan trading loss does not appear to have caused
systemic problems, it is a clear reminder that Wall Street continues to
need better risk management, vigorous oversight and, if the rules are
broken, unyielding enforcement. To repeal or weaken Wall Street Reform,
and defund the cops enforcing it, would take us back to the days before
the financial crisis of 2008.
Wall Street Reform was a response to the crisis caused by a lack of
consumer protection, reckless behavior in the financial sector, and
regulators who failed to take action in time. We now have an agency
solely focused on consumer protection, tough new rules to end negligent
and reckless practices by some on Wall Street, and regulators armed
with new powers to ensure the safety and soundness of the banks they
supervise.
The regulators are also in the process of enhancing the standards
for our Nation's largest banks, through increased capital requirements
and more judicious liquidity and leverage standards.
Wall Street Reform also requires regulators to sharpen their focus
on the largest and riskiest financial institutions. All the regulators
joining us today are members of the Financial Stability Oversight
Council, a body created to monitor risks facing our financial system.
Most here are also all working on the ``Volcker Rule'' to prohibit
proprietary trading with Government-insured deposits, and the FDIC
continues to work diligently to implement the ``living wills''
requirements and establish the Orderly Liquidation Authority for
global, large, complex financial institutions.
Similarly, while there is a need for strong regulation of all
financial institutions, Wall Street Reform recognizes that small
community banks should not be treated the same as the largest banks.
Because large, complex banks take on the most risk and pose the
greatest threat to our economic stability, they should be required to
pay their fair share into the Deposit Insurance Fund. Likewise, the
small banks that did not cause the crisis should not have to pay for
the risks taken on by their larger competitors--and their assessments
have been lowered accordingly.
A one-size-fits-all approach is not appropriate and many parties
have raised concerns about challenges faced by small community banks. I
hope to hear from our witnesses today about the steps they are taking
with regard to small banks.
Some have claimed that the Wall Street Reform Act was not the right
set of solutions to the crisis, and that it asks our regulators to
micromanage the activities of the firms they regulate. I disagree. To
restore confidence in our financial system after the crisis, we need
more, not less, scrutiny of Wall Street's activities. The Wall Street
Reform Act has built a stronger oversight framework that closes
regulatory gaps, enhances financial stability, and better protects
consumers, investors, and taxpayers.
And so despite the repeated calls to deregulate and to defund by
those who ignore the costly lessons of the financial crisis, completing
the implementation of the Wall Street Reform Act must be, and remains,
a top priority for this Committee.
In that vein, I look forward to hearing from the witnesses here
today about the progress they have made to complete implementation of
Wall Street Reform, as well as the actions they have taken regarding
the JPMorgan trading loss, and their thoughts on potential implications
of the loss for supervision and Wall Street Reform rulemakings going
forward.
I also want to thank Ranking Member Shelby and my colleagues here
on the Banking Committee for all their input and cooperation over the
past several months. At a time when most of America thinks that
Congress is in a gridlock, the Committee has been very busy getting
things done on the Senate floor. The bipartisan Export-Import Bank
Reauthorization passed with broad support and was signed into law by
the President last week. We passed in the Senate this Committee's
bipartisan Iran Sanctions bill. Both nominees for the Federal Reserve
Board of Governors received floor votes, and we helped to secure the
passage of their confirmation. We passed the bipartisan Transportation
bill in the Senate, and the Transportation Conference Committee
meetings are currently ongoing with the House. And we passed a 60-day
extension of the National Flood Insurance Program, and we have a
commitment from the Senate's leadership to bring the Banking
Committee's bipartisan NFIP reauthorization bill to the floor in the
coming weeks.
In addition, there is another important legislative matter facing
this Committee--helping responsible homeowners refinance into lower
interest rates at no cost to the taxpayers. We have already had several
full Committee and Subcommittee hearings on refinancing proposals. I
would like to take a bipartisan approach similar to the other
Committee-passed bills of this Congress where we work together on a
bipartisan vehicle with amendments limited to those related to the
underlying bill. I am hopeful that my colleagues will agree to move
forward in this manner as well so we can help responsible homeowners
and help the housing market rebound.
______
PREPARED STATEMENT OF NEAL S. WOLIN
Deputy Secretary, Department of the Treasury
June 6, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to appear here today to
discuss progress implementing the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Dodd-Frank Act).
The Dodd-Frank Act represents the most significant set of financial
reforms since the Great Depression. Its full implementation will help
protect Americans from the excessive risk, fragmented oversight, and
poor consumer protections that played such leading roles in bringing
about the recent financial crisis.
That crisis, and the recession that accompanied it, cost nearly 9
million jobs, erased a quarter of families' household wealth, and
brought GDP growth to a low of nearly negative 9 percent.
Today, our economy has improved substantially, although more work
remains ahead. More than 4.3 million private sector jobs have been
created over the past 27 months and, since mid-2009, our economy has
grown at an average annual rate of 2.4 percent.
As part of our broader efforts to strengthen the economy, Treasury
is focused on fulfilling its role in implementing the Dodd-Frank Act to
build a more efficient, transparent, and stable financial system--one
that contributes to our country's economic strength, instead of putting
it at risk.
The Dodd-Frank Act's reforms address key failures in our financial
system that precipitated and prolonged the financial crisis. The Act's
core elements include:
Tougher constraints on excessive risk-taking and leverage across
the financial system. To lower the risk of failure of large financial
institutions and reduce damage to the broader economy in the event a
large financial institution does fail, the Dodd-Frank Act provides
authority for regulators to impose tougher safeguards against risks
that could threaten the stability of the financial system and the
broader economy.
The Federal Reserve has proposed new standards to require banks to
hold greater capital against risk and fund themselves more
conservatively. New rules restricting proprietary trading under the
Volcker Rule and limits to the size of financial institutions relative
to the total financial system have been proposed or will be proposed in
the coming months. Safeguards against excessive risk-taking and
leverage will not only apply to the biggest banks, but also designated
nonbank financial companies. Importantly, the bulk of these
requirements do not apply to small and community banks, and help level
the playing field for these smaller participants by helping eliminate
distortions that previously favored the biggest banks that held the
most risk.
The Dodd-Frank Act also established the Financial Stability
Oversight Council (the Council) to coordinate agencies' efforts to
monitor risks and emerging threats to U.S. financial stability, and the
Office of Financial Research (OFR) to collect and standardize financial
data, perform essential research, and develop new tools for measuring
and monitoring risk in the financial system.
Orderly liquidation authority. The Dodd-Frank Act created a new
orderly liquidation authority to resolve a failed or failing financial
firm if its failure would have serious adverse effects on the financial
stability of the United States. The statute makes clear that taxpayers
will not be put at risk in the event a large financial firm fails.
Investors and management, not taxpayers, will be responsible for the
cost of the failure.
The FDIC has completed most of the rules necessary to implement the
orderly liquidation authority, and is engaging in planning exercises
with Treasury and other regulators to coordinate how it would work in
practice. This summer, the largest bank holding companies will submit
the first set of ``living wills'' to regulators and the Council. These
documents will lay out plans for winding down a firm if it faces
failure.
Comprehensive oversight of derivatives. The Dodd-Frank Act created
a new regulatory framework for over-the-counter derivatives markets to
increase oversight, transparency, and stability in this previously
unregulated area of the financial system.
Regulators have proposed almost all the necessary rules to
implement comprehensive oversight of the derivatives markets, and we
expect most to be finalized this year. We are already seeing signs of
standardized derivatives moving to central clearing, and substantial
work is being done to build out new financial infrastructure to move
trades into clearing and onto electronic trading platforms.
Stronger consumer financial protection. The Dodd-Frank Act created
the Consumer Financial Protection Bureau (CFPB) to consolidate consumer
financial protection responsibilities that had been fragmented across
several Federal regulators into a single institution dedicated solely
to that purpose. The CFPB's mission is to help ensure consumers have
the information they need to make financial decisions appropriate for
them, enforce Federal consumer financial laws, and restrict unfair,
deceptive, or abusive acts and practices.
The CFPB is currently working to improve clarity and choice in
consumer financial products through the Know Before You Owe project,
which aims to simplify mortgage forms, credit card disclosures, and
student financial aid offers. The CFPB is also focused on helping
improve consumer financial protections for groups like servicemembers
and older Americans, as well as bringing previously unregulated
consumer financial institutions, like payday lenders, credit reporting
bureaus, and private mortgage originators, under Federal supervision
for the first time. Earlier this year, the CFPB commenced its
supervision of debt collectors and credit reporting agencies.
Transparency and market integrity. The Dodd-Frank Act included a
number of measures that increase disclosure and transparency of
financial markets, including new reporting rules for hedge funds, trade
repositories to collect information on derivatives markets, and
improved disclosures on asset-backed securities.
This summer, the largest hedge funds and private equity funds will
be required to report important information about their investments and
borrowing for the first time, helping regulators understand exposures
at these significant investment vehicles. New swaps data repositories
are being created that will provide regulators and market participants
with a stronger understanding of the scale and nature of exposures
within previously opaque derivatives markets.
Treasury's core responsibilities in implementing the Dodd-Frank Act
include the Secretary's role as Chairperson of the Council, standing up
the Office of Financial Research and Federal Insurance Office, and
coordinating the rulemaking processes for risk retention for asset-
backed securities and the Volcker Rule.
The Financial Stability Oversight Council
The Dodd-Frank Act created the Financial Stability Oversight
Council to identify risks to the financial stability of the United
States, promote market discipline, and respond to emerging threats to
the stability of the U.S. financial system.
The Council is actively engaged in these activities and has begun
to institutionalize its role. To date, the Council has held 17
principals meetings, four since I last testified in December. In recent
months, the Council's principals have come together to share
information on a range of important financial developments as the
Council, its members, and staff have actively engaged in monitoring the
situation in Europe, in housing markets, the interaction of the economy
and energy markets, and the lessons to be drawn from recent errors in
risk management at several major financial institutions, including the
failure of MF Global and trading losses at JPMorgan Chase. In addition
to regular engagement at the principals level, the Council has active
staff discussions through twice monthly deputies level meetings and
ongoing staff work on individual committee and project workstreams.
The Council expects to release its second annual report on
financial market and regulatory developments and potential emerging
threats to our financial system in July. In addition to providing new
recommendations, the report will include an update on the progress made
on last year's recommendations, which focused on enhancing the
integrity, efficiency, competitiveness, and stability of U.S. financial
markets, promoting market discipline, and maintaining investor
confidence.
One of the duties of the Council is to facilitate information-
sharing and coordination among its members regarding rulemaking,
examinations, reporting requirements, and enforcement actions. Through
meetings among principals, deputies, and staff, the Council has served
as an important forum for increasing coordination among the member
agencies. Some argue that the Council should be able to ensure
particular outcomes in independent agencies' rules, or perfect harmony
between rules with disparate statutory bases. While the Council serves
a very important role in bringing regulators together, the Dodd-Frank
Act did not eliminate the independence of regulators to write rules
within their statutory mandates.
Nonetheless, the Dodd-Frank Act implementation process has brought
about unprecedented cooperation among agencies in writing new rules for
our financial system. As Chair of the Council, Treasury continues to
make it a top priority that the work of the regulators is well-
coordinated.
The Treasury Secretary, as Chairperson of the Council, is
coordinating the rulemaking required for the Dodd-Frank Act's risk
retention requirements, which are designed to improve the alignment of
interests between originators of risk and securitizers of, and
investors in, asset-backed securities. After the proposed rule was
released, the rule writers received over 13,000 comment letters, and
they are continuing to review feedback as they work towards a final
rule.
The Council has also made progress on two of its direct
responsibilities under the Dodd-Frank Act: designating financial market
utilities (FMUs) and nonbank financial companies for enhanced
prudential standards and supervision.
In July 2011, the Council finalized a rule setting the process and
criteria for designating FMUs and, in August, began working to identify
FMUs for consideration in accordance with the statue and the rule. In
January 2012, an initial set of FMUs were notified that they would be
under consideration for designation. In May, the Council unanimously
voted to propose the designation of an initial set of FMUs as
systemically important. This vote is not a final determination, and
FMUs may request a hearing before the Council to contest a proposed
designation. The Council expects to make final determinations on an
initial set of FMU designations as early as this summer.
In April 2012, the Council issued a final rule and interpretive
guidance establishing quantitative and qualitative criteria and
procedures for designations of nonbank financial companies. The Council
has begun work to apply the process described in the guidance. The
Council recognizes that the designation of nonbank financial companies
is an important part of the Dodd-Frank Act's implementation and intends
to proceed with due care as expeditiously as possible.
The Dodd-Frank Act also provides for limits on the growth and
concentration of our largest financial institutions. The Council has
released a study and recommendations on the effective implementation of
these limitations, and the Federal Reserve is expected to propose a
rule to implement concentration limits later this year.
The Office of Financial Research
The Dodd-Frank Act established the Office of Financial Research to
collect and standardize financial data, perform essential research, and
develop new tools for measuring and monitoring risk in the financial
system.
In December 2011, President Obama nominated Richard Berner to be
the OFR's first Director. I appreciate this Committee's support of Mr.
Berner's nomination. Confirmation by the full Senate is important to
ensure the OFR can fulfill its critical role.
A key component of the OFR's mission is supporting the Council and
its member agencies by analyzing financial data to monitor risk within
the financial system. Currently, the OFR is working on a number of
projects with the Council, including providing analysis related to the
Council's evaluation of nonbank financial companies for potential
designation for Federal Reserve supervision and enhanced prudential
standards; providing data and analysis in support of the Council's
second annual report on financial market and regulatory developments
and potential emerging threats to our financial system; and, in
collaboration with Council member agencies, developing metrics and
indicators related to financial stability.
To avoid duplicating existing Government collection efforts or
imposing unnecessary burdens on financial institutions, the OFR is
focused on ensuring it relies on data already collected by regulatory
agencies whenever possible. The OFR is working with regulators to
catalogue the data they already collect, along with exploring ways it
could promote stronger data sharing for the regulatory community to
generate efficiencies and improved interagency cooperation.
As part of its mission, the OFR is also promoting standards to
improve the quality and scope of financial data, which in turn should
help regulators and market participants mitigate risks to the financial
system and provide firms with important efficiencies and cost-savings.
One ongoing priority is establishing a Legal Entity Identifier (LEI),
or unique, global standard for identifying parties to financial
transactions, to improve data quality and consistency. The OFR is
playing a lead role in the international process coordinated by the
Financial Stability Board (FSB) to develop an LEI. Just last week, the
FSB endorsed recommendations the OFR developed in conjunction with its
international counterparts to establish a global LEI system. This
recognition allows market participants to begin preparing for the
implementation of the global LEI next year.
A more comprehensive understanding of the largest and most complex
financial firms' exposures is critical to identifying risks to the
financial system and mitigating future crises. However, some have
expressed concerns about the OFR--involving its accountability, access
to personal financial information, and ability to secure sensitive
data--that are unfounded.
First, Congress has oversight authority over the OFR, and the
statute requires the Director to testify regularly before Congress.
Consistent with requirements under the Dodd-Frank Act, the OFR will
provide the Congress with its first Annual Report on its activities
this summer and a second report, on the Office's human resources
practices, later this year. In addition, the Dodd-Frank Act provides
authority for Treasury's Inspector General, the Government
Accountability Office, and the Council of Inspectors General on
Financial Oversight to oversee the activities of the OFR.
Second, regarding data collection, the Dodd-Frank Act does not
contemplate and the OFR will not collect personal financial information
from consumers. The OFR, like other banking regulators, only has the
authority to collect information from financial institutions, not
individual citizens. The OFR will only utilize data required to fulfill
its mission--assessing threats to stability across the financial
system.
Lastly, data security is the highest priority for the OFR. As an
office of the Department of the Treasury, the OFR utilizes Treasury's
sophisticated security systems to protect sensitive data. The OFR is
also implementing additional controls for OFR-specific systems,
including a secure data enclave within Treasury's IT infrastructure.
Access to confidential information will only be granted to personnel
that require it to perform specific functions, and the OFR will
regularly monitor and verify its use to protect against unauthorized
access. In addition, the OFR is working in collaboration with other
Council members to develop a mapping among data classification
structures and tools to support secure collaboration and data sharing.
Such tools include a data transmission protocol currently used by other
Council members that will enable interagency data exchange and a secure
collaboration tool for sharing documents.
The Federal Insurance Office
The Dodd-Frank Act created the Federal Insurance Office to monitor
all aspects of the insurance industry, identify issues or gaps in
regulation that could contribute to a systemic crisis in the insurance
industry or financial system, monitor the accessibility and
affordability of nonhealth insurance products to traditionally
underserved communities, coordinate and develop Federal policy on
prudential aspects of international insurance matters, and contribute
expertise to the Council.
As a member of the Council, FIO, in addition to two additional
Council members that focus on insurance, has been actively involved in
the rulemaking establishing the process for the designation of nonbank
financial companies. FIO will be engaged in the review of nonbank
financial companies as this process moves forward.
Until the establishment of FIO, the United States was not
represented by a single, unified Federal voice in the development of
international insurance supervisory standards. FIO is providing
important leadership in developing international insurance policy.
Recently, FIO assumed a seat on the executive committee of the
International Association of Insurance Supervisors (IAIS). The IAIS, in
cooperation with the Financial Stability Board (FSB), is developing the
methodology and indicators to identify global systemically important
insurers, and FIO is actively engaged in that process. Additionally,
FIO established and has provided necessary leadership in the EU-U.S.
insurance dialogue regarding such matters as group supervision, capital
requirements, reinsurance, and financial reporting. FIO also
participated in the recent U.S.-China Strategic and Economic Dialogue
in Beijing. Importantly, FIO has and will continue to work closely and
consult with State insurance regulators and other Federal agencies in
its work.
Priorities Ahead
Under the Dodd-Frank Act, Treasury is charged with coordinating the
implementation of the Volcker Rule. Treasury is actively engaged with
the independent regulatory agencies in their work to finalize the
Volcker Rule and make sure it is implemented effectively to prohibit
proprietary trading activities and limit investments in and sponsorship
of hedge funds and private equity funds.
The five Volcker Rule rulemaking agencies released substantially
identical proposed rules, which reflect the commitment of Treasury and
the regulators to a coordinated approach. The comment periods for all
five rulemaking agencies are now complete, and we are reviewing and
analyzing over 18,000 public comment letters. Treasury is hosting and
actively participates in weekly interagency meetings to review those
comments, and remains committed to fulfilling our coordination role and
working with the rulemaking agencies to achieve a strong and consistent
final rule.
Regulators are still in the process of conducting their evaluation
of what happened with respect to recent losses at JPMorgan Chase, and
why. The lessons learned from the recent failures in risk management at
JPMorgan are an important input into the ongoing efforts to design
strong safeguards and reforms, including, of course, those in the
Volcker Rule.
The Volcker Rule, as reflected in the statutory language enacted as
part of the Dodd-Frank Act and in the proposed rule, explicitly exempts
from the prohibition on proprietary trading the ability of firms to
engage in ``risk-mitigating hedging activities in connection with and
related to individual or aggregated positions--designed to reduce the
specific risks to the banking entity.'' To that end, the final rule
should clearly prohibit activity that, even if described as hedging,
does not reduce the risks related to specific individual or aggregate
positions held by a firm.
The exposures accumulated by JPMorgan, in the words of its
executives, resulted in potential losses that exceeded its internal
limits and those estimated by its internal risk management systems.
This raises concerns that go well beyond the scope of the Volcker Rule.
Among other things, regulators should require that banks' senior
management and directors put in place effective models to evaluate
risk, strengthen reporting structures to ensure risks are assessed
independently and at appropriately senior levels, and establish clear
accountability for failures in risk management. Regulators should make
sure that they have a clear understanding of exposures and that banks
and their senior management are held accountable for the thoroughness
and reliability of their risk management systems. To further
accountability, there should also be appropriate public transparency of
risk management systems and internal limits.
Ultimately, the true test of reform is not whether it prevents
firms from taking risk or from making mistakes, but whether our
financial regulatory system is tough enough and designed well enough to
prevent those mistakes from hurting the broader economy or costing
taxpayers money. We all have an interest in achieving this outcome.
I emphasize the broader framework of reforms because our ability to
protect the economy from financial mistakes in banks depends on the
authority and resources we have to enforce tougher capital, leverage,
and liquidity requirements on banks and the largest, most complex
nonbank financial companies.
It depends on our ability to put in place the full framework of
protections in the Dodd-Frank Act on derivatives, from margin
requirements and central clearing of standardized derivatives to
greater transparency into risks and exposures.
It depends on the resources available to the SEC, the CFTC, the
CFPB and the other enforcement authorities to police and deter
manipulation, fraud, and abuse.
It depends on our ability to protect taxpayers from future
financial failures, in particular our ability to safely unwind a large
firm without the broad collateral damage and risk to the taxpayer that
we experienced in 2008.
And it depends on making sure that no exception built into the law
is allowed to swallow the rule, frustrate the core purpose of the
legislation, or otherwise undermine the impact of the tough safeguards
we need.
The challenges our economy continues to experience since the
financial crisis in 2008 only increase our commitment to make sure we
meet our responsibility to the American public to implement lasting
financial reform.
