[Senate Hearing 112-750]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-750

 
        OVERSIGHT OF BASEL III: IMPACT OF PROPOSED CAPITAL RULES
=======================================================================


                                HEARING

                               before the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS

                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

                  EXAMINING THE OVERSIGHT OF BASEL III

                               __________

                           NOVEMBER 14, 2012

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov /




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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

                      Jeff Siegel, Senior Counsel

                 Andrew Olmem, Republican Chief Counsel

              Jelena McWilliams, Republican Senior Counsel

                Mike Piwowar, Republican Chief Economist

                     Beth Zorc, Republican Counsel

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, NOVEMBER 14, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    26

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Brown
        Prepared statement.......................................    26

                               WITNESSES

Michael S. Gibson, Director, Division of Banking Supervision and 
  Regulation, Board of Governors of the Federal Reserve System...     4
    Prepared statement...........................................    28
    Responses to written questions of:
        Senator Shelby...........................................    93
        Senator Menendez.........................................   104
        Senator Warner...........................................   106
        Senator Wicker...........................................   109
John C. Lyons, Chief National Bank Examiner, Office of the 
  Comptroller of the Currency....................................     6
    Prepared statement...........................................    43
    Responses to written questions of:
        Senator Shelby...........................................   110
        Senator Menendez.........................................   117
        Senator Warner...........................................   118
        Senator Wicker...........................................   120
George French, Deputy Director, Policy, Division of Risk 
  Management Supervision, Federal Deposit Insurance Corporation..     7
    Prepared statement...........................................    84

              Additional Material Supplied for the Record

Statement submitted by John von Seggern, President and Chief 
  Executive Officer, Council of Federal Home Loan Banks..........   123
Statement submitted by the Independent Community Banks of America   142

                                 (iii)


        OVERSIGHT OF BASEL III: IMPACT OF PROPOSED CAPITAL RULES

                              ----------                              


                      WEDNESDAY, NOVEMBER 14, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 2:35 p.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.
    After the financial crisis, Congress passed Wall Street 
Reform into law and asked our regulators to strengthen the 
financial sector by enhancing capital standards and prudential 
supervision. In addition, Federal banking agencies negotiated 
the Basel III accords, an agreement with other Nations' banking 
agencies. The proposed capital rules under discussion today 
implement that agreement. These are complex rules, and today we 
will hear from the experts at the Fed, OCC, and FDIC about the 
important goals they hope to accomplish with these proposed 
rules, as well as their potential impact.
    Since the rules were proposed in June, Members of this 
Committee have heard a number of concerns about these 
rulemakings from former Federal regulators, current State 
regulators, industry participants, and academics. These 
concerns are documented in over 2,000 comment letters submitted 
by a wide range of stakeholders, including community banks and 
insurance companies.
    While most agree the higher levels of capital are 
appropriate, the details of how to improve bank capital will 
have a broad impact and must be closely examined.
    Specifically, with respect to community banks, I appreciate 
that your agencies have undertaken a number of efforts to 
explain the proposed rules to community banks, including 
issuing a capital estimation tool for banks to evaluate how the 
proposed rules will impact them. However, I am concerned that 
the proposed risk weights could have an adverse impact on small 
banks' ability and willingness to offer mortgages, especially 
in rural areas. I look forward to hearing more today about how 
the risk weights were determined for mortgages, 
securitizations, and mortgage servicing rights, and what kind 
of impact these rules might have on our housing market.
    I also want to hear more about the proposed treatment of 
``accumulated other comprehensive income.'' At a time where 
interest rates cannot get much lower, we should pay particular 
attention to how new rules could make interest rate management 
more difficult, especially for smaller banks.
    In addition, I am concerned by the treatment of the 
business of insurance in the proposed rules. Before moving 
forward with applying these rules to insurance companies, the 
banking agencies should take additional time to work with State 
insurance regulators, the Federal Insurance Office, and the 
independent insurance expert on the Financial Stability 
Oversight Council to better understand the insurance accounting 
framework and risk-based capital model currently used. This 
feedback should then be used to develop a capital framework 
that is more suitable for financial institutions engaged in the 
traditional business of insurance and give these companies 
appropriate time to implement the new framework.
    A strong capital base is a key component of a resilient 
financial system. This was a major lesson of the financial 
crisis in 2008, and your agencies are to be commended in your 
efforts to steadily recapitalize the U.S. banking system and 
establish new standards. But while capital can serve as an 
important loss-absorbing buffer, capital alone will not prevent 
financial firms from failing and potentially threatening the 
broader financial stability. It is important that capital 
standards are well calibrated with other supervisory 
requirements, including new rules mandated by the Wall Street 
Reform Act. I look forward to hearing how each of your agencies 
is coordinating the ongoing rulemakings to ensure all of the 
pieces fit together.
    I believe we share the same goal of strong and harmonized 
capital rules to promote financial stability, but before moving 
forward, it is important to understand how the regulators have 
considered, and will continue to consider, the concerns being 
raised. I encourage your agencies to take the appropriate 
amount of time needed to get these rules right.
    Last, I want to applaud you all for the steps your agencies 
took last week to provide clarity on the Basel III rules' 
effective date. This was well in advance of the previously 
announced January 1, 2013, effective date, and I believe the 
announcement was very useful to those companies working to 
comply with these rules.
    With that, I will turn to Ranking Member Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Thank you very 
much for calling this hearing at this time. I think it is very, 
very important.
    Today, as the Chairman has pointed out, the Committee will 
hear from the Federal Reserve, the OCC, and the FDIC about 
their proposed rules to implement the Basel III international 
accord. The primary goal of Basel III is to strengthen bank 
capital requirements. I think this is a worthy goal as strong 
capital requirements are essential for a safe and sound banking 
system and also to protect against taxpayer-funded bailouts.
    Unfortunately, one of the clear lessons of the financial 
crisis is that bank regulators set capital requirements too 
low. In their proposals, the agencies themselves admit that 
when the crisis came, and I will quote, ``the amount of high-
quality capital held by banks globally was insufficient to 
absorb losses.'' We know this on this Committee. And as a 
result, taxpayers were called upon to bail out our banks, and 
our economy suffered its worst crisis since the Great 
Depression.
    In light of this recent history, I support the agencies' 
goal of enhancing capital levels to protect American taxpayers 
from having to bail out banks down the road. Yet given the 
failure of bank regulators to set appropriate capital levels 
before the crisis, I cannot help but doubt the regulators' 
ability to set them correctly after the crisis. But there is 
hope.
    Accordingly, I believe this Committee must rigorously, Mr. 
Chairman, review the agencies' proposals to ensure that the 
goal of Basel III is actually achieved. We should not, I think, 
simply rely on the agencies' assurances that their proposed 
rules will leave our banks properly capitalized. We have been 
down that road before. Instead, the agencies I hope would 
demonstrate to this Committee and to the public that their 
proposed rules are supported by proper data and rigorous 
economic analysis.
    Regrettably, the agencies have so far not provided 
sufficient data and analysis of their proposals. That is why 
weeks ago I wrote to the agencies asking them to publicly 
released detailed estimates of how capital levels will change 
for U.S. banks under Basel III, how the agencies determine that 
those levels will leave the U.S. banking system well 
capitalized, and what will be the compliance cost. All that is 
important. These were basic questions that should be publicly 
answered before this rulemaking proceeds.
    I do not believe that it will surprise anyone to learn that 
the agencies finally responded, Mr. Chairman, to my letter 
yesterday, right on the eve of this hearing. Unfortunately, 
their response relies largely on studies by the Basel Committee 
which use data only from the very largest banks. For example, 
one key study included data from only 13 U.S. banks. In 
addition, the Basel Committee's quantitative impact study 
aggregates country results. It does not specifically show how 
Basel III will impact the U.S., which we are interested in 
first and foremost here.
    Even more troubling, the agencies state that they believe 
Basel III is appropriate based on the losses experienced by 
U.S. banks, but they do not up to now provide data to support 
this conclusion. You must do that.
    It is time, I think, that our banking regulators stop 
outsourcing their economic analysis to the Basel Committee and 
start doing their own work. They need to determine, I believe, 
how Basel III will impact our diverse and unique banking system 
and the overall U.S. economy. They also need, I believe, to end 
their cloistered approach to rulemaking.
    First, the public has the right to know the consequences of 
adopting Basel III, including how it will impact the stability 
of the U.S. banking system, economic growth in the U.S., and 
the ability of American consumers to obtain loans. The public's 
right to know, I believe, is even more pronounced given the 
agencies' failure to proper set capital requirements before the 
crisis. Moreover, there are growing doubts about Basel III's 
model-based approach to setting capital requirements. We should 
know what it is. You should be able to defend it.
    Many commentators and even some regulators are concerned 
that the Basel III models are too complex and inaccurate to be 
relied upon. If the agencies want the public to have 
confidence--and that is very important--in Basel III, they need 
to make their case publicly, and this is a good place to start.
    Finally, by omitting key data and analysis from this 
important rulemaking, the agencies are also undermining the 
ability of Congress through this Committee to hold the agencies 
accountable. The public depends on Congress to conduct 
oversight and to ensure that the agencies do their jobs 
effectively. Without more information, it is impossible to 
determine if the proposed rules will actually set capital 
requirements at the appropriate levels. Congress cannot, I 
believe, effectively engage in oversight right here if we do 
not know what goes on behind closed doors at the agencies.
    It is my hope that the witnesses today can provide, at 
least to start, a more thorough and data-based explanation for 
their Basel III rule proposals. Both Congress and the public 
deserve a far better explanation than they have been given so 
far. I hope this will be a new day.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Shelby.
    Are there any other Members who wish to make a brief 
opening statement?
    [No response.]
    Chairman Johnson. Thank you all. 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.
    Mr. Michael Gibson is the Director of the Division of 
Banking Supervision and Regulation at the Board of Governors of 
the Federal Reserve System.
    Mr. John Lyons is the Chief National Bank Examiner at the 
Office of the Comptroller of the Currency.
    Mr. George French is the Deputy Director of Policy in the 
Division of Risk Management Supervision at the Federal Deposit 
Insurance Corporation.
    I ask our witnesses to limit their testimony to 5 minutes. 
Your full statements will be submitted for the record.
    Mr. Gibson, you may proceed with your testimony.

 STATEMENT OF MICHAEL S. GIBSON, DIRECTOR, DIVISION OF BANKING 
 SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL 
                         RESERVE SYSTEM

    Mr. Gibson. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, thank you for the opportunity to 
testify on the proposed interagency changes to the regulatory 
capital framework for U.S. banking organizations.
    The recent financial crisis revealed that too many U.S. 
banking organizations were not holding enough capital to absorb 
losses during periods of severe stress. In addition, some 
instruments that counted as capital were not able to absorb 
losses as expected. In short, the crisis showed us that banks 
were too highly leveraged. In response, the banking agencies' 
capital proposal would increase both the quantity and quality 
of capital held by banking organizations of all sizes.
    Another lesson from the crisis was that the largest banking 
organizations were the most severely impacted. As a result, 
many items in the agencies' proposal and in other regulatory 
reforms are appropriately focused on larger banking firms and 
would not apply to community banking organizations.
    We have assessed the impact of these proposed changes on 
banking organizations and the broader financial system. These 
analyses found that the stronger capital standards in our 
proposal would significantly lower the probability of banking 
crises and their associated economic losses, while having only 
a modest negative effect on gross domestic product and the cost 
of credit. The modest negative effects would be mitigated by 
the extensive transition periods provided in our proposal.
    Our impact analysis also showed that the vast majority of 
U.S. banking organizations, including approximately 90 percent 
of community banking organizations, would not be required to 
raise additional capital because they already meet the proposed 
higher minimum requirements on a fully phased-in basis.
    Community banking organizations play a vital role in the 
U.S. financial system. They can provide relationship-based 
lending in their local communities in a way that larger 
institutions would find difficult to duplicate. In developing 
the proposal, the agencies sought to strike the right balance 
between safety and soundness concerns and the regulatory burden 
associated with implementation, including the impact on 
community banking. We also conducted extensive industry 
outreach across the country, and we provided a tool to help 
smaller organizations estimate their capital levels under the 
proposal. As we consider the large volume of comments submitted 
by the public, the Federal Reserve will remain sensitive to 
concerns expressed by community banking organizations.
    Community banking organizations are particularly concerned 
about the proposed treatments of unrealized gains and losses on 
securities, otherwise known as AOCI, and residential mortgage 
exposures. They believe that elements of our proposal do not 
adequately take into account the community banking business 
model and that some aspects would have potential 
disproportionate effects on their organizations. We will be 
mindful of these comments when we consider potential changes to 
the proposal, and we will work to appropriately balance the 
benefits of a revised capital framework against its costs.
    The proposal would apply consolidated capital requirements 
to all assets owned by a depository institution holding company 
and its subsidiaries, including assets held by insurance 
companies. By treating all assets equally, the proposal would 
eliminate incentives to engage in regulatory capital arbitrage 
across different subsidiaries of the holding company.
    The proposal is also consistent with the Collins Amendment 
in Section 171 of the Dodd-Frank Act, which requires that bank 
capital requirements be a floor for depository institution 
holding company requirements. Depository institution holding 
companies with insurance activities have raised concerns that 
the proposed regulatory capital requirements are not suitable 
for the insurance business model. The Federal Reserve takes 
these comments seriously and will consider them carefully in 
determining how to appropriately apply regulatory capital 
requirements to depository institution holding companies with 
significant insurance activities.
    Thank you for the opportunity to describe the Federal 
Reserve's efforts to reform the regulatory capital framework 
for U.S. banking organizations, and I will be happy to answer 
any questions you have for me.
    Chairman Johnson. Thank you, Mr. Gibson.
    Mr. Lyons, you may proceed.

   STATEMENT OF JOHN C. LYONS, CHIEF NATIONAL BANK EXAMINER, 
           OFFICE OF THE COMPTROLLER OF THE CURRENCY

    Mr. Lyons. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, I appreciate the opportunity to 
discuss the three proposed capital rules issued by the Federal 
banking agencies and their potential impact on the industry. We 
have received extensive comments on the proposals from banks of 
all sizes. In response to concerns raised by commenters, we 
announced last week that we will delay the January 1st 
effective date. We are especially mindful of the concerns that 
community bankers had raised about the potential burden and the 
impact these rules could have on their institutions.
    Our goal is simple: to improve the safety and soundness of 
our Nation's banking system by ensuring that all banks of all 
sizes have sufficient capital to weather adverse conditions and 
unforeseen losses. Strong capital plays a vital role in 
promoting financial stability and moderating downturns by 
facilitate banks' capacity to lend.
    During the recent cycle, the banks that were best able to 
meet the credit needs of their customers and communities were 
those with strong capital bases. This underscores the principle 
that higher capital standards that apply to all banks are 
essential to the financial strength of the industry and our 
Nation's economy.
    Capital rules also need to reflect risks appropriately, and 
so under the proposal, riskier loans, such as certain types of 
nontraditional mortgages, would require more capital. We 
believe the proposals reinforce key objectives of the Dodd-
Frank Act, specifically promoting financial stability and 
requiring higher capital for riskier firms and activities.
    The June rulemaking package consists of three Notices of 
Proposed Rulemakings (NPR). Each NPR calibrates requirements to 
the size and riskiness of institutions so that larger banks 
will hold more capital and meet stricter standards than smaller 
ones. These are not one-size-fits-all requirements.
    The first proposal introduces a new measure for regulatory 
capital called Common Equity Tier 1 and two new capital 
buffers--a capital conservation buffer that would apply to all 
banks, and a countercyclical buffer that would apply only to 
the largest institutions. For community banks, this would 
result in a Common Equity Tier 1 requirement of 7 percent of 
risk-weighted assets. For large, internationally active banks, 
this requirement could be as high as 13 percent when combined 
with a SIFI surcharge that is being considered internationally.
    The second proposal, the Standardized Approach NPR, would 
modify certain risk weighting so that riskier loans and 
activities require more capital. Here, too, distinctions are 
made between small and large banks as certain provisions of the 
NPR, such as those related to securitization and credit risk 
mitigation, would have little or no application to most 
community banks.
    The third proposal, the Advanced Approaches NPR, applies 
only to the largest internationally active institutions and 
does not affect community banks. To reduce possible adverse 
effects, especially for community banks that have less access 
to market sources of capital, the proposals include a lengthy 
transition period.
    Our preliminary assessment is that many community banks 
hold capital well above the existing and the proposed 
regulatory minimums. Nevertheless, we took steps to maximize 
opportunities for community bankers to learn about and to 
comment on the proposals. These steps included short summaries 
aimed at community banks, extensive outreach with community 
bankers, and a tool to help them assess the impact of their 
proposals. While we have received comments on many issues, 
three overarching concerns have been raised:
    First, many have cited the complexity of the rules. 
Community bankers in particular have questioned whether 
proposals should apply to them.
    Second, many have raised concerns about including 
unrealized losses and gains and available-for-sale debt 
securities and regulatory capital and volatility that could 
result in capital levels and other limits tied to regulatory 
capital such as lending limits.
    Third, bankers have expressed concerns about the 
recordkeeping burdens resulting from the proposed rules, the 
proposed use of loan-to-value measures for residential 
mortgages, and the higher risk weights that would be assigned 
to balloon residential mortgages.
    As we consider these issues, we will continue to look for 
ways to reduce burden and complexity while maintaining our key 
objectives of raising the quantity and quality of capital and 
matching capital to risk. These enhancements will lead to a 
stronger, more stable financial system.
    I appreciate your interest in this matter and would be 
happy to answer your questions.
    Chairman Johnson. Thank you, Mr. Lyons.
    Mr. French, you may proceed.

 STATEMENT OF GEORGE FRENCH, DEPUTY DIRECTOR, POLICY, DIVISION 
   OF RISK MANAGEMENT SUPERVISION, FEDERAL DEPOSIT INSURANCE 
                          CORPORATION

