[Senate Hearing 113-72]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 113-72

 
          MITIGATING SYSTEMIC RISK THROUGH WALL STREET REFORMS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

     EXAMINING THE AGENCIES' IMPLEMENTATION OF WALL STREET REFORMS

                               __________

                             JULY 11, 2013

                               __________

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


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                  Laura Swanson, Deputy Staff Director

                   Glen Sears, Deputy Policy Director

                    Phil Rudd, Legislative Assistant

                  Greg Dean, Republican Chief Counsel

              Jelena McWilliams, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                      Kelly Wismer, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        THURSDAY, JULY 11, 2013

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2

                               WITNESSES

Mary J. Miller, Under Secretary for Domestic Finance, Department 
  of the Treasury................................................     3
    Prepared statement...........................................    25
    Responses to written questions of:
        Senator Crapo............................................    63
        Senator Menendez.........................................    64
        Senator Brown............................................    66
        Senator Warren...........................................    67
Daniel K. Tarullo, Governor, Board of Governors of the Federal 
  Reserve System.................................................     4
    Prepared statement...........................................    27
    Responses to written questions of:
        Senator Crapo............................................    70
        Senator Menendez.........................................    72
        Senator Brown............................................    77
        Senator Warren...........................................    80
Martin J. Gruenberg, Chairman, Federal Deposit Insurance 
  Corporation....................................................     6
    Prepared statement...........................................    36
    Responses to written questions of:
        Senator Crapo............................................    90
        Senator Menendez.........................................    93
        Senator Brown............................................    94
        Senator Warren...........................................    95
Thomas J. Curry, Comptroller of the Currency, Office of the 
  Comptroller of the Currency....................................     7
    Prepared statement...........................................    46
    Responses to written questions of:
        Senator Crapo............................................   100
        Senator Menendez.........................................   101
        Senator Brown............................................   103
        Senator Warren...........................................   105

                                 (iii)


          MITIGATING SYSTEMIC RISK THROUGH WALL STREET REFORMS

                              ----------                              


                        THURSDAY, JULY 11, 2013

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 11:02 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. Good morning. I call this hearing to 
order.
    Today, the Committee continues its oversight of the 
implementation of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act. The officials before us today have 
been asked to update the Committee on their agencies' efforts 
to improve financial stability and mitigate systemic risk. This 
includes strengthening risk-based capital liquidity and 
leverage rules for our Nation's largest banks, enhancing risk 
management, facilitating the orderly resolution of any failing 
financial firm, and finalizing the Volcker Rule and other 
pending rules. These are important efforts to help realize the 
goals of Wall Street Reform.
    Recently, significant progress has been made. In the past 2 
weeks, the Fed, FDIC, and OCC finalized the Basel III capital 
rules and issued a proposal to reduce leverage at the largest 
firms. The FSOC also tagged certain financial companies for 
heightened supervision.
    I also want to commend the agencies for working to strike 
the right balance in the rule-writing process and for taking 
steps to address concerns Ranking Member Crapo and I raised in 
our February letter regarding the treatment of community banks 
and insurance companies. New rules should focus on reducing 
risk, not applying a one-size-fits-all approach to a diverse 
marketplace.
    While progress has been made, it has been nearly 5 years 
since reckless financial firms put our economy in jeopardy and 
3 years since the passage of the Wall Street Reform Act. It is 
time to finish implementing these reforms as quickly as 
possible to put an end to ``too big to fail'' and to protect 
American taxpayers from ever again bailing out a failing 
financial company.
    I have asked our witnesses to outline when their agencies 
will finalize the remaining rules required by the Act.
    Congress must also do its job by confirming well-qualified 
nominees and providing funding to allow regulators to write and 
enforce the rules. Only then will we have a regulatory system 
that is ready to identify and respond to the greatest risk to 
our Nation's economic well being.
    I now turn to Ranking Member Crapo for his opening 
statement.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman.
    Today, we have asked our regulators to address the 
implementation of Title I and Title II of the Dodd-Frank Act. 
Title I of Dodd-Frank brought us the Financial Stability 
Oversight Council, heightened prudential standards, increased 
leverage and risk-based capital requirements, while Title II 
established a new system for resolution of systemically 
important nonbank financial companies.
    The U.S. banking system and capital markets must remain the 
preferred destination for investors throughout the world. It is 
important that the implementation of capital standards and 
orderly liquidation are done properly without overburdening our 
financial system and without placing the United States markets 
at a competitive disadvantage.
    In the past couple of weeks, the Federal banking regulators 
have been very busy, issuing a number of rules and guidance 
regarding capital standards. And very recently, the Federal 
Reserve, the OCC, and the FDIC issued final rules strengthening 
the regulatory capital framework for banking organizations, 
including Basel III. And as the Chairman indicated, earlier 
this year, he and I sent a letter regarding potential effects 
of Basel III proposals on community banks and insurance 
entities. So I also appreciate the distinctions made by the 
regulators in the final rules for these banks and insurers.
    With regard to the overall capital standards and whether 
Dodd-Frank ended too big to fail, I look forward to hearing 
from the regulators on these issues today. I appreciate the 
hard work that has gone into these capital standards and into 
producing and reviewing living wills. But many, including 
myself, believe that Dodd-Frank did not yet end too big to 
fail.
    Going forward, we must learn more about the additional 
steps that regulators plan to undertake to determine leverage 
and debt-to-equity ratios for big banks as well as how to treat 
short-term wholesale funding. It also remains to be seen 
whether and how orderly liquidations are able to address 
dissolution of systemically important nonbank financial 
companies while avoiding financial shocks to the market.
    As we approach Dodd-Frank's third anniversary, there is a 
considerable amount of work to be done, such as working through 
the complexity of the Volcker Rule and issuing the outstanding 
risk retention rules.
    Encouragingly, there does appear to be a building 
bipartisan consensus that some elements of Dodd-Frank may need 
to be fixed. At the last Humphrey-Hawkins hearing, Chairman 
Bernanke identified the end user exemption, the swap push-out, 
and community bank matters for relief in which specific Dodd-
Frank provisions could be reconsidered.
    At our recent hearing on community banks, it became clear 
that both sides of the aisle agreed that there is a need to 
provide relief to community banks, especially in rural areas. 
The regulatory framework that emerged out of Dodd-Frank has 
made it increasingly difficult for community banks as they are 
disproportionately affected by the increased regulation because 
they are less able to absorb the additional costs.
    In the brevity of time, so that we can get to the panel 
quickly, I also wish to reiterate the points that I have made 
at other hearings this year about the potential for cumulative 
regulatory burdens and the drain to our financial system by the 
necessity of well-prepared economic analysis and how these 
rules will affect our economy as a whole and may affect our 
global competitiveness. It is my hope that today's hearing will 
also allow us to address the critical and needed Dodd-Frank 
reforms as a bipartisan consensus grows that we can fix at 
least some of these issues.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Crapo.
    This morning, opening statements will be limited to the 
Chairman and Ranking Member to allow more time for questions 
from the Committee Members. I want to remind my colleagues that 
the record will be open for the next 7 days for opening 
statements and any other materials you would like to submit.
    Now, I would like to introduce our witnesses. Mary Miller 
is the Under Secretary for Domestic Finance of the U.S. 
Department of the Treasury. Dan Tarullo is a member of the 
Board of Governors of the Federal Reserve System. Martin 
Gruenberg is the Chairman of the Federal Deposit Insurance 
Corporation. And Tom Curry is the Comptroller of the Currency.
    I thank all of you again for being here today. I would like 
to ask the witnesses to please keep your remarks to 5 minutes. 
Your full written statements will be included in the hearing 
record.
    Under Secretary Miller, you may begin your testimony.

   STATEMENT OF MARY J. MILLER, UNDER SECRETARY FOR DOMESTIC 
              FINANCE, DEPARTMENT OF THE TREASURY

    Ms. Miller. Chairman Johnson, Ranking Member Crapo, and 
Members of the Committee, thank you very much for the 
opportunity to testify today.
    I would like to update the Committee on several important 
regulatory developments since I appeared before you in 
February.
    In April, the Financial Stability Oversight Council 
released its 2013 Annual Report, and in May, Secretary Lew 
testified before this Committee on the report.
    At the beginning of June, the Council voted to make 
proposed designations of an initial set of nonbank financial 
companies under Section 113 of the Dodd-Frank Act. Earlier this 
week, the Council made final designations of two companies in 
this initial set that did not request hearings, American 
International Group and General Electric Capital Corporation. 
One other company currently subject to a proposed designation 
requested a hearing, which will be held no later than early 
August, with a final decision by the Council no later than the 
beginning of October. This is an ongoing process and the 
Council will continue to evaluate other companies for potential 
designation.
    The bank regulatory agencies have just finalized an 
important set of rules codifying the Basel capital requirements 
for banks and bank holding companies. They also proposed a 
leverage requirement earlier this week as a companion to the 
capital requirements. I will defer to my colleagues on the 
panel to discuss the details of these rules, but the progress 
we have made on both a significantly stronger capital regime 
and the expansion of the supervisory umbrella to cover 
designated nonbank financial companies are key developments in 
strengthening our financial system.
    In February, I also highlighted the Council's work on money 
market mutual fund reform. At the end of 2012, the Council 
issued proposed recommendations on money fund reforms for 
public comment. Throughout this process, we have made it clear 
that the SEC is the primary regulator and should take the lead 
in driving reforms.
    In June, the SEC proposed regulations to reduce the risks 
presented by money funds. Public comments will provide 
important feedback and information for the SEC to consider in 
developing a final rule.
    Also in June, Treasury's Federal Insurance Office released 
its first Annual Report on the Insurance Industry and is 
working to complete its report on the Modernization and 
Improvement of Insurance Regulation in the United States.
    I would also like to highlight for the Committee a few 
areas where Treasury intends to direct significant attention 
and resources during the remainder of the year to complete key 
outstanding pieces of reform. In his capacity as Chairperson of 
the Council, Secretary Lew is responsible for coordinating the 
regulations issued by the rule-making agencies responsible for 
implementing the Volcker Rule and the Risk Retention Rule. 
Finalizing these regulations will continue to be a top priority 
for the Secretary and the Treasury Department.
    Treasury will also continue to engage closely with our 
regulatory counterparts at home and abroad to strengthen our 
ability to wind down failing financial companies while 
minimizing the negative impact on the rest of the financial 
system and the economy.
    By the end of this year, we expect to approach the point of 
substantial completion of implementation of the Dodd-Frank Act, 
but that does not mean that we will be able to relax our guard. 
Constant evolution in the financial system and the activities 
of financial institutions will require regulators to be 
flexible and to stand ready to address new threats to the 
financial system.
    Thank you, and I would be happy to answer any questions.
    Chairman Johnson. Thank you.
    Governor Tarullo, please proceed.

STATEMENT OF DANIEL K. TARULLO, GOVERNOR, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr. Tarullo. Thank you, Mr. Chairman, Senator Crapo, and 
the rest of the Members of the Committee.
    At this Committee's oversight hearing in February, I 
expressed the hope that 2013 would be the beginning of the end 
of the major portion of rulemakings implementing Dodd-Frank and 
strengthening capital rules. Progress over the intervening 5 
months is bearing out this hope. The Basel III capital package 
is now final, as the Chairman has noted. I will say more on 
that in a moment. The Section 716 rule is done. We have made 
good progress on the Volcker Rule and are on track to be done 
by the end of the year.
    Late this year, we will publish a proposed rule for capital 
surcharges on firms of global systemic importance. The proposed 
rule on the liquidity coverage ratio, which is one of the 
special prudential standards for larger banks, will be out in 
the fall. And with one exception, we should have final versions 
of the other special prudential rules for firms with over $50 
billion in assets done this year. The one exception is the rule 
on counterparty credit risk on which, as I mentioned in 
February, we thought we needed to do a quantitative impact 
study.
    On capital, the finalization of the Basel III package marks 
the end of major modifications to the capital rules applicable 
to the vast majority of the Nation's banks. The final capital 
rule substantially simplified some of the elements of the 
proposed rule that had been of greatest concern to smaller 
banks.
    For the eight largest banking organizations already 
identified as of global systemic importance, we still have some 
work to do in building out a capital regime of complementary 
requirements that focus on different vulnerabilities and 
together compensate for the inevitable shortcomings of any 
single capital measure.
    The first element of this regime, the Basel III risk-
weighted capital ratio, is now complete.
    Second, as I already mentioned, since the Basel Committee 
has just completed its methodological refinements for the 
capital surcharge on the largest, most systemically important 
firms, we will be getting out a proposed rule on this subject 
later in the year.
    The third element, our stress testing and capital review 
requirements, is in place. These requirements provide a 
forward-looking projection of capital needs under adverse and 
severely adverse scenarios, taking account of losses that would 
be associated with each firm's specific portfolios.
    Fourth, the three banking agencies have just proposed a 
rule establishing a higher leverage ratio threshold that will 
be an effective counterpart to the combination of risk-weighted 
requirements.
    Fifth, we will be issuing an Advance Notice of Proposed 
Rulemaking on possible approaches to addressing directly the 
risks related to short-term wholesale funding, including a 
requirement that large firms substantially dependent on such 
funding hold additional capital.
    Sixth, in the next few months, we will issue a proposed 
rule on the combined amount of equity and long-term debt these 
firms should have in order to facilitate orderly resolution in 
appropriate circumstances. This is really a gone concern, as 
opposed to a going concern capital measure, but it is an 
important piece of an overall effort to confine the systemic 
risks posed by large banking organizations.
    As to the form of systemic risk most in need of further 
attention and regulatory action, I will repeat what I said in 
February. It lies in the very large amounts of short-term 
funding other than insured deposits used by financial 
intermediaries. The various forms of this funding, though 
varying in the degree of vulnerability they pose, are all to a 
greater or lesser extent susceptible to destabilizing runs of 
the sort that set off the worst phase of the financial crisis.
    The Advance Notice of Proposed Rulemaking to which I 
referred a few moments ago will address the particular 
vulnerability that exists when large amounts of this funding 
are concentrated in individual firms. But I should also 
emphasize that a financial system heavily reliant on such 
funding could create a good bit of systemic risk even if no 
individual firms were thought too big to fail. As the rules 
applicable to prudentially regulated banking organizations take 
effect, the chances increase that more such activity will 
migrate outside the prudential regulatory perimeter.
    Measures on money market mutual funds and the tri-party 
repo market would represent a good beginning to address this 
vulnerability, but I believe we need to consider carefully 
possible additional steps in areas such as securities financing 
transactions to address the potential for runs in short-term 
funding regardless of whether the borrower is a large regulated 
institution.
    Thank you very much for your attention.
    Chairman Johnson. Thank you.
    Chairman Gruenberg, please proceed.

  STATEMENT OF MARTIN J. GRUENBERG, CHAIRMAN, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Mr. Gruenberg. Thank you, Chairman Johnson, Ranking Member 
Crapo, and Members of the Committee, for the opportunity to 
testify today on the FDIC's actions to implement the Dodd-Frank 
Act, particularly in regard to mitigating systemic risk.
    I will focus my comments on the recent capital rulemakings 
by the banking agencies and also on the FDIC's implementation 
of the systemic resolution provisions of Dodd-Frank.
    Earlier this week, as Governor Tarullo mentioned, the FDIC 
Board acted on two important regulatory capital rulemakings. 
First, the FDIC issued an interim final rule that significantly 
revises and strengthens risk-based capital regulations through 
implementation of Basel III. The rule would strengthen the 
quality and quantity of risk-based capital for all banks, 
including by placing greater emphasis on Tier 1 common equity 
capital, which is widely recognized as the most loss absorbing 
form of capital.
    The rule also makes significant changes to address a number 
of community bank concerns raised during the comment period on 
the proposed rule that I describe in some detail in my written 
testimony.
    Second, the FDIC joined with the Federal Reserve and the 
OCC in issuing a Notice of Proposed Rulemaking which would 
strengthen the supplementary leverage ratio requirements for 
the eight largest, most systemically significant U.S. bank 
holding companies and their insured banks. The NPR would 
require these insured banks to satisfy a 6-percent 
supplementary leverage ratio requirement to be considered well 
capitalized for prompt corrective action purposes. Bank holding 
companies covered by the NPR would need to maintain 
supplementary leverage ratios of a 3-percent minimum plus a 2-
percent buffer for a total 5-percent requirement.
    Maintenance of a strong base of capital at the largest, 
most systemically important institutions is particularly 
important because capital shortfalls at these institutions can 
contribute to systemic distress and can have material adverse 
economic effects. Analysis by the banking agencies suggests 
that a 3-percent minimum supplementary leverage ratio, which is 
required under Basel III, would not have appreciably mitigated 
the growth in leverage among these organizations in the years 
preceding the recent crisis.
    In addition to these capital proposals, the FDIC has made 
significant progress in developing a more effective resolution 
framework for large, systemically important financial 
institutions, or SIFIs, as required by the Dodd-Frank Act.
    Title I of the Act requires that certain large financial 
institutions prepare resolution plans, or living wills, to 
demonstrate how the company could be resolved in a rapid and 
orderly manner under the Bankruptcy Code.
    Eleven large, complex financial companies submitted initial 
resolution plans in 2012, with the remaining covered companies 
required to file plans in 2013. Following the review of the 
initial eleven resolution plans, the agencies have developed 
guidance for these firms to detail what information should be 
included in their 2013 revised resolution plan submissions. 
These revised resolution plans will be subject to reviews for 
resolvability under the Bankruptcy Code. The FDIC and the 
Federal Reserve will be evaluating how each plan addresses a 
set of benchmarks outlined in the guidance which pose the key 
impediments to an orderly resolution.
    While bankruptcy is the preferred option for resolution 
under Dodd-Frank, if resolution under the Bankruptcy Code would 
result in serious adverse effects on financial stability in the 
United States, Title II of Dodd-Frank sets out the orderly 
liquidation authority to serve as a last resort alternative.
    To implement the orderly liquidation authority, the FDIC 
has developed a strategic approach to resolving a SIFI, which 
is referred to as a Single Point of Entry. In the Single Point 
of Entry resolution, the FDIC would be appointed as receiver of 
the top tier parent holding company of the financial group 
following the company's failure. Shareholders would be wiped 
out. Unsecured debt holders would have their claims written 
down to reflect any losses the shareholders cannot cover. And 
culpable senior management would be replaced. As I detail in my 
testimony, we believe the Single Point of Entry strategy holds 
the best promise of achieving Title II's goals of holding 
shareholders, creditors, and management of the failed firm 
accountable for the company's losses and maintaining financial 
stability at no cost to taxpayers.
    Mr. Chairman, that concludes my remarks. I would be glad to 
respond to your questions.
    Chairman Johnson. Thank you.
    Comptroller Curry, please proceed.