Recent events provide an additional reminder that comprehensive
reform must continue to move forward. The Administration will continue
to resist all efforts to roll back reforms already in place or block
progress for those that remain to be implemented. The lessons of the
financial crisis should not be left unlearned or forgotten, nor should
American workers--or American taxpayers--be left unprotected from the
consequences of future financial instability.
I appreciate the opportunity to discuss the priorities and progress
associated with our work implementing the Dodd-Frank Act, and the
leadership and support of this Committee in those efforts.
Thank you.
______
PREPARED STATEMENT OF DANIEL K. TARULLO
Member, Board of Governors of the Federal Reserve System
June 6, 2012
Chairman Johnson, Ranking Member Shelby, and other Members of the
Committee, thank you for the opportunity to testify on the Federal
Reserve's implementation of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank Act).
As we approach the second anniversary of the Dodd-Frank Act,
implementation of the financial reforms enacted by the Congress remains
a formidable task. At the Federal Reserve, staff teams with a wide
range of expertise continue to contribute to Dodd-Frank Act projects,
many as part of joint rulemaking efforts with other Federal agencies.
We have been working to put final Dodd-Frank Act rules in place and to
negotiate and implement international reforms compatible with various
Dodd-Frank Act provisions; these include enhanced capital requirements
for systemically important banks, liquidity requirements, resolution
mechanisms, and margining requirements for over-the-counter
derivatives.
As we continue rule implementation and the related international
initiatives, we are trying to provide as much clarity as possible to
financial markets and the public about the post-crisis financial
regulatory landscape, and are also taking the time to consider comments
and alternatives carefully. In addition, the Federal Reserve continues
to work cooperatively with other supervisors to ensure that prudential
supervision is conducted in a manner that supports these important
reforms.
As a final introductory point, it bears noting that both the Dodd-
Frank Act reforms and the international regulatory reforms share an
important feature--a strong focus on the largest, most complex, and
most interconnected financial firms and the systemic risks posed by
those firms. This effort reflects the provenance of both the Dodd-Frank
Act and international reform initiatives, which were motivated largely
by the failure or near failure of a number of major financial firms and
the significant public policy problems created by the market perception
that such firms are ``too big to fail.'' As the Federal Reserve
implements reforms, we have maintained this core focus on the largest
firms by proposing rules that try to mitigate the systemic risks posed
by those firms and minimize the burden on smaller entities,
particularly community banks. Similarly, we seek to implement reforms
in a manner that is faithful to statutory requirements and that
maximizes financial stability and other economic benefits at the least
cost to credit availability and economic growth.
This morning I will briefly describe the Federal Reserve's progress
on several important Dodd-Frank Act rules and recent reforms to the
international bank regulatory framework. I will also describe briefly
the Federal Reserve's role in supervising and examining the largest
financial firms in cooperation with other Federal and State
supervisors.
Enhanced Capital Standards
While robust bank capital requirements alone cannot ensure the
safety and soundness of our financial system, they are central to good
financial regulation precisely because capital is available to absorb
all kinds of potential losses--unanticipated as well as anticipated.
Indeed, the best way to safeguard against taxpayer-funded bailouts in
the future is for our large financial institutions to have capital
buffers commensurate with their own risk profiles and the damage that
would be done to the financial system if such institutions were to
fail. Recent events serve to remind us that the presence of substantial
amounts of high-quality capital is the best way to ensure that
significant losses at individual firms are borne by their shareholders,
and not by depositors or taxpayers. Ensuring the capital adequacy of
financial firms requires both improvement of the traditional, firm-
based approach to capital regulation and the creation of a more
systemic, or macroprudential, component of capital regulation.
With respect to improving the traditional approach to capital
regulation, the Federal Reserve's work has principally involved the
development of stronger regulatory capital standards in cooperation
with other supervisors in the Basel Committee on Banking Supervision.
This work includes the so-called Basel 2.5 reforms that strengthened
the market-risk capital requirements of Basel II. This work also
includes the Basel III reforms, which improve the quality of regulatory
capital, increase the quantity of required minimum regulatory capital,
require banks to maintain a capital conservation buffer and, for the
first time internationally, introduce a minimum leverage ratio. The
Federal Reserve and other U.S. banking agencies are moving to finalize
regulations to implement Basel 2.5 in the United States and soon will
be proposing regulations to implement Basel III.
These significant changes to the international regulatory capital
framework have been supplemented by an important element of the Dodd-
Frank Act known as the ``Collins Amendment.'' The Collins Amendment
provides a safeguard against declines in minimum capital requirements
in the Basel II capital regime based on bank internal modeling. The
Federal Reserve and other U.S. banking agencies issued final rules to
implement this provision in June 2011.
Capital Surcharges for Systemically Important Financial Firms
The recent financial crisis also made clear that the existing
international regulatory capital framework was not sufficiently
responsive to macroprudential concerns, such as the threat to financial
stability posed by systemically important financial institutions.
Accordingly, in Basel Committee deliberations, the Federal Reserve
advocated for capital surcharges on the world's largest, most
interconnected banking organizations based on their global systemic
importance. Last year, an international agreement was reached on a
framework for such surcharges, to be implemented during the same 2016-
2019 transition period for the capital conservation buffers in Basel
III. This initiative is consistent with the Federal Reserve's
obligation under section 165 of the Dodd-Frank Act to impose more
stringent capital standards on systemically important financial
institutions, including the requirement that these additional standards
be graduated based on the systemic footprint of the institution.
Both the Dodd-Frank Act provision and the Basel framework are
motivated by the fact that the failure of a systemically important firm
would have dramatically greater negative consequences on the financial
system and the economy than the failure of other firms. Stricter
capital requirements on systemically important firms should also help
offset any funding advantage these firms derive from any remaining
perceived status as too-big-to-fail and provide an incentive for such
firms to reduce their systemic footprint. The Federal Reserve's aim has
been to fashion the enhanced capital requirements of section 165 and
work toward an associated international framework in a simultaneous and
congruent manner.
Stress Testing and Capital Planning
Recent improvements to the regulatory capital framework have
important supervisory complements in the Federal Reserve's development
of firm-specific stress testing and capital planning requirements.
These supervisory tools serve two related functions. First, they make
capital regulation more forward-looking by testing whether firms would
have enough capital to remain viable financial intermediaries if they
sustained hypothetical losses in asset values and earnings in an
adverse macroeconomic scenario. Second, they contribute to the
macroprudential dimension of supervision by enabling simultaneous
examination of the risks faced by all large financial institutions in a
hypothetical adverse economic scenario.
The Dodd-Frank Act creates two forms of stress-testing
requirements. These requirements mirror the Supervisory Capital
Assessment Program model, a 2009 effort led by the Federal Reserve that
helped restore confidence in the viability of the banking system during
the financial crisis. First, the act mandates that the Federal Reserve
conduct annual stress tests on all bank holding companies with $50
billion or more in assets to determine whether they have the capital
needed to absorb losses in hypothetical baseline, adverse, and severely
adverse economic conditions. Second, the act requires both these
companies and certain other regulated financial firms with assets
between $10 billion and $50 billion to conduct internal stress tests.
The Federal Reserve must publish a summary of results of the
supervisory stress tests and issue regulations requiring firms to
publish a summary of the company-run stress tests.
Regular and rigorous stress testing provides regulators with
knowledge that can be applied to both microprudential and
macroprudential supervision efforts. Disclosure of the general
methodology and firm-specific results of our stress testing has
additional regulatory benefits. First, the release of certain details
about assumptions, methods, and conclusions exposes the supervisory
approach to greater external scrutiny and discussion. Such discussions
will almost surely help us improve our assumptions and methodology over
time. Second, because bank portfolios are difficult to value without a
great deal of detailed information, the stress test results should be
very useful to investors in and counterparties of the largest banking
firms. Further, I believe the demands of supervisors for well-specified
data and projections from firms have improved risk management at these
firms. The stress testing that the Federal Reserve has instituted
during the past few years has become an important part of our
horizontal, interdisciplinary approach to supervising the largest bank
holding companies.
Firm-specific capital planning has also become an important
supervisory tool. In November 2011, the Federal Reserve issued a new
regulation requiring large banking organizations to submit an annual
capital plan; This tool serves multiple purposes. First, it provides a
regular, structured, and comparative way to promote and assess the
capacity of large bank holding companies to understand and manage their
capital positions. Second, it provides supervisors with an opportunity
to evaluate any capital distribution plans against the backdrop of the
firm's overall capital position, a matter of considerable importance
given the significant distributions that some firms made in 2007 even
as the financial crisis gathered momentum. Third, at least for the next
few years, it will provide a regular assessment of whether large bank
holding companies will readily meet the Basel 2.5 and Basel III capital
requirements as they take effect in the United States.
A stress test is a critical part of the annual capital plan review.
But, as these three different purposes indicate, the capital plan
review is about more than using a stress test to determine whether a
firm's capital distribution plans are consistent with remaining a
viable financial intermediary in adverse economic conditions. As
indicated during our capital plan reviews in both 2011 and 2012, the
Federal Reserve may object to a capital plan because of significant
deficiencies in a firm's capital planning process, as well as because'
one or more relevant capital ratios would fall below required levels
under the assumptions of stress and planned capital distributions.
Likewise, the stress test is relevant not only for its role in the
capital planning process. As noted earlier, it also serves other
important purposes, not least of which is increased transparency of
both bank holding company balance sheets and the supervisory process of
the Federal Reserve.
Enhanced Liquidity Standards
As with capital, the financial crisis also brought attention to
defects in the liquidity risk-management practices of large financial
firms. As seen during the crisis, a financial firm-particularly one
with significant amounts of short-term funding--can become illiquid
before it becomes insolvent, as creditors run in the face of
uncertainty about the firm's viability. While higher levels and quality
of capital can mitigate some of this risk, it was widely agreed that
quantitative liquidity requirements should be developed. The Basel
Committee generated two liquidity standards: one, a Liquidity Coverage
Ratio (LCR) with a 30-day time horizon; the other, a Net Stable Funding
Ratio (NSFR) with a 1-year time horizon. However, insofar as this was
the first-ever effort to specify such requirements, the Governors and
Heads of Supervision of the countries represented on the Basel
Committee determined that implementation of both frameworks should be
delayed while they are subject to further examination and possible
revision. As is the case with enhanced capital standards for the
largest banking firms, the Basel Committee's liquidity initiatives are
consistent with the Federal Reserve's obligation under section 165 of
the Dodd-Frank Act to impose more stringent liquidity standards on the
largest bank holding companies as well as other systemically important
nonbank financial firms.
The LCR has been actively reconsidered within the Basel Committee
over the last year or so. As this work proceeds, four types of changes
appear particularly ripe for consideration. First, the LCR's definition
of high-quality liquid assets should be broadened. In this regard, we
support efforts to move away from the current credit risk-based
approach and toward a quantitative liquidity-based approach. Second,
some of the assumptions embedded in the LCR about run rates of
liabilities and the liquidity of assets might be grounded more firmly
in actual experience during the crisis, as the LCR may overstate in
particular the liquidity risks of commercial banking activities. Third,
additional consideration needs to be given to the liquidity risks
inherent in trading activities that rely upon large amounts of short-
term wholesale funding. Fourth, the LCR could be better adapted to
ensure usability of the high-quality liquid asset buffer in appropriate
circumstances: for example, by making credibly clear that ordinary
minimum liquidity levels need not be maintained in the midst of a
crisis. As currently constituted, the LCR may have the unintended
effect of exacerbating a period of stress by forcing liquidity
hoarding. The Basel Committee will likely suggest a set of changes to
the LCR later this year, with a goal of introducing the LCR in 2015.
Work on the NSFR is on a considerably slower track; the current plan is
for implementation in 2018.
Enhanced Prudential Standards for the Largest Financial Firms
Sections 165 and 166 of the Dodd-Frank Act require the Federal
Reserve to establish a broad set of enhanced prudential standards, both
for bank holding companies with total consolidated assets of $50
billion or more and for nonbank financial companies designated by the
Financial Stability Oversight Council (Council). In addition to
enhanced risk-based capital and liquidity requirements and stress
testing, the required standards also include single-counterparty credit
limits, an early remediation regime, and risk-management and
resolution-planning requirements. Sections 165 and 166 also require
that these prudential standards become more stringent as the systemic
footprint of a firm increases.
In December, the Federal Reserve issued a package of proposed rules
to implement sections 165 and 166 of the Dodd-Frank Act. The Federal
Reserve's proposed rules would apply the same set of enhanced
prudential standards to covered companies that are bank holding
companies and to covered companies that are nonbank financial companies
designated by the Council. As we made clear in the proposal, however,
the Federal Reserve expects to tailor the application of the enhanced
standards to different companies individually or by category, taking
into consideration each company's capital structure, riskiness,
complexity, financial activities, size, and any other risk-related
factors that the Federal Reserve deems appropriate. The comment period
for our enhanced prudential standards proposal closed on April 30.
Nearly 100 comment letters were received. The Federal Reserve is
currently reviewing those comments carefully as we work to develop
final rules.
The Volcker Rule
Section 619 of the Dodd-Frank Act, commonly known as the ``Volcker
Rule,'' generally prohibits banking entities from engaging in
proprietary trading or acquiring an ownership interest in, sponsoring,
or having certain relationships with a hedge fund or private equity
fund. In October, the Federal Reserve joined the Office of the
Comptroller of the Currency (OCC), the Federal Deposit Insurance
Corporation (FDIC), and the Securities and Exchange Commission in
seeking public comment on a proposal to implement the Volcker Rule. The
Commodities Futures Trading Commission issued its substantially similar
proposal for comment shortly thereafter. Because of the importance and
complexity of the issues raised by the statutory provisions that make
up the Volcker Rule, the Federal Reserve and other agencies provided
the public with a 120-day opportunity to submit comments. The comment
period is now closed, and nearly 19,000 public comments were received.
The agencies are now working together to review and consider these
comments and put final implementing rules in place as soon as
practicable.
In April, after consultation with the other agencies, the Federal
Reserve issued guidance on a Volcker Rule conformance period that was
intended to help limit any confusion about when banking entities will
need to comply with the final rules once issued. The Federal Reserve's
statement clarified that a banking entity has the full 2-year period
provided by the statute (i.e., until July 21, 2014), unless that period
is extended by the Board, to fully conform its activities and
investments to the requirements of the Volcker Rule, including any
final implementing rules adopted by the agencies.
Prudential Supervision of Large Financial Firms
In the wake of the Dodd-Frank Act, the prudential supervision of
the largest, most complex financial firms remains a cooperative effort.
As before, the law mandates that a variety of Federal and State
supervisors execute particular supervisory and examination
responsibilities for certain parts of a firm. This allocation of
supervisory oversight among different agencies reflects, among other
factors, the historical development of various types of financial
intermediaries in the United States and a series of legislative
decisions about regulatory and supervisory structure.
As the regulator and supervisor of bank holding companies, the
Federal Reserve's role in this statutory arrangement is typically that
of consolidated regulator and supervisor of the parent holding company.
Accordingly, our supervisory program for such firms generally takes a
broad view of the activities, risks, and management of the consolidated
firm, with a particular focus on the capital adequacy, governance, and
risk-management practices and competencies of the firm as a whole.
Many of the principal business activities of the largest financial
firms are conducted through the functionally regulated subsidiaries of
those firms, such as insured depository institutions, broker-dealers,
and insurance companies. As required by section 5 of the Bank Holding
Company Act, the Federal Reserve generally relies to the fullest extent
possible on the examination and supervision of those subsidiaries by
the functional regulators. Together, the Federal Reserve and other
functional regulators work to discharge the supervisory and examination
responsibility given to each agency for particular parts of a large
financial firm in a way that maximizes the expertise and resources of
each agency and best ensures the safety and soundness of the
consolidated firm and each of its constituent parts.
Just as the financial crisis revealed the need for change in the
prudential standards applicable to financial firms and activities, so
too did it make clear that important changes in supervisory practices
were needed to improve both the microprudential and macroprudential
oversight of banks and bank holding companies. To that end, even before
passage of the Dodd-Frank Act, the Federal Reserve began to reorient
its supervisory structure and strengthen its supervision of the
largest, most complex financial firms.
The most important change has been creation of the Large
Institution Supervision Coordinating Committee (LISCC). The LISCC is
founded on several principles: that large institution supervision
should be more centralized; that it should conduct regular,
simultaneous, horizontal (cross-firm) supervisory exercises; and that
it should be more interdisciplinary than it has been in the past. Thus,
the LISCC includes senior Federal Reserve staff from research, legal
and other divisions at the Board, from the markets and payments systems
groups at the Federal Reserve Bank of New York, and senior bank
supervisors from the Board and relevant reserve banks. Relative to
previous practices, this approach to supervision relies more on
quantitative methods for evaluating the performance and vulnerabilities
of firms.
To date, the LISCC has developed and administered various
horizontal supervisory exercises, notably the capital stress tests and
the related comprehensive capital reviews of the Nation's largest bank
holding companies, and is now extending its activities to coordinate
other supervisory processes more effectively. It also has focused its
attention on potential implications for financial stability in the
United States from stresses arising in Europe.
Review of JPMorgan Chase & Co. Trading Loss
In response to the significant trading losses that were recently
announced by JPMorgan Chase & Co. (JPMorgan) as a result of trading
operations at the London branch of its national bank, the Federal
Reserve--in its capacity as consolidated supervisor of the bank holding
company--is working with the OCC, the regulator of the national bank,
to review the firm's response and remedial actions. In particular, the
Federal Reserve has been assisting in the oversight of JPMorgan's
efforts to manage and de-risk the portfolio in question. As this
process proceeds, we anticipate also working with the OCC and FDIC to
identify the changes in risk measurement, management, and governance
that will be necessary to improve risk-control practices surrounding
the firm's trading activities and to address trading strategies that
led to these losses.
In addition, the Federal Reserve has been looking at other parts of
the holding company to determine if governance, risk management, and
control weaknesses--similar to those exposed by this incident--are
present elsewhere. While we have, to date found no evidence that they
are, this review is not yet complete.
Conclusion
The recent financial crisis disrupted the financial system and the
broader economy on a scale and scope not seen since the 1930s. Some of
the world's largest financial firms collapsed or required Government
assistance to stay afloat, sending shock waves through the highly
interconnected global financial system. Asset prices fell sharply,
flows of credit to American families and businesses slowed
dramatically, and millions of people lost their jobs. Extraordinary
actions by Governments around the world helped to provide stability,
but more than 4 years after the onset of the crisis, the recovery is
far from complete. It is critical that we complete the implementation
of capital and other prudential measures to prevent another crisis and
protect taxpayers from having again to recapitalize financial firms.
Thank you very much for your attention. I would be pleased to
answer any questions you may have.
______
PREPARED STATEMENT OF THOMAS J. CURRY
Comptroller of the Currency, Office of the Comptroller of the Currency
June 6, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, it is a pleasure to be here as the 30th Comptroller of the
Currency to testify as part of the Committee's ongoing hearings on the
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act or Act). Before beginning, I want to
express my appreciation for the confidence and trust that Members of
this Committee and the President have bestowed upon me to lead the
Office of the Comptroller of the Currency (OCC).*
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*Statement Required by 12 U.S.C. 250: The views expressed herein
are those of the Office of the Comptroller of the Currency and do not
necessarily represent the views of the President.
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The OCC supervises nearly 2,000 national banks and Federal savings
associations (collectively ``banks''), which constitute approximately
26 percent of all federally insured banks and thrifts, holding more
than 69 percent of all commercial bank and thrift assets. These
institutions range in size from nearly 1,800 community banks with
assets of $1 billion or less to the Nation's largest and most complex
financial institutions with assets exceeding $100 billion. More than 90
percent of the institutions the OCC supervises are community banks and
75 percent of our bank supervision staff directly supports the
supervision of these important institutions across the country. At the
same time, examiners with diverse experience and specialized skills are
embedded in the large banks we regulate to provide continuous ongoing
supervision. To meet the supervisory needs of banks with such
diversity, the OCC has structured its supervision activities into three
lines of business: our Large Bank program, which typically covers banks
with assets of $50 billion or more; our Midsize Bank program, which
covers banks with assets generally ranging from $10 billion to $50
billion; and our Community Bank program, which is focused on banks
under $10 billion in assets. We tailor our supervisory activities for
these three groups of institutions to the challenges they face.
The Dodd-Frank Act and rulemakings by the OCC and other agencies
have done much to strengthen the regulatory framework for our country's
financial institutions. Translating these reforms into improved
soundness and fair treatment of customers by individual institutions
requires strong, effective supervision. I am committed to strong
supervision and to taking additional steps to enhance our supervision
where necessary. Strong supervision is a theme that will flow through
the balance of my testimony and mark my tenure as Comptroller. The
agency has already begun efforts to heighten supervisory expectations
among the largest institutions we oversee. This process includes
increasing the awareness of risks facing banks and the banking system,
reducing risk to manageable levels, and raising expectations for
management, capital, reserves, liquidity, risk management, and
corporate governance and oversight. This is a process that will take
time to accomplish, and we must be vigilant to maintain our course.