    Mr. French. Thank you. Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee, good afternoon. I 
appreciate the opportunity to testify on behalf of the FDIC 
about these proposed regulatory capital rules. My statement 
will focus on the two Notices of Proposed Rulemaking that 
pertain to community banks and some of the comments we have 
received.
    One of these NPRs deals with the Basel III capital reforms. 
The core elements of Basel III would strengthen the quality of 
bank capital and increase its required level. These are basic 
concepts of capital adequacy that are relevant for any bank, 
and the Basel III NPR would apply them to all insured banks.
    The Basel III reforms also include a number of complex 
provisions targeted at large, internationally active banks. We 
have proposed to apply these only to the largest banks, so 
these large banks would need to comply with the basic changes 
to the definition and level of capital that are proposed for 
all banks and also with additional standards that address the 
unique risks they face. The Basel III NPR also preserves the 
fundamental role of the U.S. leverage ratio. The FDIC strongly 
supports the introduction of the leverage ratio in the Basel 
framework as a transparent and objective measure of capital 
adequacy.
    The second NPR that is relevant for community banks is the 
Standardized Approach NPR. It proposes a number of changes to 
the way banks compute risk-weighted assets and removes 
references to credit ratings consistent with the Dodd-Frank 
Act. I want to clarify that the changes to risk-weighted assets 
in the Standardized Approach NPR are separate and distinct from 
the international Basel III reform package.
    The FDIC has devoted significant efforts to outreach and 
technical assistance to help community banks understand how 
these proposals may affect them. We have received more than 
1,500 comments at last count, and many of these comments 
express concern that the proposals will negatively affect 
community banks' ability to serve the credit needs of their 
local communities. As the primary Federal regulator of the 
majority of community banks, the FDIC takes these comments very 
seriously.
    In the last 5 years, we have seen over 460 insured banks 
fail and many hundreds more in problem bank status. This 
painful episode has imposed significant costs on our national 
and local economies and illustrates the importance of banks 
having a strong capital base so that they can continue to lend 
in their communities, even during periods of economic 
adversity.
    Many commenters do acknowledge the importance of strong 
bank capital, but they also have concerns about specific 
aspects of the proposals, their complexity, or the totality of 
the potential effects. Among the more frequently mentioned 
specific issues are the residential mortgage rules in the 
Standardized Approach NPR and their interaction with other 
Dodd-Frank mortgage rules.
    In the Basel III NPR, many commenters have focused on the 
proposed treatment of available-for-sale debt securities and 
many others on the phase-out of the preexisting trust preferred 
securities of smaller organizations.
    Careful review of these and other comments is a critically 
important part of our process that gives us a better 
understanding of the potential unintended consequences and 
costs of the proposals. It is important to note that we have 
not reached decisions on any of these matters. These are 
proposed rules, not final rules, and we anticipate making 
changes in response to comments.
    The basic purpose of the Basel III framework is to 
strengthen the long-term quality and quantity of the capital 
base of the U.S. banking system. In light of the recent 
financial crisis, that would appear to be an appropriate and 
important goal. However, that goal should be achieved in a way 
that is responsive to the concerns expressed by community banks 
about the potential for unintended consequences.
    I would be happy to respond to your questions.
    Chairman Johnson. Thank you for your testimony.
    We will now begin asking questions of our witnesses. Would 
the clerk please put 5 minutes on the clock for each Member?
    Mr. Gibson, last week, Governor Duke said, ``Before we 
issue final capital rules, we will do everything possible to 
address the concerns that have been expressed by community 
banks and still achieve the goal of having strong levels of 
high-quality capital built up over a reasonable and realistic 
transitional period in banks of all sizes, including community 
banks.''
    How exactly do you plan to address the concerns expressed 
by community banks and others while maintaining strong levels 
of capital?
    Mr. Gibson. We believe that the vast majority of community 
banks already meet the higher level of capital that is proposed 
in the proposal, and our impact analysis has shown that to be 
the case. We have received a lot of comments from community 
banks on many aspects of the proposal, but mostly those 
comments are not aimed at the level of capital but at other 
aspects of the proposal. As I mentioned in my testimony, the 
treatment of unrealized gains and losses on securities, the 
proposed risk weights for residential mortgages, and various 
other things have been the focus of community bank comments.
    We will definitely consider those comments as we move 
forward on a final rule, and we think that the fact that 
community banks already have a strong capital base makes them 
well positioned to meet the higher requirements. And as 
Governor Duke mentioned in her comment, allowing a longer 
transition period is another way of easing the burden, 
including the costs of implementation for new IT systems and 
other implementation costs that community banks have also 
expressed concerns about. So we definitely will take a look at 
that as we move forward.
    Chairman Johnson. Mr. French, what impact will the current 
proposals have on the ability of community banks to offer 
balloon and second mortgages, especially in rural areas like we 
have in South Dakota? Also, will the current proposal make it 
more difficult for community banks to manage interest rate 
risk?
    Mr. French. Mr. Chairman, we have heard about both of these 
issues many times from our community banks in face-to-face 
meetings. We had a good discussion of these just last week at 
our Community Bank Advisory Committee.
    With regard to balloon loans, you know, we have heard the 
comment that many rural banks offer these loans. They are 
simple structures that the banks understand and have been 
making successfully for many years. So the question is whether, 
by trying to capture some of the more risky practices that we 
saw in the crisis, we are inappropriately sweeping these loans 
up in the proposed rule. And based on the comments, the 
commenters are very concerned about the impact this will have 
on these banks and the local communities. We take those 
concerns very seriously, and it is one of the issues we are 
focused on as we review the comments.
    And with regard to AOCI, we have heard, again, many 
concerns about the volatility of regulatory capital that could 
come to pass as interest rates change, and the effect on 
managing things like legal lending limits, regulatory capital, 
capital planning, and also interest rate risk, because banks 
may feel forced to put more of their securities, their long-
term securities, into the held-to-maturity bucket so that they 
will not face these fluctuations. That could limit their 
flexibility, to some extent, in addressing these changes in 
interest rates.
    So this is, once again, an area we have heard a tremendous 
amount of comments from virtually every bank that we have 
spoken to, and we are studying the comments closely and 
deciding how to proceed with our fellow regulators.
    Chairman Johnson. Mr. Lyons, should the capital rules alone 
fix all that went wrong in the financial crisis? Can more 
capital prevent all future financial crises? If not, what role 
should capital rules play and what role should other Wall 
Street reform rules play in mitigating future crises? Are you 
coordinating these rulemakings within and between the agencies 
to make sure the rules are complementary and not duplicative?
    Mr. Lyons. Mr. Chairman, capital is important, although we 
do not believe it is the sole solution. We have coupled that 
with regulation. And we believe strong supervision is a process 
that should be in place as well. So we really look at it as 
three legs--capital buffers and liquidity buffers as well, 
coupled with regulation, that we are discussing today, the 
proposals, the capital proposals, as well as strong 
supervision.
    Chairman Johnson. Mr. Gibson, what steps have you taken or 
will you take in consultation with insurance experts at the 
State and Federal level to better understand the differences 
between insurance companies and banks to ensure that the 
capital requirements in Basel III are well calibrated for the 
business of insurance?
    Mr. Gibson. Congress has required us to set consolidated 
capital requirements for bank holding companies and savings and 
loan holding companies, including those that choose to own an 
insurance company, and our goal has been to set strong capital 
requirements for both the quality and quantity of capital. We 
have been consulting with a wide range of insurance experts 
since we got this responsibility as a result of the Dodd-Frank 
Act, and our responsibility for savings and loan holding 
companies began last year. Our supervisors have been 
responsible and have been supervising savings and loan holding 
companies, including those with insurance operations, since 
last year, and they have been working with the State insurance 
regulators, as they do that supervision.
    So far we have been learning a lot from insurance experts. 
Of course, the Federal Reserve has supervised insurance 
operations of bank holding companies for a long time, so we had 
a base of expertise to build on. We have received a lot of 
comments from insurance industry experts on many aspects of 
this proposal and we definitely intend to consider those 
comments carefully as we move forward.
    Chairman Johnson. And, last, Mr. Lyons, with all the 
concerns that have been expressed, what time next year do you 
expect to issue a final rule? And how much time will you give 
companies to begin complying with the new requirements?
    Mr. Lyons. Senator, it is a complex rule. We acknowledge 
that. In respect of that, we extended the comment period, and 
we have extended the effective date. We have, as George 
indicated earlier, over 1,500 comments that we have received. 
We are going to review each one of those, each and every one, 
and we will take those into consideration when we work on a 
final proposal and move forward.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you again, Mr. Chairman.
    My basic question to all three of you, and I will quote: 
``The Bank of England Governor, Mervyn King''--and you are 
familiar with him, and a lot of us have a lot of respect for 
him--``and several other prominent economists in the world have 
said that the Basel III capital standards are insufficient to 
prevent another crisis.''
    Do you disagree or do you agree? And if so, why? We will 
start with you, sir, Mr. Gibson.
    Mr. Gibson. We feel that our proposal to raise the quality 
and quantity of bank capital is one of the most important 
pieces of the regulatory reform agenda.
    Senator Shelby. I agree with that.
    Mr. Gibson. Not by itself the complete agenda but one of 
the most important pieces, because we saw that capital leading 
into the crisis was too low.
    Senator Shelby. What about liquidity, too? Is that very 
important at the right time with capital?
    Mr. Gibson. Yes, we agree that liquidity reform is also an 
important piece of the reform agenda.
    Senator Shelby. Mr. Lyons.
    Mr. Lyons. I would agree with what Michael has said, that 
capital and liquidity are both important, and we have 
surrounded the proposal here with--the Fed has prudential 
heightened standards that they are going to implement, and the 
FDIC will have resolution and living wills under Title 2. So we 
supplemented the regulation with what we think is stronger 
supervisory goals as well.
    Senator Shelby. Mr. French.
    Mr. French. Senator, we agree that strong capital is an 
important check on excessive leverage in the system, and it is 
a vital shock absorber for losses that come along.
    Senator Shelby. That is what it is for, is it not?
    Mr. French. That is correct. So we believe that this 
proposal is a significant strengthening of our current rules.
    Senator Shelby. So all three of you believe that the 
capital requirements of Basel III, if implemented properly, 
will be sufficient? At least we hope so, right? Is that fair? 
Nobody knows, but that is what you believe, right?
    Mr. French. It provides substantial additional comfort 
compared to what we have now.
    Senator Shelby. OK. Mr. Gibson, let me ask you this 
question, if I can: Traditionally, insurance companies have 
been regulated at the State level. The proposed Basel III rules 
will apply to financial holding companies that own insurers. In 
devising capital requirements for holding companies that own 
insurance businesses, how much did the Fed rely on State 
insurance capital requirements, if they did? And explain how 
the Fed is coordinating its oversight of financial holding 
companies that own insurers with State insurance regulators who 
are the primary regulators?
    Mr. Gibson. Our supervision and regulation of savings and 
loan holding companies that have insurance operations is 
limited to the holding company level.
    Senator Shelby. And how many would that be, roughly?
    Mr. Gibson. There are a couple dozen of those.
    Senator Shelby. OK.
    Mr. Gibson. There are, of course, thousands of insurance 
companies in the U.S., and all insurance companies are subject 
to State-based regulation at the level of the insurance 
operating company. What we have the authority to do is for the 
holding company to set consolidated capital requirements and to 
consolidate its supervision.
    With respect to working with State insurance regulators, 
our supervisors are looking at the holding company risks, and 
they work closely with the State insurance regulators who are 
focused on the risks in the insurance business.
    Senator Shelby. Let me pose this to all of you: The FDIC 
Director, Thomas Hoenig, recently gave a speech when he stated, 
and I will quote: ``The poor record of Basel I, II, and II.5 is 
that of a system fundamentally flawed. Basel III is a 
continuation of these efforts, but with more complexity.''
    I have already quoted the Bank of England Governor. I also 
understand the Bank of England Executive Director of Financial 
Stability, Andrew Haldane, gave a speech and restated that the 
Basel framework ``has spawned startling degrees of complexity 
and an over-reliance on probably unreliable models''--which is 
always dangerous.
    My question to all three: Is the Basel framework too 
complex to really work? And will you know? And what testing did 
you do or will you do to determine the accuracy of the Basel 
III models? What did those tests show? Because I think we need 
to know. You have got a new regime here. We want it to work. 
Will it work? We do not know yet. It has not been tested. Mr. 
Gibson?
    Mr. Gibson. One aspect of our capital proposal is that, in 
addition to a risk-based capital requirement, we also have a 
leveraged capital requirement which is based on a simpler 
measure of capital to assets.
    Senator Shelby. Explain that as compared to the risk-based.
    Mr. Gibson. The risk-based applies----
    Senator Shelby. The leverage-based.
    Mr. Gibson. The leverage-based, it just takes the amount of 
assets on your balance sheet as the denominator, with no risk 
weighting or models involved. We feel that by having both of 
those, it is more effective at having strong capital than just 
one by itself, because one by itself could be gamed or 
arbitraged. By having the risk-based requirement, which is more 
complicated, in combination with the leverage ratio, you get 
some protection against that gaming by banks.
    Senator Shelby. Mr. Lyons.
    Mr. Lyons. Senator, I will address your impact analysis. We 
did do an impact analysis similar to the Fed, but different. We 
did come up with a similar conclusion that most of the banks, 
the vast majority of banks will hold capital well above the 
required minimums. And we will do further analysis as we go 
through. We asked the commenters for what they have determined 
based on the estimator tool that we provided them, what type of 
impact it would be to them as well. So we will take that into 
consideration as we move forward.
    Senator Shelby. Mr. French.
    Mr. French. I do want to say that the FDIC as an 
institution has long supported simple and objective capital 
standards.
    Senator Shelby. And they have worked, too, have they not?
    Mr. French. We believe so. And we have always supported the 
leverage ratio and pushed hard to have simple floors under the 
risk-based requirements. In fact, there is a Basel Committee 
subgroup that is looking at ways to simplify these rules going 
forward, and we actually chair that group. So we----
    Senator Shelby. Will you share that data with this 
Committee, you know, what you are doing and how you are doing 
it and why?
    Mr. French. Yes, we will. In terms of whether this will 
work, we are satisfied that, in terms of the overall level and 
the direction of this proposal, it is a substantive and 
meaningful strengthening of our capital system. We have to 
deal, of course, with all the specific comments about the 
specific aspects and the complexity.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you, Mr. Chairman. I want to 
follow up on Senator Shelby's questions, but also note that 
Senator Shelby was just as astute when Basel II was before the 
Committee, and through his efforts and Senator Dodd's efforts, 
Basel II was not embraced as enthusiastically here as in 
Europe, and when the crisis came, we were in a little bit 
better position, so thank you.
    Senator Shelby. Two big skeptics right here.
    Senator Reed. Well, you are a big skeptic; I am a half-size 
skeptic. He is a very big skeptic.
    Let me ask a basic question, Mr. Gibson, and that is, what 
legal obligation do we have to follow Basel III? It seems a 
very simple-minded question, but for the record, please.
    Mr. Gibson. We do not have any legal obligation. It is not 
a treaty. But the member countries of the Basel Committee agree 
that having a global level playing field is important and 
holding banks in all the Basel Committee countries to high 
standards is important, and if we agree on what those standards 
are, we'll have an easier time doing that.
    Senator Reed. OK. So that we can shape to a degree our 
response to the Basel III concept, as you are doing right now, 
but also there is sort of a quid pro quo. If we are not 
stringent and we are not thoughtful about it, then we cannot 
expect the same process from other major financial countries.
    Mr. Gibson. That is right. We do tailor the Basel Committee 
agreements to our local U.S. circumstances, and we are allowed 
to do that within the boundaries that are set up by the Basel 
Committee.
    Senator Reed. One of the flaws with Basel II was that there 
was a great deal of reliance on internal risk models, that 
banks were essentially grading themselves on their capital. Is 
that still prevalent in the Basel III proposals?
    Mr. Gibson. The risk-weighting scheme in Basel II is 
maintained in Basel III. The change that is coming in Basel III 
is higher quantity and quality of capital requirements.
    One thing that we are doing in the Basel Committee is a 
study across Basel Committee countries of how the risk weights 
are actually put into practice, and that is one of the Basel 
Committee's major initiatives for 2012 and is currently being 
worked on. We hope to learn from that process how each country 
is doing in terms of its banks' implementing the standards in a 
consistent way because, as you say, that is very important for 
the standards to work.
    Senator Reed. Indeed, but one of the problems which I think 
we mentioned with Basel II was that banks were--they were 
categorized, but they were the ones who were essentially 
evaluating their capital status. The regulators, of course, 
come in and review that. Is that still prevalent in Basel III? 
Is that still going to be the case?
    Mr. Gibson. Yes, that aspect of Basel has not changed.
    Senator Reed. Thank you very much.
    One of the other points that was made--and I am just 
reinforcing again a point that Senator Shelby made--Mr. French, 
you talked about and Mr. Gibson responded also about the 
importance of the leverage ratio as well as the risk-asset 
ratio. And that is something that we have had in the United 
States, but this is a new aspect for Basel III for the whole 
community. Is that correct?
    Mr. French. It is new in the Basel framework. We have had 
it in the U.S. really since the early 1980s, and then formally 
in the early 1990s. But it is an important step for the Basel 
Committee. I think it reflects their recognition from the 
crisis that many of the models really did need some objective 
constraints underneath them.
    Senator Reed. And let me ask you another question, which 
comes to some of the comments I have heard, particularly from 
community banks, and that goes to--and you mentioned it, Mr. 
French, that now instead of being able to rely upon a rating by 
a credit rating agency, there has to be essentially an analysis 
by the institution of the creditworthiness of the value of the 
asset on the book or the liability. Is that one of the issues 
of complexity that is being raised by community banks?
    Mr. French. To some extent, yes. There are certain aspects 
that have not changed and, in fact, important aspects. If the 
bank holds a Treasury or an agency mortgage-backed security or 
whatever, it is going to keep doing what it has always done, 
which is use a 20-percent risk weight. If it does have a 
private label mortgage-backed or structured type of product, it 
is going to have to assess the structure of the securitization 
and apply a formula that would set capital based on the 
seniority of the tranche.
    So there is some concern about that. I would say, however, 
that a number of the servicer reports and vendors are starting 
to put out information that the banks can apply pretty easily.
    Senator Reed. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, sir, and I thank each of you for 
being here to testify. You know, we have read through the 
proposals and looked specifically at the sovereign debt issue, 
and you can almost imagine a lot of folks, heads of States in 
Basel sipping champagne and thinking about a way to create a 
mechanism where the banks around the world are there to create 
money, loan them money through all the prolific ways that all 
of us have right now.
    I am fascinated that sovereigns have a zero weighting, 
period, unless they are in default and it goes from zero to 
150. So that would mean that our great thinkers around the 
world have decided that, for instance, today they would 
encourage U.S. banks to hold Spanish debt and have a zero risk 
weighting. I would just like for you all to explain to me how 
we have succumbed to a situation where all sovereign debt has a 
risk weighting of zero, especially during these times and what 
we are watching happen around the world.
    Mr. Lyons. Senator, I will try to answer that. I do believe 
sovereign ratings--we do apply the OECD rating to those 
institutions, so there is a rating that is assigned to them. I 
would have to double-check and get back to you on the rate. You 
are saying it is a zero rate or 150. I am thinking there may be 
something in between there based on the rating of the 
sovereign, but I would have to double-check for you.
    Senator Corker. I do not think that is the case. Would one 
of the other two of you want to respond to that?
    Mr. French. I think you characterized it fairly. For 
practical purposes, most of the countries would be zero until 
default. Theoretically, there would be some other countries 
that have a rating that would not get them zero, but they are 
few and far between for practical purposes. I think you raise 
clearly a very important point, and I think my only observation 
might be, for practical purposes here in the U.S., many of 
those obligations are going to be held in trading accounts of 
large banks where these proposals are irrelevant. They are 
going to be holding capital against market risk for those 
things. You know, if we had had the ability to use credit 
ratings, we might have been able to apply those. We were not 
allowed to do that by Dodd-Frank. So we have, you know, these 
minds sitting around the table, and we have to figure out how 
is the U.S. going to assign grades to different countries. And 
it is a challenge, so we acknowledge the issue.
    Senator Corker. I understand that these may well be in 
trading accounts, but I guess as people are looking at capital 
and they are trying to create a way of having return, and they 
know they can buy Spanish debt or some other debt of a 
sovereign and get a much greater yield, and you guys are not 
going to ping them on it, then you are basically encouraging 
them to buy risky sovereigns. It just makes no sense to me. And 
it is my understanding it was the Europeans that pressed us 
hard to move into this regime, and I am just wondering why we 
did not push back, especially since they are basically using 
their banking system to fund all the problems that they are 
having right now.
    I mean, this seems to me something that would have just 
jumped out with alarms and we would have said this makes no 
sense and we are not going to be a part of this.
    Mr. French. You raise very good points. Again, here in the 
U.S., I think if we actually had a bank that was applying zero 
risk weights, we would probably be on them from the supervisory 
perspective. There would be probably securities depreciation in 
their account if they were certain countries, and we would----
    Senator Corker. So they really could not rely upon the 
Basel. You are saying that if they actually were an 
international type institution and they were relying on Basel 
and following those rules, you would come at them a different 
way and say, well, no, you really cannot do that?
    Mr. French. I think that for practical purposes, it is, 
again, the trading accounts of large banks. I do not think our 
smaller banks in the U.S. are for the most part buying these. 
That is my understanding. But I certainly take your points 
about----
    Mr. Gibson. I would just add that in our most recent stress 
test, we did impose a special look at exposures to a European 
stress event that did look at potential losses on those types 
of securities. So there are other tools besides regulatory 
capital rules to make sure that banks do not have excessive 
concentrations in sovereign debt.
    Senator Corker. I have two more questions, and I really 
would just make a comment on the second one, and then ask a 
third and try to be very brief. The complexity issue is 
fascinating. I noticed with the mortgage issues you all have 
got this grid with eight boxes, and you grade mortgages, and I 
actually thank you for doing that and appreciate it, and I hope 
we sync that up with the QM and QRM, other issues that are not 
part of Basel that are coming down the road.
    But on credit card debt and auto debt and corporate debt, 
you do not do that. I just find that fascinating, that what you 
did, you spent, it sounds like, you know, months and months and 
months grading different mortgages, which I think we would all 
agree would be a good idea--subprime would be very different 
than prime with low debt ratios, but you do not do that on 
auto, you do not do that on corporate, you do not do that on 
credit. I just find it fascinating because each of them have 
those same complexities. If one of you would just answer why, 
then I will move to my last question and stop.
    Mr. Gibson. I would say that the risk weights that you are 
describing are the ones in the standardized approach, and it is 
difficult to come up with a standardized simple way to risk-
weight corporate loans. But for the most advanced largest banks 
that are on the more complicated approaches, they would be 
required to do a more sophisticated analysis of corporate and 
other exposures.
    Senator Corker. OK. And then the countercyclical. I know 
Senator Warner, my friend from Virginia, we spent a lot of time 
a couple of years ago looking at how we can put in place 
something that is countercyclical. I actually think it is a 
novel idea that you guys have come up with this countercyclical 
buffer. No offense to you, but it seems that regulators always 
sort of are having fun when things are great and then they 
over-regulate on the downside and create self-fulfilling 
prophecies both ways.
    I am just curious as to how we are going to have the wisdom 
to do this. I kind of like the idea, but, for instance, we have 
a pretty dovish Fed right now that does not want to create any 
panic. The Fed is probably the entity that would be doing this. 
Would they be willing to signal to folks that there is 
excessive debt out there? And would that create some kind of 
negativity in the marketplace, especially during a time like 
right now? Are you going to do it with algorithms, or is 
somebody just going to wake up one day and say, gosh, we have 
got excessive debt out there, and now all of a sudden everybody 
has a 2.5 percent charge?
    I am just curious as to how you think that is going to 
work.
    Mr. Gibson. We are not in the situation of using the 
countercyclical buffer yet, so we have not completely spelled 
out the ways that we would do that. We would look at a variety 
of data indicators to try to get a sense of credit growth in 
the economy and whether there is excessive leverage and 
excessive credit growth. And then, you are right, it would be a 
tough call to actually turn on the countercyclical capital 
buffer. We have agreed that that is part of what the Basel 
Committee wants every country to be doing, and the burden will 
be on us to actually do it when the time comes. We are still 
pretty far from the point in the cycle where we will have to do 
that, but we are looking ahead and trying to think about how we 
would do that, what data we would look at, and so on.
    Senator Corker. Well, we look forward to greater input, and 
I thank you for the time, Mr. Chairman.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and I want to 
thank all of you. I think we were all struggling with you to 
figure out how we get this right as well as with some level of 
simplicity as capital markets get more and more complex. I want 
to follow up on a couple items my friend Senator Corker raised.
    First of all, how do we make sure--just as I think you 
pressed the point about sovereign debt, on one level it is good 
that there will be other regulatory tools that would be 
available if banks were purchasing this debt and it was still 
zero weighted. But if we are thinking about this in the 
international context, how do we make sure that we are not 
still at a competitive disadvantage as American banks versus 
other banks that may not have that same level of scrutiny?
    Mr. Gibson. Generally, I would say that we gain a 
competitive advantage by having strong capital and strong 
regulation in place. So the fact that we might be tougher on 
our banks, for example, through the stress test regime, at 
least currently that seems to be perceived as a strength in the 
market that U.S. banks have that strong regulation. We 
definitely worry about level playing field considerations, and 
as I mentioned earlier, the Basel Committee is spending more 
effort now looking at how countries are implementing 
regulations in different jurisdictions, which they did not used 
to spend very much time on. We think that is important to 
follow up on, but generally, we would argue that stronger 
regulation is a strength.
    Senator Warner. Well, and the flip of that or kind of the 
converse of that is--and the Chairman has already raised this, 
and Senator Toomey and I put a letter together that I think the 
majority of our colleagues signed that said--and I think you 
all have responded in certain ways to make sure that we protect 
and not have a single one-size-fits-all for all our 
institutions. We are clearly unique in terms of the number of 
community-based banks, and I would like you to comment on, 
within these Basel negotiations, is America's voice being heard 
another about making sure there is not a one-size-fits all? And 
then, two, while we have talked about these capital standards 
ranging from 6 to 13, it is also based upon their SIFI 
designation. You know, are we also making sure that the kind of 
unique aspect of our regional banks are getting their voices 
heard?
    Mr. Gibson. The first point I would make in response is 
that the Basel agreements only apply to internationally active 
banks, so in the U.S. we are only committed to strictly apply 
the Basel standards to the largest internationally active 
banks.
    Senator Warner. But as we know, what oftentimes happens 
with regulators is something that is legally applied for a big 
bank up here, by default becomes kind of best practice 
standards and trickles down then oftentimes into very small 
institutions that cannot deal with all of this additional 
regulatory burden.
    Mr. Gibson. Sure, and we are resisting that in our proposal 
because we have proposed different things, in some aspects, for 
community banks than for large banks. We are definitely trying 
to implement regulatory reform in a way that minimizes the 
burden on community banks. That is a key priority for us 
because they do, as you say, play a critical role in the 
financial system and in their local communities.
    Senator Warner. And comment on regional banks here in terms 
of how they will fit among that continuum as well?
    Mr. Gibson. We draw a line at $250 billion in assets or $10 
billion of foreign exposure, and that is the line above which 
we say----
    Senator Warner. It is either in or out.
    Mr. Gibson. You are in or out, we strictly apply Basel 
standards above that line.
    Senator Warner. A couple more questions I want to get to. 
One is--Senator Corker has left, but we did spend a lot of time 
about this notion of countercyclical, and we think it makes 
sense. Again, I have to say personally figuring out what is 
that trigger is a challenge. But I guess the other question I 
would have is even if we get that trigger right, if we think 
again from the standpoint of regional community-based banks, 
are we willing to drill down below a national level? Because we 
may very well have a roaring economy or a sinking economy at 
the national level, but a region that is doing much better. 
Think back to the 1990s in terms of some of the challenges that 
were faced in the Southwest and then, conversely, when that 
region roars. How do we make sure--and I am not being critical 
here because getting it right and then getting it right down at 
a lower level, but are you thinking if we get countercyclical, 
can we take it down one level lower to a regional base?
    Mr. Gibson. We have only proposed applying the 
countercyclical buffer from Basel to the large, internationally 
active banks in this proposal, and we have asked for comment on 
that, and we have gotten some comments that suggest we should 
apply it more widely than that. We are going to consider those 
comments as we go forward.
    Senator Warner. I think that if it ends up floating into 
best practices, we need to consider, obviously, plus with a 
large economy, but lots of regional economies that may or may 
not track national data.
    Mr. Gibson. Right, and that is challenging to apply a 
national capital standard against regional shocks.
    Senator Warner. And the only thing--and, again, my time is 
up, and I will just put this--maybe you can comment later 
because I do not want to impose on other time. But, you know, 
we urged you to make sure we look at the insurance business, 
but as we think about those assets and think about some of 
those assets that are held on a much longer time horizon than 
banks are, trying to get that right as well is going to be a 
challenge, and I hope we can visit on it.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thanks, Mr. Chairman, and thanks, 
gentlemen, for being with us today. I, too, would like to 
follow up a little bit with the train of thought that Senator 
Corker was pursuing.
    You know, when you think about some of the things that have 
been happening recently in the context of, specifically, I am 
referring to massive deficits, there is a long history, of 
course, of examples of the use by Governments of financial 
repression to help fund their own irresponsible fiscal policy. 
I would argue that the explicit exemption of U.S. Treasurys 
from the Volcker Rule is an example of financial repression in 
the United States. And when I hear that we have pressure from 
the Europeans to put zero capital weight into sovereign debt 
that intuitively to most Americans sure as heck does not sound 
like it is anything close to risk free, why should we be 
confident that there is not politically motivated financial 
repression creeping into this regulatory regime?
    Mr. French. I will start. I think that from my experience, 
at least in the U.S. rulemaking process, we have a lot of very 
smart people on the staff who are trying to come up with 
proposals that would be an appropriate way to deal with 
sovereigns, and facing a number of constraints. One is that the 
U.S. is not allowed to use an external ratings-based approach 
by statute, and then, you know, when you put out the different 
ideas on the table, they all seem to be a challenge in one way 
or another to implement or pose issues.
    My impression is not that there is some external constraint 
or influence on the process. It is really more of, frankly, a 
technical challenge, and this was the way that it came out, and 
we recognize fully and embrace the concern that you point out 
that, from a risk-based capital standpoint, it is not zero. 
But, again, as a practical matter, many of these are dealt with 
in trading portfolios in our banks and in other ways.
    So I am not disputing the concern about getting the risk 
wrong in this instance, but----
    Senator Toomey. It just seems an extraordinary coincidence 
that something so counterintuitive to suggest that some of the 
most troubled economies of Europe could have a zero risk 
weighting, at the same time when it is very convenient for 
there to be incentives for banks to hold this debt strikes me 
as a little troubling.
    Let me ask another question. We have heard a lot of 
discussion about the complexity of this, and one of the things 
that I am concerned about is the cost of compliance. Do we know 
what it is going to cost the average American bank to comply 
with this? Say a regional bank--actually, a better example 
would be a small community bank, a $1 billion bank. What will 
it cost to comply, to figure out, evaluate this rule? This rule 
is 900-some-odd pages. Is that right? Do we know what that cost 
would be?
    Mr. French. Each of us did some required statutory analysis 
of the cost issue, and I can speak to the FDIC's analysis. We 
looked at the cost of both the Standardized Approach Notice and 
the Basel III Notice. The costs in the area of the Standardized 
Approach were probably the most pronounced, in our estimation, 
and included the cost of implementing the mortgage provisions, 
gathering the data, some estimate for the cost of doing the 
securitization framework. And I think it came out to--you know, 
I think we concluded that for purposes of the statutory 
criteria, it will have a significant effect on a large number 
of small banks that it would. And so it was----
    Senator Toomey. That it would what?
    Mr. French. That it would have a significant cost, and that 
conclusion was based on a criteria of whether the cost would 
exceed in the first year more than 2.5 percent of noninterest 
expense or more than 5 percent of annual salary and bonus.
    So based on the estimates that we did, we concluded it 
would have that cost effect. We asked for comment as part of 
the NPR on that analysis, and we are now getting comments that 
shed, I think, a great deal of additional light on the 
compliance costs, and those are some of the things that we have 
to address now as we proceed.
    Senator Toomey. Well, one of the things that really 
concerns me is that it is very likely to be very significant 
compliance costs for institutions that nobody has ever 
suggested are systemically significant and why we would, you 
know, force this cost on these banks in that context. I hope 
that you will seriously reconsider this.
    The last question I had is: I know that you have announced 
that the original planned effective date of January 1 is not 
going to be the date. What sort of date should the regulated 
firms expect to have a final rule that that will be effective?
    Mr. Lyons. Senator, as I said during my testimony and 
questions from Chairman Johnson, we received over 1,500 
comments. We are reviewing each comment. It will take time, and 
we have extended the implementation date because of the number 
of comments we received. And we will need time to go through 
those. I hesitate to give you an exact date, but I guarantee 
you we are working hard and diligently to come out with a 
proposal as soon as possible.
    Senator Toomey. OK. Thanks, Mr. Chairman.
    Chairman Johnson. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman, and I would like 
to pick up right where Senator Toomey was leaving off in his 
second to the last question. These conversations can sound so 
clinical in Washington, but at home, what I am seeing among my 
community banks is, on the one hand, deep--well, first of all, 
the observation that Senator Toomey made that nobody has said 
that the community banks are in any way responsible for the 
cataclysm that we went through, and that is true. There were 
some, as Mr. French said, that failed--that is certainly true--
but did not create systemic risk in the way the large 
institutions did. And the observation of the panel today that 
community banks already have a high capital base. So from their 
perspective, the question is what problem are you trying to 
solve here. And they are worried that they are catching it from 
two ends. One is that the capital requirements will diminish 
the opportunity for equity investors to earn a return on 
investment and their investment in community banks. And I do 
not need to tell you how difficult capital formation already is 
for these guys. And, on the other hand, the cost of compliance, 
which I appreciate very much, Mr. French, your response that it 
appears based on your review that the costs will be significant 
and you are going to have to revisit that.
    My worry, talking to folks in Colorado, is that they really 
worry that they are going to be driven out of business, and 
that this is going to lead to a consolidation that is going to 
mean many fewer community banks serving our rural areas in 
particular in the State. And I wonder, first of all--you know, 
if the market is driving consolidation, that is one thing. But 
if it is because of the regulatory burden that is solving a 
problem that does not actually exist in the community banks, 
that may not be the greatest answer.
    So I guess what I am looking for is some assurance that you 
really have heard the comments that you have reflected back to 
us today and that we are actually going to significantly change 
these rules to make sure that we are not driving that kind of 
consolidation.
    Mr. French. Certainly, from the FDIC's perspective, I would 
say that our Chairman, our Acting Chairman Gruenberg, has been 
out in outreach meetings throughout the year. We have had 
meetings specifically on these notices with bankers around the 
country, many face-to-face meetings, and gotten a lot of 
letters. So, you know, as I said, we are the primary supervisor 
of the majority of community banks in this country, and we do 
not want to create a situation where the compliance costs make 
them uncompetitive or unable to serve their important roles in 
the local community.
    So, you know, I think we are all in a position of looking 
at all these letters, looking at all the individual issues 
where bankers have raised concerns, and deciding how to 
proceed, and we take the concerns very seriously.
    Senator Bennet. Mr. Gibson.
    Mr. Gibson. I would agree with that. We have heard a lot of 
comments from community banks, and especially on this issue of 
the costs of implementation. We are learning a lot from the 
comments about particular aspects of the proposal that may have 
a disproportionate impact there. And we are going to carefully 
look at that as we move forward.
    Senator Bennet. And that is, I think, an important point, 
too, that their view is, whether it is well intentioned or not, 
it is having a disproportionate effect because they cannot 
spread those fixed costs over their institution in the same way 
that a larger institution is able to do it. That seems like a 
very reasonable concern to me. And I have, Mr. French, asked--
because it is not of use to me in interacting with you when I 
get general complaints from people, too much regulation, too 
much this, too much--but when people can be specific and go to 
the trouble of being specific about it, I find it very helpful. 
I have asked my Colorado bankers to pull that information 
together, how many pages, how many lawyers, how much money are 
they going to spend, all that kind of stuff. And I would love 
the chance to share that with your director when we receive it 
in the hope that we can help inform the work.
    Mr. French. We would be glad to do that.
    Senator Bennet. OK. One last question, before I run out of 
time, on the European situation. I will ask Senator Warner's 
question in a slightly different way. What is your confidence 
that the European institutions actually are in a position to 
comply with Basel III? You talked about the competitive 
advantage that the stronger balance sheets have in the United 
States. How about our worry that the counterparts in Europe 
just are not ready to do this?
    Mr. Gibson. The European Union is at the same phase in the 
process as we are of proposing rules, having some draft rules 
out for comment but not yet final. So they are also not going 
to meet the January 1, 2013, implementation date, but one thing 
that is built into the Basel III agreement is a very long 
transition period out to 2019. We feel that is going to be 
sufficient to allow most banks to cope with the higher capital 
requirements that are coming.
    Senator Bennet. I am out of time, but I will send you my 
last question.
    Mr. Chairman, thank you very much.
    Chairman Johnson. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman. Thank you, members 
of the panel, for being with us this long today.
    I share the concerns of a number of Members of the 
Committee about insurance companies and wanted to say something 
about that and then ask a question about higher capital 
requirements.
    Congress clearly intended for regulators to respect the 
State-based insurance system, regulatory system, when crafting 
capital rules. I believe that we provide the Fed with 
sufficient authority and flexibility under Dodd-Frank to do so. 
I appreciate you said you are taking seriously the concerns we 
have raised about insurance in carefully considering comments 
about this issue. My staff has asked for the Fed's opinion 
regarding your legal authority. I would hope in the interest of 
transparency you would provide us with that information, if you 
would. And I appreciate your working with us on that.
    Mr. Gibson. OK.
    Senator Brown. My colleagues have already pointed out that 
rules can be manipulated. In addition to being too easily 
gamed, I am concerned the current 3-percent Basel III leverage 
ratio or the 4-percent U.S. leverage ratio are simply much too 
low. Mr. Haldane of the Bank of England, Sheila Bair, Tom 
Hoenig, and Anat Admadi at Stanford say that the ideal leverage 
ratio should be somewhere--not 3 or 4 percent but somewhere 
between 2 and 5 times the current proposal.
    Section 165 of Dodd-Frank requires the Fed to establish 
special enhanced rules for both risk-based capital and pure 
leverage for the biggest systemically important banks.
    Will you consider establishing stronger leverage ratios 
than that provided in Basel III for the largest banks, the 
largest six or so banks, $800 billion to $2.2 trillion, $2.3 
trillion, whatever the largest is now, either on an individual 
or group basis? Does that make sense to you?
    Mr. Gibson. What we have proposed under Section 165 for 
domestic banking organizations--we have already put that 
proposal out for comment, and we have received a lot of 
comments, including in the capital aspect of that. We are 
working through those comments, and I cannot prejudge where we 
will wind up with that, but we have heard the comments that you 
have mentioned calling for significantly higher capital. It is 
one of the comments we have received.
    Senator Brown. Can you tell me anything about your internal 
discussions about the inadequacy, if that is how you see it, of 
the 3 percent or 4 percent from Basel III or from us?
    Mr. Gibson. As I said before, we feel like having the 
leverage ratio in the U.S. was a valuable complement to the 
risk-based ratio, so I cannot really address your comment about 
the exact level of the leverage ratio that is the right one. We 
definitely found that having the leverage ratio prohibited some 
of the gaming of regulatory capital charges that took place 
elsewhere. We are very supportive of continuing with both the 
risk-based and the simple leverage ratio.
    In terms of what the level of the leverage ratio should be, 
that is included in this proposal that we are discussing here. 
We have got a lot of comments on that, including the comments 
that you are mentioning, and we are going to review those 
carefully as we move forward.
    Senator Brown. Any thoughts, Mr. French or Mr. Lyons, on 
that?
    Mr. French. I would only add that, as I said, I think the 
FDIC has had an institutional predisposition to fairly simple 
and objective capital standards, including the leverage ratio. 
So in terms of the level, we have not engaged at that in terms 
of the specifics, and, again, I think as Mr. Gibson said, it 
would not be appropriate for me to prejudge where we might come 
out on the level.
    Senator Brown. Mr. Lyons.
    Mr. Lyons. I would only point out, Senator, that those are 
minimums, and the expectation typically is in a bank that they 
would be higher than the minimums. And we have, as Mike 
indicated, surrounded that with heightened prudential 
standards, so there are other aspects of supervision that we 
can employ to provide for additional capital in institutions.
    Senator Brown. OK. Thank you. Mr. French said that his 
proclivity is toward simpler rather than more complex. I am 
concerned Basel III allows the largest banks--and I mentioned 
six largest, but wherever you cut them off in terms of size--to 
use complex internal models to determine capital requirements 
for transactions that were some of the most troublesome during 
the crisis--collateralized debt obligations, over-the-counter 
derivatives, all of that. It makes it easier for the largest 
banks to game the system because of their complexities, to use 
their own models to make themselves look less risky than they, 
in fact--or at least I think they are. Meanwhile, small banks 
that are already better capitalized do not engage in these 
complex transactions and do not have a team of lawyers to help 
them comply in so many cases.
    The Basel II modeling approach that we adopted relied on 
banks to calculate their own capital rules. How does this new 
framework, as you have proposed, reduce the ability of the 
biggest banks to use complexity and opacity to their advantage? 
I would like all three of you to answer that, but Mr. French 
especially.
    Mr. French. Well, one aspect that we have not discussed 
here today which is important to mention is the requirements of 
Section 171 of the Dodd-Frank Act known as the Collins 
amendment, and that is an important and relevant provision for 
purposes of this discussion. Basically the requirement is that 
the large banks and any bank over a certain size would need to 
compute not only those Advanced Approach models-based capital 
requirements, but also the general capital requirements that 
any other bank would need to compute and hold to the higher of 
the two standards. So it basically is sort of a horizontal 
equity-type provision in the law that does have a significant 
effect in terms of constraining the potential benefits of those 
models.
    Senator Brown. Mr. Lyons, are you concerned about the big 
banks gaming the system to look like they are less risky?
    Mr. Lyons. I think, as George indicated, the supplemental 
leverage ratio is based on average assets, so it does not 
involve models and risk-based. It is strictly on the average 
assets of the balance sheet as well as off-balance-sheet items 
as well. So in addition to a risk-based method, we have a 
balance sheet method as well. Couple that with supervision and 
recent--not recent but since the crisis, interagency guidance 
that we issued on modeled expectations of what banks should go 
through and the risk management they have around that, I think 
we supplemented the ratios with stronger supervision.
    Mr. Gibson. I would just add that a lot of the complexity 
in our capital rules and in these proposals is aimed at the 
complex activities of the largest banks. So sometimes complex 
activities require complicated analysis. However, that only 
applies to the banks that are engaged in those trading 
activities, and, in fact, Basel III raised the capital 
requirements or is in the process of raising the capital 
requirements on a lot of those activities precisely because of 
some of the concerns that you mentioned. So the complexity is 
really being put on the banks that have the capacity to deal 
with it. Community banks would not be subject to these 
requirements because they do not engage in those sorts of 
complex activities.
    Senator Brown. Well, thank you to each of you. I think many 
of us on this Committee are concerned about an outside 
examiner's ability to understand the huge number of 
transactions. The six biggest U.S. megabanks have some 14,000 
combined subsidiaries. Someone calculate that to do the same 
audit at the largest banks as you do at--the same level of 
audit that you do at the community banks would take some 70,000 
auditors. And, you know, the belief that these banks are--I am 
not asking for comment here, but the belief that these banks 
are too big--not just too big to fail but too big to manage and 
too big to regulate stays with us. And I think anything you can 
move toward coming out of Basel III that brings a simpler 
system that the banks cannot game is so very important.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you again to our witnesses for 
being here today. Your hard work on these complicated 
rulemakings is appreciated, especially as we all work to make 
our financial system more stable.
    This hearing is adjourned.
    [Whereupon, at 3:58 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
    After the financial crisis, Congress passed Wall Street Reform into 
law, and asked our regulators to strengthen the financial sector by 
enhancing capital standards and prudential supervision. In addition, 
Federal banking agencies negotiated the Basel III accords, an agreement 
with other Nations' banking agencies. The proposed capital rules under 
discussion today implement that agreement. These are complex rules, and 
today we will hear from the experts at the Fed, OCC, and FDIC about the 
important goals they hope to accomplish with these proposed rules, as 
well as their potential impact.
    Since the rules were proposed in June, Members of this Committee 
have heard a number of concerns about these rulemakings from former 
Federal regulators, current State regulators, industry participants and 
academics. These concerns are documented in over 2,000 comment letters 
submitted by a wide range of stakeholders including community banks and 
insurance companies.
    While most agree the higher levels of capital are appropriate, the 
details of how to improve bank capital will have a broad impact and 
must be closely examined.
    Specifically, with respect to community banks, I appreciate that 
your agencies have undertaken a number of efforts to explain the 
proposed rules to community banks, including issuing a capital 
estimation tool for banks to evaluate how the proposed rules will 
impact them. However, I am concerned that the proposed risk weights 
could have an adverse impact on small banks' ability and willingness to 
offer mortgages, especially in rural areas. I look forward to hearing 
more today about how the risk weights were determined for mortgages, 
securitizations, and mortgage servicing rights, and what kind of impact 
these rules might have on our housing market.
    I also want to hear more about the proposed treatment of 
``accumulated other comprehensive income.'' At a time where interest 
rates cannot get much lower, we should pay particular attention to how 
new rules could make interest rate management more difficult, 
especially for smaller banks.
    In addition, I am concerned by the treatment of the business of 
insurance in the proposed rules. Before moving forward with applying 
these rules to insurance companies, the banking agencies should take 
additional time to work with State insurance regulators, the Federal 
Insurance Office, and the independent insurance expert on the Financial 
Stability Oversight Council to better understand the insurance 
accounting framework and risk-based capital model currently used. This 
feedback should then be used to develop a capital framework that is 
more suitable for financial institutions engaged in the traditional 
business of insurance, and give these companies appropriate time to 
implement the new framework.
    A strong capital base is a key component of a resilient financial 
system. This was a major lesson of the financial crisis in 2008, and 
your agencies are to be commended in your efforts to steadily 
recapitalize the U.S. banking system and establish new standards. But 
while capital can serve as an important loss-absorbing buffer, capital 
alone will not prevent financial firms from failing and potentially 
threatening the broader financial stability. It is important that 
capital standards are well calibrated with other supervisory 
requirements, including new rules mandated by the Wall Street Reform 
Act. I look forward to hearing how each of your agencies is 
coordinating the ongoing rulemakings to ensure all of the pieces fit 
together.
    I believe we share the same goal of strong and harmonized capital 
rules to promote financial stability, but before moving forward it is 
important to understand how the regulators have considered, and will 
continue to consider, the concerns being raised. I encourage your 
agencies to take the appropriate amount of time needed to get these 
rules right.
    Last, I want to applaud you all for the steps your agencies took 
last week to provide clarity on the Basel III rules' effective date. 
This was well in advance of the previously announced January 1, 2013, 
effective date and I believe the announcement was very useful to those 
companies working to comply with these rules.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR SHERROD BROWN
    Thank you, Mr. Chairman, for holding this very important hearing, 
and thank you to the witnesses for their testimony.
    We are here to discuss the U.S. implementation of three new 
proposed rules on capital and leverage.
    Capital rules simply require banks to fund themselves with their 
own money--usually in the form of equity--instead of other people's 
money, borrowed from the markets, regulators, or U.S. taxpayers.
    Prior to the financial crisis, financial institutions relied upon 
too much borrowed money and flawed models that used smoke and mirrors 
to make their investments appear riskless.
    But they were not riskless. And when their assets declined by even 
the smallest amount, they were unable to pay their debts.
    As a result, the taxpayers were forced to step in and cover Wall 
Street's risky bets.
    I am encouraged that there is now broad, bipartisan agreement among 
the Members of this Committee that adequate bank capital is an 
essential tool for protecting the financial system.
    Basel III is clearly an improvement over Wall Street's old way of 
doing business, but I question whether the new rules get it right.
    First, are we properly defining and measuring capital?
    Clearly there were shortcomings in the regulators' measurement of 
capital prior to the crisis.
    At the height of the crisis, seemingly healthy institutions had 
respectable levels of regulatory capital.
    According to the FDIC's Thomas Hoenig, in 2007, the 10 largest 
banks had average risk-based capital ratios of 11 percent. But their 
tangible equity ratios were about 2.8 percent.
    As a result, markets lacked confidence in these institutions.
    According to Federal Reserve Governor Dan Tarullo, this was because 
investors ignored the more exotic instruments that qualified as capital 
and instead looked at tangible equity.
    This experience provides strong support for the view that we should 
focus on pure equity as a measure of a bank's health.
    Second, are the levels sufficient to lessen the likelihood and 
severity of future crises?
    The Bank of England's Andy Haldane estimates that global banks hold 
assets with average risk-weighting of 40 percent, meaning that the 10 
percent risk-weighted Basel III ratio would amount to leverage or 25-
to-1.
    Were a megabank's assets to decline by 4 percent under that 
scenario, it would become insolvent.
    A number of studies have shown that the optimal risk-weighted 
assets to capital ratios are considerably higher than those contained 
in Basel III.
    Banks had considerably higher capital before the creation of the 
financial safety net.
    So we know that the international 3 percent leverage ratio is much 
too low--prior its failure, Bear Stearns had leverage of 33 to one.
    The U.S. benchmark of 4 percent is also too low--Haldane estimates 
that institutions would have needed a minimum 7 percent leverage to 
have survived the financial crisis.
    My legislation, the SAFE Banking Act calls for 10 percent tangible 
equity to total assets, not adjusted for risk and including those held 
off-balance sheet.
    Third, have we created a system of complex rules on top of complex 
banks that are excessively complex and opaque?
    The six largest banks currently have a combined 14,420 
subsidiaries.
    Haldane has estimated that an average large bank would have to 
conduct more than 200 million calculations in order to determine their 
regulatory capital under the Basel II framework.
    Several million scenarios could arise from a large bank's trading 
book alone.
    The evidence suggests that these complex and highly calibrated 
measurements do not work.
    Haldane has found that simple measures of equity and leverage 
actually have predictive value that is ten times greater than that of 
complex risk-weighted asset measurements.
    And finally, are we too focused on community banks or traditional 
insurance companies, and not enough on Wall Street megabanks?
    According to Dr. Hoenig, in 2009, the 20 largest financial 
institutions on average funded themselves with a mix of 3.5 percent 
equity capital, as compared to an equity capital ratio of 6 percent 
held by the second tier of institutions.
    These megabanks can use more leverage because implicit Government 
support, where the market assumes that the Government will step in to 
prevent them from failing, provides subsidies and it puts true 
community banks--those with less than $10 billion in assets--at a 
disadvantage.
    These incentives can be counteracted by requiring megabanks to 
increase their capital buffers.
    I agree with Governor Tarullo that the proposed surcharges for the 
largest institutions are at the low end of the scale.
    We should do more to impose costs that will discourage banks from 
becoming ``too big to fail.''
    This will benefit taxpayers, and it will benefit the community 
banks that compete with unfairly subsidized megabanks.
    These are all important questions, because we must ensure that Wall 
Street has a prudent amount of its own money to cover its losses.
    Thank you, Mr. Chairman.
                                 ______
                                 