  STATEMENT OF THOMAS J. CURRY, COMPTROLLER OF THE CURRENCY, 
           OFFICE OF THE COMPTROLLER OF THE CURRENCY

    Mr. Curry. Chairman Johnson, Ranking Member Crapo, and 
Members of the Committee, thank you for the opportunity to 
discuss those provisions in the Dodd-Frank Wall Street Reform 
and Consumer Protection Act that reduce systemic risk and 
improve financial stability.
    The global financial crisis was unprecedented in its 
severity and exposed a number of fundamental weaknesses in the 
regulation and structure of the financial system. The Dodd-
Frank Act sets new requirements for capital, liquidity, and 
higher-risk activities and provides additional regulatory tools 
that will mitigate future problems.
    In my written testimony, I provided a detailed update on 
what the OCC has done to implement those provisions along with 
other steps we have taken to ensure that national banks and 
Federal thrifts operate safely, even in times of economic 
stress. This morning, I would like to focus on a handful of key 
areas.
    First, I am pleased to tell you that the OCC has completed 
work on all of the rulemakings required under Dodd-Frank that 
we have authority to implement on our own. This includes rules 
related to lending limits, stress testing, credit ratings, and 
retail foreign exchange transactions. We are continuing to work 
on an interagency basis on other Dodd-Frank provisions, 
including the Volcker Rule.
    Most recently, we joined with the other bank regulatory 
agencies in a comprehensive overhaul of the capital rules that 
apply to banks and thrifts. On Tuesday, like my colleagues, I 
signed the new domestic capital rule, which takes important 
steps to improve the quantity and quality of capital for all 
banks and thrifts while setting higher standards for large 
institutions. This rulemaking includes requirements laid out in 
Dodd-Frank.
    I also issued a proposed rule with the other agencies that 
would double the leverage ratio to 6 percent for the largest 
and most interconnected U.S. banks. The new domestic capital 
rule raises capital ratios, expands the base of assets for 
risk-based capital calculations, and emphasizes common equity, 
which has proven to be the form of capital best able to absorb 
losses.
    The rule also mandates that all institutions maintain a 
buffer of additional common equity and restricts payment of 
dividends and bonuses if that buffer falls below 2.5 percent. 
In addition, for large banks and thrifts, we established a 
countercyclical buffer that could be activated during upswings 
in the credit cycle to protect against excessive lending and 
will consider in a separate rulemaking a surcharge that would 
apply to the largest, most systemically important institutions. 
With these additional requirements, the largest U.S. banks 
could be required to hold Tier 1 common equity equal to as much 
as 12 percent of their risk-adjusted assets during upswings in 
the credit cycle.
    Throughout this process, one of my top goals has been to 
minimize the impact of these rules on community institutions. 
We found that the vast majority of community banks already have 
enough capital to meet the new requirements. We conducted 
extensive outreach and paid close attention to comments we 
received from community banks and thrifts. As a result, we made 
a number of revisions to the proposed rule, particularly in the 
areas of residential mortgage exposures, AOCI, and trust 
preferred securities that, I believe, will effectively address 
their most important concerns.
    While the financial crisis revealed the need for additional 
regulations, it also highlighted the importance of strong 
supervision and close collaboration among the bank supervisory 
agencies. At the OCC, we have raised the bar on our 
expectations for the institutions in our large bank program, 
requiring higher standards for audit, governance, and risk 
management. We have focused particular attention on independent 
directors. We expect them to set strategic direction for the 
bank and to have the knowledge and the will to provide a 
credible challenge to management.
    In addition, we are working with the large banks we oversee 
to reduce the number and complexity of the legal entities 
within their organizations and to ensure that those entities 
align properly with business lines at each bank. This process 
will take time, but it will ultimately improve transparency, 
risk management, and governance, and will make it easier to 
deal with the resolution of large institutions that do get into 
trouble.
    Finally, I am pleased to say that the national banks and 
Federal thrifts supervised by the OCC have made significant 
progress in raising capital and have been reducing their 
reliance on volatile funding sources. At the same time, asset 
quality has improved across the board. The national banking 
system is substantially stronger today than it was before the 
crisis.
    We believe these are important achievements, but we also 
recognize that much remains to be done. As we continue the 
important work of implementing the Dodd-Frank Act, I can assure 
you that the OCC will work closely with the other regulatory 
agencies to ensure that the banks and thrifts we supervise are 
safe and resilient enough to stand up to future economic 
disruptions.
    Thank you very much, and I would be happy to answer any 
questions.
    Chairman Johnson. Thank you. Thank you all for your 
testimony.
    We will now ask questions of our witnesses. Will the Clerk 
please put 5 minutes on the clock for each Member.
    Ms. Miller, what steps are being taken to finalize rules 
that will do the most to mitigate systemic risk? What is the 
time table to complete key rules, and as the Chair of FSOC, 
what is the Treasury doing to better coordinate these efforts 
with regulators here and abroad?
    Ms. Miller. Thank you very much for your questions. First 
of all, I think you have heard this morning about some of the 
most recent progress to finalize rules that will put into 
effect the objectives of Dodd-Frank and the broader capital 
regimes internationally. When I was looking at the testimony 
that my colleagues prepared today, I thought it was very useful 
to look at the helpful lists they provide of finalized rules, 
of rules that are in progress, and what is left to be done, and 
I agree very much with the sentiment that we are closer to the 
end than the beginning here.
    I think that the work that has been done to strengthen 
financial institutions, to put in place the important 
architecture of Title VII on the derivatives treatment in 
markets, I think the Title II work and Title I work to help 
with winding down systemically large institutions, is 
enormously useful. I think one of the most damaging aspects of 
the financial crisis was not having in place clear rules of the 
road of the way these things should work when you get into 
difficulty.
    So I applaud the regulators for the work that has been 
done. I do think that we have some quite important roles to 
finish, and I think that it is possible that we will see 
significant progress this year.
    Chairman Johnson. Governor Tarullo and Comptroller Curry, I 
appreciate the steps taken in the final Basel III rule 
regarding insurance companies. What next steps will the Fed 
take to create capital rules that are better suited for 
companies that focus on the business of insurance?
    Mr. Tarullo. Well, Mr. Chairman, you referred to the 
provision that we included in the final rule that actually 
defers our capital rules for firms with more than 25 percent of 
their activities in insurance underwriting. The reason we did 
that was that, as you and Senator Crapo know and have pointed 
out, there are a number of products that insurance underwriters 
develop and then market to the public which are unlike bank 
products.
    The prototypical example of that would be the so-called 
separate accounts. Separate accounts come in a lot of different 
varieties. They are not susceptible to a single capital 
treatment, and they are certainly not susceptible to the kind 
of risk weighting we would do for a bank asset.
    As the three of us were trying to complete the Basel III 
package, it did not seem as though it was sensible to try to 
rush answers to some of those novel questions, but it also did 
not seem sensible to hold up the Basel package. So we have 
delayed the final rules on insurance-related holding companies 
in order to give ourselves the opportunity to look more deeply 
into some of those products.
    Now, having said that, I think it is important to note that 
we do operate under a constraint here. That is to say, the 
Collins Amendment does require that generally applicable 
capital requirements be applied to all the holding companies 
that we supervise. And while we can and will take into account 
the unique characteristics of insurance products that are not, 
by law, marketed by banks and other banking organizations, we 
do not have the ability to risk weight, for example, the same 
security that is held by a bank or by an insurance company 
differently, and at some level, it does not really make any 
sense to do it differently. The asset has the risk that it has.
    The problem here, Mr. Chairman, comes on the liability side 
of the balance sheet. Bank-centered capital requirements are 
developed with an eye to the business model of banks and the 
challenge that the FDIC would have in resolving a bank, or now 
a systemically important banking organization, that would be in 
deep trouble. The more or less rapid liquidation of a lot of 
those claims and the runs on a lot of the funding of that 
institution lie behind the setting of the capital ratio.
    But the liability side of an insurance company's balance 
sheet--a true insurance company, somebody selling life 
insurance, for example--is very different. There is not a way 
to accelerate the runs of that funding. People are going to 
continue to pay their premiums and, presumably, they are not 
going to die any more quickly just because the insurance 
company is in some sort of difficulty. But we are not in a 
position to take account of that different business model in 
setting requirements, which under Collins have to be the 
generally applicable capital requirements.
    So with that constraint, I can assure you that we are 
working as much as we can on tailoring risk weighting for 
unique insurance products, but we are a little bit confined 
here.
    Chairman Johnson. Mr. Curry and Mr. Gruenberg, how will 
each of your agencies monitor and evaluate the impact of the 
new Basel III requirements on community banks to minimize 
unnecessary burden? Mr. Curry.
    Mr. Curry. Thank you, Chairman. We would primarily rely on 
our supervisory process. We are required by statute and by 
sound supervisory policy to examine each of our national banks 
and Federal thrifts on an annual or a little bit less frequent 
basis for well-capitalized institutions and well-managed 
institutions. That would be our primary method of evaluating 
the impact.
    We are very sensitive to the impact of the capital rules on 
those institutions that we supervise, and that has been part of 
our rationale during the rule-making process itself, to make 
both our Notices of Proposed Rulemaking and our final actions 
as clear as possible to those institutions through Web casts, 
through the publications that we jointly issued, and with the 
pamphlets that my office has issued. But we plan on working 
with the institutions, and there is an extra year before the 
rules trigger for community banks and thrifts.
    Chairman Johnson. Mr. Gruenberg.
    Mr. Gruenberg. The impact of Basel III on community banks 
has been a matter of particular attention for us at the FDIC. 
As you know, we are the lead Federal supervisor for the 
majority of community banks in the United States, so it has 
been a particular focus, which is reflected in the close 
attention we paid to the comments that we received on the 
rulemaking itself and the changes, as you pointed out, that 
were made in the final rule in response to those comments.
    But, in addition, we really want to work hard as the rules 
come out and the banks have to prepare for implementation to be 
sure they really understand well what is contained in the final 
rule. We have organized a series of outreach efforts focused on 
community banks to explain and make as clear and 
straightforward as possible what the requirements are.
    We are going to be holding outreach sessions in each of our 
six regional offices around the country where we are going to 
invite community bankers from the region to either attend or 
call in. We also are creating a video of the presentation that 
will be posted on our Web site that any community bank can look 
at if they are not able to attend the session. We are creating 
two guides, a shorter one and a longer one, that can be 
utilized by community banks to facilitate their compliance with 
the rulemakings, in effect, a shorthand guide to compliance 
with the rules.
    And we are also designating experts in each of our regional 
offices. So any community bank that may have a question as they 
go through the rules and are uncertain as to how the rules 
would apply to their specific institution can call and get an 
individual to walk them through it. This will also be a matter 
of close attention by our examiners as they examine each of the 
institutions, as well.
    As Comptroller Curry pointed out, for community banks, 
there will be some lead time here in terms of the beginning of 
implementation. It will be January of 2015, and we really want 
to use that period to help the institutions prepare for 
implementation and put them in a position so they can do so in 
a reasonable and cost-effective way.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    My first question is for the Federal Reserve, the FDIC, and 
the OCC. On July 2, the Federal Reserve finalized Basel III 
capital rules and previewed plans for even tougher capital 
rules for big banks. The final Basel III rule issued by the Fed 
addressed only a subset of the issues jointly proposed by the 
Fed, the FDIC, and the OCC. And on July 9, the FDIC announced 
that it will consider Basel III as an interim final rule and 
proposed a supplementary leverage ratio of 5 percent for large 
bank holding companies and 6 percent for the banks that are 
owned by these holding companies. A number of issues remain 
outstanding, including particularly capital rules for insurers 
and large banks.
    My question is, can you provide an insight for us into what 
we can expect from the regulators on these issues and when?
    Mr. Tarullo. On the proposed rule on the leverage ratio, we 
put it out for comment, as you have to do with all proposed 
rules. We have got a number of questions in there and we will 
receive comments on it. But in the normal course, you get the 
comments, you see whether there are things you want to change, 
and then you put the rule into final. So, until we see the 
comments, obviously, we cannot give a timeframe, but I think 
everybody's intention was to get the rule out, get the 
comments, and then try to move as expeditiously as possible 
with finalizing that rule.
    With respect to some of the other things, Senator, that the 
Fed specifically mentioned that are not OCC and FDIC 
initiatives, the additional capital for--excuse me, gone 
concern capital, the long-term debt requirement, is something 
which we have been working on for quite some time in close 
consultation with the FDIC, and I anticipate we are going to 
get that proposed rule out in the fall. There are still some 
technical issues being worked through, but I think we have got 
a sense of how we want to go about making sure that the 
resolution of a large systemically important firm could proceed 
smoothly.
    The area where we have not moved as far down the road is in 
that wholesale funding area, which you mentioned in your 
introductory statement, as did I. As I say, I think the major 
vulnerability that remains is that associated with large 
amounts of runnable short-term funding. And what we want to do 
is, in an Advance Notice of Proposed Rulemaking, get out some 
ideas as to how we might address that, certainly with respect 
to the very large institutions, and that is where the 
relationship between capital and liquidity requirements comes 
in----
    Senator Crapo. And do you know when we could expect that?
    Mr. Tarullo. We will get the ANPR out in the early fall, I 
think. But just to be clear, an ANPR is basically--is not like 
a rule text. The ANPR says, here is the way we are thinking and 
tries to elicit at a relatively early stage of regulatory 
development people's reactions to those approaches.
    Senator Crapo. Thank you.
    Mr. Gruenberg.
    Mr. Gruenberg. For the FDIC, in the capital area, the big 
outstanding work will be completing the rulemaking in regard to 
the leverage ratio. We really viewed it as an important 
complement to the Basel III rulemaking. Basel III would 
strengthen the quality and quantity of risk-based capital. 
Frankly, the Basel III rule in regard to the leverage ratio did 
not have a comparable strengthening. In effect, the proposed 
leverage ratio rule is to create a balance, to strengthen the 
leverage ratio in a way that is comparable to the strengthening 
of risk-based capital.
    We think that combination actually makes for the most 
balanced and strongest foundation of capital, particularly for 
our largest and most systemically important financial 
institutions. We really view that as an important part of 
moving to completion on the entire Basel III package, and as 
Governor Tarullo indicated, we would hope to reach conclusion 
on that, I would think, by the end of the year.
    Senator Crapo. Thank you.
    Mr. Curry.
    Mr. Curry. Like the FDIC, our primary focus at the OCC is 
on reviewing the comments that we expect to receive on the 
supplemental leverage ratio. We issued the NPR with several 
questions where we are trying to determine what the potential 
impact of that proposal would be, both pros and cons. And we, 
like the FDIC, view the supplemental leverage ratio as 
basically belts and suspenders to make sure we have a properly 
calibrated leverage ratio that works well with the existing 
risk-based capital regime that we have in place.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Governor Tarullo, thank you for your comments in answer to 
Chairman Johnson's question on insurance and the Collins 
Amendment and the work you are doing there.
    This is my question for Governor Tarullo, first. We clearly 
agree we need stronger, better capital standards. We would both 
like them to be higher than they are. I am particularly 
concerned, though, that banks can use risk weights and internal 
models to game their capital rules. The Financial Times 
reported today that the biggest banks plan to use what they 
said optimization strategies, not more equity, to meet the new 
leverage ratios. An executive at a large U.S. bank on Wednesday 
said, quote, ``We are going to be able to pull a lot of 
levers.'' Analysts at Goldman Sachs noted in research for 
clients that, quote, ``Banks have a lot of options to mitigate 
the impact.''
    What more should we be doing--should you be doing--in terms 
of using Basel III, using the Collins Amendment, using the 
proposed new leverage ratios in Section 165 of Dodd-Frank to 
address this potential gaming of the capital rules that appear 
to be imminent?
    Mr. Tarullo. Well, Senator Brown, let me begin by echoing a 
term that Chairman Gruenberg used, which--I am not sure he used 
the term, but he had the concept of complementarity of the 
relationship between different capital measures.
    You know, if we think back to how we started getting risk-
weighted capital in the first place, it was actually in the 
early 1980s. Up to that point, the regulators basically used 
some variant on a leverage ratio. And then what we saw with 
savings and loans and famously with Continental Illinois was 
that the banks were gaming the leverage ratio by taking the 
most risk they could for a given amount of leverage. And it was 
at that moment when the regulators began to say they needed 
something else which looked at the actual amount of risk that 
the bank was taking. So thus was born the concept of risk 
weighting, which saw its way into the Basel I agreement.
    Now, what we saw more recently, and Basel II was kind of 
the height of this, was the opportunity for gaming or 
arbitraging once you have your risk-weighted capital 
requirements in place. The model-driven approach--the internal 
model-driven approach to risk weighting--has the potential for 
problems both because the models are backward looking and thus 
they may be honestly put together, but they do not contemplate 
new problems in the world which can create different loss 
functions. They also have the potential, obviously, to be 
gamed, because they are sometimes extremely opaque and 
difficult to monitor effectively.
    Now, it is important to note, Basel II has never governed 
the capital ratios of any U.S. bank. We are still basically on 
a variant on Basel I, and with the Collins Amendment, we will 
always have the standardized risk-weighted capital as our base. 
But, as I saw in research before coming to the Fed, in some 
other countries the introduction of the internal models-driven 
approach pushed capital down pretty quickly.
    So, in terms of what we have got to do, we have got to take 
account of the shortcomings of each of these, the potential for 
gaming, whether it is gaming of risk-based capital or, as you 
just noted in the FT story, the potential for gaming leverage 
ratio, and to make sure that we have got a good risk-weighted 
approach, which I think we have now got in the Basel III 
package; a leverage ratio which is a strong complement and 
floor to that, making sure that you cannot game risk weighting 
to get too much leverage; and third, and from my point of view, 
this has been the real innovation in banking regulation in the 
last 4 or 5 years, is the stress testing that we are now doing 
for firms over $50 billion, because what we do with stress 
testing is we basically say we are going to get portfolio 
specific and risk specific, but we are going to do it. We are 
not going to rely on the internal models of the banks to do it. 
We are going to have a set of loss functions that the Fed 
creates and we are going to run their portfolios through that 
set.
    I think those three things together provide a quite solid 
base, each of which compensates for the potential shortcomings 
of the other.
    What more do we have to do? I will come back to what I said 
earlier. I think what more we have to do is pay more attention 
to, again, the liability side of the balance sheet, the short-
term wholesale funding which can run. And what I am interested 
in is pursuing the relationship between capital and the 
liability side of the balance sheet, which has generally not 
been done. Usually it is capital and the asset side of the 
balance sheet. I think we need to complement that.
    So whether we do it through increased capital requirements 
based on the amounts of wholesale funding or, as some of my 
colleagues have suggested, through an increase in the systemic 
risk surcharge, one way or another, I think we have got to take 
account of business models and funding models which create more 
risk in each of the firms and the system. So I guess I would 
add that as a fourth piece----
    Senator Brown. Thank you.
    Let me ask my other question of Ms. Miller. You gave a 
speech in April, Ms. Miller, in which you said, and I will 
quote, ``The evidence is mixed whether market participants, 
specifically lenders to bank holding companies, nonetheless 
provide any funding advantage to the biggest financial 
companies based on some belief that the Government would bail 
them out if necessary.'' There was a lot of coverage on that 
speech and that statement.
    I am going to read you something else and then ask you a 
question. Quote, ``A perception continues to persist in the 
markets that some companies remain too big to fail, posing an 
ongoing threat to the financial system. It produces competitive 
distortions because companies perceived as too big to fail can 
often fund themselves at a lower cost than other companies. 
This distortion is unfair to smaller companies, damaging to 
fair competition, and tends to artificially encourage further 
consolidation and concentration in the financial system.''
    The second statement was made on Tuesday by the three other 
panelists. Why are they wrong and you are right?
    Ms. Miller. Thank you for the good question. I am not 
certain that it is a question of wrong and right. I think we 
are in an evolving period of time where perceptions are 
changing and where the law has put in place a regime where we 
can actually work to eliminate any perception or expectation of 
taxpayers bailing out large financial institutions.
    To come back to my statements, I think that with the 
passage of time, with the passage of the Dodd-Frank Act, with 
the implementation of a number of these rules, the data in the 
marketplace is quite mixed now looking at the funding costs for 
large institutions and small institutions and any relative 
advantage. And my ask was simply that we do some more work on 
this question, particularly asking some of the academics who 
have looked at this, because their work is rather dated and 
predates the passage of Dodd-Frank, that it would be a good 
time to step back and look at that again to measure the impact 
of the steps that have been taken.
    Senator Brown. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you very much, Mr. Chairman. Thanks 
to all the panelists for being here and for all your work.
    First, I just want to briefly and publicly again applaud 
the FDIC decision on capital. I think it is an important first 
step in the right direction. If I could ask all of the 
panelists, and I am sorry if you are repeating yourselves, it 
seems to me this sort of requirement is important and, 
hopefully, effective, because it is systemic. It does not just 
depend on sort of regulations and regulators, but it goes to 
the heart of the stability of an institution without folks 
having to catch things in real time that may be spiraling in a 
negative direction. Do all of you fundamentally agree with the 
premise of higher capital ratios as enunciated by the FDIC 