In response to the Committee's letter of invitation, my testimony
covers five broad topics
The status of several rulemakings implementing some key
provisions of the Dodd-Frank Act;
A description of the OCC's supervision of community banks
summarizing the steps we take to assure that our supervision is
consistent, balanced, and reflective of the risks these banks
face, as well as the compliance challenges they experience when
new rules or policies are introduced;
An overview of how the Dodd-Frank Act changed the
regulatory framework for the supervision of large banking
organizations and the mechanisms for regulatory collaboration;
A discussion of the OCC's large bank supervisory program
and how provisions of the Dodd-Frank Act will enhance and
supplement our supervision; and
A summary of our oversight and work underway at JPMorgan
Chase (JPMC) related to their recently announced losses.
I. Update on Key Regulatory Reform and Dodd-Frank Act Rulemakings
The OCC has taken action on several key regulatory reform and Dodd-
Frank Act rulemakings since our last testimony before this Committee.
These are summarized below.
Final Rule To Revise the OCC's Regulations To Remove References to
Credit Ratings
The OCC will soon be publishing in the Federal Register a final
rule that addresses section 939A of the Dodd-Frank Act by removing
references to credit ratings from the OCC's regulations dealing with
topics other than capital requirements. For example, the investment
securities regulation sets forth the types of investment securities
that national banks and Federal savings associations may purchase,
sell, deal in, underwrite, and hold. Under existing OCC rules,
permissible investment securities generally include Treasury
securities, agency securities, municipal bonds, and other securities
rated ``investment grade'' by nationally recognized statistical rating
organizations such as Moody's, S&P, or Fitch Ratings. The OCC's final
rule revises the definition of ``investment grade'' to remove the
reference to credit ratings and replaces it with a new nonratings based
creditworthiness standard. To determine that a security is ``investment
grade'' under the new standard, a bank will be required to perform due
diligence necessary to establish: 1) that the risk of default by the
obligor is low; and 2) that full and timely repayment of principal and
interest is expected. Generally, securities with good to very strong
credit quality will meet this standard.
In comments on the proposed rule, banks and industry groups
expressed concern about the amount of due diligence that the OCC would
require a bank to conduct to determine whether an issuer has an
adequate capacity to meet financial commitments under a security. The
OCC believes that the proposed ``investment grade'' standard and the
due diligence required to meet it are consistent with those under the
prior ratings-based standards and existing due diligence requirements
and guidance. Even under the prior ratings-based standards, national
banks and Federal savings associations of all sizes should not have
relied solely on a credit rating to evaluate the credit risk of a
security, and have been advised to supplement any use of credit ratings
with additional diligence on the credit risk of a particular security.
Nevertheless, the OCC recognizes that it may take time for some
national banks and Federal savings associations to make the adjustments
necessary to make ``investment grade'' determinations under the new
standard. Therefore, the OCC is allowing institutions until January 1,
2013, to come into compliance with the final rule.
To aid this adjustment process, the OCC also will publish guidance
to assist banks in interpreting the new standard and to clarify the
steps banks can take to demonstrate that they meet their diligence
requirements when purchasing investment securities and conducting
ongoing reviews of their investment portfolios.
Final Market Risk Capital Rule
On December 21, 2011, the OCC, Board of Governors of the Federal
Reserve System (FRB), and the Federal Deposit Insurance Corporation
(FDIC) issued a notice of proposed rulemaking (NPR) that amended the
agencies' January 2011 market risk capital proposal by removing
references to credit ratings, consistent with section 939A of the Dodd-
Frank Act. The NPR proposed alternative standards of creditworthiness
to be used in place of credit ratings to determine the capital
requirements for certain debt and securitization positions covered by
the market risk capital rule.
I will soon approve for publication in the Federal Register the
final market risk rule that implements various enhancements adopted by
the Basel Committee on Banking Supervision to strengthen the capital
requirements that apply to banks' trading activities. The final rule
modifies the scope of positions covered by the rule to better capture
positions for which the market risk capital rules are appropriate;
reduce procyclicality in market risk capital requirements; enhance the
rule's sensitivity to risks that are not adequately captured under the
current regulatory measurement methodologies; and increase transparency
through enhanced disclosures. The rule also removes references to
credit ratings from the market risk capital framework and requires
banks to receive written approval before making material changes to
models used to calculate their market risk capital requirement. The
rule will be published once approved by the boards of the FDIC and the
FRB.
Basel III Capital Standards
I also will soon approve for publication in the Federal Register a
set of proposals that would revise the agencies' current ``advanced
approaches'' risk-based capital rules and replace the agencies' current
generally applicable risk-based capital rules with rules that implement
various enhancements adopted by the Basel Committee. These
enhancements, which were more fully discussed in the OCC's December
2011 testimony, include:
A new, more rigorous definition of capital, which excludes
funds raised through hybrid instruments that were unable to
absorb losses as the crisis deepened; . Increased minimum risk-
based capital requirements, which include increased minimum
Tier 1 capital requirements and a new common equity
requirement;
The creation of a capital conservation ``buffer'' on top of
regulatory minimums to be drawn down in times of economic
stress and that trigger restrictions on capital distributions
(such as dividends), and discretionary bonus payments;
Enhanced risk-based capital requirements for counterparty
credit to capture the risk that a counterparty in a complex
financial transaction could grow weaker at precisely the time
that a bank's exposure to the counterparty grows larger;
The addition of a new leverage ratio requirement for larger
institutions that incorporates off-balance-sheet exposures; and
The removal of the references to credit ratings from the
agencies' risk-based capital rules, pursuant to section 939A of
the Dodd-Frank Act.
The agencies have divided the proposals into three separate NPRs
that will be published together in the Federal Register to allow
interested parties to better understand and focus on the various
aspects of the overall capital framework, including which aspects of
the rules will apply to which banking organizations. Separating the
proposals into three documents will make it easier for banks of all
sizes to understand which proposed changes are related to improving the
quality and increasing the quantity of capital and which are related to
enhancing the risk sensitivity of the calculation of total risk-
weighted assets.
Dodd-Frank Stress Tests
The Dodd-Frank Act requires two types of stress testing
requirements: stress tests conducted by the company and stress tests
conducted by the FRB. The company-run stress test applies to all
financial companies, including national banks and Federal savings
associations, with total consolidated assets of more than $10 billion,
and requires the primary financial regulatory agency of those financial
companies to issue regulations implementing the stress test
requirements. Company-run stress tests are required semi-annually for
financial companies with consolidated assets exceeding $50 billion, and
annually for those from $10 to $50 billion in size. The primary
financial regulatory agency is required to define ``stress test,''
establish methods for the conduct of the company-conducted stress test
that must include at least three different sets of conditions
(baseline, adverse, and severely adverse), establish the form and
content of the institution's report, and compel the institution to
publish a summary of the results of the institutional stress tests.
On January 24, 2012, the OCC published an NPR to implement the
company-run stress test for banks. We are currently reviewing the
comments we received and are working closely with the FRB and FDIC to
ensure that the final rules are consistent and reduce burden to the
greatest extent possible by avoiding duplication.
Volcker Rule
Section 619 of the Dodd-Frank Act added a new section 13 to the
Bank Holding Company Act (BHCA) that contains certain prohibitions and
limitations on the ability of a banking entity and a nonbank financial
company supervised by the FRB to engage in proprietary trading and to
have certain interests in, or relationships with, a hedge fund or
private equity fund. The OCC, FDIC, FRB, and the Securities and
Exchange Commission (SEC) issued proposed rules implementing that
section's requirements on October 11, 2011. On January 3, 2012, the
period for filing public comments on this proposal was extended for an
additional 30 days, until February 13, 2012. On January 11, 2012, the
Commodity Futures Trading Commission (CFTC) issued a substantively
similar proposed rule implementing section 13 of the BHCA and invited
public comment through April 16, 2012. The agencies are now considering
the more than 18,000 comments received.
On April 19, 2012, the FRB clarified that entities covered by the
Volcker Rule have a period of 2 years after the statutory effective
date, which would be until July 21, 2014, to fully conform their
activities and investments to the requirements of section 619 of the
Dodd-Frank Act and any final rules adopted, unless that period is
extended by the FRB.
The OCC, FDIC, SEC, and CFTC announced that they plan to administer
their oversight of banking entities under their respective
jurisdictions in accordance with the FRB's conformance rule and
statement of April 19.
Lending Limits
The OCC's lending limit rules at 12 U.S.C. 84 provide that the
total loans and extensions of credit by a national bank to a person
outstanding at one time shall not exceed 15 percent of the unimpaired
capital and unimpaired surplus of the bank if the loan is not fully
secured, plus an additional 10 percent of unimpaired capital and
unimpaired surplus if the loan is fully secured by certain types of
collateral. Section 610 of the Dodd-Frank Act amends this provision to
expand the definition of ``loans and extensions of credit'' to include
any credit exposure to a person arising from a derivative transaction,
repurchase agreement, reverse repurchase agreement, securities lending
transaction, or securities borrowing transaction between a national
bank and that person. This amendment is effective July 21, 2012.
The OCC plans to issue a rule shortly to establish how the credit
exposures from these types of transactions should be measured for
lending-limit purposes. In implementing these provisions, the OCC has
been mindful of opportunities to minimize complexity, particularly for
community banks, and of providing sufficient time for banks to comply
with the new requirements.
II. OCC's Commitment to and Supervision of Community Banks
The OCC's community bank supervision program is built around our
local field offices, staffed by local examiners, based in more than 60
cities throughout the United States in close proximity to the banks
they supervise. Every community bank is assigned to an examiner who
monitors the bank's condition on an ongoing basis and who serves as the
focal point for communications with the bank.
The OCC's structure ensures that community banks receive the
benefits of highly trained examiners with local knowledge and
experience, along with the resources and specialized expertise that a
nationwide organization provides. Examiners conduct their examinations
using the Community Bank Supervision section of the Comptroller's
Handbook that tailors procedures to community banks. While the OCC's
bank supervision policies and procedures establish a common framework
and set of expectations, examiners tailor their supervision of each
community bank to its individual risk profile, business model, and
management strategies. As a result, the OCC's Assistant Deputy
Comptrollers are given considerable decision-making authority,
reflecting their experience, expertise, and their on-the-ground
knowledge of the institutions they supervise.
The OCC has mechanisms in place to ensure that examiners apply our
supervisory policies, procedures, and expectations in a consistent and
balanced manner. The responsible manager reviews and signs off on each
report of examination before being finalized. When significant issues
are identified and an enforcement action is already in place, or is
being contemplated, additional levels of review occur prior to
finalizing the examination conclusions. The OCC also has formal quality
assurance processes, overseen by the agency's Enterprise Governance
office that reports directly to me, that assess the effectiveness of
our supervision and compliance with OCC policies through periodic,
randomly selected reviews of the supervisory record.
As a former State banking commissioner, I have a keen appreciation
for the critical role that community banks play in providing consumers
and small businesses in communities across the Nation with essential
financial services as well as the credit that is critical to economic
growth and job creation. While community banks comprise about 11
percent of the banking assets in our country, they make 39 percent of
the small business loans that keep America working. I am committed to
making sure our supervision of these institutions is fair and balanced,
and that wherever possible, we minimize their regulatory and compliance
burdens.
As the OCC has previously testified, while the focus of the Dodd-
Frank Act is generally on larger financial institutions, other
provisions broadly amend banking and financial laws in ways that affect
the entire banking sector, including community banks. \1\ Some of these
involve provisions where the OCC has rulemaking authority, while others
fall outside of the OCC's jurisdiction. As we implement regulations for
the Dodd-Frank Act and other key reform efforts, one of my early
directives to the OCC staff has been to assess the potential impact on
smaller institutions, seek ways to minimize potential burden, and
explain and organize our rulemakings in ways that help community
bankers understand the scope and application of the rules to their
institutions.
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\1\ See, http://www.occ.gov/news-issuances/congressional-
testimony/2011/pub-test-2011-42-written.pdf.
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The companion guidance to our rulemaking to remove credit ratings
from our investment securities regulations, described above, is one
example of how we are trying to minimize burden on smaller banks. In
implementing this provision of the Dodd-Frank Act, our goal has been to
meet the objective of the statute while recognizing the effectiveness
of the tools and analyses that well-managed community banks have
routinely used to aid their credit analysis and investment decisions.
III. Dodd-Frank Impact on Supervision of Large Banking Organizations
The Dodd-Frank Act will have a significant and lasting impact on
the supervision and oversight of our Nation's large financial firms.
Indeed, among the Act's key objectives are to strengthen the oversight,
regulation, and resolution regimes applicable to large financial
organizations to lessen the potential that disruptions or failures
could have on the stability of the U.S. financial system. The Act also
seeks to promote greater market stability through increased
transparency and oversight of swaps and other derivative activities.
Finally, the Act also seeks to strengthen consumer protection related
to financial products and services.
The Dodd-Frank Act establishes a variety of mechanisms to achieve
these objectives. Some of these mechanisms, such as the risk retention,
Volcker, and swap margin and central counterparty and clearing
provisions, are targeted at how and where various financial activities
and risk taking are to be conducted in the future. As more fully
described in the OCC's December 2011 and March 2012 testimonies before
this Committee, work on these rulemakings is underway. \2\ Other
provisions established new or expanded regulatory authorities. These
include the Title II orderly liquidation provisions and tools provided
to the FDIC and the FRB; the transfer of powers and functions from the
Office of Thrift Supervision to the OCC; and the creation of the
Consumer Financial Protection Bureau (CFPB) and the Financial Stability
Oversight Council (FSOC). Finally, other provisions, most notably those
related to heightened prudential standards are designed to strengthen
the risk management, capital, and liquidity that govern and support
risk-taking activities.
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\2\ See, http://www.occ.gov/news-issuances/congressional-
testimony/2011/pub-test-2011-142-written.pdf and http://www.occ.gov/
news-issuances/congressional-testimony/2012/pub-test-2012-50-
written.pdf.
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The financial crisis underscored that supervisors must be cognizant
not only of what is going on within the individual firms they oversee,
but also how those activities affect, or can be affected by, events at
other firms, markets, and the broader economy. The Dodd-Frank Act
established the FSOC to provide a formal body to assess and exchange
such information. The OCC is an active participant in FSOC and its
various operating committees, including those developing and assessing
potential designations for systemically important financial market
utilities and nonbank financial firms; the systemic risk committee,
charged with assessing and monitoring potential emerging systemic
issues; and the committee providing input to the FRB's heightened
prudential FSOC meeting last month and believe it will be a valuable
forum for exchanging market intelligence and coordinating regulatory
actions on a variety of cross-cutting issues that may affect OCC-
supervised large institutions. One such example that was widely
reported from the most recent FSOC meeting included a discussion, led
by the OCC, of risks and supervisory actions related to reports of JPMC
activities and disclosed losses--a topic also discussed later in this
testimony.
To promote consistent and comprehensive oversight of large banking
organizations, the Dodd-Frank Act appropriately requires close
collaboration among the Federal financial agencies with respect to
rulemaking and various ongoing supervisory activities. In this regard,
two provisions of the Act have had a direct impact on the scope and
nature of the OCC's supervisory activities.
The first, and most immediate impact, was the transfer to the OCC
of all functions of the OTS relating to Federal savings associations.
From an operational perspective, this transfer was successfully
completed last July, and the ongoing supervision of more than 600
Federal savings associations has been integrated into our supervisory
programs. The integration of the OTS into the OCC will help achieve a
more consistent supervisory regime for federally chartered depository
institutions. In this regard, and as discussed more fully in the OCC's
December 2011 testimony, we are conducting a comprehensive, multiphased
review of our regulations, as well as those of the OTS, to eliminate
duplication, reduce unnecessary burden, and provide consistent
treatment, where appropriate, for both national banks and Federal
savings associations. A similar effort is underway to integrate the
more than 1,000 OTS policies into a consolidated OCC policy framework.
While we believe having a common set of rules and policies will
benefit national banks and Federal savings associations, we recognize
that these changes can create uncertainty for Federal savings
associations. To help Federal savings associations understand these
changes and the OCC's approach to supervision, we continue to hold
various outreach meetings and teleconferences for Federal savings
associations. These opportunities allow Federal savings association
executives to voice concerns, to get answers to their questions, and to
gain a better understanding of supervisory issues of specific interest
to them. We are also in the process of re-establishing the OTS'
advisory committees for mutual savings associations and minority
institutions to provide a venue for industry input on the unique
challenges facing those institutions.
The second shift in OCC supervisory responsibilities as the result
of Dodd-Frank has been the transfer of oversight responsibility for
compliance with certain Federal consumer laws to the CFPB for national
banks and Federal savings associations with total assets greater than
$10 billion. To minimize regulatory burden on institutions, the Dodd-
Frank Act requires the CFPB to coordinate its activities with the
supervisory activities conducted by the prudential regulators. Section
1025 requires the CFPB to consult with the prudential regulators
regarding respective schedules for examining an institution. Similarly,
the CFPB and the prudential regulators are required to conduct their
respective examinations simultaneously in an insured depository
institution and to share and comment on related draft reports of
examination that result from the simultaneous examinations. The law
also provides that the regulated institution may opt out of a
simultaneous examination by the prudential regulator and the CFPB. I am
pleased to report that the OCC and other Federal banking agencies
recently signed and earlier this week published a Memorandum of
Understanding that implements these coordination requirements in a
realistic and practical manner.
With respect to supervision of individual large banking
organizations, the OCC serves as the primary Federal banking regulator
for activities conducted within the national bank or Federal savings
association charter and its subsidiaries, except for compliance with
statutes and regulations where jurisdiction has been expressly provided
to another supervisor, such as the SEC for certain broker-dealer
activities, and the CFPB for certain Federal consumer laws. Since most
large banks are part of a bank holding company, we work closely with
the FRB in planning and conducting our supervisory activities for these
institutions.
Successful implementation of the heightened prudential standards
provisions of the Dodd-Frank Act will require close collaboration
between the OCC and the FRB. For example, bank holding companies
subject to the heightened prudential standards, and their subsidiary
national banks and Federal savings associations, will be subject to
multiple stress tests, including the annual Comprehensive Capital
Analysis and Review (CCAR), and the supervisory and company-run stress
tests set forth in the FRB's Heightened Prudential Standards rules and
the OCC's stress test rule. It is important that our agencies work
together to align resources and strategy, and to ensure consistency in
scenarios and models, in both the CCAR and Dodd-Frank Act stress
testing processes.
IV. OCC Supervision of Large Banks and the Dodd-Frank Act
Overview of the OCC's Supervisory Program for Large Banks
The OCC's Large Bank supervision program is structured to promote
consistent risk-based supervision. It is a centralized program
headquartered in Washington with a national perspective that
facilitates coordination across large institutions.
The foundation of the OCC's supervisory efforts is our continuous,
on-site presence of examiners at each of the 19 largest banking
companies. These on-site teams are led by an Examiner-In-Charge (EIC)
who manages a staff of seasoned examiners, generally with 20 or more
years of experience across numerous banks and multiple business cycles,
and possessing advanced skills in key risk areas such as credit,
capital markets, and compliance. In addition, certain supervisory
activities are staffed by our team of PhD economists from the OCC
Economics Department. The examiners are also supplemented by lawyers,
other economists, as well as policy and subject matter experts to
support their ongoing supervision.
The on-site examination teams have three main objectives. The first
is to know the objectives of the bank and its lines of business, the
key risks, and the controls that are put in place to manage them. The
second is to assess the levels of risk in the bank and the quality of
risk management over the course of the examination cycle. Finally,
examiners are charged with communicating examination findings,
concerns, and ratings through our CAMELS and Risk Assessment System.
Examiners communicate by meeting with bank management and the board of
directors, and through written supervisory letters and reports of
examination. They identify concerns and ensure that corrective actions
are taken, through the supervisory process, or if needed, appropriate
enforcement actions.
To enhance our ability to identify key risks as well as emerging
issues and share best practices across the large banks, we have
examiner network groups across eight major disciplines: Commercial
Credit, Retail Credit, Mortgage Banking, Capital Markets, Asset
Management, Information Technology, Operational Risk, and Compliance.
These groups share information, concerns, and policy application among
examiners. They also identify areas of common interest as well as risks
that are elevated or emerging. The EICs and leadership teams of each of
the network groups work closely with specialists in our Supervision
Policy and Risk Analysis Divisions to promote consistent application of
supervisory standards and coordinated responses to emerging issues.
Examinations are conducted pursuant to risk-based supervisory
strategies that are developed for each institution. Although each
strategy is tailored to the business model and risk profile of the
individual institution, the strategy development process is governed by
supervisory objectives established annually by our senior supervision
management team. Through this planning process, the OCC identifies key
risks and issues that cut across the industry and promotes consistency
in areas of concern. Each strategy is reviewed and approved by the
appropriate Large Bank Deputy Comptroller. In addition, a Quality
Assurance group within our Large Bank program reviews selected
strategies as part of a structured process review to ensure that
examination activities are executed consistently and in a quality
manner.
It is important to remember that the job of risk management is not
to eliminate losses. Rather, risk management ensures that risk
exposures are fully identified and understood by bank management and
directors to allow them to make informed business decisions about the
firm's risks, and that the bank has sufficient capital, reserves, and
liquidity to withstand a range of potentially adverse outcomes. Banks
must manage their risks effectively to meet the credit and borrowing
needs of the customers and communities they serve.