                PREPARED STATEMENT OF MICHAEL S. GIBSON
  Director, Division of Banking Supervision and Regulation, Board of 
                Governors of the Federal Reserve System
                           November 14, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify on the proposed 
interagency changes to the regulatory capital framework for U.S. 
banking organizations. In today's testimony, I will provide an overview 
of the proposed changes and the main themes arising from the public 
comment process, especially as they relate to community banking 
organizations and depository institution holding companies with 
insurance activities.
Overview of Proposed Changes
    The recent financial crisis revealed that the amount of high-
quality capital held by banking organizations in the United States was 
insufficient to absorb losses during periods of severe stress. The 
effects of having insufficient levels of capital were further magnified 
by the fact that some capital instruments did not absorb losses to the 
extent previously expected. While robust bank capital requirements 
alone cannot ensure the safety and soundness of the banking system, we 
believe they play a key role in protecting the banking system and 
financial stability more broadly.
    As demonstrated during the recent financial crisis, banking 
organizations with strong capital positions are better equipped to 
absorb losses from unexpected sources. Furthermore, strong capital 
positions help to ensure that bank losses are borne by shareholders, 
rather than taxpayers. The June 2012 interagency proposal to amend the 
bank regulatory capital framework applies the lessons of the crisis, in 
part, by increasing the quantity and quality of capital held by banks. 
\1\ For all banking organizations, the proposal would introduce a new 
common equity tier 1 capital requirement, raise existing minimum tier 1 
capital requirements, and implement a capital conservation buffer to 
increase bank resiliency during times of stress. The proposal also 
updates and harmonizes the existing capital rules with a standardized 
approach for the calculation of risk-weighted assets, incorporating a 
more risk-sensitive treatment for certain asset classes to address 
weaknesses identified in the capital framework in recent years.
---------------------------------------------------------------------------
     \1\ See, press release and proposal, www.federalreserve.gov/
newsevents/press/bcreg/20120612a.htm.
---------------------------------------------------------------------------
    For large, internationally active organizations, the proposal would 
introduce a supplementary leverage ratio, a countercyclical capital 
buffer, and would effectively raise the capital requirement by updating 
aspects of the advanced approaches risk-based capital rule. These 
amendments, along with other recent regulatory capital enhancements, 
will require the large, systemically important banking organizations to 
hold significantly higher levels of capital relative to other 
institutions. Under the proposal, savings and loan holding companies 
would, for the first time, be subject to consolidated capital 
requirements, as required by the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act). With this proposal, U.S. bank 
capital requirements would reflect international Basel III agreements 
reached by the Basel Committee on Banking Supervision as well as 
relevant domestic legislative provisions, including sections 171 and 
939A of the Dodd-Frank Act.
    In developing this proposal, the Federal Reserve sought to strike 
the right balance between safety and soundness concerns and the 
regulatory burden associated with implementation, including the impact 
on community banking. It is important to note that numerous items in 
this proposal, and in other recent regulatory reforms, are focused on 
larger institutions and would not be applicable to community banking 
organizations. These items include the countercyclical capital buffer, 
the supplementary leverage ratio, enhanced disclosure requirements, the 
advanced approaches risk-based capital framework, stress testing 
requirements, the systemically important financial institution capital 
surcharge, and market risk capital reforms.
Impact
    The Federal Reserve has assessed the impact of the changes proposed 
by this rulemaking on banking organizations and the broader financial 
system through domestic analyses and through its participation in cost-
benefit analyses performed by the Basel Committee on Banking 
Supervision. The Macroeconomic Assessment Group, a working group of the 
Basel Committee, found that among internationally active banks, the 
stronger capital standards proposed under Basel III would significantly 
lower the probability of banking crises and their associated economic 
losses, while having only a modest negative effect on gross domestic 
product and the cost of credit. \2\ Furthermore, these modest negative 
effects can be mitigated by the phase in of the standards over time, 
which is why we have included extensive transition periods for several 
aspects of the proposal. The Federal Reserve believes that the benefits 
of the proposed changes, in terms of the reduction of risk to the U.S. 
financial system and to the broader economy, outweigh the compliance 
costs to the financial industry and any costs to the macroeconomy.
---------------------------------------------------------------------------
     \2\ See, ``Assessing the Macroeconomic Impact of the Transition to 
Stronger Capital and Liquidity Requirements'' (August 2010), 
www.bis.org/publ/othp10.pdf; and ``An Assessment of the Long-Term 
Economic Impact of Stronger Capital and Liquidity Requirements'' 
(August 2010), http://www.bis.org/publ/bcbs173.pdf.
---------------------------------------------------------------------------
    In developing the proposal, each of the Federal banking agencies 
prepared an impact analysis of the proposed requirements on banking 
organizations that currently meet the minimum regulatory capital 
requirements, based on each agency's own key assumptions using 
regulatory reporting data. The Federal Reserve's analysis and 
assumptions are included as an attachment to today's testimony. \3\ The 
overall conclusion of these analyses was that the vast majority of 
banking organizations would not be required to raise additional capital 
because they already meet, on a fully phased-in basis, the proposed 
higher minimum requirements. In addition, approximately 90 percent of 
community banking organizations already have sufficient capital to meet 
or exceed the proposed buffer, thus avoiding restrictions on capital 
distributions and certain executive bonus payments. While many of the 
largest banking organizations do not already meet the proposed new 
minimums and the buffer on a fully phased-in basis, they are generally 
making steady progress toward meeting these standards before they are 
phased in. However, the Federal Reserve is mindful that other burdens 
exist for banks, such as systems changes and other compliance costs, 
which were outside the scope of our analysis.
---------------------------------------------------------------------------
     \3\ See, Attachment A--``FRB Impact, Methodology, and 
Assumptions''.
---------------------------------------------------------------------------
Public Comments on the Proposed Changes
    The Federal banking agencies released the proposed rulemaking in 
early June with an extended comment period ending on October 22, giving 
interested parties more than 4 months to comment on the proposal rather 
than the typical 2- or 3-month comment period. The agencies have 
received thousands of comment letters from the public, including 
banking organizations of all sizes, trade groups, academics, public 
interest advocates, and private individuals. \4\ Agency staffs are 
reviewing these letters carefully and will continue to do so in the 
coming weeks. Comments include general views on the proposal, including 
concerns regarding overall complexity and burden, as well as 
suggestions for specific policy changes and technical modifications 
aimed at better conforming the proposal to market practices.
---------------------------------------------------------------------------
     \4\ See, comment letters, www.federalreserve.gov/apps/foia/
ViewComments.aspx?doc_id=R-1442&doc_ver=1.
---------------------------------------------------------------------------
    The most common specific areas of concern noted by the financial 
industry, regardless of institution size, relate to the proposed 
treatments of accumulated other comprehensive income, otherwise known 
as AOCI, and residential mortgage exposures. The proposed treatment of 
AOCI would require unrealized gains and losses on available-for-sale 
securities to flow through to regulatory capital as opposed to the 
current treatment, which neutralizes such effects. Commenters have 
expressed concern that this treatment would introduce capital 
volatility, due not only to credit risk but also to interest rate risk, 
and affect the composition of firms' securities holdings. The proposed 
treatment of AOCI is part of the Basel III Accord and is meant to 
better reflect an institution's actual loss-absorption capacity; 
however, we are analyzing commenters' concerns and will be assessing 
potential ways forward in this area as we finalize the rule.
    In light of observed high loss rates for residential mortgages 
during the crisis, the agencies proposed a modified treatment aimed at 
better differentiating the risks of these exposures, which are 
generally assigned preferential risk weights under our current 
approach. Commenters have expressed concern that the operational burden 
and compliance costs of the proposed methodology for risk weighting 
residential mortgage exposures and the higher risk weights for certain 
types of mortgage products will increase costs to consumers and reduce 
their access to mortgage credit. The Federal Reserve, along with the 
other Federal banking agencies, will take these and all comments 
received into consideration as we finalize the rule.
Community Banks
    The Federal Reserve believes capital requirements that improve the 
quantity and quality of regulatory capital would benefit the resiliency 
of all banking organizations regardless of size. However, as we 
consider comments from industry participants and other interested 
parties regarding the proposed regulatory capital requirements, the 
Federal Reserve, along with the other Federal banking agencies, will 
remain sensitive to concerns expressed by community banking 
organizations. The Board recognizes the vital role that community 
banking organizations play in the U.S. financial system. Community 
bankers typically have deep roots in their communities, allowing them 
to gain insights on their local economies and to forge strong 
relationships with customers. As a result, they can provide 
relationship-based lending to small businesses, families, and others in 
their local communities in a manner that larger institutions would find 
difficult to duplicate.
    When the agencies were developing these proposals, we recognized 
the need to carefully assess their impact on community banking 
organizations. While we conducted internal analysis to estimate the 
impact of the proposal (as discussed earlier), the Federal Reserve also 
recognized the importance of soliciting feedback directly from 
community banking organizations to understand more specifically the 
potential effects on their business activities. To facilitate review of 
the proposal, the agencies provided summaries of the requirements that 
were most relevant for community banking organizations, provided a tool 
to help smaller organizations estimate their capital levels under the 
proposal, and extended the comment period so that interested parties 
would have more time to assess the proposals and submit their comments. 
The Federal Reserve also engaged in substantial industry outreach to 
hear the views of community bankers and encourage submission of 
comments. For example, we held a series of ``Ask the Fed'' sessions 
aimed primarily at banking organizations supervised by the Federal 
Reserve that provided an overview of the proposals and gave bankers an 
opportunity to ask us questions. Following these sessions, which were 
attended by more than 3,000 bankers, we published a summary of answers 
to frequently asked questions in a new Federal Reserve publication for 
community bankers. \5\ Throughout the comment process, Board members 
and staff also met with various industry associations to clarify and 
discuss aspects of the proposal.
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     \5\ See, ``Community Banking Connections: A Supervision and 
Regulation Publication'' (Third Quarter, 2012), 
www.communitybankingconnections.org/articles/2012/Q3/CBCQ32012.pdf.
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    Through outreach efforts and as part of the comment process, 
community banking organizations have expressed concerns about 
particular elements of the proposed requirements, indicating that they 
do not adequately take into account the community banking business 
model and that some aspects would have potential disproportionate 
effects on their organizations. In particular, they have asserted that 
the proposed treatment of AOCI would have more of an impact on 
community banks because they have fewer available strategies to address 
the resultant capital volatility relative to larger institutions. In 
addition, they have expressed concern that the relatively higher risk 
weights assigned to certain mortgage products would penalize loan 
products that community banking organizations typically provide their 
customers. We will be mindful of these comments when considering 
potential refinements to the proposal and will work to appropriately 
balance the benefits of a revised capital framework against its costs. 
As we work toward finalizing the rule, we will seek to further tailor 
the requirements as appropriate for community banking organizations.
Insurance Holding Companies
    The proposal would apply consolidated risk-based capital 
requirements that measure the credit and market risk of all assets 
owned by a depository institution holding company and its subsidiaries, 
including assets held by insurance companies. In addition, the proposal 
would capture the risk of insurance underwriting activities included in 
the consolidated holding company capital requirements by requiring 
deduction of the minimum regulatory capital requirement of the relevant 
State regulator for insurance companies in the consolidated group. 
Currently, capital requirements for insurance companies are imposed by 
State insurance laws on a legal entity basis and there are no State-
based, consolidated capital requirements that cover the subsidiaries 
and noninsurance affiliates of insurance companies.
    The proposed capital requirements have been criticized by savings 
and loan holding companies that are not currently subject to 
consolidated capital requirements and that have significant insurance 
activities. Before mentioning some of the concerns raised by the 
industry, I would like to provide some background regarding the policy 
rationale for this proposal. The proposed application of consolidated 
capital requirements to savings and loan holding companies is 
consistent with the Board's long-standing practice of applying 
consolidated minimum capital requirements to bank holding companies, 
including those that control functionally regulated subsidiary 
insurance companies. Importantly, such an approach eliminates 
incentives to engage in capital arbitrage by booking individual 
exposures in the legal entity in which they receive the most favorable 
capital requirement.
    The proposed requirements are also consistent with the Collins 
Amendment in section 171 of the Dodd-Frank Act, which requires that the 
agencies establish consolidated minimum risk-based and leverage 
requirements for depository institution holding companies (bank holding 
companies and savings and loan holding companies) that are no less than 
the generally applicable risk-based capital and leverage requirements 
that apply to insured depository institutions under the prompt 
corrective action framework. At the same time, the proposal included 
provisions assigning specific risk weights to assets typically held by 
insurance companies but not depository institutions, namely policy 
loans and nonguaranteed separate accounts. These provisions were 
designed to appropriately risk weight assets particular to the 
insurance industry while at the same time ensuring that the proposals 
complied with section 171 of the Dodd-Frank Act and fulfilled the 
policy goals for consistent consolidated capital requirements 
previously described.
    Through the comment process, depository institution holding 
companies with insurance activities raised overarching concerns that 
the proposed regulatory capital requirements, which have primarily been 
developed for banking organizations, are not suitable for the insurance 
business model. In particular, they assert that the proposal does not 
appropriately recognize the longer-term nature of their liabilities and 
their practice of matching asset and liability maturities. They also 
assert that the proposal would disproportionately affect longer term 
assets held by many insurance companies, thus causing them to 
fundamentally alter their business strategy. These holding companies 
also have requested a longer transition period to implement 
consolidated capital requirements for the first time. Currently, those 
savings and loan holding companies that are also insurance companies 
report financial statements to State insurance regulators according to 
Statutory Accounting Principles and would have to begin reporting under 
the Generally Accepted Accounting Principles to comply with 
consolidated regulatory capital requirements, a change they assert 
would be unreasonably costly.
    The Federal Reserve takes these comments seriously and will 
consider them carefully in determining how to appropriately apply 
regulatory capital requirements to depository institution holding 
companies with significant insurance activities.
Timeline
    Given the breadth of the proposed changes, many industry 
participants have expressed general concern that they may be subject to 
a final regulatory capital rule on January 1, 2013, as contemplated in 
the proposals, and that this would not provide sufficient time to 
understand the rule or to make the necessary systems changes. 
Therefore, the agencies clarified on Friday that they do not expect to 
finalize the proposal by January 2013. \6\ We are working as quickly as 
possible to evaluate comments and issue a final rule that would provide 
the industry with appropriate transition periods to come into 
compliance.
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     \6\ See, ``Agencies Provide Guidance on Regulatory Capital 
Rulemakings'', www.federalreserve.gov/newsevents/press/bcreg/
20121109a.htm.
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    Thank you. I would be pleased to take your questions.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
                  PREPARED STATEMENT OF JOHN C. LYONS
Chief National Bank Examiner, Office of the Comptroller of the Currency
                           November 14, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for your invitation to testify.* I appreciate the 
opportunity to appear before you today to discuss the three proposed 
capital rules released by the Federal banking agencies (the Office of 
the Comptroller of the Currency (OCC), the Federal Reserve Board, and 
the Federal Deposit Insurance Corporation) in June, and in particular, 
the impact of those proposed rules on national banks and Federal 
savings associations and the stability of the U.S. financial system.
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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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    During the public comment period for these proposals that ended on 
October 22, 2012, the OCC and the other Federal banking agencies 
received approximately 1,500 comment letters from banks and Federal 
savings associations of all sizes. In light of the number of comments 
received and the important issues raised, the agencies announced last 
week that we do not expect to finalize the proposals by January 1, 
2013. While we are still in the process of reading and assessing the 
comments, it appears that the most fundamental issues have been raised 
by small banks and Federal savings associations (collectively, 
community banks) who have raised concerns about the applicability of 
the standards to them. Large banks have raised some of the same 
concerns as the community banks in terms of specific provisions 
contained in the proposals as well as additional concerns that are more 
technical in nature. Since our comment review process is in early 
stages, there are some limitations on the views I can express to avoid 
prejudging the outcome of the rulemaking process.
    We are committed to carefully considering all the comments we 
received; however, my testimony today will focus on some of the 
overarching concerns raised, and in particular, those raised by 
community bankers. In this regard, I want to assure you that we are 
very cognizant of the special role that smaller banks play in our 
communities and in providing financing of our country's small 
businesses and families.
    It's important to start by noting that the key reason that we 
issued the proposals was to improve the safety and soundness of our 
Nation's banking system. Strong capital standards have played an 
important role in moderating downturns and positioning the banking 
system to serve as a catalyst for recovery by ensuring that financial 
institutions stand ready to lend throughout the economic cycle. Access 
to credit by businesses and consumers is critically important to 
promoting and achieving financial stability. The recent crisis 
demonstrated the consequences of having insufficient capital in the 
banking system of the U.S. and around the world.
    The international Basel III agreements embraced many of the lessons 
learned during the crisis relating to regulatory capital. As members of 
the Basel Committee on Banking Supervision, the agencies worked to 
develop these enhanced capital standards, and the elements contained in 
the Basel III international framework are reflected in much of what we 
have proposed to apply in the U.S. As the OCC has previously testified, 
many of the key provisions and objectives of Basel III complement key 
capital provisions of the Dodd-Frank Act. \1\ However, in developing 
the U.S. capital proposals, we did not adopt a ``one-size fits all 
approach.'' We carefully evaluated each element of the Basel III 
framework and assessed to which banks it should be applied. In making 
these assessments, the agencies strove to calibrate the requirements to 
reflect the nature and complexity of the financial institutions 
involved. As a result, and consistent with the higher standards for 
larger banks required by section 165 of the Dodd-Frank Act, many of the 
provisions in the proposed rules are only for larger banks and those 
that engage in complex or risky activities; community banks with more 
basic balance sheets are largely or completely exempted. While the 
international Basel III agreements incorporate many of the lessons 
learned from the crisis, there were other key concerns that were not 
addressed in those standards, but which are important for promoting the 
resiliency and stability of the U.S. banking system--for example, the 
importance of better differentiating risks in mortgage lending. The 
U.S. proposed rules attempt to address these additional elements as 
well.
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     \1\ Testimony of John Walsh, Acting Comptroller of the Currency, 
before the Committee on Banking, Housing, and Urban Affairs, United 
States Senate (March 22, 2012).
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    We recognize that the proposed changes represent a comprehensive 
reform of regulatory capital standards and that the burden of reviewing 
and assessing the impact of new regulatory proposals can weigh 
especially heavily on community banks. This is why we have taken 
several measures to reduce the burden of this rulemaking process for 
these banks--in the way we organized the proposals, in outreach we have 
conducted, and by distributing a tool to help bankers assess the 
potential impact of the proposals on their capital requirements.
    We also appreciate that the burden for community banks lies not 
only in reviewing and understanding the proposals, but also in 
complying with them. In this context, it is important to remember that 
these are proposed rules, not final rules, and we are very interested 
in feedback on all aspects of these proposals. We posed over 80 
specific questions in the proposals, including questions related to 
regulatory burden, to elicit comments on all aspects of the proposals.
    In my testimony today, I will review briefly the proposed capital 
rules and then discuss three of the major issues raised in the comments 
we have received. These issues are: (1) the overall complexity of the 
proposals and questions about their applicability to, and 
appropriateness for, community banks; (2) the proposed treatment of 
unrealized losses (and gains) in regulatory capital; and (3) the 
treatment of real estate lending, particularly residential mortgages.
The Proposed Capital Rules
    In June, the agencies published three notices of proposed 
rulemaking (NPRs)--the Basel III NPR, the Standardized Approach NPR, 
and the Advanced Approaches NPR. \2\ Many, but not all, of the 
provisions contained in two of these three NPRs--the Basel III NPR and 
the Standardized Approach NPR--would apply to all banks, including 
community banks.
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     \2\ ``Regulatory Capital Rules: Regulatory Capital, Implementation 
of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, 
Transition Provisions, and Prompt Corrective Action'' (Basel III NPR), 
77 Fed. Reg. 52792; ``Regulatory Capital Rules: Standardized Approach 
for Risk-weighted Assets; Market Discipline and Disclosure 
Requirements'' (Standardized Approach NPR), 77 Fed. Reg. 52888; and 
``Regulatory Capital Rules: Advanced Approaches Risk-based Capital 
Rule; Market Risk Capital Rule'' (Advanced Approaches NPR) 77 Fed. Reg. 
52978.
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    The Basel III NPR would raise the quantity and quality of capital 
required to meet minimum regulatory standards. The Standardized 
Approach NPR seeks to address shortcomings in the way capital is 
aligned with risks in our current rules. The Advanced Approaches NPR 
would require the largest banks, when calculating regulatory capital, 
to take a more complete and accurate account of their risks, both on- 
and off-balance sheet. The Basel III and Advanced Approaches NPRs would 
significantly raise capital standards for large banks. Taken together, 
the three NPRs address the risks that contributed to the recent 
financial crisis and aim to enhance the safety and soundness of the 
U.S. banking system.
    Turning to the first of the three NPRs, the Basel III NPR 
concentrates largely on improving the reliability with which banks of 
all sizes can absorb future losses. It covers both the definition and 
the minimum required levels of capital. The NPR proposes a new measure 
for regulatory capital called Common Equity Tier 1 (CET1). This measure 
was introduced because some of the instruments that qualified under the 
broader existing definitions of regulatory capital did not dependably 
absorb losses during the crisis and the subsequent economic downturn.
    The proposed minimum standard for CET1 is 4.5 percent of risk-
weighted assets. On top of this, the NPR introduces two new capital 
buffers--the capital conservation buffer and the countercyclical 
buffer.
    The proposed capital conservation buffer is 2.5 percent of risk-
weighted assets, which would bring the effective CET1 requirement up to 
7 percent of risk-weighted assets. If a bank's CET1 ratio were to fall 
below that level, capital distributions and discretionary bonus 
payments would be restricted. This buffer would apply to banks of all 
sizes. During the recent financial crisis and economic downturn, some 
banks continued to pay dividends and substantial discretionary bonuses 
even as their financial condition weakened; the capital conservation 
buffer is intended to limit such practices and conserve capital at 
individual banks and for the banking system as a whole.
    The countercyclical capital buffer would apply only to the largest 
internationally active banks with assets in excess of $250 billion or 
foreign exposures of more than $10 billion. If activated by the 
agencies during the expansionary stage of a credit cycle, it could 
increase the minimum CET1 buffer by as much as another 2.5 percent of 
risk-weighted assets. The intent of the countercyclical capital buffer 
is to increase capital requirements during periods of rapid economic 
growth to reduce the excesses in lending and to protect against the 
effects of weakened underwriting standards during subsequent 
contractions.
    A separate surcharge on systemically important banks (the so-called 
``SIFI surcharge''), which is to be the subject of a separate 
rulemaking, could potentially add another 3.5 percent of risk-weighted 
assets to the risk-based capital requirements of the largest banks. The 
cumulative effect of the countercyclical buffer and the potential SIFI 
requirement is that during an upswing in the credit cycle, some large 
U.S. banks may be required to hold CET1 equal to as much as 13 percent 
of their risk-weighted assets. This difference in potential capital 
requirements--i.e., as much as 13 percent for large banks compared with 
7 percent for small banks--is intended to appropriately distinguish 
between their relative riskiness.
    In addition to risk-based capital standards, all U.S. financial 
institutions are subject to a leverage ratio that is designed to limit 
the overall amount that a bank can leverage its capital. In this 
regard, another way in which the proposals differentiate between banks 
of different sizes is the new supplementary leverage ratio introduced 
in the Basel III NPR. This ratio would be set at 3 percent of adjusted 
assets and would apply only to large internationally active banks. It 
is a more demanding standard than the existing 4 percent leverage 
requirement that already applies to all banks because it would include 
certain off-balance-sheet exposures. If this proposed change is 
implemented, small banks would be subject to only one leverage ratio 
requirement whereas large banks would have to meet two requirements.
    While the Basel III NPR focuses on raising the quality and quantity 
of capital, the Standardized Approach NPR seeks to ensure that riskier 
activities require more capital. To accomplish this, the Standardized 
Approach NPR would revise the capital treatment for exposures to non-
U.S. sovereigns, residential mortgages, commercial real estate, 
securitizations, and equities, and revise and expand the recognition of 
credit risk mitigation through collateral and guarantees. It also would 
introduce new disclosure requirements for banks over $50 billion in 
assets, as a means to impose additional market discipline. This 
disclosure requirement would not apply to community banks. Finally, the 
Standardized Approach NPR would remove external credit ratings from the 
capital standards in accordance with section 939A of the Dodd-Frank 
Act.
    The Advanced Approaches NPR applies only to the largest, 
internationally active banks. This NPR includes several changes to the 
calculation of risk-weighted assets for counterparty exposures so that 
sufficient capital will be required for this source of risk that was 
found to be significant during the recent financial crisis.
    In developing the June proposals, we were keenly aware of their 
potential impact, particularly on smaller banks throughout the country. 
The proposals include lengthy transition provisions and delayed 
effective dates to reduce the likelihood of adverse effects from 
increases in minimum required regulatory capital. For example, the 
revised risk weights included in the Standardized Approach NPR would 
not go into effect until 2015, and some of the transitional provisions 
related to capital instruments in the Basel III NPR extend out to 2022.
    We assessed the potential effects of the proposed rules on banks by 
using regulatory reporting data and certain key assumptions, which we 
noted in the preamble to the proposals. \3\ Our assessments indicate 
that many community banks hold capital well above both the existing and 
the proposed regulatory minimums. Many of the largest, internationally 
active banks already have strengthened their regulatory capital levels 
to meet the proposed minimum standards, particularly the new CET1 
standard, in order to meet market participants' expectations. 
Establishing higher minimum standards for all banks would reinforce the 
financial strength of the banking sector in the future and the 
stability of the U.S. financial system.
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     \3\ See the attached impact assessment on OCC-regulated banks and 
thrifts pursuant to the Unfunded Mandates Reform Act.
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    While we did consider the potential impact of the proposals on 
banks and the banking system as we were developing them, one of the key 
purposes of the notice and comment process is to gain a better 
understanding of the potential impact of the proposals on banks of all 
sizes. As previously noted, to foster feedback from community banks on 
potential effects of the proposals, the agencies developed and posted 
on their respective Web sites an estimator tool that allowed smaller 
banks to use bank-specific information to assess the likely impact on 
their individual institution.
Issues Raised in Comment Letters
1. Complexity and Applicability
    Commenters have raised an overarching concern about the complexity 
of the rules. More specifically, many comments have stated that the 
residential mortgage provisions in the Standardized Approach NPR are 
too complex. The NPR would separate mortgages into two risk categories 
based on product and underwriting characteristics and then, within each 
category, assign several new risk weights based on loan-to-value ratios 
(LTVs). Commenters were concerned about the costs associated with 
reviewing the existing book of mortgages and creating new systems to 
accommodate the more granular treatment of risks under the proposed 
approach. Under today's standards, all mortgages are assigned just one 
of two weights based on criteria that are relatively simple to 
administer.
    Commenters also raised concerns about complexities resulting from 
these capital proposals in combination with other regulatory 
initiatives. For example, banks of all sizes have raised concerns about 
the interactions between some of the provisions of the proposals and 
certain aspects of the Dodd-Frank Act. In particular, some commenters 
raised concerns about the interplay and overall effect that the 
proposed treatment for residential mortgages will have on the housing 
sector and availability of mortgage loans when combined with the 
pending regulations related to the definitions of ``qualified 
mortgage'' (QM) and ``qualified residential mortgage'' (QRM). \4\ In 
developing the treatment for residential mortgages, the agencies were 
mindful of the proposed definitions of QM and QRM and specifically 
requested comment on whether mortgages that meet the QM definition 
should be included in the lower risk category of residential mortgage.
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     \4\ Proposed regulations relate to the definition of ``qualified 
mortgage'' under regulations to be issued by the Consumer Financial 
Protection Bureau pursuant to the Truth in Lending Act (as revised by 
section 1412 of the Dodd-Frank Act), as well as the definition of 
``qualified residential mortgage'' under the securitization risk 
retention regulations to be issued jointly by the Federal banking 
agencies, FHFA, SEC, and HUD pursuant to section 941 of the Dodd-Frank 
Act.
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    Some commenters suggested that, given the complexity of the 
proposals, the best way to reduce regulatory burden on community banks 
would be to delay the implementation of the Standardized Approach NPR 
or to exempt community banks altogether from any new capital rules. In 
this vein, many commenters observed that community banks did not cause 
the crisis, and therefore should be exempted. We will carefully 
consider these comments as well as suggestions for improving the NPR.
    As noted earlier, we have taken steps to try to ease the burden of 
understanding the proposed set of rules for community banks. 
Nevertheless, we recognize that understanding and complying with the 
proposed rules could still be difficult for community banks. However, 
it is also important to recognize that the proposed rules are lengthy, 
in part, because they address banks of all shapes and sizes including 
banks involved in complex or risky activities, instruments, or lines of 
business. Banks engaged in these activities are not necessarily only 
the largest banks in the country but also can include smaller banks 
that engage in one or two complex or riskier activities. The proposed 
rules are comprehensive in their coverage and would therefore address 
such instances. The vast majority of community banks, however, will not 
need to consider many of these provisions.
    Finally, it is important to remember that over 460 smaller banks 
have failed in the aftermath of the financial crisis for a variety of 
reasons but, ultimately, because they did not have enough capital in 
relation to the risks that they took. The future safety and soundness 
of community banks will depend on their having sufficient capital going 
forward.
2. Unrealized Losses
    Another major issue raised by commenters is the inclusion of 
unrealized losses (and gains) on available-for-sale (AFS) debt 
securities in regulatory capital. Under our existing standards, such 
unrealized losses generally do not affect a bank's regulatory capital. 
\5\ In contrast, under the Basel III NPR, unrealized losses on AFS debt 
securities would directly impact a bank's regulatory capital. \6\ The 
rationale for the proposal is that ignoring unrealized losses has the 
potential to mask the true financial position of a bank. This is 
particularly true when a bank is under stress and when creditors are 
most likely to be concerned about unrealized losses that could inhibit 
a bank's ability to meet its obligations.
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     \5\ Under the existing standards for national banks in 12 CFR Part 
3, Appendix A, section 2, and for Federal savings associations in 12 
CFR 167.5, Tier 1 capital (national banks) and core capital (Federal 
savings associations) include ``common stockholders' equity.'' The 
definition of ``common stockholders' equity'' (listed at 12 CFR Part 3, 
Appendix A, section 1 for national banks and 12 CFR 167.1 for Federal 
savings associations) does not include unrealized gains or losses on 
AFS debt securities, but it does include unrealized losses on AFS 
equity securities with readily determinable fair values. Additionally, 
at 12 CFR Part 3, Appendix A, section 2(b)(5) (national banks) and 12 
CFR 167.5(b)(5) (Federal savings associations), the current rules also 
provide that up to 45 percent of pretax net unrealized gains on AFS 
equity securities can be included in Tier 2 capital. 12 CFR Part 3, 
Appendix A, section 2(b)(5) (national banks) and 12 CFR 167.5(b)(5) 
(Federal savings associations), further provide that unrealized gains 
and losses on other assets, including AFS debt securities, may be taken 
into account when considering a bank's overall capital adequacy, 
however, those gains and losses are not specifically included in the 
determination of a bank's regulatory capital ratios.
     \6\ Section 20(a)(1) of the proposal defines the elements that 
make up common equity tier 1 capital. Those elements include 
accumulated other comprehensive income (AOCI). Under U.S. GAAP, AOCI is 
comprised of four elements: (1) unrealized gains and losses on AFS 
securities (ASC Topic 320, Investments--Debt and Equity Securities); 
(2) gains and losses on derivatives held as effective cash flow hedges 
(ASC Topic 815, Derivatives and Hedging); (3) recognized actuarial 
gains and losses on defined benefit plans (ASC Topic 715, 
Compensation--Retirement Benefits); and (4) gains and losses resulting 
from currency translation of foreign subsidiaries financial statements 
(ASC Topic 830, Foreign Currency Matters). Under the existing capital 
standards, items one through three of AOCI are not included in 
regulatory capital.
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    Many bankers have commented that the inclusion of unrealized gains 
and losses on AFS debt securities could result in large and volatile 
changes in capital levels and other measures tied to regulatory 
capital, such as legal lending limits, especially when interest rates 
rise from the current low levels. Because these gains and losses often 
result from changes in interest rates rather than changes in credit 
risk, commenters also noted that the value of these assets on any 
particular day might not be a good indicator of the value of a security 
to a bank, given that the bank could hold the security until its 
maturity and realize the amount due in full (assuming no credit related 
issues).
    There are strategies available to banks to minimize some of these 
potential adverse effects on regulatory capital. Banks could increase 
their capital, hedge or reduce the maturities of their AFS securities, 
or shift securities into the held-to-maturity portfolio at the cost of 
reducing liquidity. However, commenters have stated that these 
strategies are all expensive and some strategies, such as hedging or 
raising additional capital, may be especially expensive and difficult 
for community banks. Commenters also have noted that under the proposed 
approach, offsetting changes in the value of other items on a bank's 
balance sheet would not be recognized for regulatory capital purposes 
when interest rates change. As a result, they stated that the proposed 
treatment could greatly overstate the real impact of interest rate 
changes on the safety and soundness of the bank.
    The agencies anticipated many of the concerns raised by commenters 
on this issue and included a discussion within the Basel III NPR 
requesting comment on potentially excluding from regulatory capital 
unrealized gains and losses associated with U.S. Treasury and GSE debt 
that can be expected to be driven solely by interest rates. Under such 
an approach, other unrealized losses and gains--for example, those 
associated with a corporate bond--would be recognized in regulatory 
capital. The OCC recognizes the importance of this issue and the 
challenges the proposed treatment could present to banks, particularly 
community banks, in managing their capital, liquidity, and interest 
rate risk positions and in affecting their ability to lend to their 
communities. We are committed to reviewing this issue carefully.
3. Real Estate Lending
    Another major concern of commenters relates to the proposed 
treatment for residential mortgages, and, to a lesser extent, 
commercial real estate. These provisions in the Standardized Approach 
NPR attempt to address some of the causes of the crisis--the collapse 
in residential mortgage underwriting standards and the prevalence of 
higher risk commercial real estate loans in some banks. Under our 
current rules, residential mortgages within a broad spectrum of risk 
attributes receive identical capital treatment. The treatment of 
commercial real estate loans is even less risk sensitive in that all 
such loans receive the same capital treatment. The proposed standard 
would raise the capital requirement for the riskiest mortgages and 
commercial real estate loans while actually lowering the charge on 
relatively safer residential mortgage loans.
    Some of the major issues that commenters have raised relate to: the 
treatment of residential balloon mortgages; recordkeeping issues 
associated with the proposed use of LTV ratios; the treatment of second 
liens and commercial real estate; and the potential impact on the 
housing market. With respect to residential balloon mortgages, the 
concentration of credit risk in the final balloon payment presents more 
risk to the lender than a loan that is fully amortized over a number of 
years--especially in situations where housing prices are not 
increasing. Therefore, the NPR proposes a relatively high capital 
charge. \7\ Many community bankers have questioned this assumption and 
noted their good experience with balloons and their wide use in 
managing interest rate risk and providing credit to established 
customers.
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     \7\ Under the proposals, balloon mortgages would receive risk 
weights between 100 and 200 percent, depending on the loan's LTV.
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    On the recordkeeping that would be required for LTVs, while higher 
LTV ratios are closely associated with higher risks of default, many 
community bankers have stated that going back through their existing 
portfolios to determine each loan's LTV at origination would be a 
burdensome task. For this reason, some have suggested applying the 
proposed treatment prospectively.
    Commenters have also raised concerns with the proposed treatments 
for second lien residential mortgages, such as home equity loans, and 
for certain commercial real estate loans. Similar to issues raised with 
balloon mortgages, commenters have expressed concern that the proposed 
rules do not adequately distinguish between prudent and more risky 
lending in such products.
    With respect to broader implications for the housing market, while 
the proposal would actually lower capital requirements for the safest 
mortgages, it would also raise capital requirements for riskier 
mortgages, which could raise the incremental costs of such mortgages. 
Commenters have raised concerns about the impact this might have on 
recovery of the housing sector.
    The OCC will pay attention to the unique and intimate knowledge 
that community banks possess of their customers and their lending 
relationships as we review the range of issues raised by commenters on 
our proposed treatment of real estate lending.
Conclusion
    Given the attention that the regulatory capital proposals have 
received recently, let me conclude by taking a moment to put these 
proposals in a broader perspective. Specifically, regulatory capital 
standards are an important component in a larger and more comprehensive 
process of bank supervision. They cannot and should not be viewed as a 
substitute for other assessments of a bank's financial position, 
including banks' internal capital adequacy assessments. They should be 
viewed as complementary to strong supervision of institutions, which 
requires in-depth and bank-specific analysis.
    With this as the context, I want to reemphasize that we are still 
in the process of reviewing the many comment letters that we have 
received. We will carefully assess the advantages and disadvantages of 
the alternatives suggested, including assessing regulatory burden 
against the value of more and better quality capital that is better 
aligned to actual risks. As the Comptroller said last month, ``As we 
finalize the rules, we will be thinking broadly about ways to reduce 
regulatory burden. As well as considering the substance of each 
provision, we will be taking a fresh look at the possible scope for 
transition arrangements, including the potential for grandfathering, to 
evaluate what we can do to lighten burden without compromising our two 
key principles of raising the quantity and quality of capital and 
setting minimum standards that generally require more capital for more 
risk.'' \8\
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     \8\ Remarks by Thomas J. Curry, Comptroller of the Currency, 
before the American Bankers Association in San Diego, California, 
October 15, 2012.
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    Given the vital role that banks serve in our national economy and 
local communities, we are committed to helping ensure that the business 
model of banks, both large and small, remains vibrant and viable. But, 
as a foundation for their future success, their capital has to stay 
strong too. If we can help ensure that, then we will be well along the 
road in ensuring that there is a stable and competitive banking system 
meeting household and business credit needs across America in the years 
ahead.






































