proposed rule?
    Mr. Curry. The OCC is a member of the FDIC Board, so in 
that respect, I voted for the FDIC proposal. But, also, this is 
an interagency effort by the OCC and the Fed, and at the same 
time that I voted at the FDIC, we issued our own as a joint 
rule and Notice of Proposed Rulemaking on the same supplemental 
leverage ratio.
    Mr. Tarullo. And, Senator, the Fed simultaneous with the 
FDIC Board meeting voted on the proposed rule, as well.
    Senator Vitter. Right.
    Mr. Gruenberg. Senator, I would underscore this really was 
a joint, collaborative effort among the three agencies, and I 
think there is really common agreement on this point.
    In regard to the strengthening of the leverage ratio, the 
importance of strengthening the cushion of capital, 
particularly for the large systemically important institutions 
that really pose a risk to the financial system and significant 
disruption to the economy if they get into difficulty, the 
value of having a stronger cushion of capital to enable them to 
better withstand a stressful environment, reduce the likelihood 
of their failure and the potential impact on the Deposit 
Insurance Fund was a threshold concern for us. There was a 
general recognition that the 3-percent minimum leverage 
requirement that is in Basel III was an important step because 
it is the first time there was an international leverage ratio 
standard established for all the participants in the Basel 
accord.
    So establishing the leverage ratio in the accord was 
meaningful and important. From our standpoint, the analysis 
suggests there really was not a strong enough standard, 
particularly for our largest most systemic institutions, which 
is why we came forward with the proposal to strengthen the 
supplementary leverage ratio requirement.
    Senator Vitter. Great. Thank you. And I did not mean to 
suggest by the question that it was somehow FDIC only. I 
understand the nature of all the discussions and decisions and 
proposed rule.
    So, all of you agree with the basic premise. Then the 
question, in essence, becomes what is the right level? What is 
the right number? What is the right percentage? And I continue 
to be concerned while this is a very important step, I think, 
in the right direction, that it is not a significant enough 
number.
    It strikes me, in particular, that you look at smaller 
banks, community banks, without any regulatory requirement. 
They are way above this. And it seems to me that is interesting 
and instructive for two reasons. Number one, because the only 
thing getting them there are market demands and pressures about 
sustainability and viability. There is not a direct regulatory 
requirement that gets them that high. Number two, they are not 
systemically significant like the megabanks we are talking 
about are.
    Does it not strike you in some sort of basic way that for 
the megabanks to be way lower than them is the reverse of, 
arguably, what it should be?
    Mr. Tarullo. Senator, I think probably there is a variance 
in where banks are on leverage ratio as opposed to risk 
weighting. And, of course, this is what a number of us were 
saying earlier, the importance of the complementarity between 
risk weighting and leverage. Each compensates for the way in 
which the other regulation can be arbitraged.
    I think what is most important, though, is the area of 
agreement which you have been identifying, which is there needs 
to be more capital in the largest systemically important 
institutions. From my vantage point, the vulnerability that I 
see is on the funding side, the short-term funding by the 
largest institutions. You know, one can differ on what you want 
as the road into the higher capital requirements. I think I 
would rather respond most directly to the vulnerabilities that 
I see.
    But, again, certainly on this side of the table and from 
what I have heard on your side of the dais, as well, there is a 
general agreement that we do need to continue the process of 
pushing up capital levels. They have already been doubled in 
our largest institutions in just the last few years. Less risk 
and a doubling of capital. And we need to continue that work 
over the next several years, as well.
    Senator Vitter. Any other response to my observation? I 
realize there is a variance in everything, but, in general, it 
is certainly true that community banks are still way above what 
we are talking about.
    Mr. Gruenberg. Senator, you raise an important point. As a 
general matter, the largest institutions have managed 
themselves to a lower leverage ratio than the smaller 
institutions. That was part of the impetus, frankly, for our 
proposal. It is a judgment call on how high and how fast to 
push it up.
    The level we proposed is a substantial increase by our 
estimates. If it had been in effect in the third quarter of 
last year for these largest institutions, it would have 
required nearly an additional $90 billion of capital at the 
bank level and over $60 billion of additional capital at the 
holding company level. We think it creates rough comparability 
with the strengthening on the risk-based side in Basel III.
    In the NPR, we ask the question for public comment, is this 
the right level? Should it be higher? Should it be lower? 
Certainly, in the comment period, we will take into account the 
input that we receive.
    Senator Vitter. Right. Mr. Chairman, if I could wrap up in 
30 seconds, I take all of your comments as encouraging in 
suggesting that this is an ongoing process. This is not the 
final word, necessarily, or the end of the road, and I 
certainly want to encourage that.
    And let me quote The Financial Times from last night as 
further encouragement of that. They say, quote, ``U.S. banks 
believe they will be able to meet the new regulatory 
requirement on debt levels by shuffling assets between their 
subsidiaries and using other optimization strategies to reduce 
the amount of leverage they report,'' and that, ``no banks are 
expected to raise equity to fill an apparent capital shortfall 
of more than $60 billion across the industry.''
    So I am out of time, but I just make that observation. Now, 
I realize that shifting of assets is not necessarily 
insignificant or trivial, but it is a significant observation, 
I think, that they are not raising any capital and I cite that 
as further encouragement to continue down this path.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman, and Mr. Chairman, 
as we all know, Wall Street's high-risk betting nearly 
destroyed the economy. But since then, we have made real 
progress with Dodd-Frank's implementation.
    But despite this progress, the four largest banks are now 
30 percent larger than they were just 5 years ago and they have 
continued to engage in dangerous high-risk practices. So later 
today, Mr. Chairman, Senators McCain, Cantwell, King, and I 
will introduce a 21st Century Glass-Steagall Act. For half a 
century after the Great Depression, Glass-Steagall kept this 
country safe by separating the risky activities of investment 
banks from the basic checking and service and savings accounts 
that consumers rely on every day. The banks lobbied for weaker 
regulations and eventually the regulators started unraveling 
Glass-Steagall, and finally in 1999, Congress repealed what was 
left of it. So now we propose a 21st Century Glass-Steagall so 
that we can return to the basics and try to keep the gamblers 
out of our banks.
    Now, based on what the regulators did to Glass-Steagall 
over the past 30 years, I do not expect anyone on this panel 
will jump up and endorse the new Glass-Steagall bill. Even so, 
we are going to keep pushing for it.
    But I want to spend my time today focusing on another part 
of this issue and that is that a few weeks ago, SEC Chair Mary 
Jo White announced that she is going to require admission of 
guilt in a wider variety of enforcement actions. Now, you 
remember that under its old policy, the SEC required an 
admission of guilt only very rarely, pretty much only when the 
defendant had already admitted guilt in some other context or 
had admitted it criminally. Now, the SEC has said it will be 
tougher when large numbers of investors have been harmed 
intentionally or when the defendant unlawfully obstructs the 
Commission's investigative process.
    Now, I think the same principles that apply to the SEC 
enforcement would also apply to other regulators. So my 
question is whether or not you have considered moving in the 
same direction as Chair White on admission of guilt policies. 
Governor Tarullo, what about the Fed?
    Mr. Tarullo. Well, Senator Warren, after the February 
hearing where you raised a similar question, I went back and 
asked people at the Fed, the people who do the compliance and 
enforcement generally, to think this through, and we have had 
conversations subsequent to that. I guess our, at least 
provisional, conclusions are the following.
    First, it is important to note that with respect to the 
Justice Department and the SEC, for example, essentially--not 
exclusively in the case of the SEC--but they are essentially 
enforcement agencies. That is, they take rules which have been 
broken and they bring enforcement actions. They do not have 
extensive on-site supervisory presences, one.
    Two, the precedent value of an admission at the SEC, for 
example, is of substantial consequence, potentially, for 
shareholders derivatives suits and other litigation that may be 
working off the same set of facts. For us, with prudential 
regulation, we are basically trying to protect the taxpayers. 
What we are most interested in is making sure that any 
violations of or unsafe and unsound practices are remedied as 
quickly as possible.
    Senator Warren. Well----
    Mr. Tarullo. We are not creating taxpayer derivative----
    Senator Warren. But let me just ask you the question on 
that, though, Governor Tarullo. I would have thought you would 
have described your job as trying to prevent them from breaking 
the law at all----
    Mr. Tarullo. Well, sure.
    Senator Warren. ----and that when you catch them breaking 
the law, you want them to stop breaking the law, but you also 
want to impose an appropriate penalty.
    Mr. Tarullo. No, and that, we do. We do impose penalties. 
We do impose penalties.
    Senator Warren. And that means that you often settle with 
them rather than taking them to trial.
    Mr. Tarullo. Well, sure, but----
    Senator Warren. And how much you can settle with them for, 
that is, how much they will really pay as a result of having 
broken the law, depends, in part, on how they evaluate your 
willingness to push them to trial. So the question I am asking 
about is really how much leverage you have, and what SEC 
Chairman White has said is that she is going to step it up. She 
is going to be tougher and she thinks that is going to give her 
better leverage, or at least I think that is the assumption she 
makes here. And what I am asking is whether or not the Fed 
plans to do the same.
    You know, when I was here back in February and I asked the 
question about when is the last time you took a large financial 
institution to trial, the answer was not good and it confirmed 
the worst fears of the American public, that the Government is 
quite willing to take ordinary individuals to trial, but when 
it comes to big banks, they are not so enthusiastic about 
enforcing the law against them. And so that is the question I 
am trying to ask about.
    I understand it is different when you have supervisory 
responsibilities, but you have a responsibility to see to it 
that this law is going to be enforced----
    Mr. Tarullo. No, no----
    Senator Warren. ----and part of that is taking people to 
trial. That is one of the tools in the toolbox.
    Mr. Tarullo. Well, it is a tool, but actually, we have, I 
think, in some ways, a more immediate and effective tool, which 
is the exercise of supervisory requirements and getting people 
to change what they have done. Now, the question of----
    Senator Warren. Forgive me, Governor Tarullo. I appreciate 
that you have another tool that you sometimes use quietly and 
out of public sight. The question I am asking about, though, is 
whether or not you are going to require something more public 
following SEC Chair White's change in policy so that she is 
going to require admissions of guilt, which at least get us to 
a place where we are doing something out in public and perhaps 
leading toward trials on a more regular basis.
    Mr. Tarullo. The third point I was going to make, actually, 
was the third conclusion of our discussions internally was that 
there may be instances in which doing so would be warranted for 
a variety of reasons. The first two points I was making were 
simply that given the tools and the abilities we have and the 
effort to maximize the benefits to the public of the resources 
that we do have, generally speaking, the use of the supervisory 
mechanisms, is probably most effective.
    Now, that does not go to the question of what the fines 
should be, and I think that is a legitimate question, whether 
you are doing it through a supervisory process or whether you 
are doing it through a quasi-judicial or a judicial one.
    Senator Warren. So, does this mean you will be considering 
reevaluating the policies along the same lines that the SEC 
has?
    Mr. Tarullo. Well, no, we are in a fundamentally different 
situation than the SEC. I think we are in a different 
situation. Now, I think, you know, if you have seen with the 
more recent fines that have been substantially larger than 
historic precedent, I think you do see some effort to ramp up 
the kind of enforcement mechanisms being used, but I----
    Senator Warren. I will say on that, Governor Tarullo, since 
I see that we are over time, and I will be careful here, Mr. 
Chairman, I will say there has been some real question about 
the settlements that you have made. We talked about the 
mortgage foreclosure settlement, also, at an earlier hearing, 
and that Congressman Cummings and I have asked for 
documentation about what the banks did wrong and more details 
about how it was determined who was going to get what kind of 
compensation from that. That was 6 months ago. We still have 
not had it.
    I just want to make the point that if you had real 
confidence in your settlements and that if people could see the 
details of those settlements, what the banks did wrong and how 
we determined--how you determined how much money would go to 
individual people, then the public could evaluate for itself 
whether or not you are really out there fighting on their 
behalf, and so far, you have not been willing to do that.
    Mr. Tarullo. I think that set of issues is a different set 
of issues, because if one is talking about the transparency of 
enforcement actions no matter what their origins--law 
enforcement, regulatory, administrative, supervisory--I 
actually do think that the bank regulators need to think more 
about when we put out the public notice of the kinds of 
supervisory actions that have been taken.
    And I think just as, in a somewhat different context, we 
have moved a long way with stress tests and the publication of 
results on the stress tests, I think there is a pretty good 
case to be made for thinking about putting enforcement actions, 
orders that we will use, as you say, internally, out on the 
public record, as well----
    Senator Warren. Well----
    Mr. Tarullo. ----which I think does serve some of those 
purposes, but in our context.
    Senator Warren. I detect in that some change and I 
appreciate it and I say, Mr. Curry, I will get you next time.
    [Laughter.]
    Senator Warren. OK. Thank you. Sorry, Mr. Chairman.
    Chairman Johnson. Senator Heitkamp.
    Senator Heitkamp. Thank you, Mr. Chairman.
    Just not to belabor Senator Warren's point, but the best 
enforcement tool is a good deterrence. And we know from a lot 
of experience and the work that we have done in the past, 
whether it is in prosecution, white collar crime is deterred by 
a little sunshine and an occasional piece of litigation that 
can, in fact, expose bad behavior. So, I just want to add my 
two cents to that effort.
    But I want to take this in a different direction, and this 
question is really for Mr. Tarullo and Mr. Curry. You know, 
there has been a lot of discussion recently on the standards of 
foreign banks compared to the standards for domestic banks. Can 
you speak to the importance of ensuring foreign banks meet the 
same capital requirements for their U.S. operations that U.S. 
banks do, and I would pass it to you, Mr. Tarullo.
    Mr. Tarullo. Thank you, Senator. Well, as I know you are 
aware, we have a proposed regulation on foreign banking 
organizations which would require that the largest foreign 
banking organizations in the United States maintain Basel III 
minimum capital levels and also have liquidity requirements. 
The reasons for that are pretty straightforward.
    One, the nature of foreign banking in the United States has 
changed substantially over the last 15 years. Five of the ten 
largest broker-dealers in this country are foreign bank owned.
    Two, during the financial crisis, foreign banking 
organizations of all sorts drew at the discount window if they 
were commercial banks. They took advantage of the various 
liquidity facilities which the Fed put in place if they were 
not commercial banks. And thus, it became pretty apparent that, 
at some level, we, the regulators and the central bank, were 
having to play a role when they were in a less-than-strong 
capital liquidity position.
    Three, I think it is notable that any large U.S. banking 
organization in the European Union already has to be separately 
incorporated and meet local capital and liquidity requirements. 
So in some sense, we are kind of catching up with what the 
European Union has already done.
    So for all those reasons, Senator, I think it is very 
important that we get that FBO reg out. We are taking comment 
on it now. I know there has been some push-back from some 
institutions that do not want to hold capital in the United 
States, but I just think it is not a sustainable position for 
us or any country that hosts large foreign financial 
institutions not to make sure that those institutions are 
stable within its own country, because, ultimately, it affects 
our financial stability, as well.
    Senator Heitkamp. Mr. Curry.
    Mr. Curry. The OCC supervises Federal branches and Federal 
agencies. Under the current set-up, we would be looking to the 
parent for capital support, so we welcome the Fed's proposal, 
its FBO proposal in terms of enhancing the availability of 
capital here domestically.
    We also, as part of our supervisory process, our agreements 
and auditors with respect to those Federal branches and 
auditors would have capital equivalent provisions to make sure 
that U.S. customers and U.S. operations would not be adversely 
impacted in the event of an insolvency of the foreign parent.
    Senator Heitkamp. And I raise this issue because as we talk 
about systemic risk and as we talk about what, in fact, are our 
challenges looking forward, not paying attention to this issue 
could, in fact, damage and undo every good deed that you have 
been trying to accomplish in all of this regulation. So we are 
going to be watching this issue very closely, not only from the 
standpoint of making sure that there is not unfair competition, 
but also making sure that we are closing the loop on all of the 
institutions that, in fact, prevent systemic risk to our 
economy.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Tester.
    Senator Tester. Yes. Thank you, Mr. Chairman, and thank you 
all for being here today.
    I have got a couple questions for Governor Tarullo and one 
for Mary Miller, so, Tom, you and Martin can breathe a sigh.
    [Laughter.]
    Senator Tester. Governor Tarullo, first off, 
congratulations on your efforts in moving forward with the 
capital and liquidity and leverage standards. I want to visit 
with you this morning on a separate Dodd-Frank issue, which is 
the treatment of nonfinancial end users and whether they are 
subject to mandatory margins.
    As you know, the Congressional intent in this area was 
explicit in that nonfinancial end users should be exempt from 
the mandatory margin. However, the legislative language in the 
statute is less clear than I would have hoped. The CFTC and the 
SEC have issued proposed rules that exempt nonfinancial end 
users from that mandatory margin and transactions in which they 
are counterparties, but the Fed has taken a slightly different 
approach.
    At a hearing before this Committee nearly a year ago, 
Chairman Bernanke indicated that the Federal Reserve's reading 
of this statute is such that it requires you to impose 
mandatory margin on nonfinancial end users despite Congress's 
intent to the contrary. Chairman Bernanke indicated that the 
Fed would be very comfortable with efforts to make the 
exemption, which was clearly the intent of Congress, more 
explicit in the statute. So we have introduced legislation, 
Senator Johanns and I, cosponsored by a number of folks on this 
Committee, that would in a surgical fashion ensure that the 
statute is clear as to Congressional intent on this matter.
    So, just to be clear, would eliminating this mandatory 
margin requirement have any impact on the Fed's ability to set 
appropriate capital or prudential standards regarding 
institutions' book of derivative trades?
    Mr. Tarullo. Simply removing that provision would not, 
Senator, so long as it did not go further and affirmatively say 
that we could not put prudential requirements in in an 
appropriate circumstance.
    Senator Tester. Super. What other checks and balances exist 
to enable the Fed to address safety and soundness concerns that 
could arise from swap transactions involving nonfinancial end 
users?
    Mr. Tarullo. Well, we have two, basically. We obviously 
have a general safety and soundness authority, and when we see 
things that are being done in an unsafe or unsound fashion, we 
can seek a change in that. That is actually the way we tried to 
navigate the Scylla and Charybdis of the legislative language 
and the legislative intent, is to set up something which tries 
to track good risk management. But you are right. Our reading 
of the statute said we could not simply exempt it.
    But I do not think anybody, certainly at the Fed, has the 
belief that we needed anything additional in the legislation, 
and if the intent of Congress was not to affect the end users, 
the vast majority of whom are posing no systemic risk whatever, 
then we have no problem with that change.
    Senator Tester. OK. Now, setting aside the tools at the 
Fed's disposal, clarifying this exemption from mandatory margin 
for nonfinancial end users would not impact the ability of 
individual financial institutions to set margin standards based 
on their credit assessment of counterparties that are 
nonfinancial end users. Would you agree with that statement?
    Mr. Tarullo. Senator, I think your intent, if I understand 
it correctly, is basically just to change current law so that 
there is no instruction from Congress to the regulators saying 
you have to put some sort of margin requirement----
    Senator Tester. Correct.
    Mr. Tarullo. ----in with end users.
    Senator Tester. With the nonfinancial end users.
    Mr. Tarullo. Right. Exactly. Limited to that, it would not 
impinge on the ability of any entity to do its own risk 
management. It would not impinge on our ability to use our full 
panoply of supervisory tools.
    Senator Tester. OK. So the banks still have the ability to 
set margin requirements, but there would not be a requirement 
to impose mandatory margin requirements that would not normally 
be required to do. OK. Good.
    Given all of the other mechanisms at the Fed's disposal in 
setting capital and prudential standards regarding these 
transactions in a more targeted fashion, is there any reason 
why the Fed would also need the statutory authority to impose 
mandatory margin on nonfinancial end users?
    Mr. Tarullo. No, sir.
    Senator Tester. OK. Thank you very much. We need to get 
this done. I mean, I think we need to deal with this issue 
very, very soon, or we are going to see $5 to $6 billion sucked 
out of the economy as the nonfinancial end users raise money to 
set aside to meet what I think are unintended consequences, and 
I think this is inefficient and a shame, particularly since the 
intent of this drafting was to shield nonfinancial end users 
from the costs which would not reduce systemic risk. So we are 
going to keep working on that.
    I have a question for you, Mary Miller. There are a group 
of us on this Committee that are working on GSE reform to move 
the housing system forward while preserving the 30-year note. 
What is your opinion on dealing with Fannie Mae and Freddie 
Mac? Would you agree that this is an important task to take on, 
to make sure that not only Fannie Mae and Freddie Mac are 
secure, but taxpayers are protected, the 30-year note exists, 
and we have a robust--we do not limit the ability to have a 
robust housing industry moving forward?
    Ms. Miller. Thank you for the question. We certainly 
welcome the development of bipartisan housing finance reform 
legislation, so we will carefully follow the progress on this. 
And I think we have been pretty clear that we want to wind down 
the GSEs in a responsible manner at the same time that we 
protect access to credit for Americans who need home mortgage 
credit. And we think that the proposals that we have seen, some 
of the white papers that are now circulating on the backs of 
improvement in the housing market, which is clearly a precedent 
for moving forward with housing finance reform, are very useful 
and supportive of many of the principles that we have already 
established.
    Senator Tester. I appreciate that and I appreciate both 
your comments and Governor Tarullo's, and thank you all for 
being here today. Thank you, Mr. Chairman.
    Chairman Johnson. Thank you.
    I understand that Senator Crapo has some questions that 
will be submitted for the panel.
    I want to thank today's witnesses for their testimony and 
their continued focus on a safe and stable financial system.
    This hearing is adjourned.
    [Whereupon, at 12:22 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]