Resident examiners apply risk-based supervision to a broad array of
issues and risks, including credit, liquidity, price, interest rate,
compliance, and operational risks. The primary focus of examiners is to
determine whether banks have sound risk control processes commensurate
with the nature of their risk-taking activities, capital, reserves, and
liquidity. Given the millions of transactions that large banks conduct
daily across varied product lines and businesses, examiners do not
review every transaction in a bank.
OCC examiners probe to see where activities, earnings, or losses
diverge from expectations to a degree indicative of a breach of
approved parameters or breakdown of controls. For example, examiners
look for lending or trading activities operating outside approved
limits, especially where risk management activities did not identify or
escalate such instances; and for models breaking or not going through
proper validation. Risk management seeks to mitigate and control risk
but not eliminate it entirely. Losses occur even when all controls
function properly. That is why banks are required to maintain capital,
reserves, and liquidity to absorb adverse outcomes and unexpected
losses.
When we find weaknesses or deficiencies, we communicate them to
bank senior management and require corrective actions. Most often this
is accomplished through ``Matters Requiring Attention'' (MRA) that are
sent to the bank's senior management and board of directors. When
needed, we take more formal enforcement actions.
OCC Actions and the Dodd-Frank Act Require Stronger Risk Management for
Systemically Important Banks
At the OCC, we have raised the bar on our supervisory expectations
for the largest banks we supervise. Large banks are critically
important to the vitality of our economy and the orderly functioning of
the capital markets. As a result, they must be managed and governed in
a higher quality manner than less systemically important banks. Our
experience in the recent crisis showed that we needed to elevate
expectations with respect to balance sheets as well as governance and
oversight processes.
Stronger Capital, Reserves, and Liquidity Standards
Since the onset of the financial crisis, we directed the largest
institutions to strengthen their capital, reserves, and liquidity
positions. As a result, the quality and level of capital at national
banks and bank holding companies with total assets over $50 billion
have improved significantly. The median percentage of Tier 1 common
capital relative to total assets for bank holding companies increased
from 5.2 percent to more than 7 percent, while the comparable ratio for
national banks and Federal savings institutions rose from 6.4 percent
to 8.7 percent, over that same period.
Under scrutiny of our examiners, the largest banks have more than
doubled their loan loss reserves as a percentage of gross loans since
the end of 2007, from 1.4 percent to 2.9 percent. Similarly, the
largest banks have materially strengthened their liquidity buffers
through increases in short-term liquid assets that can be used to meet
unanticipated liquidity demands and through a decreased reliance on
short-term, volatile funding. While these are positive developments, we
are taking actions to ensure that these are permanent and not just
temporary improvements.
In concert with the Basel Committee, we are raising both the
quality and quantity of regulatory capital that banks generally must
hold. Consistent with section 171 of the Dodd-Frank Act, these enhanced
capital requirements will also apply to bank holding companies. These
changes are being implemented by the forthcoming Basel III capital
rulemakings, which were previously described. Under the proposed rules,
large banks subject to the ``advanced approaches'' capital regime will
face additional capital requirements that will not apply to smaller
banks. These include a countercyclical capital charge, which banking
supervisors can activate to curb excessive credit growth, and a
supplemental leverage ratio that will capture off-balance-sheet
exposures. This enhanced leverage ratio is broadly consistent with
section 165 of the Dodd-Frank Act, which directs that off-balance-sheet
activities be included in the regulatory capital calculation for bank
holding companies with total consolidated assets equal to or greater
than $50 billion. Basel III also calls for adopting a capital surcharge
that would apply only to the 29 largest global, systemically important
banks, seven of which are U.S. entities. The FRB supervises all of
these bank holding companies, and the OCC supervises the national banks
in five of these companies. It is envisioned that this provision will
be included in the FRB's heightened prudential capital standards rule
as part of its implementation of section 165.
Basel III also introduces two explicit quantitative minimum
liquidity ratios to assist a bank in maintaining sufficient liquidity
during periods of financial distress: the Liquidity Coverage Ratio and
the Net Stable Funding Ratio. These ratios are designed to achieve two
separate but complementary objectives. The Liquidity Coverage Ratio,
with a 1-month time horizon, addresses short-term resilience by
ensuring that a bank has sufficient high quality liquid resources to
offset cash outflows under acute short-term stresses. The Net Stable
Funding Ratio is targeted toward promoting longer-term resilience by
creating additional incentives for a bank to fund its ongoing
activities with stable sources of funding. Its goal is to limit over-
reliance on short-term wholesale funding during times of robust market
liquidity and to encourage better assessment of liquidity risk across
all on- and off-balance-sheet items.
The Basel Committee included a lengthy implementation timeline for
both ratios to provide regulators the opportunity to conduct further
analysis and to make changes as necessary. The OCC is continuing its
work with the Basel Committee to develop and recommend changes to the
Liquidity Coverage Ratio to ensure that it will produce appropriate
requirements and incentives, especially during economic downturns, and
to otherwise limit potential unintended consequences.
These explicit liquidity thresholds, once fully implemented, will
complement the more rigorous liquidity risk management expectations
that the OCC and other banking agencies issued in 2010 and that are
helping to form the enhanced liquidity standards the FRB is
promulgating as part of the heightened prudential standards under
section 165 of the Dodd-Frank Act. In the interim, the OCC this week
published a revised Liquidity Risk Management booklet as part of its
Comptroller's Handbook series. This booklet forms the framework for our
liquidity examinations. While the core concepts in the booklet apply to
national banks and Federal savings associations of all sizes, the
booklet emphasizes that the complexity and sophistication of liquidity
risk management, along with the liquidity positions held must be
tailored to a bank's risk profile and scope of activities.
Heightened Expectations for Strong Corporate Governance and Oversight
Higher supervisory expectations, along with sharper execution by
bank management and independent directors in fundamental areas, will go
a long way toward maintaining the improvements achieved since the
financial crisis and minimizing the probability and impact of future
crises. We set higher expectations for large banks in five specific
areas.
Board willingness to provide credible challenge. A key element in
corporate governance is a strong, knowledgeable board with independent
directors who provide a credible challenge to bank management. The
capacity to dedicate sufficient time and energy in reviewing
information and developing an understanding of the key issues related
to bank activities are critical to being an effective director.
Informed directors are well positioned to engage in value-added
discussions that provide knowledgeable approvals and guidance.
Effective directors prudently question the propriety of strategic
initiatives, talent decisions, and the balance between risk taking and
reward. And obviously, it is essential to the ability of directors to
perform this role to have effective information flow and risk
identification within the organization.
Talent management and compensation. Human capital is a key asset in
any organization, and we expect large banks to have a well defined
personnel management process that ensures appropriate quality staffing
levels and provides for orderly succession. Large bank management
processes are typically extensive. OCC EICs are enhancing their
knowledge in this area and incorporating their assessments into the
``management'' rating in CAMELS, with particular focus on the adequacy
of current staffing levels, the ability to provide for orderly
succession, the proactive identification of staffing gaps that require
external hires, and appropriate compensation tools to motivate and
retain talent. Of particular importance is the need to ensure that
incentive compensation structures balance risk and financial rewards
and are compatible with effective controls and risk management. This is
a key objective of the interagency guidance on sound incentive
compensation that the OCC, FRB, and FDIC issued in June 2010, and the
proposed rulemaking that the Federal banking agencies, the National
Credit Union Administration, the SEC, and the Federal Housing Finance
Agency have issued to implement the incentive-based compensation
provisions in the Dodd-Frank Act. Work on that rulemaking is underway.
Defining and communicating risk tolerance expectations across the
company. Consistent with prudent governance practices, banks must
define and communicate acceptable risk tolerance, and results need to
be periodically compared to pre-defined limits. As banks have grown,
the process of defining and measuring risk tolerance has typically been
confined to the business unit and more micro levels. While these lower
level risk limits can generally control individual areas of risk
taking, they do not enable senior management or board members to
monitor or evaluate concentrations or risk levels at the broader firm
level. Examiners are directing banks to complement existing risk
tolerance structures with measures and limits of risk addressing the
amount of capital or earnings that may be at risk on a firm-wide basis,
the amount of risk that may be taken in each line of business, and the
amount of risk that may be taken in each of the key risk categories
monitored by the banks. This process will result in better
identification and measurement of concentrations, with attendant
monitoring and controls.
Development and maintenance of strong audit and risk management
functions. The recent crisis reinforced the importance of quality audit
and risk management functions. The scale and breadth of large banks
presents added challenges to the roles of executive management and
directors in knowing the risk profile and whether pre-defined policies
and procedures are being followed appropriately. While regulators
operated for many years with the premise that satisfactory \3\
oversight functions were generally sufficient, the financial crisis has
led us to conclude that large banks should not operate with anything
less than strong audit and risk management functions. To meet this
higher standard, we have directed bank audit and risk management
committees to perform gap analyses relative to OCC's standards and
industry practices and to take appropriate action to improve their
audit and risk management functions. We expect members of the bank's
board and its executive management team to ensure audit and risk
management teams are visibly and substantively supported. As part of
their ongoing supervision, OCC examiners are evaluating the state of
these key oversight functions and identifying areas that require
strengthening.
---------------------------------------------------------------------------
\3\ OCC examiners rate the quality of the bank's audit function
and the quality of risk management as weak, satisfactory, or strong.
---------------------------------------------------------------------------
Sanctity of the charter. While holding companies of large banks are
typically managed on a line of business basis, directors at the bank
level are responsible for oversight of the bank's charter--the legal
entity. Such responsibility requires separate and focused governance.
We have reminded the boards of banks that their primary fiduciary duty
is to ensure the safety and soundness of the national bank or Federal
savings association. Execution of this responsibility involves focus on
the risk and control infrastructure necessary to maintain it. Directors
must be certain that appropriate personnel, strategic planning, risk
tolerance, operating processes, delegations of authority, and controls
are in place to effectively oversee the performance of the bank. The
bank should not simply function as a booking entity for the holding
company. It is incumbent upon bank directors to be mindful of this
primary fiduciary duty as they execute their responsibilities.
V. JPMorgan Chase Loss and OCC Role and Responsibilities
With this background, let me turn to the recently announced losses
at JPMC. This event raises questions about the adequacy and rigor of
JPMC's risk management practices that we are actively examining.
JPMC is a $2.3 trillion bank holding company with approximately
$128 billion in Tier 1 common capital as of March 31, 2012. The FRB
oversees the holding company and its affiliates. The OCC oversees
JPMC's national banks and various subsidiaries. The lead national bank
has approximately $1.8 trillion in total consolidated assets and $101
billion in Tier 1 common capital. The OCC's supervisory team includes
approximately 65 on-site examiners who are responsible for reviewing
nearly all facets of the bank's activities and operations, including
commercial and retail credit, mortgage banking, trading and other
capital markets activities, asset liability management, bank technology
and other aspects of operational risk, audit and internal controls, and
compliance with the Bank Secrecy Act, and anti-money laundering laws
and the Community Reinvestment Act. These on-site examiners are
supported by additional subject-matter experts from across the OCC.
Given the scale of the bank, the loss by JPMC affects its earnings,
but does not present a solvency issue. JPMC, like other large banks,
has improved its capital, reserves, and liquidity since the financial
crisis, and its levels are sufficient to absorb this loss. The Basel
III rulemakings described earlier will further increase the required
level of high-quality capital for all U.S. banks, and work underway by
the Financial Stability Board will further increase capital
requirements for systemically significant firms, like JPMC.
Similarly, the events at JPMC do not threaten the broader financial
system. Under current market conditions, the JPMC effort to manage its
positions is not creating an unusual risk of contagion to other banks.
Beyond JPMC, we have directed OCC examiners to evaluate the risk
management strategies and practices in place at other large banks, and
examiners have reported that there is no activity similar to the scale
or complexity of JPMC. However, this is a continuing focus of our
supervision.
The activities that generated the reported $2 billion loss were
conducted in the national bank by JPMC's Chief Investment Office (CIO),
which is responsible for the bank's asset-liability management
activities. This asset-liability management function is separate from
JPMC's investment banking business, where most trading and market
making takes place. The CIO reports to the Chief Executive Officer of
JPMC. Its activities are conducted globally but managed and controlled
out of JPMC's New York offices. These activities are supervised by OCC
staff assigned to the JPMC headquarters in New York. Part of our
ongoing review includes an evaluation of this structure, its oversight,
and controls.
In 2007 and 2008, the bank constructed a portfolio designed to
partially offset credit risk using credit default swaps to help protect
the company from potential credit losses in a stressed global economy.
This strategy was reflected in regular reports received by OCC
examiners. The OCC focused on the risk management systems and controls
that the bank employed to mitigate credit risk in its portfolio. For
several years thereafter, risk levels operated within bank-approved
stress and other limits.
In late 2011 and early 2012, bank management revised its strategy
and decided to offset it original position and reduce the amount of
stress loss protection. The instruments chosen by the bank to execute
the strategy were not identical to the instruments used in the original
position, which introduced basis, liquidity, and other risks. As the
new strategy was executed in the first quarter, actual performance
deviated from expectations, and resulted in substantial losses in the
second quarter. Whether risk management controls, procedures, and
reports were properly structured, reviewed, approved, and acted upon in
the execution of this strategy is another focus of our ongoing
examination.
In April 2012, as part of our supervisory activities, OCC examiners
met with bank management to discuss the bank's transaction activity and
the current state of the position. OCC examiners directed the bank to
provide additional details regarding the transactions, their scope, and
risk. Our examiners were in the process of evaluating the bank's
current position and strategy when, at the end of April and during the
first days of May, the value of the position deteriorated rapidly.
Since that time, the OCC has been meeting daily with bank
management with respect to the bank's response to this situation, to
re-evaluate the risk management activities and controls of the bank and
how they applied to its CIO function, and to determine what additional
action is necessary. This includes the ongoing daily oversight of the
bank's actions to mitigate and reduce the risk of the positions at
issue. We and the Federal Reserve are conducting reviews in the bank
and are sharing information with the FDIC and other regulators.
We are also undertaking a two-pronged review of our supervisory
activities and response. The first component is focused on evaluating
the adequacy of current risk controls and risk governance at the bank,
informed by their application to the positions at issue. The second
component evaluates the lessons learned from this episode that could
enhance risk control and risk management processes at this and other
banks and improve OCC supervisory approaches. Consistent with our
supervisory policy of heightened expectations for large banks, we will
require that the bank adhere to the highest risk management standards.
We are not limiting our inquiry just to the particular transactions
at issue. We will assess not just the adequacy of risk management and
controls for the positions now spotlighted, but also activities in
comparable bank operations. We will use these events to more broadly
evaluate the effectiveness of the bank's risk management throughout the
firm and to identify ways to improve our supervision.
The first prong of our approach involves our on-site exam team
focusing on three broad areas. To begin with, we are actively assessing
the quality of management and risk management in the CIO function,
including decision making; board oversight, including whether the risk
committee is appropriately informed and engaged; the types and
reasonableness of risk measurement metrics and limits; the model
governance review process; and the quality of work by the independent
risk management team as well as internal audit. We are also assessing
the adequacy of the information provided within the bank and made
available to the OCC to evaluate the risks and risk controls associated
with the positions undertaken by the CIO. Finally, we are evaluating
the compensation process of the CIO and will assess the bank's
determination on ``claw backs'' as part of that analysis. If corrective
action is warranted, we will pursue and implement appropriate informal
and/or formal remedial measures.
Working on a parallel track, as part of the second prong of our
supervisory response, we are evaluating the events leading up to and
through the bank announcement of losses associated with the CIO, and
what these events teach us to improve risk management and to enhance
our supervisory activity. Particular attention is being directed to the
rationale for the transactions and how they fit within the framework of
the bank's risk management processes; the quality and extent of
information provided to the OCC; and consistency of the bank's
activities with OCC supervisory guidance.
We are reviewing the bank's management information systems,
committee minutes, audit reports, and conducting discussions examiners
to establish a detailed chronology of events surrounding the CIO
decision-making and the resulting losses. Our analysis will focus on
where breakdowns or failures occurred. This will include assessments of
senior management communication and monitoring of strategies; business
judgment and execution; the articulation of risk tolerance relative to
strategy; risk measurement (including models, limits, stress scenarios,
and changes to those tools during the period in question); flow of
information, proper authority, and approvals; and the appropriateness
and timeliness of particular actions.
As part of this second prong of our supervisory response, we are
also assessing relevant audit or examination findings and whether they
were addressed; how the risks associated with the strategy were
recognized and evaluated; whether there was an effective exchange of
views among the business unit and control groups; whether incentives
were properly aligned with desired behaviors; and whether the bank's
actions were consistent with OCC supervisory guidance and expectations.
Again, if corrective action is warranted, we will pursue and implement
appropriate informal and/or formal remedial measures.
Finally, a vital part of this second component of our supervisory
effort is identifying the lessons learned for improving the
effectiveness of our supervision. The areas that we will explore here
include whether the quality and extent of information available to OCC
examiners was sufficient to permit an understanding of the risk and
management processes in place to govern it. We will also determine
what, in retrospect, the OCC could have done differently, and how to
ensure that the risk management processes of this bank--and others--are
effective.
I should also note that the OCC is not drawing any conclusion about
whether the activities of JPMC's CIO would be subject to the Volcker
Rule. It is premature to reach any conclusion based upon the facts and
information as they currently exist.
VI. Conclusion
I appreciate the opportunity to appear before this Committee. While
my testimony reports significant progress on implementing the Dodd-
Frank Act and other reforms and shares insight into our ongoing efforts
to enhance supervision of community banks and large banks, I want to
stress my commitment to ensuring this process continues. The recent
events at JPMC also remind us of the need to continuously assess OCC's
supervisory processes. I look forward to providing additional
information to the Committee throughout my tenure as Comptroller and
continuing to share how we are meeting our commitment to strong,
effective, fair, and balanced supervision of the national banks and
Federal savings associations that we supervise.
______
PREPARED STATEMENT OF MARTIN J. GRUENBERG
Acting Chairman, Federal Deposit Insurance Corporation
June 6, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to testify today on the
Federal Deposit Insurance Corporation's efforts to enhance bank
supervision and reduce systemic risk. I will summarize the FDIC's
progress in implementing the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act), with a particular emphasis on the
FDIC's implementation of the Title II Orderly Liquidation Authority, as
well as how new rules promulgated under the Act affect community
banking institutions. Before concluding, I will also briefly address
the implications of the recent trading losses at JPMorgan Chase.
Implementation of the Dodd-Frank Act: Measures To Address Systemic Risk
The economic dislocations we have experienced in recent years,
which have far exceeded those associated with any recession since the
1930s, were the direct result of the financial crisis of 2007-08. The
reforms enacted under the Dodd-Frank Act were aimed at addressing the
root causes of the crisis. Foremost among these reforms were measures
to curb excessive risk-taking at large, complex banks and nonbank
financial companies, where the crisis began. Title I of the Dodd-Frank
Act includes new provisions that enhance prudential supervision and
capital requirements for systemically important financial institutions
(SIFIs), while Title II authorizes a new orderly liquidation authority
that significantly enhances the ability to resolve a failed SIFI
without contributing to additional financial market distress.
SIFI Resolution Authorities. The most important new FDIC
authorities under the Dodd-Frank Act are those that provide for
enhanced resolution planning and, if needed, the orderly resolution of
SIFIs. Prior to the recent crisis, the FDIC's receivership authorities
were limited to federally insured banks and thrift institutions. There
was no authority to place the holding company or affiliates of an
insured institution or any other nonbank financial company into an FDIC
receivership to avoid systemic consequences. The lack of this authority
severely constrained the ability of the Government to resolve a SIFI
and contributed to the excessive risk taking that led to the crisis.
Since passage of the Dodd-Frank Act, the FDIC has taken a number of
steps to carry out its new systemic resolution responsibilities. First,
the FDIC established a new Office of Complex Financial Institutions
(OCFI) to carry out three core functions:
monitor risk within and across these large, complex
financial firms from the standpoint of resolutions and risk to
the Deposit Insurance Fund;
conduct resolution planning and develop strategies to
respond to potential crises; and
coordinate with regulators overseas regarding the
significant challenges associated with cross-border resolution.
For the past year, the OCFI has been developing internal resolution
plans in order to be ready to resolve a failing systemic financial
company. These internal FDIC resolution plans, developed pursuant to
the Orderly Liquidation Authority provided under Title II of the Dodd-
Frank Act, apply many of the same powers that the FDIC has long used to
manage failed-bank receiverships to a failing SIFI. This internal
resolution planning work is the foundation of the FDIC's implementation
of its new resolution responsibilities under the Dodd-Frank Act.
The FDIC has largely completed the basic rulemaking necessary to
carry out its responsibilities under the Dodd-Frank Act. In July of
last year, the FDIC Board approved a final rule implementing the Title
II Orderly Liquidation Authority. This rulemaking addressed, among
other things, the priority of claims and the treatment of similarly
situated creditors. Last September, the FDIC Board adopted two rules
regarding resolution plans that systemically important financial
institutions themselves will be required to prepare--the so-called
``living wills.'' The first resolution plan rule, jointly issued with
the Federal Reserve Board, requires bank holding companies with total
consolidated assets of $50 billion or more, and certain nonbank
financial companies that the Financial Stability Oversight Council
(FSOC) designates as systemic, to develop, maintain, and periodically
submit resolution plans to regulators.