                  PREPARED STATEMENT OF GEORGE FRENCH
   Deputy Director, Policy, Division of Risk Management Supervision, 
                 Federal Deposit Insurance Corporation
                           November 14, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify today on behalf of 
the Federal Deposit Insurance Corporation (FDIC) regarding the recently 
proposed changes to the Federal banking agencies' regulatory capital 
requirements. The FDIC has had a longstanding concern for stronger bank 
capital requirements, and we welcome the opportunity to discuss these 
important proposals. The Federal banking agencies have received and are 
carefully reviewing a significant number of comments on these 
proposals.
Background
    As you know, in June of this year, the Federal banking agencies 
issued for public comment three separate Notices of Proposed 
Rulemaking, or NPRs, proposing changes to the regulatory capital 
requirements. Two of the NPRs would implement the recent Basel III 
standards developed by the Basel Committee on Banking Supervision and 
update our regulations in conformity with Section 939A of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). 
The first of these, the Basel III NPR, would strengthen the quality of 
bank capital and increase its required level for all institutions, 
including community banks. The Basel III NPR also includes selected 
Basel III capital requirements applicable only to banking organizations 
that use the agencies' Advanced Approaches capital regulation. The 
second NPR, the Advanced Approaches NPR, proposes additional 
requirements from the Basel III agreement and other Basel standards for 
these large Advanced Approaches organizations. The third NPR, referred 
to as the Standardized Approach NPR, proposes changes to the risk-
weighting of assets and replaces credit ratings in the agencies' 
capital regulations in accordance with Section 939A of the Dodd-Frank 
Act. This NPR would apply to all institutions. The comment period on 
all three NPRs closed on October 22, 2012. Also, in June of this year, 
the agencies finalized regulations that change the way banks with a 
large volume of trading activity calculate capital requirements for 
market risk.
    The agencies proposed the NPRs to address deficiencies in bank 
capital requirements that became evident in the recent banking crisis. 
A number of banking organizations failed or required Federal assistance 
during the crisis, and the U.S. Government provided capital, liquidity 
and guarantees to a significant portion of the financial sector, 
including depository institution holding companies and their 
affiliates. Since January 1, 2008, 463 FDIC-insured banks have failed.
    In light of this experience, strengthening bank capital 
requirements seems to be an appropriate and important step. All banks 
need strong capital to navigate periods of economic turbulence while 
continuing to serve their important role as financial intermediaries to 
the economy. The changes proposed in the NPRs are intended to address 
identified deficiencies in the existing capital regime and provide 
greater comfort in the capital adequacy of our banking system. At the 
same time, reviewing the numerous comments received will help us 
address concerns about the costs and potential unintended consequences 
of various aspects of the proposals.
    My testimony will describe the proposed rules in more detail, along 
with some of the most frequently identified concerns among the more 
than 1,500 comments we have received. It is worth emphasizing that the 
rulemaking process is ongoing and the agencies have not yet reached 
final decisions regarding how to address the various issues that have 
been raised with respect to the NPRs.
The Basel III NPR
    One of the critical lessons learned from the recent financial 
crisis was that high-quality, loss-absorbing capital is essential to 
ensuring the safety and soundness of financial institutions. As such, 
in the aftermath of the crisis, the FDIC and the other U.S. banking 
agencies participated in an intensive international effort to 
strengthen bank capital standards. The result of these efforts is the 
Basel III capital agreement. In broad terms, the Basel III capital 
standards aim to improve the quality and increase the required level of 
bank capital. Collectively, Basel III and other standards published by 
the Basel Committee address a number of features of capital regulation 
that allowed for an excessive use of leverage in the years leading up 
to the crisis.
    The FDIC Board of Directors voted to issue the Basel III NPR for 
public comment on June 12, 2012. The Basel III NPR proposes to 
strengthen the definition of regulatory capital to better absorb losses 
than under current rules, and to increase the required level of 
capital. These changes are proposed to be phased in over time. The NPR 
also includes selected requirements that apply only to banks using the 
agencies' Advanced Approaches capital regulation.
    The Basel III NPR proposes a number of changes to strengthen the 
definition of capital. The most important of these changes are 
described below.