                  PREPARED STATEMENT OF MARY J. MILLER

    Under Secretary for Domestic Finance, Department of the Treasury
                             July 11, 2013

    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, thank you for inviting me to testify today on behalf of the 
Treasury Department.
    Almost 3 years ago, President Obama signed into law a historic set 
of reforms to make our financial system stronger and more stable. As I 
testified before the Committee earlier this year, we have made 
considerable progress toward achieving those objectives through 
implementation of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act. While additional work remains to be done and we must 
always remain vigilant to potential emerging risks in financial 
institutions and markets, we are much closer to the end of this process 
than the beginning.
    Many of the key reforms have already been finalized, with 
additional pieces falling into place on an ongoing basis. The Consumer 
Financial Protection Bureau is operational and has taken important 
steps to provide clarity on financial products for American consumers 
and rein in unfair, deceptive, and abusive practices. Despite funding 
constraints, the SEC and CFTC are using the expanded enforcement 
authority granted under Dodd-Frank. The bank regulatory agencies have 
just finalized key rules strengthening the quality and quantity of 
capital that banks are required to hold. A new framework for regulatory 
oversight of the over-the-counter derivatives market is largely in 
place, with swap dealers registering with the CFTC and certain 
interest-rate and credit-index swap transactions moving to central 
clearinghouses, reducing overall risk to the financial system.
    The public is already beginning to see the benefits of reform 
through a safer and stronger financial system and a broader economic 
recovery. Although the financial markets have recovered more strongly 
than the overall economy, the economic recovery is gaining traction. 
Private sector payrolls have increased by more than 7 million jobs from 
the low point in February 2010, marking the 40th consecutive month of 
private-sector job growth. The unemployment rate, while still too high 
at 7.6 percent, has fallen almost 2.5 percentage points since its 
October 2009 peak of 10 percent. The recovery in the housing market 
appears to be taking firm hold as measured by rising home prices, 
stronger sales, and a declining number of delinquencies and defaults.
    Although we have made good progress, we must intensify our efforts 
to complete the remaining pieces of financial reform as quickly as 
possible and stand ready to identify and respond to new threats to 
financial stability. We must also continue to work with our 
international counterparts to promote strong and consistent global 
approaches to financial regulation and encourage them to move swiftly 
toward the completion and implementation of key reforms in their 
jurisdictions.
    I would like to update the Committee on several important 
regulatory developments since I appeared before you in February. In 
April, the Financial Stability Oversight Council released its 2013 
annual report, which both identified potential emerging threats to 
financial stability and made recommendations to enhance the stability 
of the financial system. In May, Secretary Lew testified before this 
Committee on the Council's report.
    At the beginning of June, the Financial Stability Oversight Council 
voted to make proposed designations of an initial set of nonbank 
financial companies under section 113 of the Dodd-Frank Act. Companies 
subject to a proposed designation had 30 days to request a hearing 
prior to the Council making a final determination. Earlier this week, 
the Council made final designations of two companies in this initial 
set that did not request hearings, American International Group, Inc. 
and General Electric Capital Corporation, Inc. With respect to one 
other company currently subject to a proposed designation that 
requested a hearing, the hearing will be conducted no later than early 
August with a final decision by the Council no later than the beginning 
of October. This is an ongoing process, and the Council will continue 
to evaluate other companies for potential designation.
    The Council's work on the designation of nonbank financial 
companies helps put us in a better position to address potential 
threats to the financial system. Large, complex nonbank financial 
companies that the Council determines could pose a threat to U.S. 
financial stability will be supervised on a consolidated basis by the 
Board of Governors of the Federal Reserve System and subject to capital 
requirements and other enhanced prudential standards.
    Last week, the Federal Reserve finalized an important set of rules 
codifying the Basel capital requirements for banks and bank holding 
companies, and the Federal Deposit Insurance Corporation and the Office 
of the Comptroller of the Currency followed suit earlier this week. 
Also, the banking regulators proposed a leverage requirement earlier 
this week as a companion to the Basel capital requirement, which is 
necessary to further the cause of safety and soundness in the financial 
system. I will defer to my colleagues on the panel to discuss the 
details of these rules, but the progress we have made on both a 
significantly stronger capital regime and the expansion of the 
supervisory umbrella to cover designated nonbank financial companies 
are key developments in making our financial system more resilient and 
protecting the American economy from the harm of another crisis.
    In February, I also highlighted the Council's work on money market 
mutual fund reform. At the end of 2012, the Council issued proposed 
recommendations on money fund reforms for public comment. The comment 
period on those recommendations closed shortly after I testified. In 
its annual report, the Council recommended that the SEC consider the 
views expressed by commenters on the Council's proposed 
recommendations. Throughout this process, we have made it clear that 
the SEC is the primary regulator and should take the lead in driving 
reforms. In June, the Securities and Exchange Commission proposed 
regulations that are intended to reduce the risks presented by money 
funds. This is an important next step in the process. Public comments 
on the SEC's proposal will provide important feedback and information 
for the SEC to consider in developing a final rule.
    In June, Treasury's Federal Insurance Office released its first 
annual report on the insurance industry. The report examines the 
principal sectors of the insurance industry, reviews key legal and 
regulatory developments affecting the insurance industry in the United 
States and internationally, and discusses current and emerging trends 
that could significantly impact the industry and the stability of the 
U.S. financial system. The Federal Insurance Office has also been 
working to complete its report on the modernization and improvement of 
the system of insurance regulation in the United States.
    In addition, the Federal Insurance Office is working on the 
international front to represent U.S. interests in the development of 
international insurance standard-setting and financial stability 
activities. The Office has worked and will continue to work closely and 
consult with State insurance regulators on these efforts. The Office 
has been involved in the work of the International Association of 
Insurance Supervisors to develop the methodology for the identification 
of global systemically important insurers (G-SIIs) and the policy 
measures to be applied to any designated G-SII. The Federal Insurance 
Office's international involvement has played an important 
complementary role to the progress that the Financial Stability 
Oversight Council has made domestically in the designation of nonbank 
financial companies.
    I would also like to highlight for the Committee a few areas where 
Treasury intends to direct significant attention and resources during 
the remainder of the year to complete key outstanding pieces of reform. 
Secretary Lew, in his capacity as Chairperson of the Council, is 
responsible for coordinating the regulations issued by the five rule-
making agencies--the Federal Reserve, the Federal Deposit Insurance 
Corporation, the Office of the Comptroller of the Currency, the 
Securities and Exchange Commission, and the Commodity Futures Trading 
Commission--to implement Section 619 of the Dodd-Frank Act, commonly 
referred to as the Volcker Rule. Starting from his first day in office, 
Secretary Lew has convened meetings with the heads of the rule-making 
agencies to stress the importance of finishing work on the Volcker 
Rule. Finalizing the regulations will continue to be a top priority for 
the Secretary and the Treasury Department. Successful completion of 
this work will impose needed limits on banks' ability to engage in 
speculative trading activities and relationships with private equity 
and hedge funds for their own benefit rather than for the benefit of 
their customers.
    Secretary Lew is similarly responsible for coordinating the rules 
to implement Section 941 of the Dodd-Frank Act. The risk-retention rule 
generally requires issuers of asset-backed securities to retain an 
interest in the asset-backed securities they sell to third parties. 
Staff from Treasury, the bank regulatory agencies, the Federal Housing 
Finance Agency, the Department of Housing and Urban Development, and 
the SEC have met regularly to review comments, analyze data, and 
coordinate on drafting the rule. Completion of these regulations is a 
priority for the Treasury Department and in particular Secretary Lew, 
who convened the heads of the rule-making agencies to discuss work on 
these rules last month.
    Treasury will also continue to engage closely with our regulatory 
counterparts in the United States and internationally to strengthen our 
ability to wind down failing financial companies while minimizing the 
negative impact on the rest of the financial system and the economy. 
The bankruptcy process, aided by the Dodd-Frank Act's living wills 
requirement, continues to be the preferred method for resolving failing 
financial companies. All of the firms that are required to submit 
living wills will have done so by the end of this year, and the largest 
11 bank holding companies will submit their second round of living 
wills this fall, providing an additional tool to facilitate their 
orderly resolution through bankruptcy should they fail.
    However, in the case where bankruptcy is unable to resolve a 
failing company without imposing serious adverse effects on U.S. 
financial stability, the Dodd-Frank Act's orderly liquidation authority 
provides critical new authorities to allow firms to fail, no matter how 
large and complex. Treasury, the Federal Reserve, the FDIC, and other 
financial regulatory agencies will continue to engage in extensive 
preparations and conduct rigorous planning exercises and simulations to 
be fully prepared to wind down any financial company whose failure 
could threaten the stability of our system. In these simulations, the 
agencies have focused on resolving a company consistent with Dodd-
Frank's important requirement that no taxpayer funds shall be used to 
prevent the liquidation of a financial company. Moreover, the law 
requires that losses be borne by creditors and shareholders of the 
company and, if necessary, the financial sector. This means that 
taxpayers will bear none of the losses.
    Treasury and the regulators will also continue to closely 
collaborate with our international counterparts through forums like the 
Financial Stability Board and on a bilateral basis to address obstacles 
to resolving large, cross-border firms. One example is the FDIC's 
recently signed memoranda of understanding with its counterparts in 
Canada and the United Kingdom defining the scope of information-sharing 
and cooperation in resolving internationally active insured depository 
institutions and certain other financial companies. Continued diligence 
and progress on this front will be essential to making the orderly 
liquidation authority an effective and reliable tool for winding down a 
failing company and mitigating threats to U.S. financial stability.
    The Dodd-Frank Act provides valuable new authorities to help 
protect our financial system. The Financial Stability Oversight 
Council's mission is to identify and respond to emerging threats to the 
stability of the United States financial system. It is actively 
carrying out those duties, as reflected both in its annual reports that 
it submits to Congress and its activities such as the designation of 
nonbank financial companies. Living wills and stress tests are the new 
rules of the road for bank holding companies, providing the companies, 
regulators, the marketplace, and the public with valuable information 
they previously lacked. These are not just one-time requirements. They 
are conducted on an annual or semi-annual basis, which will provide 
information about discrete points in time as well as long-term 
comparisons.
    By the end of this year, we expect to approach the point of 
substantial completion of implementation of the Dodd-Frank Act. That 
does not mean we will be able to relax our guard. Constant evolution in 
the financial system and the activities of financial institutions will 
require regulators to be flexible and ready to address new threats to 
the financial system.
                                 ______
                                 