Complementing this joint rulemaking, the FDIC also issued another
rule requiring any FDIC-insured depository institution with assets over
$50 billion to develop, maintain, and periodically submit plans
outlining how the FDIC would resolve the institution through the
traditional resolution powers under the Federal Deposit Insurance Act.
These two resolution plan rulemakings are designed to work in tandem
and complement each other by covering the full range of business lines,
legal entities, and capital-structure combinations within a large
financial firm. Both of these resolution plan requirements will improve
efficiencies, risk management, and contingency planning at the
institutions themselves. Importantly, they will supplement the FDIC's
own resolution planning work with information that would help
facilitate an orderly resolution in the event of failure. With the
joint rule final, the FDIC and the Federal Reserve Board have started
the process of engaging with individual companies on the preparation of
their resolution plans. The first plans, for companies with nonbank
assets over $250 billion, are due in July.
Section 210 of the Dodd-Frank Act requires the FDIC to
``coordinate, to the maximum extent possible'' with appropriate foreign
regulatory authorities in the event of a resolution of a covered
financial company with cross-border operations. The FDIC has been
working diligently on both multilateral and bilateral bases with our
foreign counterparts in supervision and resolution to address these
crucial cross-border issues.
The FDIC has participated in the work of the Financial Stability
Board through its membership on the Resolution Steering Group, the
Cross-border Crisis Management Group and a number of technical working
groups. The FDIC also has cochaired the Basel Committee's Cross-border
Bank Resolution Group since its inception in 2007. Since the
internationally active SIFIs (termed Global- or G-SIFIs) present
complex international legal and operational issues, the FDIC is also
actively reaching out on a bilateral basis to the foreign supervisors
and resolution authorities with jurisdiction over the foreign
operations of key U.S. firms. The goal is to be prepared to address
issues regarding cross-border regulatory requirements and to gain an
in-depth understanding of cross-border resolution regimes and the
concerns that face our international counterparts in approaching the
resolution of these large international organizations. As we evaluate
the opportunities for cooperation in any future resolution, and the
ways that such cooperation will benefit creditors in all countries, we
are forging a more collaborative process as well as laying the
foundation for more reliable cooperation based on mutual interests in
national and global financial stability.
Although U.S. SIFIs have foreign operations in dozens of countries
around the world, those operations tend to be concentrated in a
relatively small number of key foreign jurisdictions, particularly the
United Kingdom (U.K.). While the challenges to cross-border resolution
are formidable, they may be more amenable than is commonly thought to
effective management through bilateral cooperation.
The focus of our bilateral discussions is to: (i) identify
impediments to orderly resolution that are unique to specific
jurisdictions and discuss how to mitigate such impediments through rule
changes or bilateral cooperation and (ii) examine possible resolution
strategies and practical issues related to implementation of such
strategies with respect to particular jurisdictions. This work entails
gaining a clear understanding of how U.S. and foreign laws governing
cross-border companies will interact in any crisis. Our initial work
with foreign authorities has been encouraging. In particular, the U.S.
financial regulatory agencies have made substantial progress with
authorities in the U.K. in understanding how possible U.S. resolution
structures might be treated under existing U.K. legal and policy
frameworks. We have engaged in in-depth examinations of potential
impediments to efficient resolutions and are, on a cooperative basis,
in the process of exploring methods of resolving them.
To facilitate bilateral discussions and cooperation, the FDIC is
negotiating the terms of memoranda of understanding pertaining to
resolutions with regulators in various countries. These memoranda of
understanding will provide a formal basis for information sharing and
cooperation relating to our resolution planning and implementation
functions under the legal framework of the Dodd-Frank Act.
Financial Stability Oversight Council (FSOC). The FSOC, chaired by
the Secretary of the Treasury and comprising all of the key Federal
financial regulatory bodies, was designed to fill the gaps in oversight
between existing regulatory jurisdictions and create common
accountability for identifying and constraining risks to the financial
system as a whole. Among other requirements, the Dodd-Frank Act directs
the FSOC to facilitate regulatory coordination and information sharing
among its members regarding policy development, rulemaking, supervisory
information, and reporting requirements. The FSOC is also responsible
for determining whether a nonbank financial company should be
supervised by the Federal Reserve Board and subject to prudential
standards, and for designating financial market utilities and payment,
clearing, or settlement activities that are, or are likely to become,
systemically important. On April 3, 2012, the FSOC unanimously approved
a final rule and interpretive guidance that details the process and
analytical framework for evaluating whether a nonbank financial company
should be subject to supervision by the Federal Reserve Board and be
subject to enhanced prudential standards (including the requirement to
prepare resolution plans). On May 22, 2012, the FSOC adopted procedures
governing the conduct of hearings in connection with proposed
determinations and other related actions under Titles I and VIII of the
Act. Additionally, on May 22, the FSOC voted to propose the preliminary
designation of an initial set of financial market utilities. After
those entities are provided with an opportunity for a hearing, the FSOC
will be asked to vote on the final designation of those entities.
The Volcker Rule. The Dodd-Frank Act requires the Securities and
Exchange Commission (SEC), the Commodities Futures Trading Commission
and the Federal banking agencies to adopt regulations generally
prohibiting proprietary trading and certain acquisitions of interest in
hedge funds or private equity funds.
Last November, the FDIC, jointly with the Federal Reserve Board,
the OCC, and the SEC, published a notice of proposed rulemaking (NPR)
requesting public comment on a proposed regulation implementing the
Volcker Rule requirements of the Dodd-Frank Act. In December, the
comment period was extended to allow interested persons more time to
analyze the issues and prepare their comments, and to facilitate
coordination of the rulemaking among the responsible agencies.
The proposed rule also requires banking entities with significant
covered trading activities to furnish periodic reports with
quantitative measurements designed to help differentiate permitted
market-making-related activities from prohibited proprietary trading.
Under the proposed rule these requirements contain important exclusions
for banking organizations with trading assets and liabilities less than
$1 billion, and reduced reporting requirements for organizations with
trading assets and liabilities of less than $5 billion. These
thresholds are designed to reduce the burden on smaller, less complex
banking entities, which generally engage in limited market-making and
other trading activities.
The Agencies have requested comments on whether the proposed rule
represents a balanced and effective approach in implementing the
Volcker provision or whether alternative approaches exist that would
provide greater benefits or implement the statutory requirements with
fewer costs. The FDIC is committed to developing a final rule that
meets the objectives of the statute while preserving the ability of
banking entities to perform important underwriting and market-making
functions, including the ability to effectively carry out these
functions in less-liquid markets. Most community banks do not engage in
trading activities that would be subject to the proposed rule.
Implementation of the Dodd-Frank Act: Community Banks
In addition to the provisions relevant to systemic risk, the Dodd-
Frank Act also contains a number of other provisions that may have a
more direct effect on community institutions. For example, the Dodd-
Frank Act made changes to the FDIC's deposit insurance program, which
were implemented soon after enactment, that generally work to the
benefit of community institutions. The first of these was the rule to
implement the Act's provision to permanently increase the insurance
coverage limit to $250,000, the level that had already been introduced
on a temporary basis during the crisis. The FDIC has also implemented
the Dodd-Frank Act requirement to redefine the base used for deposit
insurance assessments as average consolidated total assets minus
average tangible equity. This change in the assessment base shifted
some of the overall assessment burden from community banks to the
largest institutions, which rely less on domestic deposits for their
funding than do smaller institutions--but did so without affecting the
overall amount of assessment revenue collected. The result has been a
sharing of the assessment burden that better reflects each group's
share of industry assets. When this provision was implemented in the
second quarter of last year, aggregate premiums paid by institutions
with less than $10 billion in assets declined by approximately 33
percent, primarily as a result of the base change.
As of March 31, 2012, the Deposit Insurance Fund (DIF) reserve
ratio stood at 0.22 percent of estimated insured deposits, up from -
0.02 percent a year earlier. The Dodd-Frank Act raised the minimum
reserve ratio for the DIF from 1.15 percent to 1.35 percent, and
requires that the reserve ratio reach 1.35 percent by September 30,
2020. The FDIC is currently operating under a DIF Restoration Plan that
is designed to meet this deadline. However, the Dodd-Frank Act also
specifically requires the FDIC to provide an offset to institutions
with total consolidated assets of less than $10 billion to relieve them
of the extra cost of increasing the reserve ratio from 1.15 percent to
1.35 percent.
A number of community bankers have expressed specific concerns
about certain Dodd-Frank Act requirements that they believe would
particularly impact them. For example, a number of community bankers
have expressed concerns about the provisions of Title XIV that deal
with real estate appraisal activities. The Federal Reserve Board
implemented these provisions by an interim rule in late 2010 that
prohibits coercion or conflicts of interest that could compromise the
independent judgment of appraisers and prohibits the extension of
credit if coercion or conflicts of interest are suspected to have
influenced an appraisal. The banking agencies followed by issuing joint
guidance describing supervisory expectations for appraisals under the
new rules. The guidelines clarify standards for the appropriate use of
analytical methods, the criteria for selecting appraisers, and the
independence of the appraisal process. Under the guidelines,
institutions also are responsible for monitoring and periodically
updating valuations of collateral for existing real estate loans and
for transactions, such as modifications and workouts.
The banking agencies have received a number of formal and informal
communications from bankers citing concerns about the new appraisal
guidelines. Of particular concern are the requirements to update
valuations for existing real estate loans. This is deemed a best
practice for evaluating and monitoring the risk of loans. However, the
agencies clarified in the guidance that working with the borrower,
particularly as the recovery takes hold, is encouraged. To that end, if
no new funds are advanced in a modification, a formal appraisal is not
required.
The agencies are still in the process of writing proposed rules for
higher risk mortgages and proposed rules for automated loan valuations
and registration requirements for the appraisal management companies.
The agencies are aware of the potential impact these rulemakings could
have on the industry and have met with small business representatives
and other industry segments in advance of writing the rules to hear
their concerns firsthand. The agencies strongly encourage the public to
comment on the proposed rules when they are issued for comment.
Another area of concern for community bankers is the new mortgage
escrow requirement. The wave of subprime and nontraditional mortgage
lending that led to the crisis frequently included loans where escrow
accounts for property taxes and insurance were not maintained. The
failure to set aside funds in escrow has been cited as contributing to
the financial distress of borrowers when their loans became delinquent.
Accordingly, the Dodd-Frank Act directed the Federal Reserve Board to
issue new proposed rules that require the establishment of escrow
accounts for many closed-end first and second mortgage loans, expand
the minimum mandatory period for escrow accounts, and establish new
disclosure requirements in this area.
While the new rule directly addresses one of the structural
weaknesses in the risky loans that led to the crisis, community bankers
have expressed concerns about applying these same requirements to what
they say are lower-risk mortgage loans that they hold in portfolio. In
many cases, bankers say they hold too few such loans or loans of such
small size that the fixed cost of setting up an escrow account would be
prohibitive--and they would cease originating such loans for their
customers. We have shared the concerns we have heard from community
bankers with the Consumer Financial Protection Bureau and they are
expected to issue a final rule on this topic later this year.
FDIC Community Banking Initiatives
During a period with significant economic challenges and many
regulatory changes, it is natural for community bankers to reflect on
their future role in the financial marketplace. As noted above, many
community bankers have expressed concerns that the Dodd-Frank Act
reforms will adversely affect their ability to compete with larger
banks and nonbank competitors. The FDIC takes these concerns seriously.
As the lead Federal regulator for the majority of community banks in
the United States and the insurer of all, it is incumbent on us to
better understand the role of community banks in our economy and the
particular challenges they face in the financial marketplace.
This is why the FDIC is undertaking a series of initiatives related
to the future of community banks. We began this effort with a
conference at our Arlington, Virginia training facility in February,
where we received a great deal of useful input on the regulatory and
competitive challenges currently facing the industry. We are also in
the process of holding a series of roundtables with groups of community
bankers in each of the FDIC's six regions around the country. At these
roundtables, I am joined by the FDIC's senior executives for
supervision so that we can hear first-hand about the concerns of
bankers and what the FDIC can do to respond to those concerns. The
roundtables are proving to be productive and frank discussions. In my
experience, community bankers are not shy about expressing their views,
and we appreciate receiving their ideas and input.
Even with all the attention community banking issues have received
in recent years, there remains a need for more thoughtful and careful
research and analysis about the role that community banks play in the
U.S. financial system. As part of our initiative, the FDIC's Division
of Insurance and Research also is undertaking a comprehensive review of
the evolution of community banking in the United States over the past
25 years. Our hope is that this study will identify the key challenges
facing community banks as well as stories of successful community bank
business models and will provide an analysis that may be useful for
community banks going forward.
Additionally, I have asked the Directors of the FDIC's Division of
Risk Management Supervision and Division of Depositor and Consumer
Protection to review the examination process for both risk management
and compliance supervision, as well as to review how we promulgate and
release rulemakings and guidance, to see if we can improve our
processes and communications in ways that benefit community banks,
while maintaining our supervisory standards.
Amid the challenging economic conditions of the past few years, the
FDIC's examination program has continued to strive for a balanced
approach. During each bank examination, our supervisory staff conducts
a fact-based review of an institution's financial risk, the quality of
its assets, and conformance with bank regulations. Care is taken to
ensure national consistency. We make sure that examiners follow
prescribed procedures and FDIC policy through our national training
program and commissioning process, through internal quality reviews,
and with ongoing communication at every level of our supervision staff.
In addition, we also strive to ensure that our examiners understand
and follow the FDIC's policies with regard to lending to creditworthy
borrowers. The FDIC has adopted supervisory policies and issued several
directives that encourage the institutions to lend to creditworthy
borrowers. We recognize that safe and sound banking is not an end in
itself but a means to an end, which is to ensure that FDIC-insured
institutions can be consistent sources of credit for our economy across
the business cycle.
Trading Losses at JPMorgan Chase
The recent losses at JPMorgan Chase revealed certain risks that
reside within large and complex financial institutions. They also
highlighted the significance of effective risk controls and governance
at these institutions. As the deposit insurer and backup supervisor of
JPMorgan Chase, the FDIC staff work through the primary Federal
regulators to obtain information necessary to monitor the risk within
the institution. The FDIC is currently working with JPMorgan Chase's
primary Federal regulators, the OCC and the Federal Reserve System, as
well as the institution itself, to investigate both the circumstances
that led to the losses and the institution's ongoing efforts to manage
the risks at the firm. Following this review, we expect to work with
the primary regulators to address inadequate risk management practices
that are identified.
Conclusion
Significant progress has been made in implementing the financial
reforms authorized by the Dodd-Frank Act. The FDIC has completed the
core rulemakings for carrying out its lead responsibilities under the
Act regarding deposit insurance and systemic resolution.
Successful implementation of the Act will provide a foundation for
a financial system that is more stable and less susceptible to crises,
and a regulatory system that is better able to respond to future
crises.
______
PREPARED STATEMENT OF RICHARD CORDRAY
Director, Consumer Financial Protection Bureau
June 6, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to testify today as part of
this panel of my colleagues. As the Director of the Consumer Financial
Protection Bureau, I am committed to being accountable to you for how
we carry out the laws that Congress enacted, and we are always happy to
have the chance to discuss our work with you. This is the 18th time
that the Bureau has testified before either the House or the Senate,
and I am pleased to be here with you again today. My testimony will
focus on the areas that you specified in the letter inviting me to
testify at this hearing.
To begin with, you asked about our Bank Supervision program. Since
certain supervisory powers were transferred to us in July of 2011, and
even before that time, we have been focused on recruiting and hiring
the best team we could find to carry out our role in supervising
financial institutions with a singular focus on consumer protection. We
are blessed with great talent: Steve Antonakes, the former
Superintendent of Banks in Massachusetts, heads up our Bank Supervision
team; Peggy Twohig, formerly the Associate Director of the Division of
Financial Practices at the FTC, heads up our Nonbank Supervision team.
Our examiners evaluate products, services, policies, and practices to
ensure compliance with Federal consumer financial laws, and to address
any harm to consumers that may be resulting from violations of those
laws. If a company is not complying with the law, we may seek
corrective actions to strengthen its programs and processes, redress
violations, and remediate any harm consumers may have suffered.
We have met with many supervised institutions to obtain a better
understanding of how they operate and how they approach compliance. We
have been engaged with our prudential and State regulator partners to
ensure open lines of communication and information sharing. As the law
contemplates, we have been coordinating the logistics of simultaneous
examinations with our fellow agencies to reduce compliance burden for
financial institutions. The Bureau has recruited and hired examiners
all across the country, reporting through our four regional offices--
covering the Northeast, Southeast, Midwest, and West. We have commenced
examination work in all four regions. For the largest and most complex
banks and credit unions in the country, the Bureau is implementing a
year-round supervision program customized to address the consumer
protection risk profile of the organization. For other companies that
we supervise, we are conducting periodic examinations and other reviews
as appropriate.
To ensure that our work is transparent, we published our
Examination Manual, along with other examination procedures covering
particular products and services. In order to implement a consistent
approach, CFPB examiners examine both banks and nonbanks, and use the
same examination procedures for the same products and services. That
means the mortgage servicing procedures that we published last October
cover both bank and nonbank mortgage servicers, and the mortgage
origination procedures we published in January guide our examiners
reviewing bank and nonbank originators. Likewise, our short-term,
small-dollar lending procedures will be used to examine payday loans
made by nonbanks and deposit advance products offered by banks, because
these products have many of the same characteristics. As such, they
should be reviewed using a consistent set of procedures. Consistency,
however, does not dictate complete uniformity in supervisory
expectations. Large, complex entities may well have different
compliance oversight and management systems than much smaller entities
or those offering a more limited number of products and services.
Our responsibility under the law, which is unique among the Federal
regulators, is to accomplish evenhanded and reasonable oversight of
both banks and nonbank institutions that compete in the consumer
finance markets. Last July, we assumed authority to supervise
depository institutions with assets of more than $10 billion, and their
affiliates, for compliance with Federal consumer financial laws. In
January of this year, with the appointment of a Director, we rolled out
our nonbank supervision program, starting with nonbank mortgage
originators, mortgage servicers, and payday lenders. There are tens of
thousands of nonbank firms, and their products affect virtually every
American. For example, according to studies and industry sources,
nonbank lenders originated almost 2 million mortgages in 2010, nearly
20 million consumers used payday loans, over 30 million people are
being pursued by debt collectors, and roughly 200 million Americans
rely on credit reporting agencies to report their credit histories
accurately.
When considering whether and how to supervise particular nonbanks,
the Dodd-Frank Act requires the CFPB to consider several relevant
factors, including the nonbank's volume of business, the risks to
consumers created by the provision of products and services, and the
extent of State oversight. Through our oversight, we are working to
level the playing field and make sure these businesses are being held
accountable for their actions. We are now considering finalizing a
regulation to allow us to examine the larger participants in the debt
collection and credit reporting industries, and others will follow as
we develop our Nonbank Supervision program. A market in which all
competing firms play by the same rules will be of special benefit to
community banks, which may operate in similar product markets as
nonbank entities.
On Monday, the CFPB and the prudential regulators released a
Memorandum of Understanding that clarifies how the agencies will
coordinate their supervisory activities, consistent with the Dodd-Frank
Act. This MOU establishes arrangements for coordination and
cooperation, to minimize unnecessary regulatory burden, avoid
unnecessary duplication of effort, and decrease the risk of conflicting
supervisory directives.
We welcome feedback on our supervision program from each of you,
and from consumer groups, industry participants, and members of the
public. We have an e-mail address on our Web site,
CFPB_Supervision@CFPB.gov, where anyone can submit comments on our exam
procedures.
Second, among the topics you identified to be addressed at this
hearing is my statutory role on the Financial Stability Oversight
Council. As you know, in the Dodd-Frank Act the Congress designated the
Director of the CFPB to serve as one of the 10 voting members of the
FSOC. The U.S. consumer finance marketplace represents over $20
trillion in loans and deposits, and hence is central to the stability
of domestic and global capital markets. We are pleased to participate
in that capacity, and to bring a consumer-facing focus to our work on
that body.
Because we share the responsibility of regulating financial
institutions with many of our fellow members of the FSOC, our mutual
participation is helpful to our efforts to coordinate with one another
so as to reduce overall regulatory burden and to maintain a
collaborative approach to the work we do together. Frequent and
sustained interactions among fellow regulators are essential for each
of us to fulfill our obligations and improve the effectiveness of our
joint oversight of the financial system. The work we are doing together
on the FSOC also helps lift our perspective out of the day-to-day work
each of us is doing so as to develop a broader vantage point on the
various factors that pose larger risks to the entire financial system
taken in the aggregate. I have found this to be valuable as we work
together to build a sound and vibrant financial system that protects
consumers, supports responsible providers, and helps safeguard the
broader economy against systemic risk.