    Under current rules, common equity is permitted to comprise 
        as little as half of Tier 1 capital, reducing the loss 
        absorbency of, and market confidence in, the regulatory capital 
        measure. The Basel III NPR proposes a new risk-based capital 
        requirement for ``common equity Tier 1,'' a form of regulatory 
        capital that would be more reliably available to absorb losses.

    Intangible assets, except for a limited amount of mortgage 
        servicing rights, are deducted from capital in the Basel III 
        NPR. Intangible assets, which are generally difficult to sell 
        in order to absorb losses, are subject to limits in current 
        capital rules, but the NPR makes these limits more stringent.

    Deferred tax assets are subject to stricter limits in the 
        Basel III NPR. These assets, as analysts noted during the 
        crisis, may have little value when a bank is losing money and 
        capital support is most needed.

    Investments in the capital instruments of other financial 
        institutions that exceed specified thresholds are deducted from 
        capital in the Basel III NPR. It was evident in the recent 
        crisis that inclusion of large amounts of such investments in a 
        banking organization's capital can create a chain of 
        interconnected losses that exacerbates a banking crisis.

    Minority interests in consolidated subsidiaries are subject 
        to stricter limits in the Basel III NPR. Minority interests can 
        absorb losses in a specific subsidiary but may be unavailable 
        to absorb losses throughout an organization.

    Trust Preferred Securities (TruPS) are subject to a phase-
        out from Bank Holding Companies' (BHC5) Tier 1 capital in the 
        Basel III NPR (a 3-year phase-out for large BHCs and a 10-year 
        phase-out for smaller BHCs). TruPS can absorb losses in a 
        failure, but do not absorb losses on a going-concern basis. The 
        application of this proposed change to smaller BHCs, and the 
        change to the treatment of accumulated other comprehensive 
        income described below, have been frequent subjects of concern 
        from commenters.

    Accumulated other comprehensive income (AOCI), which 
        includes unrealized gains and losses on available-for-sale 
        (AFS) securities, is proposed to be included in the calculation 
        of capital under the Basel III NPR. \1\ Incorporating these 
        gains and losses as proposed in the NPR may result in a better 
        indicator of the bank's capital strength if it is forced to 
        sell these securities in an adverse economic environment.
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     \1\ Under existing regulations, unrealized gains and losses on AFS 
debt securities are not included in regulatory Tier 1 capital. 
Unrealized losses on AFS equity securities with readily determinable 
fair value are included in Tier 1 capital, while a portion of 
unrealized gains on AFS equity securities can be included in Tier 2 
capital.

    We are carefully considering the comments we have received on each 
of these proposed changes to the definition of capital.
    As noted above, the Basel III NPR proposes to establish a new risk-
based capital requirement for ``common equity Tier 1'' capital. Under 
the NPR, banks would need to hold common equity Tier 1 capital in an 
amount that is at least 4.5 percent of risk-weighted assets in order to 
be considered ``Adequately Capitalized.'' The NPR also proposes to 
increase by two percentage points the minimum and ``Well Capitalized'' 
levels for the Tier 1 risk-based capital ratios that are part of the 
agencies' Prompt Corrective Action (PCA) regulations.
    The Basel III NPR also proposes a capital buffer incorporating a 
sliding scale of dividend restrictions for banks whose risk-based 
capital ratios are less than 2.5 percentage points higher than the 
regulatory minimums. The purpose of the buffer is to encourage banks to 
maintain a cushion of capital above the regulatory minimums so they 
will be able to continue to lend during periods of economic adversity 
without breaching those minimums. The Basel III buffer is similar to 
the statutory requirement that the agencies' PCA regulations include a 
capital ratio threshold for banks to be considered ``Well 
Capitalized.''
    In addition, the Basel III NPR requires banks that use the Advanced 
Approaches capital regulation to comply with a supplementary leverage 
ratio that includes certain off-balance sheet items in the denominator. 
The FDIC views the leverage ratio as a foundational measure of capital, 
and we are highly supportive of its inclusion in the Basel framework. 
The complexities specific to the Basel III leverage ratio, however, are 
mainly relevant for very large institutions with extensive off-balance 
sheet activities. For that reason, the agencies have proposed that the 
Basel III leverage ratio would be a supplementary requirement, and only 
applied to banks using the Advanced Approaches capital regulation. The 
existing U.S. leverage ratio requirements would remain in effect for 
all U.S. banks.
    The Basel III NPR also requires Advanced Approach banking 
organizations to hold additional capital in the form of a 
``countercyclical buffer'' if the agencies determine that the banking 
industry is experiencing excessive credit growth. The NPR indicated 
that the countercyclical buffer initially would be set at zero, with 
the agencies acting jointly to raise that level, if and when credit 
conditions warranted putting this buffer into effect. If a 
determination was made that the buffer was necessary, the amount of the 
buffer could be as much as 2.5 percent of risk-weighted assets. The 
countercyclical buffer would serve to provide additional capital for 
the losses that often follow a period of excessive credit growth, and 
may itself serve as a check on excessive growth. Again, the NPR 
indicates that the countercyclical buffer would only be in effect when 
credit conditions warrant and would be zero at other times.
    The minimum capital ratios and capital buffers proposed in the 
Basel III NPR were developed as part of a Basel Committee effort, in 
which the agencies participated, to estimate the amount of bank capital 
needed to absorb losses in severe economic scenarios including the 
losses experienced in banking crises in different countries over time. 
The results of this analysis were published in October, 2010. \2\ The 
results suggest that bank capital ratios at the levels agreed to by the 
Basel Committee and proposed in the Basel III NPR would provide 
reasonable assurance that banks would be able to absorb losses during a 
period of economic adversity while continuing to be able to lend--and 
certainly greater assurance than exists under the current rules.
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     \2\ ``Calibrating Regulatory Minimum Capital Requirements and 
Capital Buffers: A Top-Down Approach'', October, 2010, Basel Committee 
on Bank Supervision; http://www.bis.org/publ/bcbs180.htm.
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    While working as part of the Basel Committee to develop the capital 
ratios that were proposed in the Basel III NPR, the agencies were 
mindful that while the requirements should be sufficient to enable 
banks to withstand a period of economic adversity, they should not be 
so high as to choke off prudent lending or normal economic activity. 
The agencies participated in international efforts to evaluate the 
potential effect of the higher bank capital requirements on economic 
activity. This work focused on two issues. One issue is the potential 
costs to the broader economy of an insufficiently capitalized banking 
system. Experience suggests that banking crises have consistently been 
followed by large and long-lasting reductions in economic activity. The 
other--and competing issue--is the costs that higher capital 
requirements might impose by increasing the cost of credit and reducing 
the volume of lending.
    The literature reviews and other analysis conducted as part of 
these international efforts generally concluded that within the range 
of capital requirements being considered, the economic benefits of 
higher capital requirements from reducing the frequency and severity of 
banking crises would exceed the economic costs resulting from a modest 
increase in the cost of credit. \3\ This analysis supports the overall 
conclusion that an increase in bank capital requirements from current 
levels is warranted. Precrisis increases in leverage permitted by the 
current capital rules did stimulate financial institution growth and 
earnings for a time, but the real economy ultimately suffered a 
significant cost when the financial cycle turned. In addition to the 
financial institution failures and Government assistance mentioned 
earlier in this testimony, the U.S. economy experienced a loss of over 
eight and a half million payroll jobs as a result of the recession, and 
it suffered a 35 percent decline in home prices as well as over 10 
million new foreclosures. The decline in employment and economic 
activity reduced revenues at all levels of Government, with fiscal 
effects that reverberate back to the real economy.
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     \3\ ``An Assessment of the Long-Term Economic Impact of Stronger 
Capital and Liquidity Requirements'', August, 2010; Basel Committee on 
Bank Supervision; http://www.bis.org/publ/bcbsl73.htm, and ``Assessing 
the Macroeconomic Impact of the Transition to Stronger Capital and 
Liquidity Requirements (MAG Analysis),'' December, 2010, Financial 
Stability Board and Basel Committee on Bank Supervision; http://
www.bis.org/publ/othp12.pdf.
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    While we view strengthening bank capital requirements as an 
appropriate goal to reduce the likelihood and severity of future 
banking crises, the agencies also are mindful that the proposals in 
these three NPRs represent significant change. The review of comments 
that is now underway is expected to shed considerable light on the 
potential for unintended consequences associated with specific aspects 
of these proposals.
Advanced Approaches NPR
    In addition to the Basel III NPR, the FDIC Board of Directors 
approved a separate NPR on June 12 that proposes a number of 
enhancements to the calculation of risk-weighted assets for the large, 
complex banks using the Advanced Approaches. This NPR proposes to 
implement aspects of Basel III that are designed to improve and 
strengthen modeling standards, the treatment of counterparty credit 
risk, credit risks associated with securitization exposures, and 
disclosure requirements. The proposal also contains alternatives to 
credit ratings consistent with Section 939A of the Dodd-Frank Act. The 
proposals in this NPR would strengthen the existing Advanced Approaches 
capital rules, particularly those related to capital requirements for 
derivatives.
    The FDIC has had a longstanding concern about the reliance in the 
Advanced Approaches rule on a bank's own models and risk estimates. 
Section 171 of the Dodd-Frank Act (the Collins Amendment) addresses 
this concern by placing a floor under the Advanced Approaches capital 
requirements that ensures that the Advanced Approaches capital 
requirements are not less than the requirements that are generally 
applicable to other banks.
Standardized Approach NPR
    The third NPR, the Standardized Approach proposal, includes a 
number of proposed changes to the calculation of risk-weighted assets 
in the agencies' general risk-based capital rules. The proposal also 
includes alternatives to credit ratings consistent with Section 939A of 
the Dodd-Frank Act. The capital requirements proposed in the 
Standardized Approach NPR are separate and distinct from those under 
the Basel III framework.
    The Standardized Approach proposal was designed to address 
shortcomings in the measurement of risk-weighted assets that became 
apparent during the recent financial crisis. In part, this is addressed 
by implementing certain changes based on the Basel II Standardized 
Approach contained in the Basel international regulatory capital 
standards and by replacing credit ratings consistent with section 939A 
of the Dodd-Frank Act. The proposed risk-weightings and segmentation 
methodologies for residential mortgages were developed by the Federal 
banking agencies in response to issues observed during the financial 
crisis. Among other things, the proposed rule would:

    revise risk weights for residential mortgages based on 
        loan-to-value ratios and certain product and underwriting 
        features;

    increase capital requirements for past-due loans, high 
        volatility commercial real estate exposures, and certain short-
        term loan commitments;

    expand the recognition of collateral and guarantors in 
        determining risk-weighted assets;

    remove references to credit ratings; and

    establish due-diligence requirements for securitization 
        exposures.

    We have estimated that the large majority of insured banks would 
meet the capital requirements resulting from the combined 
implementation of the Basel III NPR and the Standardized Approach NPR. 
The attachment to this testimony describes the methodology for these 
estimates and the results for banks in different size groups. These 
estimates suggest that for most insured banks, the proposals would not 
result in a need to raise new capital. It should be emphasized that 
these are estimates, and that institutions themselves will have better 
information about the specific factors used in the proposed capital 
calculations than the agencies currently collect in financial reports. 
In particular, our estimates did not attempt to address the extent to 
which institutions might feel the need to hold additional capital 
buffers beyond those specifically proposed, for example, to offset 
future changes in AOCI. Our review of the public comments is expected 
to shed additional light on such issues.
Final Market Risk Rule
    On June 12, the FDIC Board of Directors also approved the final 
regulation making improvements to the Market Risk Rule. This final 
regulation, which takes effect on January 1, 2013, addresses important 
weaknesses of the current Market Risk Rule to reflect lessons learned 
in the financial crisis. Leading up to the crisis, low capital 
requirements under the current Market Risk Rule encouraged institutions 
to place illiquid, high-risk assets in their trading books. Large mark-
to-market losses on these assets played an important role in fueling 
the financial crisis during its early stages. The final regulation 
requires an appropriate increase in the stringency of the Market Risk 
Rule that will better address such risks.
    This final rule applies only to the largest institutions that have 
significant trading activities. It is based on reforms that were agreed 
to internationally with the Basel Committee's 2009 revisions to the 
Basel II market risk framework. These revisions are part of what is 
generally referred to as the Basel II.5 reforms.
    Concerns have been expressed that the Market Risk Rule, while 
improved, is still too reliant on internal models. The idea of 
establishing a simple, nonmodeled and higher minimum capital floor for 
all trading book capital requirements is worthy of further study, and 
is in fact being considered as part of a fundamental review of trading 
book capital requirements being conducted by the Basel Committee.
Outreach and Comments
    As the primary Federal supervisor for the majority of community 
banks, the FDIC is particularly focused on ensuring that community 
banks are able to properly analyze the capital proposals and assess 
their impact. Since the Basel III NPR and the Standardized Approach NPR 
would affect all banks, the FDIC undertook an outreach agenda to assist 
community banks in analyzing the impact of the proposals.
    First, both the Basel III NPR and the Standardized Approach NPR 
contain a relatively short and concise addendum designed to aid smaller 
banks in identifying and understanding the aspects of the proposal that 
would apply to them.
    Second, FDIC staff hosted six community bank capital outreach 
sessions, one in each of the FDIC regional offices. Each session 
included an FDIC staff overview of the NPRs that identified the most 
significant changes for community banking organizations, and a 
question-and-answer session for the bankers in attendance.
    Third, the FDIC posted an on-demand video on its Web site that 
contains the same information provided by the FDIC in the live outreach 
sessions. Copies of the materials provided to bankers at the live 
outreach sessions are also posted online.
    Fourth, FDIC staff hosted a national call to address the questions 
most frequently asked by attendees at the live outreach program 
sessions.
    Finally, the FDIC, along with the other banking agencies, developed 
a Regulatory Capital Estimation Tool designed to assist community 
banking organizations and other interested parties in evaluating the 
potential effect that the Basel III NPR and the Standardized Approach 
NPR could have on their capital ratios.
    We believe that these outreach efforts have helped many bankers 
understand these proposals and identify the issues that are of concern 
to them. As of November 8, the FDIC had received more than 1500 
comments. The vast majority of these comments are from community banks. 
Their comments have been highly substantive and provide significant 
information regarding the possible impact of the proposals.
    The FDIC is in the process of reviewing all of the comments 
received. To date, many commenters have raised concerns about the 
generally higher level of capital requirements for community banks. A 
number of commenters have requested that the agencies not apply the 
Basel III or Standardized Approach NPRs to community banks. Some 
commenters have requested that the agencies withdraw the Standardized 
Approach NPR.
    In addition to these general comments, a few more specific topics 
have been mentioned quite frequently. First, many commenters have 
expressed concern that the Basel III NPR proposes to include AOCI in 
the calculation of regulatory capital, thereby including gains and 
losses on available-for-sale debt securities. These commenters believe 
that the inclusion of AOCI will increase the volatility of regulatory 
capital, forcing banks to hold additional capital buffers, and 
complicate their ability to manage interest rate risk and comply with 
legal lending limits. Also with respect to the Basel III NPR, many 
commenters have expressed concern that trust preferred securities 
issued before May 19, 2010, by community bank holding companies with 
less than $15 billion in assets are proposed to be phased out of Tier 1 
capital.
    With respect to the Standardized Approach NPR, many commenters have 
expressed concern about the increased complexity and systems costs of 
the proposed new methods for asset risk weighting, as well as the 
proposed increase in risk weight for certain exposures, particularly 
past due exposures and residential mortgages. Many community bank 
commenters have indicated that the proposed risk-weightings for 
residential mortgages will force them to curtail or exit residential 
mortgage lending because of what they view as the excessively high 
level of some of these risk weights. Commenters also express concern 
about how the new risk weights might interact with a number of pending 
mortgage regulations whose final form remains uncertain.
Conclusion
    In conclusion, along with our fellow regulators, the FDIC is 
carefully reviewing the comments we have received regarding the NPRs. 
These are proposed rules and we expect to make changes based on the 
comments. The basic purpose of the Basel III framework is to strengthen 
the long-term quality and quantity of the capital base of the U.S. 
banking system. In light of the recent financial crisis, that would 
appear to be an appropriate and important goal. However, that goal 
should be achieved in a way that is responsive to the concerns 
expressed by community banks about the potential for unintended 
consequences.






        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                     FROM MICHAEL S. GIBSON

Q.1. Is the U.S. banking system currently adequately 
capitalized? Please list any studies or data you relied upon to 
make this determination.

A.1. U.S. banking organizations of all sizes have improved 
their capital ratios since the financial crisis. The 19 largest 
banking organizations in particular have considerably more 
higher-quality capital than they did prior to the financial 
crisis. The aggregate amount of tier 1 common equity, the most 
loss-absorbing form of capital, held by these firms has 
increased by more than $300 billion since 2009, representing an 
increase of approximately 80 percent. \1\ Implementing the 
Basel III proposal, along with related reforms such as regular 
supervisory and company-run stress tests, should help solidify 
these gains to better ensure the resiliency of the U.S. banking 
system. \2\
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     \1\ See, http://www.federalreserve.gov/newsevents/press/bcreg/
20120313a.htm.
     \2\ The Basel III proposals are reflected in three notices of 
proposed rulemaking. See, 77 Federal Register 52888, 52909, 52958 
(August 30, 2012).
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    Before developing the Basel III proposal, the Board and the 
other Federal banking agencies participated in the 
international efforts conducted by the Basel Committee on 
Banking Supervision (BCBS) to study the losses experienced in 
past banking crises in various countries to help inform the 
appropriate levels of capital that banking organizations should 
maintain. The results of this study were made publicly 
available in October, 2010, and were attached as Attachment A 
to the letter the Federal banking agencies sent to you dated 
November 13, 2012. \3\ As indicated in the BCBS analysis, there 
is no single correct approach for determining adequate capital 
ratio levels; rather, the analysis provides a variety of 
different perspectives on banking organizations' loss 
experiences to help inform what is ultimately a regulatory 
judgment regarding appropriate levels of minimum capital ratios 
and other measures of capital adequacy. The minimum ratio 
levels agreed to by the BCBS, which are the same as those in 
the Basel III proposal, fall within the ranges suggested by the 
BCBS calibration analysis. That analysis focused on information 
submitted by member countries regarding losses relative to 
risk-weighted assets incurred over long historical periods.
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     \3\ See, ``Calibrating Regulatory Minimum Capital Requirements and 
Buffers: A Top-Down Approach'' (BCBC Analysis), available at: http://
www.bis.org/publ/bcbs180.pdf.
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    If the Basel III proposal were implemented today, the vast 
majority of top-tier bank holding companies would meet the 
minimum requirements outlined in the proposals. Even after 
considering the capital conservation buffer in addition to the 
minimum requirements, a substantial majority of institutions 
would meet the proposed capital standards. Similarly, most 
banking organizations with less than $10 billion in 
consolidated assets already hold capital that would qualify 
under the proposals and exceed the proposed minimum risk-based 
regulatory ratios.

Q.2. If the proposed Basel III rules were implemented, would 
your agency consider the U.S. banking system to be adequately 
capitalized? Please explain how you made that determination and 
what studies and data you relied upon.

A.2. As detailed in the Federal banking agencies' letter of 
November 13, 2012, all banking organizations need a strong 
capital base to enable them to withstand periods of economic 
adversity yet continue to fulfill their role as a source of 
credit to the economy. The capital standards in the three 
notices of proposed rulemakings (NPRs) related to Basel III 
each address identified weaknesses in the current U.S. 
regulatory capital regime. \4\
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     \4\ See, 77 Federal Register 52888, 52909, 52958 (August 30, 
2012).
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    Generally, the NPRs can be characterized as both 
strengthening the definition of capital so that banking 
organizations are better able to absorb losses and increasing 
the required minimum levels of capital so that banking 
organizations can better withstand periods of economic 
adversity. The NPRs also would modify risk weights to better 
reflect risks inherent in specific assets. Each NPR contains 
extensive discussion of the specific proposed changes and why 
the Board and other Federal banking agencies views these 
proposed changes as appropriate for the banking organizations 
that they supervise.
    As described in the BCBS Analysis noted in the response to 
Question 1, a conceptual framework was established as the 
starting point for the calibration of the capital standards. 
Under this framework, the minimum requirement for loss-
absorbing capital is defined as the amount of capital a banking 
organization needs to maintain so that investors, creditors, 
and counterparties would view it as a viable going concern. 
Similarly, a buffer above the minimum requirement is defined as 
an amount of capital sufficient for a banking organization to 
withstand significant downturn events while continuing to meet 
its minimum capital requirements. \5\ As noted previously, the 
minimum ratio levels agreed to by the BCBS, which are the same 
as those proposed in the NPRs, fall within the ranges suggested 
by the BCBS Analysis. On this basis, the minimum capital ratios 
proposed in the NPRs, including the revised definition of 
capital, could serve as an appropriate basis for minimum 
capital requirements in the United States.
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     \5\ See, BCBS Analysis, paragraph I.A.
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    The Board is currently in the process of reviewing all 
comments on the NPRs and is carefully considering those 
comments as part of the rulemaking process.

Q.3. At an FDIC meeting in July, FDIC Director Thomas Hoenig 
stated that ``as proposed, the minimum capital ratios will not 
significantly enhance financial stability.'' Bank of England 
Governor Mervyn King and several prominent economists have said 
that Basel III capital standards are insufficient to prevent 
another crisis. Do you disagree with these assertions? If so, 
why?

A.3. While there is no single measure that will prevent future 
crises, the proposed Basel III capital standards would address 
weaknesses in the current capital standards that were 
highlighted by the recent financial crisis. Most notably, the 
proposed rules would increase both the quantity and quality of 
capital held and require banking organizations to hold more 
capital for riskier exposures. These changes are expected to 
improve banking organization's ability to absorb losses. These 
improvements also would enhance banking organizations' ability 
to continue to function as financial intermediaries in future 
periods of financial and economic stress, thus improving the 
overall resiliency of the U.S. financial system. In this way, 
the NPRs are a substantial step forward toward a more stable 
financial system.

Q.4. Given the cost and complexity of Basel III, do you have 
any concerns that Basel III will further tilt the competitive 
landscape in favor of big banks to the detriment of small 
banks? Have you studied the impact of Basel III on small 
institutions as compared to their larger counterparts?

A.4. Many requirements in the Basel III proposal are focused on 
larger organizations and would not be applicable to smaller 
banks. These requirements include the proposed countercyclical 
capital buffer, the supplementary leverage ratio, enhanced 
disclosure requirements, and enhancements to the advanced 
approaches risk-based capital framework. These proposed 
changes, along with other recent regulatory capital 
enhancements such as stress testing requirements and market 
risk capital reforms would require large, systemically 
important banking organizations to hold significantly higher 
levels of capital relative to other organizations. The BCBS has 
also proposed requiring an additional capital charge for global 
systemically important banks (the Board has not yet proposed 
such a requirement).
    In developing the Basel III-based capital requirements, the 
Board and the other Federal banking agencies conducted an 
impact analysis based on regulatory reporting data to estimate 
the change in capital that banking organizations would be 
required to hold to meet the proposed minimum capital 
requirements. Based on the agencies' analysis, the vast 
majority of banking organizations currently would meet the 
fully phased-in minimum capital requirements, and those 
organizations that would not meet the proposed minimum 
requirements would have time to adjust their capital levels by 
the end of the transition period. More specifically with regard 
to smaller banking organizations, for bank holding companies 
with less than $10 billion in assets that meet the current 
minimum regulatory capital requirements, the analysis indicated 
that more than 90 percent of organizations would meet the 
proposed 4\1/2\ percent minimum common equity tier 1 ratio 
today. In addition, quantitative analysis by the Macroeconomic 
Assessment Group (MAG), a working group of the BCBS, found that 
the stronger Basel III capital requirements would lower the 
probability of banking crises and their associated economic 
output losses while having only a modest negative impact on 
gross domestic product and lending costs, and that the 
potential negative impact could be mitigated by phasing in the 
requirements over time.
    With respect to those banking organizations that would not 
meet the proposed requirements, including community banks with 
more limited capital-raising capabilities, the proposal 
includes lengthy transition periods. During the transition 
periods, banking organizations can accrete capital through the 
retention of earnings, as well as adjust to other elements of 
the proposal. The Federal banking agencies also developed a 
capital estimation tool to help companies, particularly 
community banking organizations, gain a further understanding 
of the possible impact of the proposals on their capital 
ratios. Finally, the Board sought comment on alternatives to 
the proposed requirements applicable to small banking 
organizations that could minimize their impact on those 
entities.
    The Board is still in the process of reviewing the public 
comments it has received on the Basel III proposal, including 
those regarding the likely impact on smaller institutions. In 
reviewing these comments, the Board is mindful about the 
potential effect of the Basel III proposals on community banks. 
The Board will remain mindful of these comments when 
considering potential refinements to the proposal and will work 
to appropriately balance the benefits of a revised capital 
framework against its potential costs, including further 
tailoring the requirements for smaller institutions as 
appropriate.

