[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
__________
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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
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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
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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''.
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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.
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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.
---------------------------------------------------------------------------
\5\ See, ``Community Banking Connections: A Supervision and
Regulation Publication'' (Third Quarter, 2012),
www.communitybankingconnections.org/articles/2012/Q3/CBCQ32012.pdf.
---------------------------------------------------------------------------
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.
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\6\ 5 U.S.C. 801-808
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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\
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\7\ 5 U.S.C. 601 et seq.
Q.6. What is the estimated impact of the Basel III rules, if
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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\
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\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.
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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\
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\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.
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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.
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\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.
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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.