Third, you also indicated that my testimony should address how our
statutory obligations affect our regulation of community banks. As you
know, the Consumer Bureau generally does not examine any banks with
less than $10 billion in assets and does not enforce the law against
any such banks, which remain subject to their existing prudential
regulator in those respects. We do have the authority to adopt
regulations that can affect community banks as well as larger financial
institutions, and in this regard we understand it is important for us
to coordinate closely with my colleagues on this panel, who will
continue to examine and enforce various regulations that we formulate.
For this reason, we are creating a consultative rulemaking process with
the other agencies to ensure that we develop rules that are consistent
with the objectives and obligations of the prudential regulators and
other agencies. We have already convened meetings to work cooperatively
on issues like overdraft protection and mortgage servicing, and we are
consulting with them as we devise the various mandated rules on the
mortgage market that Congress has directed us to complete by early next
year.
In this respect, it is critical to keep in mind that Congress
created the Consumer Financial Protection Bureau in response to the
greatest financial crisis since the Great Depression. The United States
learned--or relearned--a hard lesson in that crisis: unregulated or
poorly regulated markets destabilize the economy and undermine the
general welfare. Over-regulation can indeed stifle entrepreneurship,
but under-regulation can also lead to terribly antibusiness results.
The most mortal threat to many banks, thrifts, and credit unions in our
lifetime was dramatically posed by the extreme credit crunch and
freezing-up of the financial markets in 2008. In their wake, the
ensuing financial meltdown and the enduring consequences of the deep
recession continue to dog our economy, particularly the housing market,
now 4 years later and counting.
What will be very helpful to community banks around the country is
our new mandate to oversee and regularize the practices of nonbank
financial institutions that often compete in the same markets. We hear
much favorable comment from the community banks about this important
task. We saw with the meltdown in the mortgage market how a partial and
incomplete regulatory scheme was doomed to fail. Banks, thrifts, and
credit unions were subject to explicit oversight, whereas many other
mortgage market participants, such as lenders and brokers and
originators, were held to little or no standards of accountability at
all. The competitive pressure fostered by this regime stimulated a race
to the bottom to capture market share. Regulatory arbitrage through
charter choice placed further pressures on the system that impeded its
effectiveness. The result was a kind of Gresham's Law for financial
regulation: the bad practices drove out the good.
I have heard stories from many community bankers who refused to
make ill-considered loans to prospective customers, only to see those
people go down the street and get that very loan from someone else who
did not uphold the same standards. That other lender often required no
documentation of income or assets, engaged in no form of recognizable
underwriting, but still managed to sell those bad loans into the
secondary market. There they were bundled into securities that
eventually crashed the entire financial system and with it the broader
economy.
Consistent application of consumer financial laws will promote
safety and soundness of supervised entities. Over the next year, the
Bureau is required to adopt new mortgage rules that protect consumers.
These include a new statutory requirement that lenders make a good
faith and reasonable determination that borrowers have the ability to
repay a residential mortgage loan. Similarly, ensuring that consumers
receive required disclosures to help them understand financial products
and make informed decisions will help prevent some of the problems we
saw in the run-up to the crisis. Other rules are intended to return to
sound underwriting standards and sound customer service--the kind of
practices that are traditional at our good community banks.
As we develop these initiatives, we know that one size does not fit
all. Where it makes sense to treat smaller institutions differently
from larger institutions, we have pledged to consider doing so. We also
want our regulations to be more accessible, and to find ways to work
with institutions to implement regulations successfully and in ways
that will help minimize the burdens of properly complying with the law.
To ensure that our rulemaking process is transparent and that we have
the benefit of informed comments from a wide variety of stakeholders
and the public, the Bureau's regulatory agenda and proposed rules are
published on our Web site at www.ConsumerFinance.gov/regulation. We are
implementing small business review panels on several of our mortgage
rules, and find the input from small providers to be helpful in
calibrating our proposals.
As we think about systemic risks to the financial system, I would
note that the financial world that today's consumers are navigating has
become more complex in recent years. The failure to navigate that world
successfully can lead to poor choices being made, especially about
life-changing decisions that people may confront only once or twice in
their lifetimes. When decisions like how to finance an education or a
home purchase do not work out well, that can spell disaster for entire
families and alter the trajectory of people's opportunities. When this
is happening on a large scale, the resulting dislocation can become a
trigger for instability, given the trillions of dollars that are
represented by loans and deposits in consumer finance markets.
Clear and accurate disclosures benefit the public and the markets
by driving competition based on informed customer choice. We have
launched several ``Know Before You Owe'' projects, all of which are
pushing to make costs and risks clear up front for consumers. Our
signature ``Know Before You Owe'' mortgage project is focused on
simplifying and streamlining the conflicting mortgage forms that
reflected no functional need or reality other than the fact that
multiple Government agencies were involved. These forms have been
confusing homebuyers and burdening industry for many years--an all-too-
common occurrence in the realm of consumer finance--and we are taking
head-on the responsibility to effect meaningful change in this area.
We are eager to explore alternatives to compulsory regulations
where we can make alternatives work. We are collaborating with the
industry on a new approach to credit card disclosures. We released a
prototype credit card contract that is significantly shorter and
clearer than current credit card agreements. We tried to keep the
prototype simple and written in plain language to make it accessible to
as many consumers as possible. This prototype is now being piloted at
the Pentagon Federal Credit Union, and we are spurring similar efforts
by other leading financial institutions. More and more of them appear
to be recognizing the value for their customers in consumer-friendly
information that is more accessible. We wholeheartedly agree.
By working closely with the Department of Education, we have also
created a ``Financial Aid Shopping Sheet.'' The Shopping Sheet presents
young people and their families with a uniform, easy-to-understand
explanation of the total cost of post-secondary education and the
available options for financing it. We followed that by launching the
``Financial Aid Comparison Shopper''. The Comparison Shopper builds on
the Shopping Sheet by helping students to compare--in an online, side-
by-side format--information about the cost of different schools and how
their decisions will affect the level of debt they can expect to incur.
We see financial education and disclosure as a way to help close
the gap between consumers' financial capability and where they need to
be to navigate consumer finance markets successfully. We can close that
gap in two distinct ways: by striving to elevate people's capacity to
handle personal finance matters, and by reducing unnecessary complexity
in the information provided in that marketplace. And we are actively
pursuing both approaches. The work we do in our specialty offices
prescribed by Congress, such as our Office of Servicemember Affairs,
Office of Older Americans, and Student Loan Ombudsman, also is crucial
to understanding and meeting the particular needs of consumers who
deserve protection across the country and--as pertains to
servicemembers--around the globe.
When I became Director of the Consumer Bureau at the beginning of
the year, I barely knew my colleagues on this panel. Now, 5 months
later, from our work together in various roles on various bodies such
as FSOC, I have come to know and respect them all. Our team is glad to
be working with their teams--and with the Members of this Committee--to
strengthen and support a sound and vibrant financial system that serves
both the interests of consumers and the long-term foundations of the
American economy. I am happy to answer any questions you may have.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM DANIEL K. TARULLO
Q.1. During the June 6th hearing, Mr. Gruenberg agreed that
``historically, including to the present day, the biggest risk
of banking is the lending activity that is inherent to the
banking process.''
In testimony before the Subcommittee on Financial
Institutions and Consumer Protection on May 9th, the former
Chief Economist of the Senate Committee on Banking, Housing,
and Urban Affairs stated:
In a remarkably understated 2007 annual inspection
report on Citigroup, the Federal Reserve Bank of New
York observed that ``[m]anagement did not properly
identify and assess its subprime risk in the CDO
trading books, leading to significant losses. Serious
deficiencies in risk management and controls were
identified in the management of Super Senior CDO
positions and other subprime-related traded credit
products.'' By the end of 2008 Citigroup had written
off $38.8 billion related to these positions and to ABS
and CDO securities it held in anticipation of
constructing additional CDOs. [Testimony of Marc
Jarsulic, Chief Economist, Better Markets, Inc., before
the Senate Committee on Banking Housing and Urban
Affairs Subcommittee on Financial Institutions and
Consumer Protection, ``Is Simpler Better? Limiting
Federal Support for Financial Institutions'', May 9,
2012.]
According to accounts of the hearings held by the Financial
Crisis Inquiry Commission, two witnesses agreed that CDOs were
responsible for Citigroup's financial difficulties:
[Former Citigroup chief executive Charles] Prince
ultimately blamed much of Citi's problems on CDOs,
which he said were complex and entirely misunderstood.
He said the company, its risk officers, regulators and
credit rating agencies believed CDOs were low-risk
activities. As it turned out, they resulted in $30
billion worth of losses . . .
[Former Comptroller of the Currency John] Dugan, too,
put much of the blame on CDOs, partly as a way of
defending his own agency. He said the bank, which the
Office of the Comptroller of the Currency oversaw, did
not damage the holding company, while Citi's securities
broker-dealers, which managed the CDOs and were
overseen by the Securities and Exchange Commission,
were at fault.
``The overwhelming majority of Citi's mortgage problems
did not arise from mortgages originated by Citibank,''
Dugan said. ``Instead, the huge mortgage losses arose
primarily from the collateralized debt obligations
structured by Citigroup's securities broker-dealer with
mortgages purchased from third parties.''--Cheyenne
Hopkins, ``No One Was Sleeping as Citi Slipped'', Am.
Banker, Apr. 8, 2010.
Do you agree with the New York Fed, the former Comptroller
of the Currency, the former Chief Economist of the Senate
Banking Committee, and the former CEO of Citigroup that CDOs
were a substantial cause of Citigroup's financial difficulties
in 2008, resulting in significant support from the Federal
Government, including capital injections from the Treasury
Department, debt guarantees from the FDIC, and loans from the
Federal Reserve?
A.1. Although information regarding examinations of banks and
bank holding companies is protected by law, testimony before
the Senate Banking Committee, as you note, disclosed that
management of Citigroup did not properly identify, monitor, and
assess the risk of certain CDO positions in its portfolio. The
SEC reported that by September 2007 Citigroup amassed a
position in asset-backed security CDOs in excess of $50
billion. Between the third quarter of 2007 and the first
quarter of 2009, Citigroup reported losses on ``subprime
related direct exposures'' of approximately $35 billion, the
majority of which was attributed to this CDO position.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM DANIEL K. TARULLO
Q.1. At what point in the process of JPMorgan making this trade
and the public reporting of the losses did the Fed examiners
become aware of this trade?
A.1. See response to Question 2.
Q.2. Precisely when were Fed regulators aware of this trade?
A.2. JPMorgan Chase publicly announced in May 2012 that it had
suffered significant trading losses on credit derivative
positions entered into by its Chief Investment Office (CIO).
The CIO is an organizational unit of JPMorgan Chase, N.A., that
carries out a variety of asset-liability management and other
activities. The activities of the CIO are managed and
controlled out of JPMorgan Chase's New York headquarters, with
a substantial portion of the CIO's activities conducted through
the bank's London branch and other overseas branches or
offices.
The Federal Reserve, in its capacity as JPMorgan Chase's
holding company supervisor, first discussed the losses on the
trades in the CIO with JPMorgan Chase's senior management in
the first half of April 2012.
Q.3. How many trades does JPMorgan have of this magnitude and
what are the possibilities, given Europe and a softening
domestic economy, that a number of these bets go bad at the
same time?
A.3. JPMorgan Chase has admitted that it did not have
appropriate risk management processes in place to monitor the
risk of its trading activities. As indicated in the response to
Question 4, the Federal Reserve is working with JPMorgan Chase
and the OCC to address these risk management failures.
Confidential information regarding specific positions held by a
bank holding company and examinations of bank holding
companies, such as JPMorgan Chase, are protected by law.
Q.4. Does the Fed examine each of these trades as they occur?
If not, how does the OCC monitor the risk that the bank it
supervises is undertaking?
A.4. The trading losses suffered by the CIO arose out of a
complex synthetic credit portfolio that the CIO had developed
over time, which was primarily composed of both long and short
credit default swap positions on a number of different credit
assets and indices. Trading in this synthetic credit portfolio
was executed through the London branch of JPMorgan Chase's
subsidiary national bank. JPMorgan Chase has stated that,
because of a combination of risk-management failures and
execution errors, and the complexity and illiquidity of the
positions involved, the CIO's synthetic credit portfolio gave
rise to significant trading risks that resulted in the losses.
The Federal Reserve--in its capacity as consolidated
supervisor of the bank holding company--is working with the OCC
to review the firm's response and remedial actions. In
particular, the Federal Reserve has been assisting in the
oversight of JPMorgan's efforts to manage and de-risk the
portfolio in question. As this process proceeds, the Federal
Reserve anticipates that it would also work with the OCC and
FDIC to identify the changes in risk measurement, management
and governance that will be necessary to improve risk-control
practices surrounding the firm's trading activities and to
address trading strategies that led to these losses.
In addition, the Federal Reserve has been looking at other
parts of the holding company to determine if governance, risk
management and control weaknesses--similar to those exposed by
this incident--are present elsewhere. While we have, to date,
found no evidence that they are, this review is not yet
complete.
Q.5. If regulators are focused on regulating risk management
practices, and not focused on individual trades regardless of
size, would the regulators and the banking system would be
safer and better off if the larger banks were required to hold
more capital than regional or community banks?
A.5. The trading losses at JPMorgan Chase have served to remind
us of the fundamental importance of capital regulation in our
prudential oversight of the largest banking firms to ensure
that capital is available to absorb all kinds of losses. For
precisely this reason, the Federal Reserve has been a strong
advocate for higher and better quality capital at the largest
and most complex banking organizations. Crucially, the Federal
Reserve through the Supervisory Capital Assessment Program,
Comprehensive Capital Analysis and Review (CCAR), and its
supervisory efforts has encouraged the large banking firms to
increase their tier 1 common ratio, which compares high-quality
capital to risk-weighted assets, by more than double during the
past 3 years to a weighted average of 10.9 percent from 5.4
percent in the first quarter of 2009. The Federal Reserve has
also worked both nationally and internationally to improve and
increase capital positions at large banking firms. In the
United States, the Federal Reserve has worked with the other
Federal banking regulators to take important steps to
strengthen bank capital regulation, especially for the largest,
most complex banks. Over the past several months, the Federal
Reserve, OCC, and FDIC have acted jointly to finalize U.S.
implementation of the so-called Basel 2.5 reforms that will
materially strengthen the market risk capital requirements of
Basel II. We have also requested public comment on changes to
the U.S. regulatory capital rules to implement the Basel III
reforms and the capital requirements in the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act). The
proposed changes would improve the quality and quantity of
regulatory capital held at our Nation's banking organizations.
Importantly, many of these regulatory reforms specifically
address and strengthen the capital requirements applicable to
trading activities and positions, including complex
derivatives.
The Federal Reserve has also advocated internationally for
capital surcharges on the world's largest, most interconnected
banking organizations based on their global systemic
importance. Last year, an international agreement was reached
on a framework for such surcharges, to be implemented over a
2016-19 transition period. This initiative is consistent with
the Federal Reserve's obligation under section 165 of the Dodd-
Frank Act, 12 U.S.C. 5365, to impose more stringent capital
standards on systemically important financial institutions,
including the requirement that these additional standards be
graduated based on the systemic footprint of the institution.
In December 2011, the Board issued a proposal to implement
section 165, including enhanced capital requirements for large
bank holding companies, such as JPMorgan Chase, that would
require these bank holding companies to meet higher capital
requirements than apply to smaller banking organizations. See
77 Federal Register 592 (January 5, 2012).
Q.6. Dodd Frank very clearly limits the potential that
commercial companies could somehow become regulated like banks.
One of the ways it does this is achieved through an amendment
that I and Senator Pryor offered, which clearly limits the
definition of ``financial activities'' to those things listed
under Section 4(k) of the Bank Holding Company Act. However the
Fed has proposed that it can ignore the definition contained in
4(k) and create a separate list of ``financial activities'' for
purposes of Dodd Frank. That is clearly contrary to both the
plain language and the intent of our amendment.
A.6. See response to Question 9.
Q.7. As you know section 113 of Dodd-Frank gives the FSOC the
authority to designate a company that is intentionally
structured to avoid the 85 percent test, and 167 of Dodd-Frank
allows the Fed to regulate only a separately set up financial
company of an otherwise validly designated NBFC. Neither
provision gives the Fed the ability to create its own list.
A.7. See response to Question 9.
Q.8. Can you tell me why the Federal Reserve thinks it can
ignore the law in this area, and put commercial companies that
were not involved in the financial crisis at risk?
A.8. See response to Question 9.
Q.9. What is the intent of the Federal Reserve's rulemaking in
this area if the intent isn't to circumvent the Vitter-Pryor
amendment to Dodd-Frank?
A.9. Questions 6 through 9 address the provisions of the Dodd-
Frank Act that define the type of firm that is eligible to be
designated by the Financial Stability Oversight Council for
enhanced supervision by the Federal Reserve where the Council
finds that the firm poses a threat to the financial stability
of the United States. These provisions apply only to firms that
derive 85 percent or more of their annual gross revenues from
financial activities or where 85 percent or more of the firm's
consolidated assets are related to financial activities. \1\ As
you note, for purposes of this provision, financial activities
are defined by reference to section 4(k) of the Bank Holding
Company Act (BHC Act). \2\
---------------------------------------------------------------------------
\1\ Section 102(a)(6) of the Dodd-Frank Act; 12 U.S.C.
5311(a)(6).
\2\ Id.
---------------------------------------------------------------------------
In April 2012, the Board invited public comment on proposed
rules implementing these provisions (April 2012 proposal). The
proposal would adopt the list of financial activities created
under section 4(k) of the BHC Act. The April 2012 proposal also
noted that the list of financial activities published by the
Federal Reserve in its Regulation Y incorporates various
conditions that the Board has imposed on bank holding companies
to ensure that bank holding companies that engage in these
financial activities do so in a safe and sound manner. Many of
these conditions were imposed so that a bank holding company's
financial activities did not threaten the safety and soundness
of its subsidiary insured depository institution. Other
conditions were imposed by the Board because they were required
by other provisions of law, such as the Glass-Steagall Act. In
each of these cases, the condition was distinct from the
definition of the activity itself or the nature of the activity
as financial. The April 2012 proposal sought public comment on
whether any of the conditions were essential to the definition
of an activity as financial.
We appreciate your views, which we will take into
consideration in formulating our final rule. We will place your
letter in the public comment file for this proposed rule.
------
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM THOMAS J. CURRY
Q.1. Mr. Curry, in response to my question during the hearing
about the risk management of JPMorgan Chase & Co. (JPMorgan),
you stated that the Office of the Comptroller of the Currency
(OCC) is reviewing ``what exactly transpired with the trading
operation within the CIO's office, and . . . looking to make
sure that there were appropriate limits and controls on those
activities in that area and how they compared to other areas
within the organization.'' Two weeks later, you stated that
``we do believe, as a preliminary matter, that there are
apparent serious risk management weaknesses or failures at the
bank. We're attempting . . . to continue to examine the root
causes for those failures and to determine whether or not there
are other weaknesses in the bank besides the CIO.''
When do you expect to complete your review? Do you have any
further preliminary conclusions on your review of the bank's
risk management? What gaps have you identified as supervisors?
Please provide additional detail about what you meant by
``serious risk management weaknesses or failures at the bank.''
A.1. Our examination process is well advanced and we expect to
reach conclusions and communicate our findings to bank
management before the end of the third quarter. Our work will
also consider whether any additional remediation is warranted.
At this time our preliminary conclusions regarding the
weaknesses or failures that have been identified are consistent
with the findings and principal conclusions of the bank's
internal task force. In mid-July, 2012 these determinations
were publicly communicated:
The core issue was that CIO was not subjected to
the same level of scrutiny as client facing businesses,
causing a lack of effective challenge by senior
management and the board.
CIO judgment, execution, and escalation in 1Q12
were poor.
The level of scrutiny did not evolve commensurate
with the increasing complexity of CIO activities.
CIO risk management was ineffective in dealing with
the synthetic credit portfolio.
Risk limits for CIO were not sufficiently granular.
Approval and implementation of CIO synthetic credit
VaR model were inadequate.
The company is implementing corrective actions. An entirely
new CIO senior management group is in place and is undertaking
an end-to-end review of all CIO processes and practices. Firm-
wide risk management and processes are also being evaluated and
new committees and processes are being put in place.
Q.2. How many staff members are ordinarily involved in
supervising JPMorgan, especially with regard to the company's
risk management, and how many additional staff have you
dedicated to this review?
A.2. The OCC's supervisory team includes approximately 65 full
time on-site examiners who are responsible for reviewing nearly
all facets of the bank's activities and operations, including
commercial and retail credit, mortgage banking, trading and
other capital markets activities, asset liability management,
bank technology and other aspects of operational risk, audit
and internal controls, and compliance with the Bank Secrecy
Act, antimoney laundering laws, and the Community Reinvestment
Act. These on-site examiners are supported by additional
subject matter experts from across the OCC. All these examiners
are essentially involved in supervising the risk management
practices of JPMorgan as risk management systems are in place
throughout the bank's operations to identify, measure, monitor,
and control risk.
We have one dedicated examiner who directly oversees the
CIO with support of a team of capital markets specialists
representing 8 FTEs to review specific capital markets areas
depending on the topic. We have added staff on assignment from
our London team, our Risk Analysis Division (quantitative
experts), and received assistance from our Office of Chief
Accountant.