                PREPARED STATEMENT OF DANIEL K. TARULLO
       Governor, Board of Governors of the Federal Reserve System
                             July 11, 2013

    Chairman Johnson, Ranking Member Crapo, and other Members of the 
Committee, thank you for the opportunity to testify on the Federal 
Reserve's activities in mitigating systemic risk and implementing the 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 
(Dodd-Frank Act).
    With the third anniversary of the Dodd-Frank Act upon us, it is a 
good time to reflect on what has been accomplished, what still needs to 
be done, and how the work on the Dodd-Frank Act fits with other 
regulatory reform projects. Indeed, the deliberate pace and 
multipronged nature of the implementation of the act--occasioned as it 
is by complicated issues and decision-making processes--may be 
obscuring what will be far-reaching changes in the regulation of 
financial firms and markets. Indeed, the Federal Reserve and other 
banking supervisors have already created a very different supervisory 
environment than what was prevalent just a few years ago.
    Today, I will review recent progress in key areas of financial 
regulatory reform, with special--though not exclusive--attention to 
implementation of the Dodd-Frank Act, including how that law affects 
the regulation of community banks. I will also highlight areas in which 
proposals are still outstanding and, in a few cases, in which we intend 
to make new proposals in the relatively near future.
Implementation of Basel III Capital Rules
    Let me begin by noting the completion of our major rulemakings on 
capital regulation. Although most of the provisions in these rules do 
not directly implement provisions of the Dodd-Frank Act, implementation 
of that law is occurring against the backdrop of implementation of the 
Basel III framework.
    This month, the Federal Reserve, the Office of the Comptroller of 
the Currency, and the Federal Deposit Insurance Corporation (FDIC) 
approved final rules implementing the Basel III capital framework, as 
well as certain related changes required by the Dodd-Frank Act. \1\ The 
rules establish an integrated regulatory capital framework designed to 
ensure that U.S. banking organizations maintain strong capital 
positions, enabling them to absorb substantial losses on a going-
concern basis and to continue lending to creditworthy households and 
businesses even during economic downturns.
---------------------------------------------------------------------------
     \1\ See, www.federalreserve.gov/newsevents/press/bcreg/
20130702a.htm.
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    The rules increase the quantity and improve the quality of 
regulatory capital of the U.S. banking system by setting strict 
eligibility criteria for regulatory capital instruments, by raising the 
minimum tier 1 capital ratio from 4 percent to 6 percent of risk-
weighted assets, and by establishing a new minimum common equity tier 1 
capital ratio of 4.5 percent of risk-weighted assets. The rules also 
require a capital conservation buffer of 2.5 percent of risk-weighted 
assets to ensure that banking organizations build capital during benign 
economic periods so that they can withstand serious economic downturns 
and still remain above the minimum capital levels. In addition, the 
rules improve the methodology for calculating risk-weighted assets to 
enhance risk sensitivity and incorporate certain provisions of the 
Dodd-Frank Act, such as sections 171 and 939A. \2\ The rules also 
contain certain provisions, including a supplementary leverage ratio 
and a countercyclical capital buffer, that apply only to large and 
internationally active banking organizations, consistent with their 
systemic importance and their complexity. The rules will have several 
important consequences.
---------------------------------------------------------------------------
     \2\ Section 171 of the Dodd-Frank Act, commonly referred to as the 
Collins Amendment, requires the Federal banking agencies to establish 
minimum risk-based and leverage capital requirements for bank holding 
companies, savings and loan holding companies, insured depository 
institutions, and nonbank financial holding companies designated by the 
Financial Stability Oversight Council for supervision by the Federal 
Reserve. Under section 171, among other things, these minimum capital 
requirements may not be less than, nor quantitatively lower than, the 
generally applicable capital requirements that were in effect for 
insured depository institutions on the date of enactment of the Dodd-
Frank Act. Section 939A requires all Federal agencies to remove 
references to credit ratings in their regulations, including the 
capital rules.
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    First, they consolidate the progress made by banks and regulators 
over the past 4 years in improving the quality and quantity of capital 
held by banking organizations. Second, they remedy shortcomings in our 
existing generally applicable risk-weighted asset calculations that 
became apparent during the financial crisis. In so doing, they also 
enhance the effectiveness of the Collins Amendment, the scope of which 
we have extended through these rules by applying standardized floors to 
capital buffer, as well as minimum requirements. Third, adoption of 
these rules meets international expectations for U.S. implementation of 
the Basel III capital framework. This gives us a firm position from 
which to press our expectations that other countries implement Basel 
III fully and faithfully.
    In crafting these rules, the banking agencies made a number of 
changes to the 2012 proposals, mostly to address concerns by community 
banks. For example, the new rules maintain current practice on risk 
weighting residential mortgages and provide community banking 
organizations the option of maintaining existing standards on the 
regulatory capital treatment of ``accumulated other comprehensive 
income'' (AOCI) and preexisting trust preferred securities. These 
changes from the proposed rule are meant to reduce the burden and 
complexity of the rules for community banks while preserving the 
benefits of more rigorous capital standards. Most banking organizations 
already meet the higher capital standards, and the rules will help 
preserve the benefits of the stronger capital positions banks have 
built under the oversight of regulators since the financial crisis.
    The capital rules also apply risk-based and leverage capital 
requirements to certain savings and loan holding companies for the 
first time. In another change from the proposal, savings and loan 
holding companies with significant commercial and insurance 
underwriting activities will not be subject to the final rules at this 
time. During the comment period, these firms raised significant 
concerns regarding the appropriateness of the proposed regulatory 
capital framework for their business models. To address these concerns, 
the Federal Reserve will take additional time to evaluate the 
appropriate regulatory capital framework for these entities.
    All financial institutions subject to the new rules will have a 
significant transition period to meet the requirements. The phase-in 
period for smaller, less complex banking organizations will not begin 
until January 2015, while the phase-in period for larger institutions 
begins in January 2014.

Stress Testing and Capital Planning Requirements for Large Banking 
        Firms
    Important as higher capital requirements and a better quality of 
capital are to the safety and soundness of financial institutions, 
conventional capital requirements are by their nature somewhat 
backward-looking. First, they reflect loss expectations based on past 
experience. Second, losses that actually reduce reported capital levels 
are often formally taken by institutions well after the likelihood of 
losses has become clear. Rigorous stress testing helps compensate for 
these shortcomings through a forward-looking assessment of the losses 
that would be suffered under stipulated adverse economic scenarios, so 
that capital can be built and maintained at levels high enough for the 
firms to withstand such losses and still remain viable financial 
intermediaries. In the middle of the financial crisis, the Federal 
Reserve created and applied a stress test to the Nation's largest 
financial firms. The next year, Congress mandated stress tests for a 
larger group of firms in the Dodd-Frank Act. This fall, we will extend 
the full set of stress testing requirements to the dozen or so banking 
organizations with greater than $50 billion in assets covered in the 
Dodd-Frank Act but not fully covered in our previous stress tests.
    Regular, comprehensive stress testing, with published results, has 
already become a key part of both capital regulation and overall 
prudential supervision. In the annual Comprehensive Capital Analysis 
and Review (CCAR), the Federal Reserve requires each large bank holding 
company to demonstrate that it has rigorous, forward-looking capital 
planning processes that effectively account for the unique risks of the 
firm and maintains sufficient capital to continue to operate through 
times of extreme economic and financial stress. CCAR and Dodd-Frank Act 
stress tests have shown the significant supervisory value of conducting 
coordinated cross-firm analysis of the major risks facing large banks.
    The Federal Reserve has used stress testing and its broader 
supervisory authority to prompt a doubling over the past 4 years of the 
common equity capital of the Nation's 18 largest bank holding 
companies, which collectively hold more than 70 percent of the total 
assets of all U.S. bank holding companies. Specifically, the aggregate 
tier 1 common equity ratio--which is based on the strongest form of 
loss-absorbing capital--at the 18 firms covered by the stress test has 
more than doubled, from 5.6 percent at the end of 2008 to 11.3 percent 
at the end of 2012. That reflects an increase in tier 1 common equity 
from $393 billion to $792 billion during the same period.

Enhanced Prudential Requirements for Large Banking Firms
    Sections 165 and 166 of the Dodd-Frank Act require the Federal 
Reserve to establish a broad set of enhanced prudential standards, both 
for bank holding companies with total consolidated assets of $50 
billion or more and for nonbank financial companies designated by the 
Financial Stability Oversight Council (Council) as systemically 
important. The required standards include capital requirements, 
liquidity requirements, stress testing, single-counterparty credit 
limits, an early remediation regime, and risk-management and 
resolution-planning requirements. The sections also require that these 
prudential standards become more stringent as the systemic footprint of 
a firm increases.
    The Federal Reserve has issued proposed rules to implement sections 
165 and 166 for both large U.S. banking firms and foreign banks 
operating in the United States. In addition, earlier this week the 
Federal banking agencies jointly issued a proposal to implement higher 
leverage ratio standards for the largest, most systemically important 
U.S. banking organizations. We have already finalized the rules on 
resolution planning and stress testing, and we are working diligently 
this year toward finalization of the remaining standards.
    On liquidity, we will also be implementing the Basel III 
quantitative liquidity requirements for large U.S. banking firms. We 
expect that the Federal banking agencies will issue a proposal later 
this year to implement the Basel Committee's Liquidity Coverage Ratio 
for large U.S. banking firms. These quantitative liquidity requirements 
would complement the stricter set of qualitative liquidity standards 
that the Federal Reserve has already proposed pursuant to section 165 
of the Dodd-Frank Act.
    On capital, we will be proposing risk-based capital surcharges on 
the most systemically important U.S. banking firms. The proposal will 
be based on the risk-based capital surcharge framework developed by the 
Basel Committee for global systemically important banks, under which 
the size of the surcharge will increase with a banking firm's systemic 
importance. These surcharges are a critical element of the Federal 
Reserve's efforts to force the most systemic financial firms to 
internalize the externalities caused by their potential failure and to 
reduce any residual subsidies such firms may enjoy as a result of 
market perceptions that they may be too big to fail. We anticipate 
issuing a proposed regulation on these capital surcharges around the 
end of this year.
    With one exception, we expect to finalize the remaining proposed 
enhanced prudential standards around the end of the year as well. The 
one exception is single-counterparty credit limits. We are conducting a 
quantitative impact study (QIS) on the effects of the counterparty 
credit limits included in the proposed rule. Based on the comments 
received and ongoing internal staff analysis, we concluded that a QIS 
was needed to help us better assess the optimal structure of the rule. 
Moreover, since the Federal Reserve issued its single-counterparty 
credit limit proposal, the Basel Committee began developing a similar 
large exposure regime that would apply to all global banks. We are 
coordinating our single-counterparty credit limit rule with this 
effort.
    A core element of the Federal Reserve's proposed enhanced 
prudential standards for large banking firms is our December 2012 
foreign bank proposal. The foreign bank proposal responds to 
fundamental changes over the last 15 years in the scope and scale of 
the U.S. operations of foreign banking organizations, many of which 
have moved beyond their traditional lending activities to engage in 
substantial capital markets activities and, in some cases, have become 
more reliant on short-term wholesale U.S. dollar funding. The proposed 
rule would increase the resiliency of the U.S. operations of foreign 
banks and help protect U.S. financial stability. The proposal would 
also promote competitive equality for all large banking firms--domestic 
and foreign--operating in the United States and would, in many 
respects, result in greater harmony between how the U.S. operations of 
foreign banking organizations and the foreign operations of U.S. bank 
holding companies are regulated.
    The foreign bank proposal generally would require foreign banks 
with a large U.S. presence to organize their U.S. subsidiaries under a 
single U.S. intermediate holding company that would serve as a platform 
for consistent supervision and regulation. The U.S. intermediate 
holding companies of foreign banks would be subject to the same risk-
based capital and leverage requirements as U.S. bank holding companies. 
In addition, U.S. intermediate holding companies and the U.S. branches 
and agencies of foreign banks with a large U.S. presence would be 
required to meet liquidity requirements similar to those applicable to 
large U.S. bank holding companies. Importantly, however, the foreign 
bank proposal does not entail full subsidiarization--foreign banks 
generally will continue to be allowed to directly branch into the 
United States on the basis of their consolidated capital. The comment 
period for this proposal closed at the end of April, and we are now 
carefully reviewing comments.