Q.5. Recently, the agencies announced that they are pushing 
back the effective date of the proposed Basel III rules beyond 
January 1, 2013. This affords the agencies more time to 
carefully review comment letters, engage in additional outreach 
and collect additional data. Will the agencies use this extra 
time to conduct an analysis about the impact of the proposed 
rules on the U.S. economy and a quantitative impact study that 
covers all banks, regardless of size, before implementing the 
final rules?

A.5. As noted above, in developing the Basel III proposal, the 
Board used regulatory reporting data to consider the potential 
impact of the proposed requirements on banking organizations of 
all sizes. As also noted above, the Board, working with the 
BCBS, has already analyzed the impact of the proposed rules on 
U.S. economic growth and found that the net impact would likely 
be positive. The comment period was extended to allow 
interested persons more time to understand, evaluate, and 
prepare comments on the proposals, and the Board has to date 
received over 2,000 public comments on the proposals. The Board 
is carefully considering the commenters' views on and concerns 
about the effects of the NPRs on the U.S. economy and on 
banking organizations.
    Before issuing any final rule, the Board will prepare an 
analysis under the Congressional Review Act (CRA). \6\ As part 
of this analysis, the Board will assess whether the final rule 
is a ``major rule,'' meaning the rule could (1) have an annual 
effect on the economy of $100 million or more; (2) increase 
significantly costs or prices for consumers, individual 
industries, Federal, State, or local government agencies, or 
geographic regions; or (3) have significant adverse effects on 
competition, employment, investment, productivity, or 
innovation. Consistent with the CRA, any such analysis will be 
provided to Congress and the Government Accountability Office.
---------------------------------------------------------------------------
     \6\ 5 U.S.C. 801-808
---------------------------------------------------------------------------
    In addition, as mentioned previously, the Board sought 
comment on significant alternatives to the proposed 
requirements applicable to covered small banking organizations 
that would minimize their impact on those entities, as well as 
on all other aspects of its analysis. After consideration of 
comments received during the public comment period and prior to 
adopting any final rule, the Board will conduct a final 
regulatory flexibility analysis under the Regulatory 
Flexibility Act. \7\
---------------------------------------------------------------------------
     \7\ 5 U.S.C. 601 et seq.

Q.6. What is the estimated impact of the Basel III rules, if 
---------------------------------------------------------------------------
finalized as proposed, on:

  a.  The U.S. GDP growth?

  b.  The probability of bank failure?

  c.  Availability and cost of mortgages, auto loans, student 
        loans and small business credit?

  d.  The compliance costs for small, medium, and large banks?

  e.  The cost of insurance for consumers?

    Please provide data to support your conclusions.

A.6. The recent financial crisis revealed that the amount of 
high-quality capital held by banking organizations in the 
United States was insufficient to absorb losses during periods 
of severe stress. The effects of having insufficient levels of 
capital were further magnified by the fact that certain 
regulatory capital instruments did not absorb losses to the 
extent previously expected. The lack of confidence in the 
banking sector drove up credit spreads on corporate bonds 
issued by banks, impaired banks' access to short-term funding, 
and depressed values of bank equities. Concerns about banking 
institutions arose not only because market participants 
expected steep losses on banking assets, but also because of 
substantial uncertainty surrounding estimated loss rates, and 
thus future earnings. \8\ Further, heightened systemic risks, 
falling asset values, and tightening credit took a heavy toll 
on business and consumer confidence. \9\
---------------------------------------------------------------------------
     \8\ See, Chairman Bernanke's speech available at http://
www.federalreserve.gov/newsevents/speech/bernanke20100506a.htm.
     \9\ See, Chairman Bernanke's speech available at http://
www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm.
---------------------------------------------------------------------------
    The Board believes that the proposals would result in 
capital requirements that better reflect banking organizations' 
risk profiles and enhance their ability to continue functioning 
as financial intermediaries, including during periods of 
financial stress, thereby improving the overall resiliency of 
the banking system. The agencies participated in the 
development of a number of studies to assess the potential 
impact of the revised capital requirements, including 
participating in the BCBS's MAG, as well as its Quantitative 
Impact Study, the results of which were made publicly available 
by the BCBS upon their completion. \10\
---------------------------------------------------------------------------
     \10\ See, ``Assessing the Macroeconomic Impact of the Transition 
to Stronger Capital and Liquidity Requirements'' (MAG Analysis), 
Attachment E, available at: http://www.bis.org/publ/othp12.pdf; see 
also ``Results of the Comprehensive Quantitative Impact Study'', 
Attachment F, available at: http://www.bis.org/publ/bcbs186.pdf.
---------------------------------------------------------------------------
    This analysis has suggested that stronger capital 
requirements could help reduce the likelihood of banking crises 
while yielding positive net economic benefits. Moreover, the 
MAG analysis found that the requirements would only have a 
modest negative impact on the gross domestic product of member 
countries, and that any such negative impact could be 
significantly mitigated by phasing in the proposed requirements 
over time. Thus, the benefits of the Basel III proposals, as 
measured by the reduction of risk to the deposit insurance fund 
and to the financial system, would outweigh the short-term cost 
of compliance with the new standards and potential impact on 
economic growth.

Q.7. Our housing market is currently entirely dependent on 
taxpayer-funded Government support through FHA and the GSEs. 
The Administration, however, has yet to prepare a housing 
finance reform plan. As a result, the future of the GSEs is 
still undetermined. One issue that will have to be addressed in 
housing finance reform is ensuring that the Basel rules are 
properly coordinated with the capital requirements for the GSEs 
in order to avoid creating any adverse incentives. Prior to the 
crisis, Fannie and Freddie had much lower capital requirements 
than did comparable banking institutions. According to one 
study, from 1992 through 2007 the GSE leverage ratios were 
between 20 and 40 (50 and 100 if MBS credit guarantees are 
included) whereas commercial banking sector had ratios between 
10 and 15. With an implicit Government guarantee, Fannie and 
Freddie were able to borrow at artificially low interest rates, 
making it quite profitable for the GSEs to purchase mortgages 
and offer credit default guarantees below market rates. As a 
result, Fannie and Freddie grew to become institutions that 
threatened the financial stability of the U.S. economy. In 
devising the proposed Basel capital rules, did your agency 
consider how the rules would interact with the capital 
requirements of any GSE? If yes, please explain whether any 
changes were made to the rules to protect against adverse 
consequences you identified.

A.7. The proposal would maintain the banking agencies' current 
20-percent risk weight for claims of or guaranteed by GSEs that 
are not equity exposures. The proposal would apply a 100 
percent risk weight to equity securities issued by a GSE, which 
previously was not a uniform treatment among the agencies. As 
discussed in the proposal, although certain GSEs currently are 
in conservatorship and receive capital support from the U.S. 
Treasury, they remain privately owned corporations, and their 
obligations do not have the explicit guarantee of the full 
faith and credit of the United States. The agencies have long 
held the view that obligations of the GSEs should not be 
assigned the same risk weight as obligations that carry the 
explicit guarantee of the U.S. Government.
    Our proposal would not affect the capital requirements 
faced by GSEs, such as Fannie Mae and Freddie Mac. Those 
capital requirements are not under the authority of the Federal 
banking agencies. In determining the risk weight for an 
exposure to a GSE, the Federal banking agencies have considered 
the potential risk associated with such exposures that would be 
borne by a banking organization holding the exposure. Any 
changes to the capital requirements for GSEs, including those 
that reduce any perceived advantages at the expense of private 
sector entities, would be determined by the FHFA and are 
outside the scope of this rulemaking.

Q.8. A key concern that must be addressed is ensuring that the 
capital requirements for Fannie and Freddie do not create 
incentives for banks to excessively transfer risk to the GSEs, 
like they did before the crisis when banks were charged a 4 
percent capital requirement for holding a portfolio of mortgage 
loans, but only 1.6 percent if they held GSE MBS instead. Do 
you believe that the proposed rules appropriately address that 
concern, and if so, how? What analysis have you done to make 
that determination?

A.8. In developing the proposals, the Federal banking agencies 
sought to establish capital requirements and risk weights for 
exposures in order to ensure that banking organizations hold 
capital commensurate with the risk of their exposures. Thus, 
under the proposed framework, residential mortgages are 
assigned to risk-weight categories based on the relative risk 
of the exposures as measured by product type and underwriting 
criteria. Similarly, in determining the 20-percent risk weight 
for an exposure to a GSE, the Federal banking agencies have 
considered the potential risk associated with such exposures 
that would be borne by a banking organization holding the 
exposure. Further, the proposed rules would not affect the 
capital requirements faced by GSEs, such as Fannie Mae and 
Freddie Mac. Any changes to the capital requirements for GSEs, 
including those that reduce any perceived advantages at the 
expense of private sector entities, would be determined by the 
FHFA and are outside the scope of this rulemaking.

Q.9. Mr. Gibson, does the Federal Reserve have in-house 
capacity to conduct an adequate Quantitative Impact Study (QIS) 
for the U.S. financial institutions, including holding 
companies, based on their size and asset class?

A.9. The Federal Reserve has the capacity to conduct QIS 
exercises and previously has conducted impact analyses of banks 
and bank holding companies of varying sizes. For example, on an 
annual basis, the Federal Reserve analyzes data from the 19 
large bank holding companies that have participated in the 
Federal Reserve's Comprehensive Capital Analysis and Review 
exercises, particularly with regard to those bank holding 
companies' ability to maintain adequate capital under stressed 
conditions and meet future capital requirements. These entities 
generally are on a transition path to meet the proposed capital 
requirements. Further, as described more fully below, we 
performed a domestic analysis of the impact of the proposals on 
banks and bank holding companies of varying sizes in June 2012.

Q.10. In your prepared remarks, you stated that ``staff from 
the interagency group used both qualitative measures (such as 
discussions with banks) as well as quantitative measures (such 
as QIS data) to create the assumptions used to estimate capital 
as proposed.'' Is the QIS that you refer to a domestic study 
conducted by the Federal Reserve or the global study done by 
the Basel Committee? If it is a global study, why did the 
Federal Reserve rely on a global study?

A.10. The analysis I referred to in my prepared remarks is a 
domestic analysis that was conducted by Federal Reserve staff 
in June, 2012. In particular, staff considered the potential 
impact of the proposed requirements on banking organizations 
using regulatory reporting data, supplemented by certain 
assumptions where data needed to calculate the capital 
requirements was not reported. The results of the study, as 
well as related assumptions, and descriptions of methodologies 
used for the analyses were made available to the public as part 
of my November 14, 2012, testimony before the Committee on 
Banking, Housing, and Urban Affairs. These documents are 
available at: http://www.federalreserve.gov/newsevents/
testimony/gibson20121114a.htm.

Q.11. The data for the global QIS done by the Basel Committee 
was collected as of December 31, 2009, almost 3 years ago. 
Would the results of that QIS differ if the same data were 
collected now? If so, how?

A.11. The Basel Committee publishes regular updates to the QIS 
as it tracks how global banks are affected by their 
implementation of the changes proposed by Basel III. Based on 
QIS data as of December 31, 2011, banks globally are in a 
stronger capital position than in 2009 and are closer to 
meeting the Basel III standards. We anticipate that future 
updates to the QIS using current data will show additional 
strengthening as banks continue their efforts to meet the fully 
phased-in Basel III standards.

Q.12. In response to a question on Basel that I asked Chairman 
Bernanke after a hearing in 2010, he stated that the Federal 
Reserve began conducting QIS in February 2010 and ``has 
contributed data from the domestic QIS on a confidential basis 
to the global QIS.'' What were the results of the domestic QIS? 
Are you prepared to make those results publicly available? From 
how many banks did you collect data? How many small and 
community banks contributed data to that study?

A.12. Your letter specifically references the quantitative 
impact study (QIS) that the agencies participated in with other 
members of the Basel Committee on Banking Supervision (BCBS), 
and requests the specific U.S. findings. Although the BCBS 
found that, based on the QIS, the proposed changes would 
require surveyed banking organizations to hold more regulatory 
capital to meet the proposed minimum requirements, the agencies 
are unable to provide the specific survey information submitted 
by U.S. institutions as it was collected on a confidential 
basis, conditioned on the assurance that it would only be 
distributed anonymously to the BCBS for purposes of the QIS. 
The domestic QIS did not include data from small and community 
banks.

Q.13. Traditionally, insurance companies have been regulated at 
the State level. The proposed Basel III rules, however, will 
apply to thrift holding companies that own insurers. In 
devising the capital requirements for financial holding 
companies that own insurance businesses, how much did the 
Federal Reserve rely on State insurance capital requirements? 
If significantly, please explain the collaborative process that 
the Federal Reserve engaged in with State insurance 
commissioners. If not significantly, please explain why not and 
whether the Federal Reserve believes that capital levels for 
insurance enterprises as currently required by State regulators 
are insufficient?

A.13. Board staff met with industry representatives and the 
National Association of Insurance Commissioners (NAIC) on 
several occasions to discuss insurance-related issues, 
including those relating to the proposed regulatory capital 
framework. Board staff also consulted with the Federal 
Insurance Office in the context of capital requirements and 
stress testing.
    As explained in the proposed rulemaking, the capital 
requirements would be consistent with section 171 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act), which requires the Board to establish consolidated 
minimum capital requirements for depository institution holding 
companies (bank holding companies and savings and loan holding 
companies) that are no less than the generally applicable 
capital requirements that apply to insured depository 
institutions. The proposals would apply consolidated risk-based 
capital requirements that measure the credit risk of all assets 
owned by a depository institution holding company and its 
subsidiaries, including assets held by insurance companies. 
Currently, capital requirements for insurance companies are 
imposed by State insurance laws on a legal entity basis and 
there are no State-based, consolidated capital requirements 
that cover subsidiaries and noninsurance affiliates of 
insurance companies. As such, the proposed consolidated capital 
requirements do not rely directly on the State-based regulatory 
capital requirements. However, the proposal would require 
depository institution holding companies to consolidate and 
deduct the minimum regulatory capital requirement of insurance 
underwriting subsidiaries from total capital to reflect the 
capital needed to cover insurance risks. The proposed deduction 
treatment recognizes that capital requirements imposed by the 
functional regulator to cover the various risks that insurance 
risk-based capital captures reflect capital needs a the 
particular subsidiary and that this capital is therefore not 
generally available to absorb the losses in other parts of the 
organization.
    The Board continues to consider the comments received on 
the proposed Basel III framework, including those focused on 
insurance activities of depository institution holding 
companies, as it works with the other Federal banking agencies 
through the rulemaking process.

Q.14. The Federal Reserve and the National Association of 
Insurance Commissions (NAIC) joined efforts in 2002 to study 
the adequacy of capital requirements for banks and insurance 
companies. In a joint working paper, the Federal Reserve and 
NAIC concluded that ``the effective regulatory capital 
requirements for assets, liabilities, and various business 
risks for insurers are not the same as those for banks . . . 
[and] effective capital charges cannot be harmonized simply by 
changing the nominal capital charges on individual assets.'' 
Does the Federal Reserve still agree with the conclusion of the 
2002 study? How does the Federal Reserve tailor or otherwise 
recognize in the proposed rules the differences in business 
models, funding characteristics and general risk profile 
between banks and insurance companies with respect to capital 
requirements?

A.14. In 2002, the National Association of Insurance 
Commissioners (NAIC) and the Federal Reserve System Joint 
Subgroup on Risk-Based Capital and Regulatory Arbitrage 
prepared a report that explored the similarities and 
differences between risk-based capital frameworks of the 
insurance sector and the banking sector. The report noted that 
the two frameworks differ fundamentally in the treatment and 
assignment of certain risks and that the effective capital 
charges cannot be harmonized simply by changing the nominal 
capital charges on individual assets.
    In June 2012, the Board proposed to revise the regulatory 
capital requirements and to apply consolidated regulatory 
capital minimums to savings and loan holding companies. In 
developing the proposed capital rules, the Board sought to meet 
legal requirements and policy objectives while including 
flexibility for depository institution holding companies that 
are primarily engaged in the insurance business. As explained 
in the response to Question 5 above, the proposed rules are 
consistent with the requirements of section 171 of the Dodd-
Frank Act. The proposed rules are also consistent with the 
Board's long-standing practice of applying consolidated capital 
requirements to bank holding companies, including those that 
include functionally regulated subsidiary insurance companies. 
This approach helps to eliminate regulatory capital arbitrage 
opportunities when a company has an incentive to book its risky 
exposures in legal entities in which the exposures would 
receive a more favorable regulatory capital treatment.
    In developing the proposal, the Board also considered 
assets typically held by insurance companies but not depository 
institutions and accordingly tailored the proposed capital 
requirements with respect to certain insurance-related assets. 
The proposals would apply specific risk weights for policy 
loans and nonguaranteed separate accounts, which are typically 
held by insurance companies but not banks. These risk weights 
were developed after a careful review of the characteristics of 
these assets.
    The Board has received numerous comments from the public on 
the proposals with respect to depository institution holding 
companies that have significant insurance activities and will 
carefully consider all of the comments raised over the course 
of the rulemaking.

Q.15. The Senate Banking Committee Report on the Dodd-Frank 
Wall Street Reform and Consumer Protection Act made it clear 
that the law did not mandate insurers use GAAP accounting. 
However, the proposed rules would require insurance enterprises 
to switch to GAAP. What analysis has the Federal Reserve 
conducted to justify such change? How will this mandated change 
in accounting provide more useful information about the 
financial health of insurance companies? How will this change 
impact insurance companies, both practically and financially?

A.15. As noted above, section 171 of the Dodd-Frank Act 
requires that the Board establish minimum consolidated risk-
based and leverage capital requirements for savings and loan 
holding companies that are not less than the ``generally 
applicable'' risk-based and leverage capital requirements for 
insured depository institutions. The ``generally applicable'' 
capital requirements for insured depository institutions are 
calculated and reported based on U.S. generally accepted 
accounting principles (GAAP). This is consistent with section 
37 of the Federal Deposit Insurance Act, which requires that 
accounting principles applicable to reports or statements that 
insured depository institutions file with their Federal 
regulators be ``uniform and consistent'' with GAAP. If an 
alternative accounting standard is required by the Federal 
regulator, it must be ``no less stringent'' than GAAP.
    The proposed requirement that savings and loan holding 
companies calculate their capital standards on a consolidated 
basis using a framework that is based on GAAP standards is 
consistent with section 171 of the Dodd-Frank Act and would 
facilitate comparability across institutions. In contrast, the 
statutory accounting principles (SAP) framework for insurance 
companies is a legal entity-based framework and does not 
provide a consolidated basis for applying regulatory capital 
requirements.
    In developing the proposals, the Board took into account 
the public comments received in response to a notice of intent 
(published on April 22, 2011) regarding the application of the 
regulatory capital requirements to savings and loan holding 
companies. Board staff also met with a number of industry 
representatives to discuss challenges associated with applying 
consolidated capital requirements to savings and loan holding 
companies, including those challenges related to GAAP.
    Following the publication of the proposals, the Board 
received additional comments on the application of the 
consolidated capital requirements for savings and loan holding 
companies, including on cost and burden considerations for 
those firms that currently prepare financial statements based 
solely on SAP. The Board is carefully evaluating these concerns 
and will consider all the comments received as part of the 
rulemaking process.

Q.16. Under the proposals, mortgages will be assigned to two 
risk categories and several subcategories, but the agencies did 
not explain how risk weights for those subcategories are 
determined and why they are appropriate. How did the Federal 
Reserve determine the appropriate range for those 
subcategories? Will the Federal Reserve release the underlying 
research and analysis to the public?

A.16. The proposed modified mortgage treatment is designed to 
better differentiate and align the risks of these exposures 
with the appropriate category. The mortgage categories were 
largely informed by the historical loss-rate data of various 
residential mortgage products during the crisis. The proposed 
treatment is, therefore, designed to more accurately reflect 
the risk characteristics of a loan. For instance a fixed-rate, 
first-lien mortgage that exhibits low risk because it has a low 
loan-to-value ratio and has product characteristics that 
qualify it as a category 1 residential mortgage exposure is 
eligible for a preferential risk weight. Mortgages with a 
riskier credit profile based on product type or loan-to-value 
ratio would be assigned a higher risk weight.
    When developing the proposed requirements, the agencies 
considered their various potential effects on the business 
activities of community banking organizations. The Board is 
evaluating comments from the industry that provide further 
clarity on potential burdens and unintended consequences of the 
proposed requirements and will consider the concerns raised in 
these comments as it works with the other Federal banking 
agencies through the rule-making process.

Q.17. How does the Federal Reserve plan to integrate its 
capital planning requirements for the CCAR process with the 
Basel III proposals now that the effective date of the Basel 
III final rule has been delayed?

A.17. As indicated in the Board's rule regarding capital plans, 
the Federal Reserve requires a U.S.-domiciled, top-tier bank 
holding company with total consolidated assets of $50 billion 
(large bank holding companies) or more to submit a capital plan 
on an annual basis. In connection with the Board's capital plan 
rule (12 CFR 225.8), 19 of the largest bank holding companies 
are required to participate in the Federal Reserve's 
Comprehensive Capital Analysis and Review (CCAR). CCAR involves 
a detailed assessment of a bank holding company's capital plan. 
The capital plan must include projections of a bank holding 
company's pro forma capital levels over a nine-quarter forward-
looking planning horizon under both expected and stressful 
conditions. Furthermore, in the capital plan, the bank holding 
company must demonstrate an ability to maintain its regulatory 
capital ratios and at least a 5 percent tier 1 common ratio 
under both expected and stressful conditions.
    Currently, the capital plan rule defines regulatory capital 
ratios as any minimum regulatory capital ratio that the Federal 
Reserve may require of a large bank holding company, by 
regulation or order, including the bank holding company's 
leverage ratio and tier 1 and total risk-based capital ratios 
as calculated under 12 CFR part 225, Appendices A, D, E, and G, 
or any successor regulation. In the future, the Board may 
propose to modify the existing minimum regulatory capital 
requirements. In particular, if the Basel III proposals are 
finalized, the minimum regulatory ratios under the capital plan 
rule would include any revised risk-based capital and leverage 
ratio, including the common equity tier 1 ratio, which, if 
finalized, would replace the existing tier 1 common 
requirement. Finally, consistent with prior CCAR exercises, the 
Federal Reserve will continue to assess bank holding companies' 
strategies for addressing the proposed Basel III revisions to 
the regulatory capital framework.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
            SENATOR MENENDEZ FROM MICHAEL S. GIBSON

Q.1. A fundamental objective of Dodd-Frank was to reduce 
systemic risk. I am concerned that the Fed's Basel III proposal 
could result in bank clearing members having to hold 
significantly more capital when their customers use less-risky 
instruments. Some argue that this incentive will make it more 
expensive to use exchange-traded futures than bespoke swaps. 
Should the rule be designed to encourage the use of lower risk 
profile products, rather than potentially discourage it?

A.1. The Basel III proposals were designed to incentivize the 
use of lower risk profile products by assigning a lower risk 
weight to centrally cleared derivatives relative to the risk 
weight assigned to over-the-counter (OTC) derivatives, which 
are generally considered less transparent and frequently more 
complex. While the proposed treatment under the proposals is a 
departure from the zero percent risk weight assigned to 
exchange-traded derivatives or futures under the Board's 
current rules, the proposed risk weight of generally 2 percent 
for qualifying cleared transactions is not significantly higher 
than the current treatment and is substantially lower than risk 
weights that would be applied to OTC derivative transactions. 
Furthermore, the risk weighting of OTC derivatives is 
structured so that riskier asset classes, as well as products 
with longer-dated tenors, receive a higher risk weight than 
those asset classes that are less risky and shorter-dated.

Q.2. With the proposed use of Loan-to-Value (LTV) ratios on 
home mortgages in Basel III, community banks would be required 
to recordkeep (or keep records of) the LTVs of future and 
existing mortgages. Some have argued that going back through 
their existing portfolios and determining each individual 
loan's LTV at origination would be burdensome and costly. Have 
you considered applying this standard prospectively for smaller 
banks and what thoughts have gone into that?

A.2. The Federal banking agencies sought comment on the 
proposed treatment of residential mortgage exposures, including 
on the use of loan-to-value amounts in order to assign risk-
based capital requirements to these exposures. In response, 
many commenters stated that it would be difficult for banking 
organizations, especially community banking organizations, to 
determine and track the required data on existing loan 
portfolios. Some commenters proposed alternatives that would 
reduce implementation burden, such as allowing existing 
mortgages to remain subject to the current risk-based capital 
requirements or phasing in the new requirements over time for 
existing portfolios. The Federal Reserve will take the 
commenters' concerns and alternatives into consideration as it 
works with the other Federal banking agencies to finalize the 
proposal.

Q.3. Elizabeth Duke recently said that in her discussions with 
community bankers, more of them report that they are reducing 
or eliminating their mortgage lending due to regulatory burdens 
than are expanding their mortgage business. In fact, she says 
that even if the specific issues in capital proposals can be 
addressed, the lending regulations might still ``seriously 
impair'' the ability of community banks to offer traditional 
mortgages. How or what are you going to do to ensure that the 
fragile housing market does not take another hit as it relates 
to capital requirements and Basel implementation?

A.3. In developing the proposals, the Federal banking agencies 
sought to better differentiate risks of mortgage exposures and 
ensure that banking organizations, regardless of size, hold 
capital commensurate with the risk of these exposures. As 
proposed, mortgage exposures with greater risks based on 
product characteristics and loan-to-value ratios would be 
subject to higher capital requirements.
    In the proposals, the Federal banking agencies also sought 
to promote financial stability while avoiding undue burden on 
the economy as well as unintended consequences. The Federal 
Reserve recognizes the vital role that community banking 
organizations play in the U.S. mortgage market. The Federal 
Reserve is carefully reviewing comments from the public on the 
proposed risk weights for mortgages, including those from 
community banking organizations and will be mindful of the 
concerns raised in these comments as it works with the other 
Federal banking agencies in moving forward on the proposed 
capital rules.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
                     FROM MICHAEL S. GIBSON

Q.1. I, and many other Members, have brought up concerns about 
the need to tailor rules to the size and type of entity. 
However, I recognize the U.S.'s leadership role on the Basel 
Committee, and the need to move through this period of 
regulatory uncertainty so that businesses can make investment 
decisions. How can the Committee provide regulated entities 
more certainty about the timeline of rules being reproposed or 
finalized in the future?

A.1. The Basel Committee on Banking Supervision provides a 
forum for regular cooperation on banking supervisory matters 
and promotes improvements in bank capital adequacy and risk 
management practices, in part, through the adoption of 
international standards that member countries then may 
implement through domestic regulation. Therefore, the Basel 
Committee itself is not in a position to provide certainty 
about the timeline regarding the U.S. domestic rulemaking 
process. The Federal Reserve, along with the other Federal 
banking agencies, is currently reviewing the thousands of 
comment letters received on the notices of proposed rulemaking 
that would revise the U.S. regulatory capital framework. The 
Federal Reserve is mindful of the concerns regarding 
uncertainty for banking organizations and is working with the 
other Federal banking agencies to finalize the proposals as 
expeditiously as possible after considering the public 
comments.

Q.2. I've heard concerns that the proposed rules require 
unrealized gains and losses on available for sale assets to be 
recognized within AOCI. Insurers that are Savings & Loan 
Holding Companies are especially apprehensive about managing 
increased asset-liability mismatches. Can you discuss your 
broader goals to encourage a long-term focus in capital 
management, and address these AOCI concerns?