Q.3. In testimony, you stated that ``in hindsight, if the
reporting were more robust or granular, we believe we may have
had an inkling of the size and potential complexity and risk of
the position.'' You also stated before this Committee, that the
``concentrated nature of the trading and the illiquidity of
[the trading] are red flags that are clearly apparent now.''
What requirements or guidelines does the OCC have for
granularity of reporting, and what does the OCC plan to require
in the future as a result of these events?
A.3. We expect risk reports to accurately present the nature
and level(s) of risk taken and compliance with approved limits.
Q.4. What role do concentrations and liquidity of positions
play in your assessment of trading risks, and how will the OCC
ensure that it can capture such red flags in its supervision?
A.4. We consider both concentrations and position liquidity
when we assess trading activities. We expect that risk limits
and controls fully address the nature of risks being
undertaken. In instances where there is limited market
liquidity, or excessive concentrations, we expect limits to
address the risk and that appropriate valuation adjustments are
made.
Q.5. Please describe how the OCC works with other regulators
that may be collecting information that would be helpful in
identifying developing risks or problems. Does the OCC work
with the Office of Financial Research, for example, in a way to
maximize data collection and analysis, across financial
agencies in a way that will provide a stronger early warning
system?
A.5. OCC is an active member of the Office of Financial
Research (OFR) data advisory group. This group is undertaking
several initiatives involving data collection involving the
financial agencies. The most recent initiatives of this group
are the data inventory, and the legal entity identifier
projects. For the data inventory project, OFR has completed an
inventory of all the financial agencies purchased data and they
are working on building a portal to share this inventory with
all participating agencies. OCC is also a member of the
Financial Stability Oversight Council (FSOC) data subcommittee.
The data subcommittee is working to develop a strategy for
managing the set of data initially needed by the OFR to monitor
and study the financial stability of the Nation's economy.
Q.6. You indicated that because you may not have been given
adequate or accurate information by bank management, your
supervisory abilities were limited, and that ``quality
supervision is dependent on the quality of information
available to examiners.''
What is the role of institution-generated information in
your agency's assessment of an institution's risk management?
Please describe the process and importance of how your agency
independently verifies that any information a company provides
is accurate.
A.6. The role of institution-generated information is critical
in our assessment of the bank's risk profile and risk
management processes. We assess management's process to develop
and maintain management information systems (MIS) that will
ensure information is timely, accurate, and pertinent. This
assessment not only includes the processes to develop and test
new MIS, but also the reliability of this information through
the bank's quality assurance process at the line of business
level and the independent reviews performed by the bank's risk
management and audit functions. We check to confirm that the
scope and frequency of these independent reviews include
verification procedures for the quality of MIS. In addition,
the examiners through ongoing supervision and target
examinations perform transactional testing that confirms the
accuracy of critical MIS relied upon by bank management and the
regulators.
Q.7. You stated before this Committee that ``it does not appear
that the [OCC] met the heightened expectations'' of ``strong
risk management and audit.'' Please explain what these
heightened expectations are, and what steps you are taking to
ensure the OCC meets them.
A.7. My intent was that the bank did not meet the OCC's
heightened expectations for strong risk management and audit
functions. The OCC sets higher expectations for our large banks
as part of our lessons learned from the financial crisis. I
described the OCC's heightened expectations in my testimony
before the U.S. Senate's Committee on Banking, Housing, and
Urban Affairs on June 6, 2012, including comments on strong
risk management and audit. We have communicated the importance
of meeting these expectations to our large banks and their
boards of directors. We are monitoring, evaluating, and
discussing with bank management the bank's progress in working
towards our heightened expectations. We will use our
supervisory tools including informal or formal enforcement
actions to ensure each large bank achieves a strong risk
management and audit function.
Q.8. At the Committee's hearing where Jamie Dimon, Chairman of
the Board, President and Chief Executive Officer of JPMorgan
testified, Mr. Dimon indicated that while the company has a
compensation claw back policy in place, that authority has not
been exercised. For the largest national banks the OCC
regulates, are you aware of any bank exercising a claw back of
compensation when major mistakes are made? Is it important for
Boards of Directors of national banks to utilize their claw
back authority to deter other employees from making the same
mistakes, and correct some of the misaligned pay incentives we
saw leading up to the recent financial crisis?
A.8. We are not aware of the use of claw backs to date in large
national banks. As conveyed in the Interagency Guidance on
Sound Incentive Compensation Policies (OCC Bulletin 2010-24),
the OCC believes boards of directors should use claw back
authority under appropriate circumstances. JPMC notified us and
subsequently has announced that it plans to claw back
compensation from the individuals directly responsible for the
CIO losses. The bank's investigation into the matters is
ongoing and additional claw backs may be coming. The OCC will
review these decisions to ensure they are appropriate.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM THOMAS J. CURRY
Q.1. In the wake of the JPMorgan loss there has been a lot of
discussion about hedging activities. Many financial
institutions develop hedging strategies with interest rate and
credit derivatives to hedge volatility.
What is the oversight process for banks who hedge risk and
how are these hedges examined?
How do you determine whether a particular activity is or is
not ready ``hedging''?
A.1. As banking is a risk-taking business, we fully expect that
banks will take actions to reduce or eliminate unwanted risk
exposures. Hedging actions can take place on a transaction-by-
transaction basis, or on a portfolio basis. Transaction hedging
is easier to define and understand as one can see the risk
additive transactions being offset by risk reduction
transactions.
The concept is the same for portfolio hedging, but the
measurement of the correlation between the portfolio of risk
and the hedge is more difficult to document, as the hedging
instrument is not always the specific offset to the underlying
risk. Similar to transaction hedging, we look to understand the
nature of the portfolio of risk, how its value changes with
price or rate changes. We then look to see how the hedge
performs in similar situations. We expect bank reports to
document and support a strong negative correlation between the
risk position and the hedge.
A hedge position must be offsetting some existing risk
exposure. Bank risk reports need to identify the underlying
position and document its sensitivity to price or rate
movements.
Q.2. Given the complexities identified during the hearing with
determining whether or not a trade is a hedge or a proprietary
trade, it appears the real issue is whether a trade threatens
the safety and soundness of the bank.
How do you determine whether the trade presents risks to
the safety and soundness of a bank?
If a trade does present such risks, what authority do you
have to stop or prevent the trade from occurring?
A.2. A trade (or trading position consisting of multiple
trades) would present risks to the safety and soundness of a
bank if the loss exposure materially impacted the earnings and
capital of the bank. We evaluate risk measures, position
reports, and limits (including VaR and others established to
guard against illiquid or concentrated positions) to ensure
that the risk appetite is reasonable and would not pose a
material threat to earnings or capital. Controls should also be
in place and be tested regularly to ensure that risk-takers
operate within their limits.
Through the examination process, the OCC will evaluate risk
mitigation activities. In the event that we determine
inappropriate risk, we will call this to management's attention
and require actions to remediate our concerns.
If bank management is not sufficiently responsive, the OCC
has a wide-range of supervisory tools that it can use to
address an unsafe and unsound position that threatens the bank
including a temporary Cease and Desist Order. A temporary Cease
and Desist Order is an interim order issued by the OCC pursuant
to its authority under 12 U.S.C. 1818(c) and is used to impose
measures that are needed immediately pending resolution of a
final Cease and Desist Order. Such orders are typically used
only when immediately necessary to protect the bank against
ongoing or expected harm. A Temporary Cease and Desist Order
may be challenged in U.S. district court within 10 days of
issuance, but is effective upon issuance and remains effective
unless overturned by the court or until a final order is in
place.
Q.3. The FDIC has testified today that small bankers have told
the FDIC that compliance with the escrow account requirement in
Dodd-Frank could be so costly as to be prohibitive, and that
they would cease originating mortgage loans for their
customers.
Do you agree with the FDIC?
What specific recommendations has the OCC given the Bureau
as it develops the final rule implementing the Dodd-Frank
escrow requirements?
A.3. While we have not received direct communication from the
community banks that we supervise about the potential changes
to the escrow requirements, we have received anecdotal reports
that indicate some community bankers have concerns about these
proposed changes. We are also aware of the comment letters that
the Independent Bankers Association of Texas submitted to the
Federal Reserve Board and more recently, to the Consumer
Financial Protection Bureau (CFPB) on this issue.
Community bankers, however, have expressed concerns to us
about the overall cumulative impact that the Dodd-Frank Act may
have on their operations. In the area of mortgage lending, for
example, the Dodd-Frank Act also directs the CFPB to issue new
standards for mortgage loan originators; minimum standards on
mortgages themselves; limits on charges for mortgage
prepayments; new disclosure requirements in connection with
mortgage origination and in monthly statements; a new regime of
standards and oversight for appraisers; and a significant
expansion of HMDA requirements for mortgage lenders to report
and publicly disclose detailed information about mortgage loans
they originate. We support strong consumer protections for
residential mortgages, but it is also important to recognize
that the fixed costs associated with new regulatory
requirements have a proportionately larger impact on community
banks due to their smaller revenue base. As the OCC has
previously testified, a particular concern is whether these and
other forthcoming regulations combine to create a tipping point
causing banks to exit lines of business that provide important
diversification of their business, and increase their
concentration in other activities that raise their overall risk
profile.
For these reasons, we believe it is important that the OCC
and other regulatory agencies seek to implement the Dodd-Frank
Act in a manner that accomplishes the legislative intent
without unduly harming the ability of community banks to
fulfill their role of supporting local economies and providing
the services their customers rely on. Over the past year, OCC
has engaged in constructive dialogue with the CFPB on a range
of supervisory and regulatory matters of mutual concern. As the
CFPB rulemaking process moves forward, OCC will continue to
participate in the consultative process to ensure that
alternatives that lessen the burdens on community banks are
considered.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR MENENDEZ FROM THOMAS J. CURRY
Q.1. Do you agree with the comments that former Comptroller of
the Currency John Walsh made in London at the Center for the
Study of Financial Innovation in 2011 to the effect that
regulators should not require more capital at our largest
banks?
A.1. As I have stated previously to the Senate Banking
Committee, I am a strong proponent of increasing both the
quantity and quality of the capital reserves held by our
financial institutions. Towards that end, I support and
continue to move forward with the revisions to capital
standards developed by the Basel Committee. The OCC and the
other Federal banking agencies recently approved a set of
proposed rules and a final rule that move the United States
forward in adopting the Basel capital standards often referred
to as Basel III.
More specifically, we continue to support the higher
capital standards developed by the Basel Committee for
systemically important banks, and we are working with the
Federal Reserve Board as it develops enhanced prudential
standards (including capital) for bank holding companies with
over $50 billion in assets as part of the implementation of
section 165 of the Dodd-Frank Act.
Q.2. Are there any tools that you need to correct the problems
with large trading losses at systemically significant
institutions that Congress has not already given you in the
Wall Street reform law or that is in other existing authority?
A.2. No. The OCC has appropriate authority to review and assess
trading operations conducted within the institutions we
supervise, and, if warranted, take appropriate enforcement
actions based on those assessments. Our authority includes the
ability to access relevant books and records of a bank's
trading activities and its associated policies, procedures, and
controls to manage those risks. We likewise have an array of
tools that we can use to compel corrective action, ranging from
Matters Requiring Attention to formal cease and desist orders.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM THOMAS J. CURRY
Q.1. During the June 6th hearing, Mr. Gruenberg agreed that
``historically, including to the present day, the biggest risk
of banking is the lending activity that is inherent to the
banking process.''
In testimony before the Subcommittee on Financial
Institutions and Consumer Protection on May 9th, the former
Chief Economist of the Senate Committee on Banking, Housing,
and Urban Affairs stated:
In a remarkably understated 2007 annual inspection
report on Citigroup, the Federal Reserve Bank of New
York observed that ``[m]anagement did not properly
identify and assess its subprime risk in the CDO
trading books, leading to significant losses. Serious
deficiencies in risk management and controls were
identified in the management of Super Senior CDO
positions and other subprime-related traded credit
products.'' By the end of 2008 Citigroup had written
off $38.8 billion related to these positions and to ABS
and CDO securities it held in anticipation of
constructing additional CDOs. [Testimony of Marc
Jarsulic, Chief Economist, Better Markets, Inc., before
the Senate Committee on Banking Housing and Urban
Affairs Subcommittee on Financial Institutions and
Consumer Protection, ``Is Simpler Better? Limiting
Federal Support for Financial Institutions'', May 9,
2012.]
According to accounts of the hearings held by the Financial
Crisis Inquiry Commission, two witnesses agreed that CDOs were
responsible for Citigroup's financial difficulties:
[Former Citigroup chief executive Charles] Prince
ultimately blamed much of Citi's problems on CDOs,
which he said were complex and entirely misunderstood.
He said the company, its risk officers, regulators and
credit rating agencies believed CDOs were low-risk
activities. As it turned out, they resulted in $30
billion worth of losses . . .
[Former Comptroller of the Currency John] Dugan, too,
put much of the blame on CDOs, partly as a way of
defending his own agency. He said the bank, which the
Office of the Comptroller of the Currency oversaw, did
not damage the holding company, while Citi's securities
broker-dealers, which managed the CDOs and were
overseen by the Securities and Exchange Commission,
were at fault.
``The overwhelming majority of Citi's mortgage problems
did not arise from mortgages originated by Citibank,''
Dugan said. ``Instead, the huge mortgage losses arose
primarily from the collateralized debt obligations
structured by Citigroup's securities broker-dealer with
mortgages purchased from third parties.''--Cheyenne
Hopkins, ``No One Was Sleeping as Citi Slipped'', Am.
Banker, Apr. 8, 2010.
Do you agree with the New York Fed, the former Comptroller
of the Currency, the former Chief Economist of the Senate
Banking Committee, and the former CEO of Citigroup that CDOs
were a substantial cause of Citigroup's financial difficulties
in 2008, resulting in significant support from the Federal
Government, including capital injections from the Treasury
Department, debt guarantees from the FDIC, and loans from the
Federal Reserve?
A.1. Yes. Excessive risk-taking in subprime collateralized debt
obligations (CDOs) was a substantial cause of Citigroup's
financial difficulties in 2008.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM THOMAS J. CURRY
Q.1. At what point in the process of JPMorgan making this trade
and the public reporting of the losses did the OCC examiners
become aware of this trade?
A.1. The OCC knew the bank was planning to modify its position;
however, we were not fully aware of the manner in which
management chose to do that, or the rapid build-up in the size
or complexity of the bank's CDS positions in the first quarter
of 2012. Bank reports did not initially fully identify and
convey measurements of the change in risk, and bank executive
management did not understand the full impact of the new
exposures. Unexpected losses were first identified in late
March. The CEO of the CIO explained that these were an anomaly
in market prices and that the market would ``mean-revert.''
Profit and loss volatility increased in early April leading up
to the ``London Whale'' article on April 6, 2012. We spoke with
bank management at various times in April and obtained more
detailed information on the position as press reports appeared
about the bank's positions in the market. At the time,
management indicated the situation was managed and under
control. We advised bank management to keep us informed and
notify us of material changes, and we began discussing
additional follow up actions. From that time forward, the
losses became larger and the explanation of market anomaly was
less viable. On May 4, management contacted the OCC EIC to
notify him of the changed assessment and the magnitude of
losses realized during the second half of April.
Q.2. Does the OCC examine each of these trades as they occur?
If not, how does the OCC monitor the risk that the banks it
supervises is undertaking?
A.2. The OCC does not examine individual trades (or loans) as
they occur. Our role is not to approve or manage the bank's
risk positions. Rather, we assess the bank's risk management
and controls over its activities.
Bank management is responsible for managing risks. The OCC
focuses on whether a bank has a sound risk management system. A
sound program will identify risk, measure risk, monitor risk,
and control risk. Through a combination of discussions with
management supported by review of board and management reports,
examination activities are targeted based on assessment of
risk. OCC examiners evaluate policies, procedures, activities
and performance. Under this approach, examiners focus on a
bank's risk appetite and the limits and controls that are
designed and implemented to identify and control the risks they
assume.
The OCC recognizes that banking is a business of taking
risks in order to earn a profit. However, when risk is not
properly managed, the OCC directs bank management to take
corrective action. In all cases, the OCC's primary concern is
that the bank operates in a safe and sound manner and maintains
capital, reserves, and liquidity commensurate with its risk.
Q.3. How many trades does JPMorgan have of this magnitude and
what are the possibilities, given Europe and a softening
domestic economy that a number of these bets go bad at the same
time?
A.3. Trading in these instruments historically occurs primarily
in the Investment Bank, where the controls are appropriate for
the risk and activity. We do not believe that other such
significant positions exist in the company. Stress testing for
a variety of stress scenarios occurs regularly, and both
European and domestic considerations are among those analyzed.
Q.4. If regulators are focused on regulating risk management
practices, and not focused on individual trades regardless of
size, would the regulators and the banking system would be
safer and better off if the larger banks were required to hold
more capital than regional or community banks?
A.4. The OCC supports both the Basel Committee's efforts to
require higher capital for systemically important banks and the
provisions of the Dodd-Frank Act which require enhanced
prudential standards (including capital) for bank holding
companies with over $50 billion in assets. Both of these
initiatives will lead large banks to hold more capital than
regional and community banks.
In addition, the U.S. bank regulatory agencies recently
finalized changes to capital standards that apply to banks'
trading activities. These changes are consistent with changes
made by the Basel Committee to reflect lessons learned during
the financial crisis. These enhancements, often referred to as
Basel 2.5, should improve the risk sensitivity of capital
standards with respect to banks' trading exposures.
While the changes to capital standards represent marked
improvements in risk measurement and material increases in
capital requirements for large banks, we do not view them as a
substitute for, but rather as a complement to, strong
supervision and improved bank risk management practices.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM THOMAS J. CURRY
Q.1. When Congress passed the Volcker Rule provisions of the
Dodd-Frank Act, Congress intended to give regulators the
authority to exclude venture capital funds from the definition
of ``covered funds.'' In a recent study, the FSOC recommended
``that Agencies carefully evaluate the range of funds and other
legal vehicles that rely on the exclusions contained in section
3(c)(1) or 3(c)(7) and consider whether it is appropriate to
narrow the statutory definition by rule in some cases.''
Do you agree that you have the authority and discretion to
exclude venture capital funds from the definition of ``covered
funds''?
A.1. The agencies are reviewing and carefully considering the
many comments we have received on the scope of our authority
and discretion to exclude certain funds and other legal
vehicles that rely on the exclusions contained in section
3(c)(1) or 3(c)(7) from the definition of ``covered fund.''
Because we are in the midst of this joint rulemaking, we are
unable to express our views on the merits of the question you
raised or provide interpretive advice on the provisions of
section 619. Rest assured, however, that the OCC is committed
to working expeditiously with the other regulators to develop a
final rule that is consistent with statutory requirements.
As you know, the OCC regulates national banks and Federal
thrifts that have limited authority to directly make venture
capital investments. The involvement of national banks and
Federal thrifts in venture capital investments is limited given
the restrictions on their authority to invest in securities
under applicable laws and regulations. See 12 U.S.C. 24
(Seventh) and 1464(c); and 12 CFR Part 1 and 160.30.
However, national banks and Federal thrifts may rely on
their small business investment company and public welfare
investment authorities to make equity and equity-like venture
capital investments. See 15 U.S.C. 682(b); 12 U.S.C. 24
(Eleventh) and 1464(c)(4)(F). For example, national banks and
Federal thrifts each may invest up to specified limits in small
business investment companies (SBICs), which are privately
owned and managed investment funds licensed by the Small
Business Administration (SBA) that can make venture capital
investments, and in community development venture capital
companies (CDVCs), which operate similarly to an SBIC but
without SBA involvement. We note that section 619 expressly
preserves the ability of banks and thrifts to invest in SBICs
and other public welfare investments of the type permitted
under 12 U.S.C. 24 (Eleventh).
Q.2. Do you agree that sound venture capital investments lead
to job creation and economic growth?
A.2. While questions related to the impact of specific types of
entities on job creation and economic growth are not within the
scope of the OCC's mission, the sound deployment of capital is
clearly critical to a well-functioning economy.
------
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM MARTIN J. GRUENBERG
Q.1. In recent testimony on the trading loss by JPMorgan Chase
& Co. (JPMorgan), you stated that the FDIC's ``discussions have
also focused on the quality and consistency of the models used
in the CIO as well as the approval and validation processes
surrounding them.'' What have you learned about the quality and
consistency of the models and the approval and validation
processes at JPMorgan?
A.1. The FDIC continues to work with both OCC and Federal
Reserve staff to review the models used in JPMorgan Chase's CIO
unit for the assessment of risk associated with that unit's
credit hybrid's business. This review has focused on an
assessment of the JPMorgan Chase's VaR methodology and the
identification of any weaknesses in the firm's processes and
procedures for model governance, validation, and controls. This
evaluation is ongoing and the FDIC does not publicly disclose
regulators' findings.
Q.2. You have stated that your agency is in the process of
internally reviewing the transactions, including identifying
any ``potential gaps within the firm's overall risk
management.'' Mr. Curry has additionally stated that the Office
of the Comptroller of the Currency (OCC) will be assessing how
it can improve supervisory processes at the OCC. What gaps have
you identified at the bank and as supervisors?