Improving Resolvability of Large Banking Firms
    An important reform included in the Dodd-Frank Act was the creation 
of the Orderly Liquidation Authority (OLA). Under OLA, the FDIC can 
resolve a systemic financial firm by imposing losses on the 
shareholders and creditors of the firm and replacing its management, 
while preserving the operations of the sound, functioning parts of the 
firm. This authority gives the Government a real alternative to the 
Hobson's choice of bailout or disorderly bankruptcy that authorities 
faced in 2008. Similar resolution mechanisms are under development in 
other countries, and the Basel Committee and the Financial Stability 
Board have devoted considerable attention to developing new 
international standards for statutory resolution frameworks. Although 
much work remains to be done by all countries, the Dodd-Frank Act 
reforms have paved the way for the United States to be a leader in 
shaping the development of international policy on effective resolution 
regimes for systemic financial firms.
    In implementing OLA, the FDIC is developing the single-point-of-
entry (SPOE) resolution approach. SPOE is designed to focus losses on 
the shareholders and long-term unsecured debt holders of the parent 
holding company of the failed firm. It aims to produce a well-
capitalized bridge holding company in place of the failed parent by 
converting long-term debt holders of the parent into equity holders of 
the bridge. The critical operating subsidiaries of the failed firm 
would be recapitalized by the parent, to the extent necessary, and 
would remain open for business. The SPOE approach should reduce 
incentives for creditors and customers of the operating subsidiaries to 
run and, as financial stress increases, for host-country regulators to 
engage in ring-fencing or other measures disruptive to an orderly, 
global resolution of the failed firm.
    Successful execution by the FDIC of its preferred SPOE approach in 
OLA depends on the availability of a sufficient combined amount of 
equity and loss-absorbing debt at the parent holding company of the 
failed firm. Accordingly, in consultation with the FDIC, the Federal 
Reserve is working on a regulatory proposal that requires the largest, 
most complex U.S. banking firms to maintain a minimum amount of 
outstanding long-term unsecured debt on top of their regulatory capital 
requirements. Such a requirement could have a number of public policy 
benefits. Most notably, it would increase the prospects for an orderly 
resolution under OLA by ensuring that shareholders and long-term debt 
holders of a systemic financial firm can bear potential future losses 
at the firm and sufficiently capitalize a bridge holding company in 
resolution. In addition, by increasing the credibility of OLA, a 
minimum long-term debt requirement could help counteract the moral 
hazard arising from taxpayer bailouts and improve market discipline of 
systemic firms.
    The Dodd-Frank Act also requires that all large bank holding 
companies develop, and submit to supervisors, resolution plans. The 
Federal Reserve has been working with the FDIC to review resolution 
plans submitted by the largest U.S. bank holding companies and foreign 
banks. The largest firms--generally those with $250 billion or more in 
total nonbank assets--submitted their first annual resolution plans to 
the Federal Reserve and the FDIC in the third quarter of 2012. These 
``first-wave'' resolution plans yielded valuable information that is 
being used to identify, assess, and mitigate key challenges to 
resolvability under the Bankruptcy Code and to support the FDIC's 
development of backup resolution plans under OLA. These plans also are 
very useful supervisory tools that have helped the Federal Reserve and 
the subject firms focus on opportunities to simplify corporate 
structures and improve management systems in ways that will help the 
firms be more resilient and efficient, as well as easier to resolve.
    Further work is being done on resolution plans this year. On July 
1, bank holding companies in the second group--generally those with 
between $100 billion and $250 billion in total nonbank assets--
submitted their initial plans to the Federal Reserve. The public 
portions of these resolution plans were made available on the FDIC and 
Federal Reserve Web sites on July 2. \3\ The first-wave filers will 
submit updated plans in October that reflect further guidance from the 
FDIC and the Federal Reserve.
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     \3\ See, www.federalreserve.gov/newsevents/press/bcreg/
20130702b.htm.
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Structural Reform of Banking Firms
    The Dodd-Frank Act also includes provisions calling for structural 
reform of the U.S. banking system. Key elements are the Volcker Rule in 
section 619 of the act and the derivatives push-out provision in 
section 716 of the act.
    The Volcker Rule generally prohibits a banking entity from engaging 
in proprietary trading or acquiring an ownership interest in, 
sponsoring, or having certain relationships with a hedge fund or 
private equity fund. The Federal banking agencies and the Securities 
and Exchange Commission (SEC) jointly proposed a rule to implement the 
Volcker Rule in October 2011. The Commodity Futures Trading Commission 
issued a substantially similar proposal a few months later.
    The rule-making agencies have carefully analyzed the nearly 19,000 
public comments on the proposal and have made steady and significant 
progress toward crafting a final rule that attempts to maximize bank 
safety and soundness and financial stability while minimizing cost to 
the liquidity of the financial markets, credit availability, and 
economic growth. The implementation of the Volcker Rule has taken a 
significant amount of time for a variety of reasons--the interpretive 
and policy issues implicated by the rule are complex, the completion of 
the Volcker Rule requires negotiations among a variety of banking and 
market regulators, and the potential costs of getting the Volcker Rule 
wrong are high. But I think most observers would agree that the 
agencies need to provide firms, markets, and the public with the 
product of all this work, so that they can begin to adjust their plans 
and expectations accordingly. During this Committee's last oversight 
hearing in February, I expressed the hope that we would complete the 
Volcker Rule by the end of this year. Since that time, there has been 
good interagency progress, and I maintain both the hope and expectation 
of 5 months ago.
    The derivatives push-out provision in section 716 of the Dodd-Frank 
Act generally prohibits the provision of Federal assistance, such as 
FDIC deposit insurance or Federal Reserve discount window credit, to 
swap dealers and major swap participants. The provision becomes 
effective on July 16, 2013, although the statute provides insured 
depository institutions the right to request a 2-year extension from 
their primary Federal supervisor. Last month, the Federal Reserve 
issued an interim final rule that clarified that uninsured U.S. 
branches and agencies of foreign banks will be treated in the same 
manner as insured depository institutions under section 716 and, as a 
result, will qualify for the same exemptions and 2-year transition 
period available by statute to U.S. insured depository institutions. 
The interim final rule also establishes the process for State member 
banks and uninsured State branches or agencies of foreign banks to 
apply to the Federal Reserve for transition relief. \4\ Although the 
rule is already effective, we are seeking comments on it and will 
revise the rule, as necessary, in light of comments received.
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     \4\ For approvals granted by the Board for the 2-year transition 
period, see, www.federalreserve.gov/bankinforeg/716f-requests.htm.
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Oversight of Community Banks
    In addition to overseeing large banking firms, the Federal Reserve 
supervises approximately 800 State-chartered community banks that are 
members of the Federal Reserve System. \5\ Community banks play an 
important role in extending credit in local economies across the 
country--particularly, though by no means only, in their lending to 
small and medium-sized businesses. Recognizing the disproportionate 
burden that regulatory compliance can impose on smaller institutions, 
the Federal Reserve has put in place special processes for taking 
account of the circumstances and more limited compliance resources of 
community banks, while still achieving safety-and-soundness aims. We 
created a special subcommittee of our regulatory and supervisory 
oversight committee to review all proposals with an eye to their 
effects on community banks. We have also established a Community 
Depository Institutions Advisory Council to enable community bankers to 
comment on the economy, lending conditions, supervisory policies, and 
other matters of interest.
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     \5\ For supervisory purposes, community banks are generally 
defined as those with less than $10 billion in assets.
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    The changes we will be seeing in the financial regulatory 
architecture as a result of the Dodd-Frank Act and Basel III are 
principally directed at our largest and most complex financial firms. 
Many of the Basel III requirements will not apply to smaller banks--
including the countercyclical capital buffer, supplementary leverage 
ratio, trading book reforms, AOCI flow through, higher capital 
requirements for counterparty credit risk on derivatives, and 
disclosure requirements. In fact, most of the significant changes from 
the proposed capital rules published by the three banking agencies last 
year that we made in the final version of the rules issued earlier this 
month were in response to concerns expressed by smaller banks. 
Community banking organizations also will not be subject to the Federal 
Reserve's additional enhanced prudential standards that larger banking 
firms face or will face, such as capital plans, stress testing, 
resolution plans, single-counterparty credit limits, and capital 
surcharges for systemically important financial firms. In addition, 
most of the major systemic risk and prudential provisions of the Dodd-
Frank Act--such as the Volcker Rule, derivatives push-out, derivatives 
central clearing requirements, and the Collins Amendment--will have a 
far smaller impact on community banks than on large banking firms.
Constraining Systemic Risk Outside the Banking Sector
    While strengthening the regulation and improving the resolvability 
of banking firms is of paramount importance, we should not forget that 
one of the key elements of the recent financial crisis was the 
precipitous unwinding of large amounts of short-term wholesale funding 
that had been made available to highly leveraged and maturity-
transforming financial firms, many of which were clearly outside of the 
traditional banking sector. Nonbank financial intermediaries can 
provide substantial benefits to an economy, but a complete financial 
reform program must address financial stability risks that emanate from 
the shadow banking system. Particularly as we tighten the oversight of 
the regulated banking system, it will become more and more essential 
that we are able to monitor and constrain the build-up of systemic 
risks in the nonbank financial sector.
    Among other things, financial stability depends on strong 
consolidated supervision and regulation of all financial firms whose 
failure could pose a threat to the financial system--whether or not 
they own a bank. One of the key lessons of the financial crisis was the 
prodigious amount of systemic risk that was concentrated in several 
nonbank financial firms. To mitigate these risks, the Dodd-Frank Act 
gave the Council authority to bring systemically important financial 
firms that are not already bank holding companies within the perimeter 
of Federal Reserve supervision and regulation. Last month, the Council 
made three proposed designations of nonbank financial firms, and 
earlier this week the Council made final designations of two of these 
firms. The Federal Reserve already supervises these two firms as 
savings and loan holding companies and we will now begin the process of 
applying relevant enhanced prudential regulatory and supervisory 
standards. We remain committed to applying a supervisory and regulatory 
framework to such firms that is tailored to their business mix, risk 
profile, and systemic footprint--consistent with the Collins Amendment 
and other legal requirements under the Dodd-Frank Act.
    The threats to financial stability from the shadow banking system 
do not reside solely in a few individual nonbank financial firms with 
large systemic footprints. Significant threats to financial stability 
emanate from systemic classes of nonbank financial firms and from 
vulnerabilities intrinsic to short-term wholesale funding markets. Many 
of the key problems related to shadow banking and their potential 
solutions are still being debated domestically and internationally, but 
some of the necessary steps are already clear.
    First, we need to increase the transparency of shadow banking 
markets so that authorities can monitor for signs of excessive leverage 
and unstable maturity transformation outside regulated banks. Since the 
financial crisis, the ability of the Federal Reserve and other 
regulators to track the types of transactions that are core to shadow 
banking activities has improved markedly. But there remain several 
areas, notably involving transactions organized around an exchange of 
cash and securities, where gaps still exist. For example, many 
repurchase agreements and securities lending transactions can still 
only be monitored indirectly. Improved reporting in these areas would 
better enable regulators to detect emerging risks in the financial 
system.
    Second, we need to reduce further the risk of runs on money market 
mutual funds. Late last year, the Council issued a proposed 
recommendation on this subject that offered three reform options. Last 
month, the SEC issued a proposal that includes a form of the floating 
net asset value (NAV) option recommended by the Council.
    Third, we need to be sure that initiatives to enhance the 
resilience of the triparty repo market are successfully completed. 
These marketwide efforts have been underway for some time and have 
already reduced discretionary intraday credit extended by the clearing 
banks by approximately 25 percent. Market participants, with the active 
encouragement of the Federal Reserve and other supervisors, are on 
track to achieve the practical elimination of all such intraday credit 
in the triparty settlement process by the end of 2014.
    Completing these three reforms would represent a strong start to 
the job of reducing systemic risk in the short-term wholesale funding 
markets that are key to the functioning of securities markets. Still, 
important work would remain. For example, a major source of unaddressed 
risk emanates from the large volume of short-term securities financing 
transactions (SFTs) in our financial system, including repos, reverse 
repos, securities borrowing, and lending transactions. Regulatory 
reform has mostly passed over these transactions because SFTs appear to 
involve minimal risks from a microprudential perspective. But SFTs, 
particularly large matched books of SFTs, create sizable 
macroprudential risks, including vulnerabilities to runs and asset fire 
sales. Although the Dodd-Frank Act provides additional tools to address 
the failure of a systemically important broker-dealer, the existing 
bank and broker-dealer regulatory regimes have not been designed to 
materially mitigate these systemic risks. Continued attention to these 
potential vulnerabilities is needed, both here in the United States and 
abroad.

Conclusion
    As I hope is apparent from this review of progress on the 
implementation of regulatory reforms, we are at the beginning of the 
end of the rule-making process tor most of the major Dodd-Frank Act 
provisions. Some regulations already finalized are now in effect. 
Others provide a transition period for firms and markets to prepare for 
the new rules of the road. Still others will be completed in the coming 
months. With respect to all three sets of regulations, the emphasis 
will soon be shifting from rule-writing to rule compliance, 
interpretation, and enforcement. Here, the benchmarks for progress and 
performance are less visible, at least until something goes wrong. For 
that reason, it is all the more important that the regulatory agencies 
put in place institutional mechanisms to assure strong, sensible 
oversight of the new regulatory framework.
    Thank you for your attention. I would be pleased to answer any 
questions you might have.





               PREPARED STATEMENT OF MARTIN J. GRUENBERG
            Chairman, Federal Deposit Insurance Corporation
                             July 11, 2013
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, thank you for the opportunity to testify today on the 
Federal Deposit Insurance Corporation's (FDIC) actions to implement the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act).
    With the 3-year anniversary of the Dodd-Frank Act approaching, the 
FDIC has made significant progress in implementing the new authorities 
granted by the Act, \1\ particularly with regard to the authorities to 
address the issues presented by institutions that pose a risk to the 
financial system. We also have moved forward in our efforts to 
strengthen the Deposit Insurance Fund and to improve the resiliency of 
the capital framework for the banking industry.
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     \1\ A summary of the FDIC's progress implementing the provisions 
of the Dodd-Frank Act is attached to this testimony.
---------------------------------------------------------------------------
    My written testimony will address three key areas. First, I will 
provide a brief overview of the current state of the banking industry 
and the Federal deposit insurance system. Second, I will provide an 
update on our progress in implementing the new authority provided to 
the FDIC to address the issues posed by systemically important 
financial institutions. Finally, I will discuss the Act's impact on our 
supervision of community banks.

Overview of the Banking Industry
    The financial condition of the banking industry in the United 
States has experienced three consecutive years of gradual but steady 
improvement. Industry balance sheets have been strengthened and capital 
and liquidity ratios have been greatly improved.
    Industry net income has now increased on a year-over-year basis for 
15 consecutive quarters. FDIC-insured commercial banks and savings 
institutions reported aggregate net income of $40.3 billion in the 
first quarter of 2013, a $5.5 billion (15.8 percent) increase from the 
$34.8 billion in profits that the industry reported in the first 
quarter of 2012. Half of the 7,019 FDIC-insured institutions reporting 
financial results had year-over-year increases in their earnings. The 
proportion of banks that were unprofitable fell to 8.4 percent, down 
from 10.6 percent a year earlier.
    Credit quality for the industry also has improved for 12 
consecutive quarters. Delinquent loans and charge-offs have been 
steadily declining for over 2 years. Importantly, loan balances for the 
industry as a whole have now grown for six out of the last eight 
quarters. These positive trends have been broadly shared across the 
industry, among large institutions, midsize institutions, and community 
banks.
    The internal indicators for the FDIC also have been moving in a 
positive direction over this period. The number of banks on the FDIC's 
``Problem List''--institutions that had our lowest supervisory CAMELS 
ratings of 4 or 5--peaked in March of 2011 at 888 institutions. By the 
end of last year, the number of problem banks stood at 651 
institutions, dropping further to 612 institutions at the end of the 
first quarter 2013. In addition, the number of failed banks has been 
steadily declining. Bank failures peaked at 157 in 2010, followed by 92 
in 2011, and 51 in 2012. To date in 2013, there have been 16 bank 
failures compared to 31 through the same period in 2012.
    Despite these positive trends, the banking industry still faces a 
number of challenges. For example, although credit quality has been 
improving, delinquent loans and charge-offs remain at historically high 
levels. In addition, tighter net interest margins and relatively modest 
loan growth have created incentives for institutions to reach for yield 
in their loan and investment portfolios, heightening their 
vulnerability to interest rate risk and credit risk. Rising rates could 
heighten pressure on earnings at financial institutions that are not 
actively managing these risks. The Federal banking agencies have 
reiterated their expectation that banks manage their interest rate risk 
in a prudent manner, and supervisors continue to actively monitor this 
risk.