A.2. The recent financial crisis revealed that the amount of 
high-quality capital held by banking organizations in the 
United States was insufficient to absorb losses during periods 
of severe stress. The effects of having insufficient levels of 
capital were further magnified by the fact that certain 
regulatory capital instruments did not absorb losses to the 
extent previously expected. The June 2012 proposal to amend the 
U.S. banking agencies' regulatory capital framework applies the 
lessons of the crisis, in part, by increasing the quantity and 
quality of capital held by banking organizations.
    In addition, the proposed application of consolidated 
capital requirements to savings and loan holding companies is 
consistent with section 171 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act), which 
requires the Board to establish consolidated minimum capital 
requirements for depository institution holding companies (bank 
holding companies and savings and loan holding companies) that 
are no less than the generally applicable capital requirements 
that apply to insured depository institutions. The proposal is 
also consistent with the Board's long-standing practice of 
applying consolidated minimum capital requirements to bank 
holding companies, including those that control functionally 
regulated subsidiary insurance companies.
    The proposed treatment of AOCI, which would require 
unrealized gains and losses on available-for-sale securities to 
flow through to regulatory capital, would better reflect an 
institution's actual loss-absorption capacity. Commenters on 
the proposal have expressed concern that this treatment would 
introduce capital volatility, due not only to credit risk but 
also to interest rate risk, and would affect the composition of 
firms' securities holdings. In particular, depository 
institution holding companies with insurance activities have 
asserted that the proposal does not appropriately recognize the 
longer-term nature of their liabilities and their practice of 
matching asset and liability maturities. They also assert that 
the proposal would disproportionately affect longer term assets 
held by many insurance companies, thus causing them to 
fundamentally alter their business strategy. The Federal 
Reserve is evaluating these and all of the comments received 
and will consider them carefully as it works with the other 
Federal banking agencies to determine how to treat AOCI in 
regulatory capital.

Q.3. We've seen some recent sales of MSRs from banks to 
nonbanks since the proposal was released saying that MSRs may 
only be counted for up to 10 percent of CET1, and additional 
MSR holdings will be weighted at 250 percent. This is a 
significant change from allowing MSRs to be counted up to the 
equivalent of 100 percent of Tier 1 capital. The MSRs change 
comes in combination with more sophisticated risk-weights for 
mortgages that will require more capital for nonstandard and 
high LTV mortgages. We also have QM and QRM on the way, which 
will have distinct definitions from Basel rules. I am 
supportive of a more nuanced approach to holding capital for 
mortgages, but is the panel concerned that the limited overlap 
in these regulations could cause much greater compliance 
difficulty for small institutions and negatively affect access 
to credit among low-to-middle income borrowers?

A.3. In developing the proposed treatment for mortgage 
servicing assets, the Federal banking agencies considered the 
specific characteristics and risks of these assets and the 
potential safety and soundness benefits that could result from 
their proposed treatment. The Federal banking agencies 
requested comments and supporting data on the proposed 
treatment for MSRs. Likewise, in developing the proposed risk 
weights for mortgage exposures, the agencies were mindful of 
the proposed standards for the QM and QRM and have requested 
comment from the public on all aspects of the proposed changes 
to the regulatory capital framework. Moreover, the agencies 
specifically requested comment on whether mortgages that meet 
the QM definition (which had not yet been finalized at the time 
of the proposal) should be included in category 1 residential 
mortgage exposures.
    During the comment period, the Federal Reserve and the 
other banking agencies also participated in various outreach 
efforts, such as engaging community banking organizations and 
trade associations, among others, to better understand industry 
participants' concerns about the proposals and to gather 
information on their potential effects, including with respect 
to MSRs and the proposed risk weighting of mortgages. These 
efforts have provided valuable additional information. The 
Federal Reserve will carefully consider all comments on the 
proposals in determining, along with the other Federal banking 
agencies, how to move forward with the rulemaking.

Q.4. Trade finance transactions rely on letters of credit and 
other off-balance sheet items, and lenders will have to set 
aside 100 percent capital for these items if current proposals 
are implemented. This transition requires 5 times more capital 
compared to Basel II. Do you believe that these changes are 
likely to affect smaller companies and emerging countries to a 
much greater extent? Can you respond to concerns that these 
proposals, as they are written, could constrict trade finance 
opportunities?

A.4. In 2011, the Basel Committee on Banking Supervision (BCBS) 
revised the Basel framework regarding trade finance 
transactions. \1\ The BCBS revised the standardized approach to 
remove the sovereign floor, permitting a 20-percent risk-
weighting for short-term exposure to banks in lower-income 
countries. The advanced approach was revised to remove the 1-
year maturity floor for trade finance instruments. The U.S. 
banking agencies' Basel III NPR is consistent with these 
revisions, which would likely result in reduced capital 
requirements for trade finance transactions that meet certain 
conditions.
---------------------------------------------------------------------------
     \1\ See, BCBS, ``Treatment of Trade Finance Under the Basel 
Capital Framework'', (October 2011), available at http://www.bis.org/
publ/bcbs205.pdf.
---------------------------------------------------------------------------
    In addition, trade finance exposures would impact the 
calculation of the proposed ``Basel III'' supplementary 
leverage ratio. \2\ The Basel III proposals would require 
companies that use the advanced approaches rules to calculate 
their capital requirements to maintain a minimum supplementary 
leverage ratio of 3 percent of total assets. This ratio's 
denominator calculation requires inclusion of the notional 
amount (effectively a 100 percent credit conversion factor) of 
trade finance exposures the banking organization cannot 
unconditionally cancel. For trade finance commitments that are 
unconditionally cancellable by the banking organization, they 
would be included in the denominator calculation at 10 percent 
of the notional amount.
---------------------------------------------------------------------------
     \2\ See, i.d.
---------------------------------------------------------------------------
    As a general matter, the Basel Committee has indicated that 
it will continue to assess the supplementary leverage ratio, 
including through supervisory monitoring during a parallel run 
period in which the proposed design and calibration of the 
Basel III leverage ratio will be evaluated. A final decision by 
the Committee on the measure of exposure for certain 
transactions and calibration of the leverage ratio is not 
expected until closer to 2018. Further, the agencies have 
requested specific comment on the supplementary leverage ratio 
and are evaluating these comments, including those relating to 
trade finance.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER
                     FROM MICHAEL S. GIBSON

Q.1. In comment letters to Federal regulators, the Conference 
of State Banking Supervisors raised concerns regarding the 
complexity of the approach proposed by Federal banking agencies 
for implementing the Basel III capital accords. How has this 
input influenced your approach to the rulemaking process?

A.1. The Board is mindful of potential burdens that may arise 
from the proposed requirements. To this end, the agencies 
sought specific comment in the proposal regarding potential 
burden as well as alternatives to decrease the burden of the 
proposal's requirements, while still addressing safety and 
soundness concerns. Board staff is carefully considering all 
comments received on the proposal, including those provided by 
the Conference of State Banking Supervisors.

Q.2. In applying Basel III to community banks, did the 
regulators consider that most privately held community banks 
have fewer options for sources of capital than large banks, 
making it especially challenging for them to raise additional 
capital in the current economic climate, and that the Basel III 
proposal could disproportionately impact such community banks?

A.2. Before issuing the proposal, the agencies evaluated the 
potential impact of the proposed requirements on banking 
organizations by size and asset class, and determined that the 
vast majority of banking organizations, including community 
banks, already would meet the proposed minimum requirements on 
a fully phased-in basis and would also have capital sufficient 
to exceed the proposed capital buffer threshold. With respect 
to those banking organizations that would not meet the 
requirements, including community banks with more limited 
capital-raising capabilities, the proposal includes lengthy 
transition periods. During the transition period, banking 
organizations can accrete capital through the retention of 
earnings, as well as adjust to other elements of the proposal. 
The agencies have also developed a capital estimation tool to 
help companies, particularly community banking organizations, 
gain a further understanding of the possible impact of the 
proposals. The Board is carefully considering all the comments 
received on the proposed changes, including comments that 
address how to address burdens on community banks.

Q.3. Will the implementation of the proposed Standardized 
Approach and the mandate that mortgage loan-to-values (LTVs) be 
tracked require many of the Nation's smaller banks to make 
costly software upgrades? If so, have you considered the cost 
impact of such a requirement on community banks?

A.3. In developing the standardized approach proposal, the 
Federal banking agencies generally sought to balance increased 
risk sensitivity with the potential regulatory and compliance 
burden on banking organizations. The Board is sensitive to 
concerns expressed by commenters that the requirement to track 
loan-to-value ratio information as part of the framework to 
assign risk weights to mortgage exposures would represent 
additional burden for banking organizations, especially smaller 
banking organizations that may need to upgrade their data 
systems. As it works to finalize the proposal with the other 
agencies, the Board will be taking into account these comments 
as well as proposed alternatives to reduce the burden of 
implementation on banking organizations under the proposed 
framework.

Q.4. Did the regulators consider the effect on the economy and 
consumers if community banks reduce mortgage lending 
significantly due to Basel III?

A.4. The agencies have considered the costs and benefits of the 
various proposed treatments of the Basel proposals, 
specifically seeking to balance the need to promote financial 
stability while minimizing the impact on economic growth and 
credit availability. The agencies also included several 
specific questions in the proposal regarding the mortgage 
treatment. The Board is sensitive to concerns that higher risk 
weights and increased compliance cost may lead to more 
expensive mortgages and reduce access to credit and will 
carefully consider community bankers' as well as all other 
comments on the proposal as it works with the other Federal 
banking agencies on the rulemaking.

Q.5. Please explain whether or not the proposed higher capital 
requirements for past due loans are a form of ``double 
accounting,'' given that banks already are supposed to reserve 
for these losses.

A.5. The proposed 150 percent risk weight for past-due loans 
reflects the increased risk of loss associated with an exposure 
that is 90 days or more past due or on nonaccrual status. By 
contrast, the allowance for loan and lease losses (ALLL) 
addresses losses that have been incurred, which is defined 
under U.S. GAAP as probable of occurring (based on historical 
loss statistics). Thus, the 150 percent risk weight for past-
due loans complements rather than duplicates the ALLL.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                       FROM JOHN C. LYONS

Q.1. Is the U.S. banking system currently adequately 
capitalized? Please list any studies or data you relied upon to 
make this determination.

A.1. Generally speaking, national banks and Federal thrifts of 
all sizes are better capitalized today than they were prior to 
the crisis. The Call Report data below show national bank and 
Federal thrift capital ratios before the crisis and the ratios 
in the middle of 2012.


Q.2. If the proposed Basel III rules were implemented, would 
your agency consider the U.S. banking system to be adequately 
capitalized? Please explain how you made that determination and 
what studies and data you relied upon.

A.2. While capital positions have improved based on current 
capital metrics, the proposed changes to our capital standards 
should help to cement these improved capital positions and 
ensure that banks are in a better position to deal with future 
financial market turbulence. In addition, the proposed changes 
are intended to provide a better metric by which to measure 
each bank's capital position as they should enhance the risk 
sensitivity of the existing capital framework.

Q.3. At an FDIC meeting in July, FDIC Director Thomas Hoenig 
stated that ``as proposed, the minimum capital ratios will not 
significantly enhance financial stability.'' Bank of England 
Governor Mervyn King and several prominent economists have said 
that Basel III capital standards are insufficient to prevent 
another crisis. Do you disagree with these assertions? If so, 
why?

A.3. We believe that the proposed enhancements to our capital 
standards will help to strengthen the banking system's 
resiliency and will enhance financial stability through higher 
levels and quality of capital and through improved risk 
sensitivity. Banking crises have occurred for as long as there 
have been banks, and we do not, therefore, believe that the 
proposed standards would necessarily succeed in preventing 
another crisis. However, we expect that banks would be better 
positioned to navigate any future crisis under the proposed 
rules than under the current rules.

Q.4. Given the cost and complexity of Basel III, do you have 
any concerns that Basel III will further tilt the competitive 
landscape in favor of big banks to the detriment of small 
banks? Have you studied the impact of Basel III on small 
institutions as compared to their larger counterparts?

A.4. We do not anticipate that small banks will be 
disadvantaged under the proposed rules relative to large banks 
for a number of reasons. First, large banks will be subject to 
essentially two capital regimes under section 171 of the Dodd-
Frank Act. Under this provision, the largest banks are required 
to not only comply with the capital standards that have been 
developed specifically for large, internationally active banks, 
but they are also required to comply with the standards that 
are ``generally applicable'', i.e., those that are applied to 
smaller institutions. In addition, there are several aspects of 
the proposals that would apply only to the largest banks. For 
example, smaller banks can ignore the advanced approaches NPR 
in its entirety, which contains changes from Basel III that 
only apply to the largest U.S. banks. In addition, the 
countercyclical buffer, which is meant to make banks hold more 
capital during periods of excessive credit growth, is a Basel 
III provision that would apply only to the largest banks. 
Similarly, enhanced disclosures would apply only to banks with 
total consolidated assets of $50 billion or more. While not 
included as part of this set of proposals, the largest banks 
will also have to hold an additional cushion of capital under 
the Global Systemically Important Bank (G-SIB) surcharge, which 
could be up to 3.5 percent of additional common equity.
    To measure the potential impact of the proposals, the OCC 
conducted burden and cost estimates for all OCC-supervised 
banks consistent with the Unfunded Mandates Reform Act and for 
OCC-supervised small banks pursuant to the Regulatory 
Flexibility Act. Our analysis showed that the majority of 
banks, including community banks, will meet the new higher 
capital requirements without raising additional capital. For 
those banks that might need to raise additional capital, the 
proposals include a number of transition provisions to ease the 
burden. However, for a substantial number of the smallest banks 
(i.e., those with assets of $175 million or less), our initial 
analysis determined that the compliance costs likely could be 
significant. These costs include additional recordkeeping and 
systems costs associated with implementing the alternatives to 
credit ratings.
    The Comptroller has stated publicly that he is aware of the 
concerns of community bankers and is very interested in looking 
at ways to reduce the potential burden on small banks without 
compromising the OCC's goal of raising the quantity and quality 
of capital and setting minimum standards that require more 
capital for more risk. To help facilitate community bank 
comments, the Federal banking agencies provided an estimator 
tool so that community bankers could give us more specific 
empirical data on the potential impact of the proposals. The 
agencies will consider any such empirical analysis that 
community banks provide.
    For any final rule, the OCC will complete final assessments 
under both the Unfunded Mandates Reform Act and the Regulatory 
Flexibility Act. Also, for any final rule, the OCC will 
determine whether the rule is a ``major rule'' for purposes of 
the Congressional Review Act (e.g., whether it will have an 
annual effect on the economy of $100 million or more).

Q.5. Recently, the agencies announced that they are pushing 
back the effective date of the proposed Basel III rules beyond 
January 1, 2013. This affords the agencies more time to 
carefully review comment letters, engage in additional outreach 
and collect additional data. Will the agencies use this extra 
time to conduct an analysis about the impact of the proposed 
rules on the U.S. economy and a quantitative impact study that 
covers all banks, regardless of size, before implementing the 
final rules?

A.5. The OCC is required to complete a final assessment of the 
rule under the Regulatory Flexibility Act, and we plan to 
complete an assessment under the Unfunded Mandates Reform Act. 
We will take into account any comments received on the costs 
and benefits of the NPRs in fulfilling these statutory 
mandates. Additionally, at the final rule stage, the OCC will 
prepare an analysis under the Congressional Review Act. As part 
of this analysis we will assess whether the final rule is a 
``major rule,'' meaning the rule could (1) effect the economy 
by $100 million or more; (2) increase significantly costs or 
prices for consumers, individual industries, Federal, State, or 
local government agencies, or geographic regions; or (3) have 
significant adverse effects on competition, employment, 
investment, productivity, or innovation. The analysis will be 
provided to the Congress and the Government Accountability 
Office (GAO).

Q.6. What is the estimated impact of the Basel III rules, if 
finalized as proposed, on:

  a.  The U.S. GDP growth?

  b.  The probability of bank failure?

  c.  Availability and cost of mortgages, auto loans, student 
        loans and small business credit?

  d.  The compliance costs for small, medium, and large banks?

  e.  The cost of insurance for consumers?

    Please provide data to support your conclusions.

A.6. If finalized as proposed, we estimate that the overall 
cost of the proposed capital rules would be approximately 
$145.1 million. This estimate reflects one-time systems costs 
of approximately $46.5 million and ongoing capital costs of 
$98.6 million per year once banks fully implement the new rule. 
The overall estimate reflects the cost of capital some banks 
would need to raise to meet the new minimum capital standards, 
compliance costs associated with establishing the 
infrastructure to determine correct risk weights using the new 
alternative measures of creditworthiness, and compliance costs 
associated with new disclosure requirements.
    The vast majority of banks in the United States already 
hold capital that would satisfy even the highest new capital 
standard set to take effect on January 1, 2019. Table 1 shows 
our estimates of the cumulative number of OCC-regulated banking 
organizations that would fall short of the new minimum capital 
standards if the banks took no action and held their capital at 
December 31, 2011, levels. We estimate that those 195 
institutions would have to raise approximately $84 billion in 
new capital, which is approximately nine percent of the amount 
of capital currently held by OCC-regulated banking 
organizations. Because most banks in the United States already 
meet the new Basel III capital standards and those institutions 
that do need to raise capital have 6 years in which to do it, 
we estimate that the proposed rule will not affect U.S. GDP 
growth. Most of the dampening effect on GDP growth that can 
occur when banks reduce lending to increase capital would have 
occurred in the past when banks increased their capital levels 
in response to the financial crisis.
    While higher capital levels reduce the probability of bank 
failure, \1\ we did not estimate how Basel III rules will 
affect these probabilities. The probability of bank failure 
will vary from bank to bank and will depend on capital and a 
variety of other factors, best summarized in regulatory CAMELS 
ratings. These CAMELS factors include capital adequacy, asset 
quality, management quality, earnings, liquidity, and 
sensitivity to market risk.
---------------------------------------------------------------------------
     \1\ See, for instance, Arturo Estrella, Sangkyun Park, and Stavros 
Perlstlanl, ``Capital Ratios as Predictors of Bank Failure'', Economic 
Policy Review, Federal Reserve Bank of New York, July 2000, pp. 33-52.
---------------------------------------------------------------------------
    Because the proposed rules would change the risk weights 
for residential mortgages, we do expect the increased risk 
sensitivity could have some effect on the cost and availability 
of residential mortgages. Indeed, one of the objectives of the 
proposed rule is to use variations in risk weights to 
differentiate between high-risk and low-risk mortgages, 
securitizations, and sovereign debt. In particular, for 
residential mortgages with a lower risk weight under the 
proposed rule, namely category one mortgages with loan-to-value 
ratios less than or equal to 60 percent, costs may decrease and 
availability may increase. For residential mortgages with 
higher risk weights under the proposed rules, for example, 
mortgages with loan-to-value ratios greater than 90 percent, we 
expect that costs may increase and availability decrease. There 
are, however, a large number of factors beyond risk weights 
that affect the cost and availability of mortgages and other 
loans. The interaction of these factors along with possible 
changes in bank behavior towards risk makes it difficult to 
arrive at an accurate estimate of the proposed rules' impact on 
mortgage cost and availability. The risk weights for auto 
loans, student loans, and small business loans do not change 
under the proposed rules.
    Table 2 shows our estimates of compliance costs associated 
with determining new risk weights under the proposed rule. As 
shown in Table 2, we estimate compliance costs of approximately 
$36,000 per institution for small- and medium-sized banks. For 
large banks, we estimate compliance costs of approximately 
$111,000 per institution. We did not attempt to estimate the 
cost of insurance for consumers.




Q.7. Our housing market is currently entirely dependent on 
taxpayer-funded Government support through FHA and the GSEs. 
The Administration, however, has yet to prepare a housing 
finance reform plan. As a result, the future of the GSEs is 
still undetermined. One issue that will have to be addressed in 
housing finance reform is ensuring that the Basel rules are 
properly coordinated with the capital requirements for the GSEs 
in order to avoid creating any adverse incentives. Prior to the 
crisis, Fannie and Freddie had much lower capital requirements 
than did comparable banking institutions. According to one 
study, from 1992 through 2007 the GSE leverage ratios were 
between 20 and 40 (50 and 100 if MBS credit guarantees are 
included) whereas commercial banking sector had ratios between 
10 and 15. With an implicit Government guarantee, Fannie and 
Freddie were able to borrow at artificially low interest rates, 
making it quite profitable for the GSEs to purchase mortgages 
and offer credit default guarantees below market rates. As a 
result, Fannie and Freddie grew to become institutions that 
threatened the financial stability of the U.S. economy. In 
devising the proposed Basel capital rules, did your agency 
consider how the rules would interact with the capital 
requirements of any GSE? If yes, please explain whether any 
changes were made to the rules to protect against adverse 
consequences you identified.

A.7. In developing our proposed capital standards, we focused 
on the institutions that we regulate, although we did consider 
the potential impact of the proposals on the broader economy. 
We did not explicitly consider the regulatory capital 
requirements for Fannie Mae and Freddie Mac as set forth by 
their regulator, the Federal Housing Finance Agency.

Q.8. A key concern that must be addressed is ensuring that the 
capital requirements for Fannie and Freddie do not create 
incentives for banks to excessively transfer risk to the GSEs, 
like they did before the crisis when banks were charged a 4 
percent capital requirement for holding a portfolio of mortgage 
loans, but only 1.6 percent if they held GSE MBS instead. Do 
you believe that the proposed rules appropriately address that 
concern, and if so, how? What analysis have you done to make 
that determination?

A.8. While the proposed rules attempt to provide for a more 
risk sensitive approach to mortgage loans held by banks, the 
proposed treatment for exposures to Fannie Mae and Freddie Mac 
are carried over from the existing rules. This was partly due 
to the explicit Government support that has been provided to 
these institutions. If and when the two housing entities are 
restructured, we will consider the risks that exposures to the 
firms present to banks and will revise the capital treatment 
for such exposures accordingly. However, given the uncertainty 
as to what the ultimate structure and risks of these entities 
might look like, we believed it was premature to make 
significant changes to the capital standards at this time.

Q.9. Mr. Lyons, how do the proposed rules address the diverse 
landscape of our financial system, including mid-size banks, 
community banks, regional banks, and other market participants? 
Please provide specific examples. What analysis did OCC conduct 
to determine that the Basel III model should be applied to 
those market participants? How did OCC determine that the 
proposed capital regime is adequate for institutions based on 
their size or asset class?

A.9. As I noted in my testimony, in developing the U.S. capital 
proposals we did not adopt a ``one-size fits all approach.'' 
Rather, we carefully evaluated each element of the Basel III 
framework and assessed to which banks it should be applied. In 
making these assessments, the Federal banking agencies strove 
to calibrate the requirements to reflect the nature and 
complexity of the financial institutions involved. As a result, 
and consistent with the higher standards for larger banks 
required by section 165 of the Dodd-Frank Act, many of the 
provisions in the proposed rules are only for larger banks and 
those that engage in complex or risky activities: community 
banks with more basic balance sheets are largely or completely 
exempted. For example, smaller banks can ignore the advanced 
approaches NPR in its entirety, which contains changes from 
Basel III that only apply to the largest U.S. banks. In 
addition, the countercyclical buffer, which is meant to make 
banks hold more capital during periods of excessive credit 
growth, is a Basel III provision that would apply only to the 
largest banks. Similarly, enhanced disclosures would apply only 
to banks with total consolidated assets of $50 billion or more. 
While not included as part of this set of proposals, the 
largest banks will also have to hold an additional cushion of 
capital under the Global Systemically Important Bank (G-SIB) 
surcharge, which could be up to 3.5 percent of additional 
common equity.
    There are areas, however, where we believe a more uniform 
regulatory capital approach across banks is warranted. For 
example, the proposals include a consistent definition of what 
counts as regulatory capital for banks of all sizes. A 
consistent definition helps to limit the complexity of having 
multiple definitions for banks of varying size and also helps 
to reduce opportunities for regulatory capital arbitrage.
    The regulatory capital standards set forth in the proposals 
are meant to be minimum requirements that are appropriate for 
banks of various sizes and with varying business models. These 
standards do not obviate the need for more tailored analysis of 
each bank's capital adequacy, which is part of our overall 
supervisory process.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
              SENATOR MENENDEZ FROM JOHN C. LYONS

Q.1. A fundamental objective of Dodd-Frank was to reduce 
systemic risk. I am concerned that the Fed's Basel III proposal 
could result in bank clearing members having to hold 
significantly more capital when their customers use less-risky 
instruments. Some argue that this incentive will make it more 
expensive to use exchange-traded futures than bespoke swaps. 
Should the rule be designed to encourage the use of lower risk 
profile products, rather than potentially discourage it?

A.1. While the use of central counterparties improves the 
safety and soundness of both cleared OTC and exchange-traded 
products through the multilateral netting of exposures and 
market transparency, the increased use of central 
counterparties also has the potential for increased systemic 
risk as counterparty credit risk is concentrated in these 
entities. The proposed rules introduce a capital requirement 
for banks' exposure to this risk. The proposed capital 
requirement takes into account the margin provided to the 
central counterparty by its members as well as the capital of 
the central counterparty itself. We are still reviewing the 
comments received on this issue to determine the ultimate 
resolution of this topic.

Q.2. With the proposed use of Loan-to-Value (LTV) ratios on 
home mortgages in Basel III, community banks would be required 
to recordkeep (or keep records of) the LTVs of future and 
existing mortgages. Some have argued that going back through 
their existing portfolios and determining each individual 
loan's LTV at origination would be burdensome and costly. Have 
you considered applying this standard prospectively for smaller 
banks and what thoughts have gone into that?

A.2. These changes are part of the Standardized Approach 
proposal. As proposed, they would be applicable to all 
mortgages with no grandfathering provisions; however this 
treatment would not come into effect until 2015. This proposed 
delayed implementation was intended to provide sufficient time 
for banks to adapt to the new standards. Several commenters 
have suggested that we apply the proposed mortgage treatment on 
a prospective basis, and that is something that we will 
carefully consider as we move forward.

Q.3. Elizabeth Duke recently said that in her discussions with 
community bankers, more of them report that they are reducing 
or eliminating their mortgage lending due to regulatory burdens 
than are expanding their mortgage business. In fact, she says 
that even if the specific issues in capital proposals can be 
addressed, the lending regulations might still ``seriously 
impair'' the ability of community banks to offer traditional 
mortgages. How or what are you going to do to ensure that the 
fragile housing market does not take another hit as it relates 
to capital requirements and Basel implementation?

A.3. Our goal with the proposed modifications to our regulatory 
capital framework is to create a more robust and stronger 
banking system that is better positioned to withstand financial 
market stresses. Ultimately, this would help to ensure that 
access to financing can flow more efficiently to all sectors of 
the economy, including housing. In addition, the proposed rules 
included long transition provisions to allow banks to more 
easily adjust to the higher capital standards. Nevertheless, we 
recognize the concerns that commenters have raised with our 
proposals, particularly as they relate to the housing market, 
the multitude of regulatory reforms that are underway in this 
sector of the economy, and the burden the proposals may pose to 
community banks. We are committed to carefully considering all 
of these comments in deciding how to best move forward.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
                       FROM JOHN C. LYONS

Q.1. I, and many other Members, have brought up concerns about 
the need to tailor rules to the size and type of entity. 
However, I recognize the U.S.'s leadership role on the Basel 
Committee, and the need to move through this period of 
regulatory uncertainty so that businesses can make investment 
decisions. How can the Committee provide regulated entities 
more certainty about the timeline of rules being reproposed or 
finalized in the future?