A.2. Along with the OCC and the Federal Reserve, the FDIC
continues its evaluation of the CIO portfolio, its governance
structure, and the results of the work performed by JPMorgan
Chase's internal investigation. The firm has identified major
gaps in several areas within the CIO business line that
contributed to the losses incurred. The primary areas of focus
for the firm include the CIO trading strategy, VaR methodology
and model governance, strength of risk management, and the CIO
limit structure/escalation process.
Q.3. You also stated in recent testimony, that the FDIC has
added temporary staff to assist in its review. How many staff
members have been hired, and do you have any updates on the
FDIC's review?
A.3. The FDIC has a permanent staff of four professionals on-
site at JPMorgan Chase. Three additional FDIC staff members
have been engaged to focus on the analysis of CIO related
issues in addition to the analytical support of other FDIC
examiners on an ad hoc basis.
Q.4. At the Committee's hearing where Jamie Dimon, Chairman of
the Board, President and Chief Executive Officer of JPMorgan
testified, Mr. Dimon indicated that while the company has a
compensation claw back policy in place, that authority has not
been exercised. For the largest banks that benefit from the
$250,000 deposit insurance guarantee, are you aware of any bank
exercising a claw back of compensation when major mistakes are
made? Is it important for Boards of Directors of a large bank
to utilize their claw back authority to deter other employees
from making the same mistakes, and correct some of the
misaligned pay incentives we saw leading up to the recent
financial crisis?
A.4. JPMorgan Chase announced during its second quarter
earnings release that the firm intended to claw back
compensation from CIO managers in London responsible for the
CIO Synthetic Credit Portfolio. These employees were terminated
without a severance or 2012 incentive compensation and the firm
imposed the maximum claw back amount of 2 years of annual
compensation. In one instance, an employee volunteered the claw
back; and all claw back decisions were reviewed by JPMorgan
Chase's Board of Directors. A firm's board of directors should
be involved in the application of claw back provisions; and in
the JPMorgan Chase situation, it appears that senior management
took action without prompting from the Board.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM MARTIN J. GRUENBERG
Q.1. You testified today that small bankers have told the FDIC
that compliance with the escrow account requirement in Dodd-
Frank could be so costly as to be prohibitive, and that they
would cease originating mortgage loans for their customers.
What specific recommendations have you given the Bureau as it
develops the final rule implementing the Dodd-Frank escrow
requirements?
A.1. As you know, the FDIC is the primary Federal regulator for
the Nation's small community banks. My staff engages frequently
with community banks in roundtables around the country to be
certain that we understand how regulatory changes affect them
and to listen to their concerns. We know that in many rural and
underserved areas, community banks are the primary source to
meet the financial services needs in those communities.
We understand that the Dodd-Frank Act's mandatory escrow
accounts do not apply to all mortgage lending. The requirement
does not apply to market-rate loans that are not insured by a
Government agency, unless State or Federal law provides
otherwise. \1\ Additionally, the Dodd-Frank Act allows the
Bureau to exempt banks and other lenders operating in rural or
underserved areas from the escrow requirements.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 1639d(b).
---------------------------------------------------------------------------
Prior to the implementation of the CFPA (Consumer Financial
Protection Act of 2010) and the Consumer Financial Protection
Bureau's start-up date, the Federal Reserve Board issued a
notice of proposed rulemaking that would amend the existing
escrow rule to reflect the Dodd-Frank Act changes. \2\ As of
July 21, 2011, this proposal became a CFPB proposed rule.
---------------------------------------------------------------------------
\2\ 76 Fed. Reg. 11598 (March 2, 2011), proposing amendments to
Regulation Z, 12 C.F.R. 1026.35(b)(3).
---------------------------------------------------------------------------
The proposed rule contemplated an exemption for creditors
in rural and underserved areas. We have shared with the CFPB
the feedback we have received from community banks,
particularly those in rural areas, regarding the banks'
concerns about the impact of the proposed escrow rule, and we
have suggested that the Bureau exempt from the escrow
requirement all banks that operate predominantly in rural
areas.
We will continue to explore options to improve the
examination process for community banks while preserving the
benefits of appropriate regulation that ultimately will serve
the interest of lenders, consumers, and the economy as a whole.
We will continue to offer to the Bureau the perspective we
bring as a result of our commitment both to the health and
continued vibrancy of small community banks and to the needs of
the customers they serve.
Q.2. Mr. Gruenberg, in a recent speech you said that the
failure of a systemically important financial institution will
likely have significant international operations and that this
will create a number of challenges. What specific steps have
been taken to improve the cross-border resolution of a SIFI?
A.2. The following specific steps have been taken to improve
the cross-border resolution of a SIFI:
Identification of Priority Jurisdictions: The FDIC
has conducted a series of ``heat map'' exercises with
respect to the global footprint of U.S. SIFIs to
identify the priority jurisdictions and regulators for
cross-border coordination in connection with crisis
management, recovery and resolution planning, and
implementation. Based on the onbalance sheet and off-
balance sheet information reported by each of the top
eight U.S. SIFIs, the FDIC has identified 12 priority
jurisdictions that are host to over 97 percent of the
total reported foreign activities of the top U.S.
SIFIs. Of these 12 jurisdictions, over 90 percent of
the SIFIs' total reported foreign activities are in two
jurisdictions, the United Kingdom and Ireland. The FDIC
is conducting robust outreach in these priority
jurisdictions.
Jurisdictional Survey: In addition to these heat
mapping exercises, the FDIC is conducting a survey on
the legal and regulatory regimes in the priority
jurisdictions. The survey assists us in identifying the
obstacles to effective cross-border resolution and
cooperation and the coordination measures we may take
with fellow regulatory and resolution authorities to
mitigate such obstacles.
Participation in Crisis Management Group Meetings:
Under the auspices of the Financial Stability Board,
the FDIC and its U.S. and non-U.S. banking regulatory
authority colleagues are working in Crisis Management
Groups on recovery and resolution strategies for each
of the global systemically important financial
institutions identified by the G20 at their November 4,
2011, meeting. The work of these Crisis Management
Groups, consisting of both home and host authorities,
is intended to enhance cross-border institution-
specific planning and cooperation for a possible
resolution, should it become necessary. The work also
allows regulators to identify impediments to a more
effective resolution based on the unique
characteristics of a particular financial company and
the jurisdictions in which it operates.
Q.3. In your view, what additional steps must be taken with
respect to the cross-border resolution of a SIFI?
A.3. In our view, the following additional steps must be taken
with respect to the cross-border resolution of a SIFI:
Dialogues with foreign resolution counterparties
must continue. Many jurisdictions are in the process of
amending their resolution regimes and we are following
these developments with great interest.
As jurisdictions develop resolution strategies for
their respective SIFis, we must understand their impact
on the U.S. operations.
The FDIC is in the process of understanding the
usage of financial market utilities by each SIFI and
the impact of a SIFI's entry into Title II receivership
on its membership and processing arrangements with
financial market utilities.
Through the review of the Title I resolution plans
or ``living wills'' and enhanced heat mapping
exercises, the FDIC will gain transparency on the
location and usage of each SIFI's data and profit
centers, as well as location where liquidity is
concentrated.
The FDIC is working with fellow regulators in
determining the extent of information with respect to
each SIFI that may be shared on a confidential basis
with other resolution authorities in connection with
our cross-border coordination efforts on crisis
management, recovery and resolution planning, and
implementation.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM MARTIN J. GRUENBERG
Q.1. During the June 6th hearing, Mr. Gruenberg agreed that
``historically, including to the present day, the biggest risk
of banking is the lending activity that is inherent to the
banking process.''
In testimony before the Subcommittee on Financial
Institutions and Consumer Protection on May 9th, the former
Chief Economist of the Senate Committee on Banking, Housing,
and Urban Affairs stated:
In a remarkably understated 2007 annual inspection
report on Citigroup, the Federal Reserve Bank of New
York observed that ``[m]anagement did not properly
identify and assess its subprime risk in the CDO
trading books, leading to significant losses. Serious
deficiencies in risk management and controls were
identified in the management of Super Senior CDO
positions and other subprime-related traded credit
products.'' By the end of 2008 Citigroup had written
off $38.8 billion related to these positions and to ABS
and CDO securities it held in anticipation of
constructing additional CDOs. [Testimony of Marc
Jarsulic, Chief Economist, Better Markets, Inc., before
the Senate Committee on Banking Housing and Urban
Affairs Subcommittee on Financial Institutions and
Consumer Protection, ``Is Simpler Better? Limiting
Federal Support for Financial Institutions'', May 9,
2012.]
According to accounts of the hearings held by the Financial
Crisis Inquiry Commission, two witnesses agreed that CDOs were
responsible for Citigroup's financial difficulties:
[Former Citigroup chief executive Charles] Prince
ultimately blamed much of Citi's problems on CDOs,
which he said were complex and entirely misunderstood.
He said the company, its risk officers, regulators and
credit rating agencies believed CDOs were low-risk
activities. As it turned out, they resulted in $30
billion worth of losses . . .
[Former Comptroller of the Currency John] Dugan, too,
put much of the blame on CDOs, partly as a way of
defending his own agency. He said the bank, which the
Office of the Comptroller of the Currency oversaw, did
not damage the holding company, while Citi's securities
broker-dealers, which managed the CDOs and were
overseen by the Securities and Exchange Commission,
were at fault.
``The overwhelming majority of Citi's mortgage problems
did not arise from mortgages originated by Citibank,''
Dugan said. ``Instead, the huge mortgage losses arose
primarily from the collateralized debt obligations
structured by Citigroup's securities broker-dealer with
mortgages purchased from third parties.''--Cheyenne
Hopkins, ``No One Was Sleeping as Citi Slipped'', Am.
Banker, Apr. 8, 2010.
Do you agree with the New York Fed, the former Comptroller
of the Currency, the former Chief Economist of the Senate
Banking Committee, and the former CEO of Citigroup that CDOs
were a substantial cause of Citigroup's financial difficulties
in 2008, resulting in significant support from the Federal
Government, including capital injections from the Treasury
Department, debt guarantees from the FDIC, and loans from the
Federal Reserve?
A.1. Without getting into the specifics with respect to
Citigroup, I agree that CDOs and other model-driven, structured
products played a substantial role in the most recent crisis.
Many banks viewed the creation of these products as a means to
fund lending activities and shift credit risk off balance
sheet. Unfortunately, as these products continued to develop,
they resulted in untenable concentrations of systemic risk and
leverage in products that, by their very nature, lacked
transparency. The popularity of these instruments as investment
vehicles increased dramatically as the senior-most tranches
received the highest investment-grade ratings, and their coupon
rates dramatically exceeded the steadily declining Federal
Funds and U.S. Treasury rates. The high investor demand for
CDOs placed considerable stress on banks and nonbank mortgage
brokers to underwrite the significant volume of mortgages that
ultimately backed the CDOs. This resulted in the weakening of
underwriting standards and the issuance of poorer quality CDOs.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM MARTIN J. GRUENBERG
Q.1. On December 31st, Section 343 of the Dodd-Frank Act,
addressing unlimited FDIC-insurance coverage for noninterest
bearing transaction accounts, is scheduled to sunset. As you
know this section was based upon the FDIC's Transaction Account
Guarantee Program. Whether or not TAG is extended through the
end of the year, it is clear that this type of supernatural
Government involvement cannot be maintained indefinitely. Can
you advise the Committee whether any alternatives exist, or
which are under consideration by the FDIC, that would instill
the confidence our small businesses and our local governments
need to avoid having to pull payroll or transaction accounts
from their local community banks since each Friday it seems
that these folks read about some local bank being put on the
FDIC's receiverships list?
What precisely has the FDIC done to foster the development
of private sector solutions to TAG?
A.1. From the FDIC's standpoint, the most effective action that
bank regulatory agencies can take to maintain the confidence of
small business and local Government depositors in their
community banks is to ensure that these banks strengthen their
capital and liquidity positions. To the great credit of
community banks, with the encouragement of bank examiners, they
have significantly strengthened their capital and liquidity
over the past several years. As of June 2012, the average
leverage capital ratio for banks with less than $1 billion in
assets was 10.3 percent, almost exactly what it was at the end
of 2007, when it was 10.4 percent, and more than it was at the
end of 2002, when it was 9.6 percent. As of June 2012 the
average ratio of short-term assets to short-term liabilities
for commercial banks with less than $1 billion in assets was
105.7 percent, compared to 84.7 percent at the end of 2007 and
86.7 percent at the end of 2002. These actions by community
banks to increase their capital and liquidity are, in fact, a
strong private sector response to the issue of maintaining
confidence.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM MARTIN J. GRUENBERG
Q.1. When Congress passed the Volcker Rule provisions of the
Dodd-Frank Act, Congress intended to give regulators the
authority to exclude venture capital funds from the definition
of ``covered funds.'' In a recent study, the FSOC recommended
``that Agencies carefully evaluate the range of funds and other
legal vehicles that rely on the exclusions contained in section
3(c)(1) or 3(c)(7) and consider whether it is appropriate to
narrow the statutory definition by rule in some cases.''
Do you agree that you have the authority and discretion to
exclude venture capital funds from the definition of ``covered
funds?''
Do you agree that sound venture capital investments lead to
job creation and economic growth?
A.1. Section 619(h)(2) of the Dodd-Frank Act defines the terms
``hedge fund'' and ``private equity fund'' as ``an issuer that
would be an investment company, as defined in the Investment
Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act, or such similar funds as the
appropriate Federal banking agencies, the Securities and
Exchange Commission, and the Commodity Futures Trading
Commission may, by rule, as provided in subsection (b)(2),
determine.'' This definition, as written, would cover the
majority of venture capital funds.
As part of the Notice of Proposed Rulemaking (NPR), the
agencies sought public comment on whether venture capital funds
should be excluded from the definition of ``hedge fund'' and
``private equity fund'' for purposes of the Volcker Rule. In
Question 310 in the NPR, the agencies ask:
Should venture capital funds be excluded from the
definition of ``covered fund''? Why or why not? If so,
should the definition contained in rule 203(l)-(1)
under the [Investment] Advisers Act be used? Should any
modifications to that definition of venture capital
fund be made? How would permitting a banking entity to
invest in such a fund meet the standards contained in
section 13(d)(1)(J) of the [Bank Holding Company Act]?
Sound venture capital investments, like other investment
activities, can contribute to job creation and economic growth.
In conjunction with the development of the final rule, the
agencies are reviewing public comments responding to the NPR,
including comments on Question 310 related to venture capital
funds. The agencies will take these and all comments into
consideration in the development of the final rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER
FROM MARTIN J. GRUENBERG
Q.1. Section 165 of the Dodd-Frank Act requires certain nonbank
financial companies and each bank holding company with total
consolidated assets of $50 billion or more to periodically file
a Resolution Plan, or ``living will,'' for the company's
resolution in the event of material financial distress or
failure, and to report on the nature and extent of each
company's credit exposures. In implementing this requirement,
please explain:
Whether and to what extent the FDIC will compare Resolution
Plans submitted by each institution to assess how many have
identified the same issues in their plans and whether that
might have systemic risk implications.
A.1. The FDIC's plan review process is designed to include a
``horizontal review'' of certain identified topics expected to
be addressed by each institution. This horizontal review
includes an analysis of the strategies of each institution put
forward for its material entities, as well as the various
resolution regimes (such as bankruptcy for holding companies,
receiverships for insured depository institutions and
administrations for foreign entities) under which the material
entities will be required to be resolved, identified obstacles,
related mitigants to those identified obstacles, and the
assumptions upon which the institution relies to support the
feasibility of those strategies.
This comparative review will help to focus on key systemic
issues that have been raised in the industry domestically as
well as globally. The review will include:
interconnections and interdependencies such as
cross company borrowing, lending, or shared services;
the treatment and booking of derivatives,
domestically and cross-border
the impact of qualified financial contracts;
the ability to separate and substitute core
business lines and critical operations; and
the reliance on common global payment systems and
financial market utilities and infrastructures.
Additionally, the comparative review and assessment will
help to identify gaps and areas that may require further
regulatory consideration and guidance in order to strengthen
the oversight of systemically important financial institutions.
Q.2. To what extent regulators have ascertained the costs to
the private sector of preparing Resolution Plans. (Has the FDIC
considered asking each company to compile a cost of assembling
such a plan?)
A.2. Each of the companies that were required to submit plans
by July 1, 2012, expended significant resources in developing
their resolution plans, representative of the seriousness
placed on these plans and the challenges associated with a
first time reporting requirement. In addition to the dedication
of internal staff resources, many of these initial companies,
which included the largest and most complex financial
institutions, also hired external legal, accounting, and
general consulting firms to support their efforts. The FDIC has
not asked each company to compile the total cost of assembling
such plan. In conjunction with the 165(d) rulemaking, the FDIC
developed some preliminary estimates of the hours that would
likely be required to complete the initial plan submissions,
which assumed an internal preliminary estimate of 9,200 hours
for an initial full report by the largest institutions and
approximately half that amount for others. Once baseline plans
are established, we would anticipate the burden to be
substantially less in future years. These estimates did not
include the cost of systems upgrades and other investments that
firms may make in order both to comply with the ongoing
requirements and to better manage resolution risk.
Q.3. Whether the FDIC intends to report to Congress or
otherwise release any information about what the FDIC has
learned as a result of receiving such information.
A.3. Please see response to Question 2.
Q.4. Whether the FDIC expects that its review of the initial
Resolution Plans will form the basis of revising the
requirement for the institutions required to file by July 1,
2013.
A.4. Yes, we expect that the FDIC and the Federal Reserve Board
(FRB) will provide further guidance to those institutions that
are required to submit initial plans by July 1, 2013, that will
be informed by our review of the first submissions. These
initial plans will inform the FDIC and FRB as to whether the
guidance provided to the firms needs further clarification, and
which assumptions provided to the firms should be modified.
Through a comparative review of the plans, we expect to
identify the approaches which best address the intent of the
resolution plan requirement and facilitate FDIC and FRB review.
We also anticipate that guidance for those institutions
required to file by July 1, 2013, may be modified beginning in
the fourth quarter of 2012 because of the nature of those firms
relative to the initial filers, which included some of the
largest and most complex financial institutions.
Q.5. With respect to the FDIC's stated intention to resolve a
failing financial institution by placing the top-tier holding
company into the orderly liquidation authority and continuing
to operate all of the subsidiaries, how, if at all, this
approach should affect the content or direction of a Resolution
Plan.
A.5. The ``Living Wills'' are the firms' plans to resolve
themselves under the U.S. Bankruptcy Code and therefore the
plans should not be affected by the FDIC's strategies for
resolving the firms under Title II of the Dodd-Frank Act.
Q.6. Whether the FDIC intends to report to Congress or
otherwise release any information about what the FDIC has
learned as a result of reviewing Resolution Plans.
A.6. The public portion of the plans are currently available to
the public on our Web site and have been the subject of
considerable analyst comment.
Q.7. Whether Resolution Plans will be used in enforcement
actions.
A.7. The Resolution Plans are not being sought for the purpose
of developing or supporting an enforcement action. If, however,
a situation arises in which a Resolution Plan (or a portion of
it) would constitute relevant evidence in an enforcement
action, there is no prohibition on the FDIC or another
appropriate Federal regulator using it for that purpose.
Q.8. While the Dodd-Frank Act does not appear to require that
an institution make any part of its Resolution Plan public,
Federal regulations seem to permit an institution to prepare a
public section (with the institution exercising its own
judgment about what information is proprietary and should not
be disclosed). Does the FDIC plan to second guess those
judgments? Does it plan to issue any further guidance about the
content of the public section?
A.8. 12 CFR Part 381.8(c) sets forth the required elements of
the public section of a resolution plan filed pursuant to
section 165(d) of the Dodd-Frank Act. The FDIC intends to
review the public section of each resolution plan for
compliance with this subsection of the regulation. Based on
this review, the FDIC's Office of Complex Financial
Institutions may add to or amend one or more of the required
elements. However, there are no specific plans to do so at this
time.
Q.9. With regard to the confidential portion of a Resolution
Plan, will the FDIC accord it the same degree of
confidentiality that it accords reports of examination? If not,
why not, and what degree of confidentiality would the FDIC
extend to such information? How widely will the FDIC share a
Resolution Plan with other banking regulators?
A.9. Yes, the FDIC will provide the Resolution Plans with the
same level of confidentiality as accorded to reports of
examination. Section 112(d)(5)(A) of the Dodd-Frank Act (18
U.S.C. 5322(d)(5)(A)) requires the Federal Reserve Board and
the FDIC to maintain the confidentiality of any data,
information, and reports submitted under Title I (including the
resolution plans prepared and submitted as required under
section 165(d) of the Dodd-Frank Act), and the FDIC fully
intends to comply with that legal requirement. The FDIC has
implemented security practices for the plans to ensure that we
maintain their confidentiality consistent with applicable
exemptions under the Freedom of Information Act (5 U.S.C.
552(b)) and the FDIC's Disclosure of Information Rules (12 CFR
part 309).
The FDIC will share the resolution plans with other banking
regulators to the extent permitted by law.