Condition of the FDIC Deposit Insurance Fund
    As the industry has recovered over the past 3 years, the Deposit 
Insurance Fund (DIF) also has moved into a stronger financial position.
            Restoring the DIF
    The Dodd-Frank Act raised the minimum reserve ratio for the DIF 
(the DIF balance as a percent of estimated insured deposits) from 1.15 
percent to 1.35 percent, and required that the reserve ratio reach 1.35 
percent by September 30, 2020. The FDIC is currently operating under a 
DIF Restoration Plan that is designed to meet this deadline, and the 
DIF reserve ratio is recovering at a pace that remains on track under 
the Plan. As of March 31, 2013, the DIF reserve ratio stood at 0.59 
percent of estimated insured deposits, up from 0.44 percent at year-end 
2012 and 0.22 percent at March 31 of last year. Most of the first 
quarter 2013 increase in the reserve ratio can be attributed to the 
expiration of temporary unlimited deposit insurance coverage for non- 
interest-bearing transaction accounts under the Act on December 31, 
2012.
    The fund balance has grown for 13 consecutive quarters and stood at 
$35.7 billion at March 31, 2013. This is in contrast to the negative 
$21 billion fund balance at its low point at the end of 2009. 
Assessment revenue and fewer anticipated bank failures have been the 
primary drivers of the growth in the DIF balance.
            Prepaid Assessments
    At the end of 2009, banks prepaid to the FDIC more than 3 years of 
estimated deposit insurance assessments, totaling $45.7 billion. The 
prepaid assessments were successful in ensuring that the DIF had 
adequate liquidity to handle a high volume of bank failures without 
having to borrow from the Treasury. In accordance with the regulation 
implementing the prepaid assessment, the FDIC refunded almost $6 
billion in remaining unused balances of prepaid assessments to 
approximately 6,000 insured institutions at the end of June.
Improving Financial Stability and Mitigating Systemic Risk
Capital Requirements
    On July 9, the FDIC Board acted on two important regulatory capital 
rulemakings. First, the FDIC issued an interim final rule that 
significantly revises and strengthens risk-based capital regulations 
through implementation of Basel III. This rule consolidates the 
proposals issued in the three separate notices of proposed rulemakings 
(NPRs) that the agencies issued last year and includes significant 
changes from the original proposals to address concerns raised by 
community banks. Second, the FDIC issued a joint interagency NPR to 
strengthen the leverage requirements for systemically important banking 
organizations.
            Interim Final Rule on Basel III
    The interim final rule on Basel III would strengthen both the 
quality and quantity of risk-based capital for all banks by placing 
greater emphasis on Tier 1 common equity capital. Tier 1 common equity 
capital is widely recognized as the most loss-absorbing form of 
capital. The interim final rule adopts with revisions the three notices 
of proposed rulemakings or NPRs that the banking agencies proposed last 
year. These are the Basel III NPR, the Basel III advanced approaches 
NPR, and the so-called Standardized Approach NPR. These changes will 
create a stronger, more resilient industry better able to withstand 
environments of economic stress in the future.
    This interim final rule is identical in substance to the final 
rules issued by the Federal Reserve Board and the Office of the 
Comptroller of the Currency (OCC) and allows the FDIC to proceed with 
the implementation of these revised capital regulations in concert with 
our fellow regulators. Issuing the interim final rule also allows us to 
seek comment on the interactions between the revised risk-based capital 
regulations and the proposed strengthening of the leverage requirements 
for the largest and most systemically important banking organizations 
which is described in more detail below.
    During the comment period on these proposals, we received a large 
number of comments, particularly from community banks, expressing 
concerns with some of the provisions of the NPRs. The interim final 
rule makes significant changes to aspects of the NPRs to address a 
number of these community bank comments. Specifically, unlike the NPR, 
the rule does not make any changes to the current risk-weighting 
approach for residential mortgages. It allows for an opt-out from the 
regulatory capital recognition of accumulated other comprehensive 
income, or AOCI, except for large banking organizations that are 
subject to the advanced approaches requirements. Further, the rule 
reflects that the Federal Reserve has adopted the grandfathering 
provisions of section 171 of the Dodd-Frank Act for Trust Preferred 
Securities issued by smaller bank holding companies. Comments received 
on all these matters were extremely helpful to the agencies in reaching 
decisions on the proposals.
    The interim final rule includes requirements for large banking 
organizations subject to the advanced approaches requirements that do 
not apply to community banks. For example, these advanced approach 
large institutions would be required to recognize AOCI in regulatory 
capital and also would face strengthened capital requirements for over-
the-counter derivatives.
    Consistent with the Basel III international agreement, the interim 
final rule includes a 3-percent supplementary leverage ratio that 
applies only to the 16 large banking organizations subject to the 
advanced approaches requirements. This supplementary leverage ratio is 
more stringent than the existing U.S. leverage ratio as it would 
include certain off-balance sheet exposures in its denominator. Given 
the extensive off-balance sheet activities of many advanced approaches 
organizations, the supplementary leverage ratio will play an important 
role. Finally, the rule maintains the existing U.S. leverage 
requirements for all insured banks, with the minimum leverage 
requirements continuing to set a floor for the leverage requirements of 
advanced approaches banking organizations.
    Although the new requirements are higher and more stringent than 
the old requirements, the vast majority of banks meet the requirements 
of the interim final rule. Going forward, the rule would have the 
effect of preserving and maintaining the gains in capital strength the 
industry has achieved in recent years. As a result, banks should be 
better positioned to withstand periods of economic stress and serve as 
a source of credit to local communities.
    While much contained in these rules does not apply to community 
banks, we want to be certain that community banks fully understand the 
changes in the capital rules that do apply to them. To that end, the 
FDIC is planning an extensive outreach program to assist community 
banks in understanding the interim final rule and the changes it makes 
to the existing capital requirements. We will provide technical 
assistance in a variety of forms, targeted specifically at community 
banks, including community bank guides on compliance with the rule, a 
video that will be available on the FDIC Web site, a series of regional 
outreach meetings, and subject matter experts at each of our regional 
offices whom banks can contact directly with questions.
            Interagency NPR on the Supplementary Leverage Ratio
    The FDIC joined the Federal Reserve and the OCC in issuing an NPR 
which would strengthen the supplementary leverage requirements 
encompassed in the interim final rule for certain large institutions 
and their insured banks. Using the NPR's proposed definitions of $700 
billion in total consolidated assets or $10 trillion in assets under 
custody to identify large systemically significant firms, the new 
requirements would currently apply to eight U.S. bank holding companies 
and to their insured banks.
    As the NPR points out, maintenance of a strong base of capital at 
the largest, most systemically important institutions is particularly 
important because capital shortfalls at these institutions can 
contribute to systemic distress and can have material adverse economy 
effects. Analysis by the agencies suggests that a 3-percent minimum 
supplementary leverage ratio would not have appreciably mitigated the 
growth in leverage among these organizations in the years preceding the 
recent crisis. Higher capital standards for these institutions would 
place additional private capital at risk before calling upon the DIF 
and the Federal Government's resolution mechanisms.
    The NPR would require these insured banks to satisfy a 6-percent 
supplementary leverage ratio to be considered well capitalized for 
prompt corrective action (PCA) purposes. Based on current supervisory 
estimates of the off-balance sheet exposures of these banks, this would 
correspond to roughly an 8.6-percent U.S. leverage requirement. For the 
eight affected banks, this would currently represent $89 billion in 
additional capital for an insured bank to be considered well-
capitalized.
    Bank Holding Companies (BHCs) covered by the NPR would need to 
maintain supplementary leverage ratios of a 3-percent minimum plus a 2-
percent buffer for a 5-percent requirement in order to avoid 
conservation buffer restrictions on capital distributions and executive 
compensation. This corresponds to roughly a 7.2-percent U.S. leverage 
ratio, which would currently require $63 billion in additional capital.
    An important consideration in calibrating the proposal was the idea 
that the increase in stringency of the leverage requirements and the 
risk-based requirements should be balanced. Leverage capital 
requirements and risk-based capital requirements are complementary, 
with each type of requirement offsetting potential weaknesses of the 
other. Balancing the increase in stringency of the two types of capital 
requirement should make for a stronger and sounder capital base for the 
U.S. banking system.

Resolution of Systemically Important Financial Institutions
    In addition to these capital proposals, the FDIC has made progress 
on policies and strategies to build a more effective resolution 
framework for large, complex financial institutions. One of the most 
important aspects of the Dodd-Frank Act is the establishment of new 
authorities for regulators to use in the event of the failure of a 
systemically important financial institution (SIFI).
            Resolution Plans--``Living Wills''
    Under the framework of the Dodd-Frank Act, bankruptcy is the 
preferred option in the event of the failure of a SIFI. To make this 
objective achievable, Title I of the Dodd-Frank Act requires that all 
bank holding companies with total consolidated assets of $50 billion or 
more, and nonbank financial companies that the Financial Stability 
Oversight Council (FSOC) determines could pose a threat to the 
financial stability of the United States, prepare resolution plans, or 
``living wills'', to demonstrate how the company could be resolved in a 
rapid and orderly manner under the Bankruptcy Code in the event of the 
company's financial distress or failure. The living will process is an 
important new tool to enhance the resolvability of large financial 
institutions through the bankruptcy process.
    The FDIC and the Federal Reserve Board issued a joint rule to 
implement Section 165(d) requirements for resolution plans (the 165(d) 
rule) in November 2011. The FDIC also issued a separate rule which 
requires all insured depository institutions (IDIs) with greater than 
$50 billion in assets to submit resolution plans to the FDIC for their 
orderly resolution through the FDIC's traditional resolution powers 
under the Federal Deposit Insurance Act (FDI Act). The 165(d) rule and 
the IDI resolution plan rule are designed to work in tandem by covering 
the full range of business lines, legal entities and capital-structure 
combinations within a large financial firm.
    The FDIC and the Federal Reserve review the 165(d) plans and may 
jointly find that a plan is not credible or would not facilitate an 
orderly resolution under the Bankruptcy Code. If a plan is found to be 
deficient and adequate revisions are not made, the FDIC and the Federal 
Reserve may jointly impose more stringent capital, leverage, or 
liquidity requirements, or restrictions on growth, activities, or 
operations of the company, including its subsidiaries. If compliance is 
not achieved within 2 years, the FDIC and the Federal Reserve, in 
consultation with the FSOC, can order the company to divest assets or 
operations to facilitate an orderly resolution under bankruptcy in the 
event of failure. A SIFI's plan for resolution under bankruptcy also 
will support the FDIC's planning for the exercise of its Title II 
resolution powers by providing the FDIC with a better understanding of 
each SIFI's structure, complexity, and processes.
            2013 Guidance on Living Wills
    Eleven large, complex financial companies submitted initial 165(d) 
plans in 2012. Following the review of the initial resolution plans, 
the agencies developed Guidance for the firms to detail what 
information should be included in their 2013 resolution plan 
submissions. The agencies identified an initial set of significant 
obstacles to rapid and orderly resolution which covered companies are 
expected to address in the plans, including the actions or steps the 
company has taken or proposes to take to remediate or otherwise 
mitigate each obstacle and a timeline for any proposed actions. The 
agencies extended the filing date to October 1, 2013, to give the firms 
additional time to develop resolution plan submissions that address the 
instructions in the Guidance.
    Resolution plans submitted in 2013 will be subject to informational 
completeness reviews and reviews for resolvability under the Bankruptcy 
Code. The agencies will be looking at how each resolution plan 
addresses a set of benchmarks outlined in the Guidance which pose the 
key impediments to an orderly resolution. The benchmarks are as 
follows:

    Multiple Competing Insolvencies. Multiple jurisdictions, 
        with the possibility of different insolvency frameworks, raise 
        the risk of discontinuity of critical operations and uncertain 
        outcomes.

    Global Cooperation. The risk that lack of cooperation could 
        lead to ring-fencing of assets or other outcomes that could 
        exacerbate financial instability in the United States and/or 
        loss of franchise value, as well as uncertainty in the markets.

    Operations and Interconnectedness. The risk that services 
        provided by an affiliate or third party might be interrupted, 
        or access to payment and clearing capabilities might be lost;

    Counterparty Actions. The risk that counterparty actions 
        may create operational challenges for the company, leading to 
        systemic market disruption or financial instability in the 
        United States; and

    Funding and Liquidity. The risk of insufficient liquidity 
        to maintain critical operations arising from increased margin 
        requirements, acceleration, termination, inability to roll over 
        short term borrowings, default interest rate obligations, loss 
        of access to alternative sources of credit, and/or additional 
        expenses of restructuring.

    As reflected in the Dodd-Frank Act and discussed above, the 
preferred option for resolution of a large failed financial firm is for 
the firm to file for bankruptcy just as any failed private company 
would. In certain circumstances, however, resolution under the 
Bankruptcy Code may result in serious adverse effects on financial 
stability in the United States. In such cases, the Orderly Liquidation 
Authority set out in Title II of the Dodd-Frank Act serves as the last 
resort alternative and could be invoked pursuant to the statutorily 
prescribed recommendation, determination, and expedited judicial review 
process.
            Orderly Liquidation Authority
    Prior to the recent crisis, the FDIC's receivership authorities 
were limited to federally insured banks and thrift institutions. The 
lack of authority to place the holding company or affiliates of an 
insured depository institution or any other nonbank financial company 
into an FDIC receivership to avoid systemic consequences severely 
constrained the ability to resolve a SIFI. Orderly Liquidation 
Authority provided under Title II of the Dodd-Frank Act gives the FDIC 
the powers necessary to resolve a failing systemic nonbank financial 
company in an orderly manner that imposes accountability on 
shareholders, creditors and management of the failed company while 
mitigating systemic risk and imposing no cost on taxpayers.
    The FDIC has largely completed the core rulemakings necessary to 
carry out its systemic resolution responsibilities under Title II of 
the Dodd-Frank Act. For example, the FDIC approved a final rule 
implementing the Orderly Liquidation Authority that addressed, among 
other things, the priority of claims and the treatment of similarly 
situated creditors.
    Under the Dodd-Frank Act, key findings and recommendations must be 
made before the Orderly Liquidation Authority can be considered as an 
option. These include a determination that the financial company is in 
default or danger of default, that failure of the financial company and 
its resolution under applicable Federal or State law, including 
bankruptcy, would have serious adverse effects on financial stability 
in the United States and that no viable private sector alternative is 
available to prevent the default of the financial company.
    To implement its authority under Title II of the Dodd-Frank Act, 
the FDIC has developed a strategic approach to resolving a SIFI which 
is referred to as Single Point-of-Entry. In a Single Point-of-Entry 
resolution, the FDIC would be appointed as receiver of the top-tier 
parent holding company of the financial group following the company's 
failure and the completion of the recommendation, determination, and 
expedited judicial review process set forth in Title II of the Act. 
Shareholders would be wiped out, unsecured debt holders would have 
their claims written down to reflect any losses that shareholders 
cannot cover, and culpable senior management would be replaced. Under 
the Act, officers and directors responsible for the failure cannot be 
retained.
    During the resolution process, restructuring measures would be 
taken to address the problems that led to the company's failure. These 
could include shrinking businesses, breaking them into smaller 
entities, and/or liquidating certain assets or closing certain 
operations. The FDIC also would likely require the restructuring of the 
firm into one or more smaller nonsystemic firms that could be resolved 
under bankruptcy.
    The FDIC would organize a bridge financial company into which the 
FDIC would transfer assets from the receivership estate, including the 
failed holding company's investments in and loans to subsidiaries. 
Equity, subordinated debt, and senior unsecured debt of the failed 
company would likely remain in the receivership and be converted into 
claims. Losses would be apportioned to the claims of former equity 
holders and unsecured creditors according to their order of statutory 
priority. Remaining claims would be converted, in part, into equity 
that will serve to capitalize the new operations, or into new debt 
instruments. This newly formed bridge financial company would continue 
to operate the systemically important functions of the failed financial 
company, thereby minimizing disruptions to the financial system and the 
risk of spillover effects to counterparties.
    The healthy subsidiaries of the financial company would remain open 
and operating, allowing them to continue business and avoid the 
disruption that would likely accompany their closings. Critical 
operations for the financial system would be maintained. However, 
creditors at the subsidiary level should not assume that they avoid 
risk of loss. For example, if the losses at the financial company are 
so large that the holding company's shareholders and creditors cannot 
absorb them, then the subsidiaries with the greatest losses would have 
to be placed into resolution, thus exposing those subsidiary creditors 
to loss.
    The FDIC expects the well-capitalized bridge financial company and 
its subsidiaries to borrow in the private markets and from customary 
sources of liquidity. The new resolution authority under the Dodd-Frank 
Act provides a back-up source for liquidity support, the Orderly 
Liquidation Fund (OLF). If it is needed at all, the FDIC anticipates 
that this liquidity facility would only be required during the initial 
stage of the resolution process, until private funding sources can be 
arranged or accessed. The law expressly prohibits taxpayer losses from 
the use of Title II authority.
    In our view, the Single Point-of-Entry strategy holds the best 
promise of achieving Title II's goals of holding shareholders, 
creditors and management of the failed firm accountable for the 
company's losses and maintaining financial stability at no cost to 
taxpayers.
            Statement of Policy
    Informing capital markets, financial institutions, and the public 
on what to expect if the Orderly Liquidation Authority were to be 
invoked is an ongoing effort. While the FDIC has already been highly 
transparent in our planning efforts, we also are currently working on a 
Statement of Policy which would provide more clarity on the resolution 
process. We anticipate the release of a proposal for public comment 
before the end of the year.
    In addition, the Federal Reserve, in consultation with the FDIC, is 
considering the merits of a regulatory requirement that the largest, 
most complex U.S. banking firms maintain a minimum amount of unsecured 
debt at the holding company level. Such a requirement would ensure that 
there are creditors at the holding company level to absorb losses at 
the failed firm. Questions surrounding a debt requirement are complex 
and include issues on the amount, seniority structure, and its relation 
to equity capital.
            Cross-Border Issues
    Advance planning and cross border coordination for the resolution 
of globally active, systemically important financial institutions (G-
SIFIs) will be critical to minimizing disruptions to global financial 
markets. Recognizing that G-SIFIs create complex international legal 
and operational concerns, the FDIC is actively reaching out to foreign 
host regulators to establish frameworks for effective cross-border 
cooperation and the basis for confidential information sharing, among 
other initiatives.
    As part of our bilateral efforts, the FDIC and the Bank of England, 
in conjunction with the prudential regulators in our respective 
jurisdictions, have been working to develop contingency plans for the 
failure of G-SIFIs that have operations in both the U.S. and the U.K. 
Of the 28 G-SIFIs designated by the Financial Stability Board (FSB) of 
the G20 countries, four are headquartered in the U.K., and another 
eight are headquartered in the U.S. Moreover, approximately 70 percent 
of the reported foreign activities of the eight U.S. G-SIFIs emanates 
from the U.K. The magnitude of these financial relationships makes the 
U.S.-U.K. bilateral relationship by far the most significant with 
regard to the resolution of G-SIFIs. As a result, our two countries 
have a strong mutual interest in ensuring that, if such an institution 
should fail, it can be resolved at no cost to taxpayers and without 
placing the financial system at risk. The FDIC and U.K. authorities 
released a joint paper on resolution strategies in December 2012, 
reflecting the close working relationship between the two authorities. 
This joint paper focuses on the application of ``top-down'' resolution 
strategies for a U.S. or a U.K. financial group in a cross-border 
context and addresses several common considerations to these resolution 
strategies.
    In addition to the close working relationship with the U.K., the 
FDIC is coordinating with representatives from other European 
regulatory bodies to discuss issues of mutual interest including the 
resolution of European G-SIFIs. The FDIC and the European Commission 
(E.C.) have established a joint Working Group comprised of senior 
executives from the FDIC and the E.C. The Working Group convenes 
formally twice a year--once in Washington, once in Brussels--with 
ongoing collaboration continuing in between the formal sessions. The 
first of these formal meetings took place in February 2013. Among the 
topics discussed at this meeting was the E.C.'s proposed Recovery and 
Resolution Directive, which would establish a framework for dealing 
with failed and failing financial institutions. The overall authorities 
outlined in that document have a number of parallels to the SIFI 
resolution authorities provided here in the U.S. under the Dodd-Frank 
Act. The next meeting of the Working Group will take place in Brussels 
later this year.
    The FDIC also is engaging with Switzerland, Germany, Japan, and 
Canada on a bilateral basis. Among other things, the FDIC has further 
developed its understanding of the Swiss resolution regime for G-SIFIs, 
including an in-depth examination of the two Swiss-based G-SIFIs with 
significant operations in the U.S. During the past year, we also have 
participated in several productive workshops with the Federal Financial 
Supervisory Authority (BaFin), the German resolution authority. The 
FDIC anticipates a principals-level meeting with Japan later this year.
    To place these working relationships in perspective, the U.S., the 
U.K., the European Union, Switzerland and Japan account for the home 
jurisdictions of 27 of the 28 G-SIFIs designated by the Financial 
Stability Board (FSB) of the G20 in November 2012. Progress in these 
cross-border relationships is thus critical to addressing the 
international dimension of SIFI resolutions.