A.1. While we are dedicated to the Basel process of developing 
and promulgating globally consistent standards for the largest 
internationally active banks, our ultimate goal is to ensure 
the safety and soundness of the U.S. banking system. 
Fortunately, standards advanced by the Basel Committee are 
generally consistent with our domestic priorities and 
objectives, and if they are not, we will make adjustments as 
necessary.
    While we are constantly seeking to improve both the 
international and domestic processes for proposing and 
finalizing standards and regulations, there are limits to our 
ability to provide certainty during the rulemaking process. We 
continue to strive to provide as much information as possible, 
both at the domestic rulemaking stage and on an international 
level as part of the Basel Committee, to ensure that our 
proposals can be understood and assessed by industry 
participants so that meaningful comment can be provided. 
Nevertheless, certainty in terms of the structure of rules and 
when those rules might be finalized is difficult given that we 
are open to revising our proposals based on the feedback that 
we receive. The Basel Committee and the Federal banking 
agencies attempted to mitigate some of this uncertainty by 
providing for long transition periods over which banks could 
adjust and adapt to any new regulations.
    As I noted in my testimony, in developing the U.S. capital 
proposals we did attempt to tailor our proposals. We carefully 
evaluated each element of the Basel III framework and assessed 
to which banks it should be applied. In making these 
assessments, the Federal banking agencies strove to calibrate 
the requirements to reflect the nature and complexity of the 
financial institutions involved. As a result, and consistent 
with the higher standards for larger banks required by section 
165 of the Dodd-Frank Act, many of the provisions in the 
proposed rules would affect only larger banks and those that 
engage in complex or risky activities; community banks with 
more basic balance sheets are largely or completely exempted 
from such provisions.

Q.2. I've heard concerns that the proposed rules require 
unrealized gains and losses on available for sale assets to be 
recognized within AOCI. Insurers that are Savings & Loan 
Holding Companies are especially apprehensive about managing 
increased asset-liability mismatches. Can you discuss your 
broader goals to encourage a long-term focus in capital 
management, and address these AOCI concerns?

A.2. The OCC is committed to ensuring banks maintain adequate 
capital, and, as I noted in my testimony, regulatory capital 
standards are but one component in a larger and more 
comprehensive process of bank supervision. For example, we 
recently issued guidance for national banks and federally 
chartered thrifts (the Federal Reserve Board regulates Savings 
and Loan holding companies) that focuses on the need for these 
institutions to assess their capital adequacy. \1\ Part of this 
process, as well as part of our examination process of 
assessing the strength of a bank's capital position, involves 
evaluating a bank's unrealized gains and losses.
---------------------------------------------------------------------------
     \1\ See, OCC Bulletin 2012-16, ``Guidance for Evaluating Capital 
Planning and Adequacy''.
---------------------------------------------------------------------------
    The rationale for the proposed AOCI treatment is that 
ignoring unrealized losses has the potential to mask the true 
financial position of a bank. This is particularly true when a 
bank is under stress and when creditors are most likely to be 
concerned about unrealized losses that could inhibit a bank's 
ability to meet its obligations. Nonetheless, this is an issue 
that numerous commenters flagged as a concern and is one that 
we are carefully reviewing. Because our review and rulemaking 
process have not been completed, it would be difficult to 
comment on the ultimate resolution of this topic without 
prejudging the process.

Q.3. We've seen some recent sales of MSRs from banks to 
nonbanks since the proposal was released saying that MSRs may 
only be counted for up to 10 percent of CET1, and additional 
MSR holdings will be weighted at 250 percent. This is a 
significant change from allowing MSRs to be counted up to the 
equivalent of 100 percent of Tier 1 capital. The MSRs change 
comes in combination with more sophisticated risk-weights for 
mortgages that will require more capital for nonstandard and 
high LTV mortgages. We also have QM and QRM on the way, which 
will have distinct definitions from Basel rules. I am 
supportive of a more nuanced approach to holding capital for 
mortgages, but is the panel concerned that the limited overlap 
in these regulations could cause much greater compliance 
difficulty for small institutions and negatively affect access 
to credit among low-to-middle income borrowers?

A.3. We recognize the concerns about regulatory burden, 
including concerns about overlap with other regulatory 
initiatives related to residential mortgages, and we take these 
concerns very seriously. Our intention is not to negatively 
affect credit access to low-to-middle income borrowers, and we 
will carefully consider the comments we have received in 
deciding on the best way forward.

Q.4. Trade finance transactions rely on letters of credit and 
other off-balance sheet items, and lenders will have to set 
aside 100 percent capital for these items if current proposals 
are implemented. This transition requires 5 times more capital 
compared to Basel II. Do you believe that these changes are 
likely to affect smaller companies and emerging countries to a 
much greater extent? Can you respond to concerns that these 
proposals, as they are written, could constrict trade finance 
opportunities?

A.4. One of the main effects of the proposed rules on trade 
finance relates to the treatment of off-balance sheet trade-
related transactions such as letters of credit under the 
supplementary leverage ratio. The supplementary leverage ratio 
is proposed to apply only to the largest, internationally 
active banking organizations, some of which are active in the 
trade finance arena. Commenters have raised concerns with this 
treatment as well as some concerns with other technical aspects 
of the proposals as they relate to trade finance. We will 
review these comments carefully to assess whether any changes 
to the proposals are warranted.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER
                       FROM JOHN C. LYONS

Q.1. In comment letters to Federal regulators, the Conference 
of State Banking Supervisors raised concerns regarding the 
complexity of the approach proposed by Federal banking agencies 
for implementing the Basel III capital accords. How has this 
input influenced your approach to the rulemaking process?

A.1. We are carefully reviewing all of the comments we received 
on the proposals, including those submitted by the Conference 
of State Bank Supervisors. Given that the rulemaking process 
has not been completed and that we are still reviewing 
comments, it would be difficult to speak to how particular 
comments have shaped our views at this time.

Q.2. In applying Basel III to community banks, did the 
regulators consider that most privately held community banks 
have fewer options for sources of capital than large banks, 
making it especially challenging for them to raise additional 
capital in the current economic climate, and that the Basel III 
proposal could disproportionately impact such community banks?

A.2. Yes. The proposed transition period, which in some cases 
extends to 2022, was intended to allow banks time to adjust to 
the heightened capital standards. Nevertheless, concerns 
related to the ability of community banks to access capital 
markets has been raised by many commenters, and we will weigh 
these issues as we decide how to move forward.

Q.3. Will the implementation of the proposed Standardized 
Approach and the mandate that mortgage loan-to-values (LTVs) be 
tracked require many of the Nation's smaller banks to make 
costly software upgrades? If so, have you considered the cost 
impact of such a requirement on community banks?

A.3. For a substantial number of the smallest banks (i.e., 
those with total assets of $175 million or less), our initial 
analysis determined that the compliance costs could be 
significant. These costs include additional recordkeeping and 
systems costs associated with implementing the alternatives to 
credit ratings. The Comptroller has stated publicly that he is 
aware of the concerns of community bankers and is very 
interested in looking at ways to reduce the potential burden on 
small banks without compromising the OCC's goal of raising the 
quantity and quality of capital and setting minimum standards 
that require more capital for more risk. The Federal banking 
agencies requested comment on their costs and burden estimates 
and on ways to reduce cost and burden without sacrificing 
safety and soundness. As I noted in my testimony, the Federal 
banking agencies received a substantial number of comments, and 
as we move forward with any final rules, we will consider the 
comments and empirical analysis that community banks provided 
in their comments.

Q.4. Did the regulators consider the effect on the economy and 
consumers if community banks reduce mortgage lending 
significantly due to Basel III?

A.4. Because the proposed rules will change the risk weights 
for residential mortgages, we do expect that increased risk 
sensitivity could have some effect on the cost and availability 
of residential mortgages. Indeed, one objective of the proposed 
rule is to use variations in risk weights to differentiate 
between high-risk and low-risk mortgages, securitizations, and 
sovereign debt. In particular, for residential mortgages with a 
lower risk weight under the proposed rule, namely category one 
mortgages with loan-to-value ratios less than or equal to 60 
percent, costs may decrease and availability may increase. For 
residential mortgages with higher risk weights under the 
proposed rule, for example, mortgages with loan-to-value ratios 
greater than 90 percent, we expect that costs may increase and 
availability decrease. There are, however, a large number of 
factors beyond risk weights that affect the cost and 
availability of mortgages and other loans. The interaction of 
these factors along with possible changes in bank behavior 
towards risk makes it difficult to arrive at an accurate 
estimate of the proposed rules' impact on mortgage cost and 
availability.

Q.5. Please explain whether or not the proposed higher capital 
requirements for past due loans are a form of ``double 
accounting,'' given that banks already are supposed to reserve 
for these losses.

A.5. The capital requirements for past due loans is not a form 
of double counting or ``double accounting.'' Allowance for loan 
losses (reserves) under accounting standards and regulatory 
capital serve fundamentally different roles. Under existing 
U.S. GAAP, accounting reserves represent the estimated amount 
needed to recognize losses that have been incurred as of the 
balance sheet date. In contrast, the role of regulatory capital 
is to protect a bank from unexpected (and thus unreserved) 
losses. For example, if a loss has been incurred on a past due 
loan, an accounting reserve should be established in a 
sufficient amount to recognize the estimated loss. There is no 
automatic requirement that an accounting allowance be 
established for all past due loans. Nevertheless, the ultimate 
loss on that past due loan is not known with certainty, and it 
is this uncertainty that the capital charge is meant to cover. 
It is also worth noting that the existing capital rules require 
capital for past due loans, even though these loans generally 
already have accounting reserves established. The difference 
between the existing and proposed treatment, therefore, is more 
a matter of the amount of capital that must be set aside, 
rather than whether capital should be set aside or not.
              Additional Material Supplied for the Record
STATEMENT SUBMITTED BY JOHN VON SEGGERN, PRESIDENT AND CHIEF EXECUTIVE 
              OFFICER, COUNCIL OF FEDERAL HOME LOAN BANKS
    The Council of Federal Home Loan Banks (Council), appreciates this 
opportunity to submit a written statement for the Committee's 
consideration in connection with the hearing entitled ``Oversight of 
Basel III: Impact of Proposed Capital Rules''. The Council is a trade 
association whose members are the 12 Federal Home Loan Banks 
(FHLBanks), \1\ and the proposed rules will have a significant impact 
on FHLBank member institutions as well as the mortgage markets as a 
whole. The Council is therefore very interested in the Basel III 
rulemaking proposals and the congressional oversight of their 
development.
---------------------------------------------------------------------------
     \1\ Created by Congress in 1932, the FHLBanks are 12 regional 
banks, cooperatively owned and used to finance housing and economic 
development. More than 7,700 lenders nationwide are members of the 
FHLBank System, representing approximately 80 percent of America's 
insured lending institutions. The FHLBanks and their members have been 
the largest and most reliable source of funding for community lending 
for nearly eight decades.
---------------------------------------------------------------------------
    The Council agrees that the capital rules need to be revisited, and 
that a strong capital buffer is an important safeguard for both 
individual institutions and our financial system as a whole. 
Accordingly, the Council supports the underlying goals of the Basel III 
accord to strengthen the capital base of depository institutions and 
their holding companies; to provide a buffer against systemic risk; and 
to better correlate the required amount of capital and the risks 
presented by particular assets and financial activities. However, for 
the reasons described below, we are unable to support the rules as 
proposed. We have attached to this statement a copy of the comment 
letter we submitted to the regulatory agencies concerning these 
proposed rules.
I. Risk Weight for Mortgages Held in Portfolio
    We are concerned that the proposed capital treatment of mortgage 
loans held in portfolio by community-based institutions is excessive. 
Under the proposal there would be a significant increase in the minimum 
capital requirements for both first and second mortgages, up to twice 
the current requirements, unless the loan-to-value ratio of the 
mortgage loan is 80 percent or less. As a result, unless a home buyer 
can put down at least 20 percent of the cost of the home, plus closing 
costs, the cost of mortgage credit will increase as the mandated 
capital increases. This will harm both the consumer and the overall 
economy.
    Today, and for the foreseeable future, mortgage underwriting 
standards are very stringent. Under recent statutory reforms, the 
Federal banking agencies and the Consumer Financial Protection Bureau 
(CFPB) have many new tools that will significantly raise the credit 
standards utilized in the extension of mortgage credit by regulated 
financial institutions without the need for across the board higher 
capital requirements. Mortgages being made today, and that will be made 
under these new rules, will look much more like the traditional 
mortgages that were originated prior to 2005. These mortgages have 
proven to be safe with very low default and foreclosure rates. 
Burdening these loans with excessive capital requirements will 
unnecessarily impede the availability of mortgage credit, increase 
costs to consumers, and hurt our economic recovery. Especially hard hit 
will be first-time home buyers, who often require high loan-to-value 
(LTV) lending.
    LTV ratio is an important factor in loan performance. A significant 
cash investment in a home purchase clearly lowers the risk of default 
and the loss given a default. However, further analysis needs to be 
undertaken regarding the impact of lower downpayments when other 
factors indicate that the borrower is creditworthy. When other factors 
indicate that the borrower is a prime credit, the fact that the 
downpayment is less than 20 percent should not automatically push the 
loan into a higher capital category.
II. Effect of Other Laws and Regulations and Market Conditions
    Another concern in the proposal is that it fails to recognize the 
impact of all of the statutory and regulatory changes that have been 
adopted or that are expected to be adopted shortly. The CFPB is 
currently promulgating regulations to implement the requirement of the 
Dodd-Frank Act that prohibits a creditor from making a mortgage loan 
without considering the ability of the borrower to repay. These 
regulations will effectively require that lenders use very conservative 
mortgage underwriting standards, or face potential liability for 
failure to consider adequately repayment ability when originating the 
loan. The Dodd-Frank Act also requires regulators to implement new 
rules relating to the securitization of mortgage loans. These 
regulations will define a ``qualified residential mortgage'' which will 
likely become the standard for all new mortgages that are going to be 
placed into securitization vehicles. These regulations will also 
require stringent loan underwriting. The CFPB is given broad powers to 
regulate mortgage originators, including restrictions on incentive 
compensation. All of these new mandates will significantly raise the 
credit standards utilized in the extension of mortgage credit by 
regulated financial institutions. In establishing new capital rules, it 
is critically important to consider these new laws and regulations, 
both in terms of the quality of mortgages that will be originated going 
forward, and also in the cumulative impact these new rules will have on 
mortgage availability and cost. We are concerned that the cumulative 
effect of the proposed capital requirements coupled with the other new 
statutory and regulatory requirements could result in an adverse impact 
on mortgage availability and affordability.
III. Balloon Payments
    Under the proposal, loans that have balloon payment features are 
subject to more onerous capital requirements. Many of our member 
institutions, including community financial institution members, view 
balloon loans as an effective way to provide low cost mortgages to 
their customers. Many customers desire these loans because they know in 
advance that they will be moving within a prescribed number of years, 
or for other legitimate reasons. For community-based lenders, the use 
of these products has not been problematic. We also note that from an 
asset-liability management perspective, community banks are more 
readily able to retain balloon mortgages on their balance sheet, 
reducing the need for securitization. Retention of the mortgages on 
balance sheet also provides a strong incentive for community banks to 
effectively and prudently underwrite and manage the risks in these 
loans.
    Congress specifically recognized the importance of these loans in 
rural and agricultural communities and created an exception in the 
Dodd-Frank Act's qualified mortgage standard for balloon loans made by 
lenders in these communities. We urge that any final capital rule treat 
well underwritten balloon loans like any other first mortgages, 
especially if such loans are written by lenders in rural or 
agricultural areas.
IV. Home Equity Lines of Credit and Second Liens
    During the past decade, some borrowers avoided making any 
meaningful downpayment towards the purchase of the home by using a 
second loan. These so-called ``piggy back'' loans increased the risk to 
the lender. However, home equity lines of credit (HELOC) and second 
liens that are not used for the purpose of funding downpayments are an 
important source of financing for home improvement projects, medical 
expenses, educational payments, and paying off more expensive credit 
card debt. Under the proposal, junior liens are subject to more 
stringent capital requirements, which can double the capital required 
under current rules.
V. Commercial Real Estate
    The proposal would increase the risk weight of certain commercial 
real estate loans from 100 percent to 150 percent. The increased risk 
weight would apply to so-called High Volatility Commercial Real Estate 
(HVCRE) exposures: loans for the acquisition, development and 
construction of multifamily residential properties and commercial 
buildings. The higher risk weight would not apply to loans made for the 
development and construction of 1-4 family residential units.
    Commercial real estate lending is very important to our community 
bank members to support their local communities. We understand that 
this can be a volatile asset, and that during the financial crisis 
these loans deteriorated, but not across the board for every community 
bank. Recent indications are that this market is recovering, 
underwriting standards have improved, and there is a significant need 
for credit in this sector. The regulators have numerous tools to 
prevent a deterioration in underwriting standards, and the use of these 
tools would be a more effective means of addressing the potential risks 
in this type of asset than raising the capital charge for these loans 
without regard to the quality of the loan. Further, it makes little 
sense to have a higher capital charge for a secured loan (150 percent) 
than the capital charge that would result from making an unsecured loan 
to the same builder.
VI. Mortgage Servicing Rights
    Another area of our concern is the treatment of mortgage servicing 
rights (MSRs). These are valuable assets that produce a stream of 
income that can contribute to the health of our financial institutions. 
Under current rules the value of these assets is marked to market 
quarterly, and the market value is then haircut by 10 percent.
    We understand that MSRs are sensitive to changes in interest rates, 
prepayment rates and foreclosure rates. However, they are nevertheless 
a valuable asset that can be sold in a liquid market. Under the 
proposal these assets would essentially be driven out of the banking 
system, to the detriment of both consumers and insured institutions and 
their holding companies. We believe that the proposed treatment needs 
to be reevaluated to ensure that it will not result in harming our 
institutions rather than protecting them.
    We recommend that the agencies' concerns with regard to MSRs focus 
on the quality of the loans associated with the servicing rights, and 
not lump all MSRs together. If the underlying loans are prudently 
underwritten the associated MSRs should be allowed to count as an asset 
for up to 100 percent of Tier 1 capital. If the underlying loan does 
not meet this standard, a more stringent limit on the associated MSRs 
may be appropriate.
VII. Securitization Issues
    The proposal does not change the treatment of MBS that are issued 
or backed by a U.S. agency (zero-percent risk weight), or MBS that are 
issued or backed by Fannie Mae or Freddie Mac (20-percent risk weight). 
However, the proposal makes significant changes in the treatment of 
private label MBS, that will make it much more difficult for community 
banks to purchase private label MBS, and increase the capital charge 
for those that do. This result will unnecessarily impede the return of 
private capital to the mortgage markets.
VIII. Inclusion of AOCI in Calculation of Tier 1 Capital
    The ``minimum regulatory capital ratios, capital adequacy'' 
proposal would require that unrealized gains and losses on securities 
held as ``available for sale'' (AFS) be reflected in a banking 
organization's capital account. The inclusion of these unrealized gains 
and losses creates the potential for several unintended consequences.
    Community banks holding interest rate sensitive securities for 
asset-liability management or other sound business reasons, would see 
changes to their capital ratios based solely on interest rate movements 
rather than changes from credit quality, without commensurate change in 
capital ratios resulting from movements in the market price for other 
assets classes or long term or structured liabilities.
    Community banks would be incented to hold short term or floating 
rate securities to minimize the impact on their capital ratios from 
changes in interest rates. Although there could be beneficial reasons 
for holding longer term fixed rate assets such as municipal or mortgage 
securities, banks could be hesitant to do so realizing the long term, 
fixed rate nature of these investments would subject them to increased 
price sensitivity and impact on their Tier 1 capital.
    Community banks would be incented to hold their securities in 
``held to maturity'' category rather than available for sale to avoid 
the impact on their capital ratios. This would adversely affect a 
bank's ability to manage its balance sheet to respond to growing loan 
demand or changing economic fundamentals.
    The inclusion of unrealized gains and losses in AFS securities 
would diminish the relevance and transparency of the Tier 1 capital 
measure due to institutions receiving inflated levels of Tier 1 capital 
from declining interest rates (and hence) rising market values of fixed 
rate, noncallable securities. This change in capital could overstate 
the amount of Tier 1 capital if the subject bank had no intention of 
monetizing the gain on the securities; this could be the case in a 
scenario where economic activity is stagnant resulting in falling 
interest rates.
IX. Disparate Competitive Impacts
    As discussed above, we believe that the proposal will impose 
capital charges that are far in excess of the actual risks presented, 
especially for mortgages written since the financial crisis of 2008. As 
a result, nonregulated lenders will be able to gain market share at the 
expense of regulated banking institutions. Making this problem more 
severe, the bifurcated capital approach (standardized vs. advanced) 
creates the potential for significant disparate competitive impacts 
across the two approaches. The significant differences in capital 
requirements across the advanced and standardized approaches will 
almost certainly negatively impact community financial institutions as 
they compete with larger institutions in low credit risk portfolios 
like traditional mortgages.
X. Conclusion
    The Council supports the efforts of the Federal regulators to 
enhance regulatory capital requirements for insured depository 
institutions and their holding companies. However, overall we are 
unable to support these rules as proposed. We believe that any 
increased risk weight must be appropriately aligned with the actual 
risk presented by the asset. High capital for nontraditional or poorly 
underwritten loans makes sense, and we support that policy. However, 
applying higher capital charges for traditional and prudently 
underwritten mortgages would be extremely counterproductive to our 
economy and to the American consumer.
    Thank you for the opportunity to include our views in the hearing 
record. If you have any questions, please contact me at the Council's 
Washington office.






























   STATEMENT SUBMITTED BY THE INDEPENDENT COMMUNITY BANKS OF AMERICA
Basel III Should Exempt Community Banks
    On behalf of its nearly 5,000 community bank members, ICBA is 
pleased to submit this statement for the record for the Senate Banking 
Committee hearing titled: ``Oversight of Basel III: Impact of Proposed 
Capital Rules.'' We appreciate the opportunity to share the community 
bank perspective on this issue. ICBA urges the banking regulators to 
exempt all banks with less than $50 billion in assets from the proposed 
rules in order to avoid significant unintended consequences including 
further industry consolidation that would harm small business lending, 
consumers, and small communities.
    ICBA supports strong capital requirements that will make the 
banking system more resilient and help deter another global financial 
crisis. However, Basel III and the standardized approach introduce 
drastic changes to both the definition and calculation of regulatory 
capital that will negatively impact a fragile housing recovery and the 
overall economy. For community banks, Basel III and the standardized 
approach are regulatory overkill and will have a devastating impact on 
small communities and rural areas.
    ICBA strongly believes the complex risk weights and capital 
requirements of Basel III and the standardized approach should not be 
applied to financial institutions in the United States with 
consolidated assets of $50 billion or less. These institutions are not 
deemed to be systemically important financial institutions (SIFIs) 
under the Dodd-Frank Act and are not subject to enhanced prudential 
standards. Applying Basel III and the standardized approach to banks 
beneath this threshold will lead to large scale consolidation in an 
industry already overly concentrated. Without a vibrant community 
banking system, consumers will be left with fewer choices and 
communities and rural areas across the country will be deprived of the 
credit needed to sustain and grow local economies.
    Absent a total exemption, ICBA strongly favors the following 
modifications to Basel III to simplify the rule and better align the 
proposed capital standards to the unique strengths and risks of 
community banking:

    Banks under $50 billion in assets should be exempt from the 
        standardized approach for risk-weighted assets. The 
        standardized approach's complex and punitive risk weighting for 
        residential mortgages could force community banks out of this 
        line of business.

    Unless it can be empirically shown that these assets are 
        risky, the proposed substantially higher risk weights for 
        balloon mortgages and second mortgages should be reduced to 
        their current Basel I levels. Basel I risk weighting better 
        reflects the high-quality nature of this asset class.

    Accumulated other comprehensive income (AOCI) should 
        continue to be excluded from the calculation of regulatory 
        capital for banks under $50 billion in assets to avoid harmful 
        and unnecessary volatility in capital adequacy.

    If AOCI is not excluded from the calculation of regulatory 
        capital for community banks, then changes in the fair value of 
        all obligations of the U.S. Government, mortgage-backed 
        securities issued by Fannie Mae and Freddie Mac, and all 
        municipal securities should be exempt.

    Consistent with the Collins Amendment of the Dodd-Frank 
        Act, bank regulators should continue the current Tier 1 
        regulatory capital treatment of TruPS issued by bank holding 
        companies with consolidated assets between $500 million and $15 
        billion. This change would reflect Congressional intent and 
        reduce the capital burden for community banks.

    Consistent with the proposal for bank holding companies, 
        the Federal Reserve should exempt all thrift holding companies 
        with assets of $500 million or less from Basel III and the 
        standardized approach or provide a policy rationale for why 
        they are not exempt.

    The allowance for loan and lease losses (ALLL) should be 
        included in Tier 1 capital in an amount up to 1.25 percent of 
        risk-weighted assets and the remaining balance of ALLL should 
        qualify for inclusion in Tier 2 capital so that the entire ALLL 
        will be included in a community bank's total capital. This 
        treatment will give proper recognition to the loss-absorbing 
        capacity of the ALLL.

    Mortgage servicing assets should be subject to the current 
        higher deduction thresholds because they do not pose a risk to 
        community bank capital.

    Community banks should be exempt from the provisions of the 
        capital conservation buffer. This is particularly important for 
        Subchapter S banks. Alternatively, the phase-in period for the 
        capital conservation buffer should be extended by at least 3 
        years to January 1, 2022, to provide community banks with 
        enough time to meet the new regulatory minimums.

    The proposed risk weights for equity investments should be 
        substantially simplified so community banks will not be 
        discouraged from investing in other financial institutions such 
        as banker's banks, which are key business partners in community 
        bank lending.

    In the absence of a full exemption from the standardized 
        approach, any changes to the risk weights should be applied 
        prospectively to give community banks enough time to comply.

    Regulators should make accommodations to ensure Basel III 
        and the standardized approach do not negatively impact the 
        Nation's minority banks and the diverse communities they serve. 
        Minority banks should be preserved and promoted.

    If Basel III and the standardized approach are to apply to 
        community banks, then they should also apply to credit unions 
        to limit their competitive advantage.

    Again, the most sensible and prudent policy, the policy that would 
avoid severe unintended consequences, would be an outright exemption 
for financial institutions with assets of less than $50 billion. Basel 
III was originally intended to apply only to large, complex, and 
internationally active institutions. Applying Basel III more broadly in 
a one-size-fits-all manner would harm all consumers and businesses that 
rely on credit and the impact would be especially harsh in small 
communities and rural areas not served by larger institutions.
    ICBA encourages this Committee to consult our October 22 comment 
letter to the banking regulators for more detail substantiating the 
above views. (The ICBA letter is available at: http://www.icba.org/
files/ICBASites/PDFs/cl102212.pdf.)
    ICBA thanks this Committee for convening this important hearing and 
helping to raise the profile of a significant economic policy issue 
with far reaching implications. We appreciate the opportunity to 
present the views of the community banking industry.