The Volcker Rule
    The Dodd-Frank Act requires the Securities and Exchange Commission 
(SEC), the Commodities Futures Trading Commission (CFTC), and the 
Federal banking agencies to adopt regulations generally prohibiting 
proprietary trading and certain acquisitions of interest in hedge funds 
or private equity funds. The FDIC, jointly with the FRB, OCC, and SEC, 
published an NPR requesting public comment on a proposed regulation 
implementing the prohibition against proprietary trading. The CFTC 
separately approved the issuance of its NPR to implement the Volcker 
Rule, with a substantially identical proposed rule text.
    The proposed rule also requires banking entities with significant 
covered trading activities to furnish periodic reports with 
quantitative measurements designed to help differentiate permitted 
market-making-related activities from prohibited proprietary trading. 
Under the proposed rule, these requirements contain important 
exclusions for banking organizations with trading assets and 
liabilities less than $1 billion, and reduced reporting requirements 
for organizations with trading assets and liabilities of less than $5 
billion. These thresholds are designed to reduce the burden on smaller, 
less complex banking entities, which generally engage in limited 
market-making and other trading activities.
    The agencies are evaluating a large body of comments on whether the 
proposed rule represents a balanced and effective approach or whether 
alternative approaches exist that would provide greater benefits or 
implement the statutory requirements with fewer costs. The FDIC is 
committed to developing a final rule that meets the objectives of the 
statute while preserving the ability of banking entities to perform 
important underwriting and market-making functions, including the 
ability to effectively carry out these functions in less-liquid 
markets. Most community banks do not engage in activities that would be 
impacted by the proposed rule.

The Dodd-Frank Act and Community Banks
    While the Dodd-Frank Act has changed the regulatory framework for 
the financial services industry, many of the Act's reforms are geared 
toward larger institutions, as discussed above. At the same time, the 
Act included a number of provisions that impacted community banks. Of 
particular relevance to the FDIC, the Act made changes to the deposit 
insurance system that have specific consequences for community banks.
    In the aftermath of the crisis, the Dodd-Frank Act made permanent 
the increase in the coverage limit to $250,000, a provision generally 
viewed by community banks as a helpful means to attract deposits.
    The FDIC also implemented the Dodd-Frank Act requirement to 
redefine the base used for deposit insurance assessments as average 
consolidated total assets minus average tangible equity. As Congress 
intended, the change in the assessment base shifted some of the overall 
assessment burden from community banks to the largest institutions, 
which rely less on domestic deposits for their funding than do smaller 
institutions. The result was a sharing of the assessment burden that 
better reflects each group's share of industry assets. Aggregate 
premiums paid by institutions with less than $10 billion in assets 
declined by approximately one-third in the second quarter of 2011, 
primarily due to the assessment base change.
    In the aftermath of the financial crisis and recession, as well as 
the enactment of the Dodd-Frank Act, many community banks had concerns 
about their continued viability in the U.S. financial system. Prompted 
by that concern, the FDIC initiated a comprehensive review of the U.S. 
community banking sector covering 27 years of data and released the 
FDIC Community Banking Study in December 2012.
    Our research confirms the crucial role that community banks play in 
the U.S. financial system. As defined by the Study, community banks 
represented 95 percent of all U.S. banking organizations in 2011. These 
institutions accounted for just 14 percent of the U.S. banking assets, 
but held 46 percent of all the small loans to businesses and farms made 
by FDIC-insured institutions. While their share of total deposits has 
declined over time, community banks still hold the majority of bank 
deposits in rural and micropolitan counties. \2\ The Study showed that 
in 629 U.S. counties (or almost one-fifth of all U.S. counties), the 
only banking offices operated by FDIC-insured institutions at year-end 
2011 were those operated by community banks. Without community banks, 
many rural areas, small towns and urban neighborhoods would have little 
or no physical access to mainstream banking services.
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     \2\ The 3,238 U.S. counties in 2010 included 694 micropolitan 
counties centered on an urban core with populations between 10,000 and 
50,000 people, and 1,376 rural counties with populations less than 
10,000 people.
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    The Study found that community banks that grew prudently and that 
maintained diversified portfolios or otherwise stuck to their core 
lending competencies funded by stable core deposits during the Study 
period exhibited relatively strong and stable performance over time. 
Institutions that departed from the traditional community bank business 
model generally underperformed over the long run. These institutions 
pursued higher-growth strategies--frequently through commercial real 
estate or construction and development lending--financed by volatile 
funding sources. This group encountered severe problems during real 
estate downturns and characterized the community banks that failed 
during the aftermath of the crisis.
    As the primary Federal regulator for the majority of smaller 
institutions (those with less than $1 billion in total assets), the 
FDIC is keenly aware of the challenges facing community banks. The FDIC 
has tailored its supervisory approach to consider the size, complexity, 
and risk profile of the institutions it oversees. For example, large 
institutions (those with $10 billion or more in total assets) are 
generally subject to continuous supervision (targeted reviews 
throughout the year), while smaller banks are examined periodically 
(every 12 to 18 months) based on their size and condition. 
Additionally, the frequency of our examinations of compliance with the 
Community Reinvestment Act can be extended for smaller, well-managed 
institutions. Moreover, in Financial Institution Letters issued to the 
industry to explain regulations and guidance, the FDIC includes a 
Statement of Applicability to institutions with less than $1 billion in 
total assets.
    In addition to the changes in the Dodd-Frank Act affecting 
community banks, the FDIC also reviewed its examination, rulemaking, 
and guidance processes during 2012 as part of our broader review of 
community banking challenges, with a goal of identifying ways to make 
the supervisory process more efficient, consistent, and transparent, 
while maintaining safe and sound banking practices. Based on the 
review, the FDIC has implemented a number of enhancements to our 
supervisory and rule-making processes. First, the FDIC has restructured 
the pre-exam process to better scope examinations, define expectations, 
and improve efficiency. Second, the FDIC is taking steps to improve 
communication with banks under our supervision through the use of Web-
based tools, regional meetings and outreach. Finally, the FDIC has 
instituted a number of outreach and technical assistance efforts, 
including increased direct communication between examinations, 
increased opportunities to attend training workshops and symposiums, 
and conference calls and training videos on complex topics of interest 
to community bankers. The FDIC plans to continue its review of 
examination and rule-making processes, and continues to explore new 
initiatives to provide technical assistance to community banks.

Conclusion
    Thank you for the opportunity to share with the Committee the work 
that the FDIC has been doing to address systemic risk in the aftermath 
of the financial crisis. I would be glad to respond to your questions.





                 PREPARED STATEMENT OF THOMAS J. CURRY
 Comptroller of the Currency, Office of the Comptroller of the Currency
                             July 11, 2013

    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, thank you for the opportunity to discuss those provisions in 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act or Act) that reduce systemic risk and improve financial 
stability.* The global financial crisis was unprecedented in its 
severity and exposed a number of fundamental weaknesses in the 
regulation of the financial system. In response, Congress passed the 
Dodd-Frank Act, which contains the most comprehensive reforms to the 
financial system since the Great Depression. These reforms address 
systemic issues that contributed to the crisis, strengthen the 
oversight, regulation, and resolution provisions applicable to large 
financial institutions, and promote greater market stability by, among 
other things, increasing the transparency and oversight of swaps and 
other derivatives activities, and mandating that the largest bank 
holding companies and systemically significant nonbank companies 
prepare resolution plans demonstrating how they can be resolved in a 
bankruptcy proceeding. The Act requires Federal regulators to put in 
place new buffers and safeguards to protect against future financial 
crises, such as requiring enhanced prudential capital and liquidity 
standards for large, complex banks, and provides Federal regulators 
with a number of new tools to help avoid future problems. While many of 
the rules to implement these reforms are still being developed, once in 
place they will serve to reduce systemic risk and add to the resiliency 
of the largest financial institutions and, ultimately, our economy.
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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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    As economic conditions have improved, so has the condition of the 
institutions the Office of the Comptroller of the Currency (OCC) 
supervises. These institutions have made significant progress in 
repairing their balance sheets with stronger capital, improved 
liquidity, and timely recognition and resolution of problem loans. For 
national banks and Federal savings associations, tier 1 common equity 
is at 12.3 percent of risk-weighted assets, up from its low of just 
over 9 percent at the end of 2008. \1\ The current capital leverage 
ratio is now about 9 percent, which is up almost a third from its 
recent low. Reliance on volatile funding sources has dropped from its 
fall 2006 peak of 46 percent of total liabilities to 22 percent today. 
Asset quality indicators are improving with charge-off rates declining 
for all major loan categories. Indeed, for all but residential 
mortgages, charge-off rates have now dropped below their post-1990 
averages.
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     \1\ Performance and financial data are based on March 31, 2013, 
Call Report information.
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    While these are positive developments, there remains much to do, 
and we are continuing to stress that institutions must stay vigilant 
about monitoring new and existing risk. This is certainly not the time 
to dispense with this renewed focus on risk management and, as I 
discuss in my testimony, the OCC is actively raising the bar on our 
supervisory expectations for the largest banks we oversee.
    In response to the Committee's letter of invitation, my testimony 
will cover actions we have taken to improve financial stability through 
enhanced prudential regulation and supervision, to finalize those rules 
for which the OCC has independent rule writing authority, and to 
strengthen risk-based capital, liquidity, and leverage. I will also 
address developments regarding the provisions of Title VII of the Act, 
our work with other Federal banking agencies regarding the resolution 
of any failing systemically important financial institution under Title 
II, and the Volcker Rule. Finally, I will conclude with a discussion of 
how the Act has affected the OCC's regulation of the many community 
banks and thrifts we supervise and an update on the status of certain 
interagency Dodd-Frank Act regulations.

I. Improving Financial Stability Through Enhanced Prudential Regulation 
        and Supervision
    As I have noted in previous testimony, \2\ large banks are critical 
to the proper functioning of the capital markets and to a vital economy 
and thus need to be regulated and supervised more rigorously than less 
systemically important banks. In applying the lessons we learned from 
the financial crisis, the OCC is focusing on improving its supervisory 
program and has increased expectations for the largest banks. In 
addition, the OCC has increased collaboration and coordination with 
both domestic and international regulators in order to leverage our 
collective resources and supervise our institutions more efficiently 
and effectively. The OCC has also worked diligently to complete all 
rulemakings required by the Act both where the OCC has authority to 
issue rules independently and in collaboration with the other 
regulators on interagency rules. We believe that these actions will 
result in a stronger and safer banking system.
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     \2\ http://www.occ.treas.gov/news-issuances/congressional-
testimony/2012/pub-test-2012-86-written.pdf
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A. Improving Supervision
            Examiner Oversight
    The financial crisis underscored the importance of bank supervision 
and the role of examiner judgment, along with strong regulation and 
robust analytics, as cornerstones of a healthy financial system. While 
laws and regulations take a long view and cannot be easily tailored to 
new developments, our examiners pay close attention to changes in the 
financial environment generally and changes in individual risk profiles 
specifically. This proactive approach helps to identify and correct 
emerging issues before they become major problems. Our examiners are 
seasoned professionals who bring the benefit of sound judgment and 
years of experience to their work. This work demonstrates the 
importance of having examiners' ``boots on the ground'' to better 
communicate our expectations and to ensure that these expectations are 
met.
            Heightened Expectations
    Higher supervisory expectations for the large banks we oversee, 
together with bank management's implementation of these expectations, 
are consistent with the broad goal of the Dodd-Frank Act to strengthen 
the financial system. We believe that this increased focus on strong 
corporate governance and risk management will both help to maintain the 
balance sheet improvements achieved since the financial crisis and make 
these institutions better able to withstand the impact of future 
crises. For example, as part of this increased focus, we have 
communicated our expectations for independent directors to present a 
credible challenge to bank management and to have a thorough 
understanding of the bank's risks. Informed directors can better 
question the propriety of strategic initiatives and assess the balance 
between risk-taking and reward. We also expect these banks to have 
strong audit and risk management functions, and we directed bank audit 
and risk management committees to perform gap analyses relative to the 
OCC's standards and industry practices and to close the identified 
gaps. While more work is required, I am pleased to say that progress is 
being made in closing identified gaps.
    Our views on heightened expectations for strong corporate 
governance and risk management also extend to the way banks define and 
communicate risk tolerance expectations across the company. For 
example, our examiners are directing banks to complement existing risk 
tolerance structures with measures that address the amount of capital 
or earnings that may be at risk on a firm-wide basis, the amount of 
risk that may be taken in each line of business, and the amount of risk 
that may be taken in each of the key risk categories monitored by the 
banks.
    The OCC is reinforcing these heightened expectations through our 
ongoing supervisory activities and frequent communication with bank 
management and boards of directors. Examiners prepare and discuss with 
bank management a quarterly analysis of each large bank's progress 
toward meeting the OCC's heightened expectations. In addition, each 
bank's Report of Examination now includes an overall rating of how the 
bank is meeting these heightened expectations.
    Another OCC initiative that complements our views on heightened 
expectations is the idea of legal entity structure simplification. The 
OCC is working with the large banks we oversee to reduce the number and 
complexity of legal entities within their organizations and to ensure 
that remaining legal entities are properly aligned with the banks' key 
lines of business. While we understand that banks may need time and 
will likely incur some expense in undertaking such restructuring, we 
believe it will greatly improve transparency, resolvability, risk 
management, and governance at the largest banks we supervise.
            Risk Identification
    The OCC's National Risk Committee (NRC) contributes to our 
supervisory responsibilities by monitoring the condition of the Federal 
banking system as a whole as well as emerging threats to the system's 
safety and soundness. The NRC also monitors evolving business practices 
and financial market issues and helps to shape our supervisory efforts 
to address emerging risk issues. NRC members include senior agency 
officials who supervise banks of all sizes, as well as officials from 
the legal, policy, and economics departments. The NRC helps to 
formulate the OCC's annual bank supervision operating plan that guides 
our supervisory strategies for the coming year. The NRC also publishes 
the Semiannual Risk Perspective report to provide information to the 
industry and to the general public on issues that may pose threats to 
the safety and soundness of OCC-regulated financial institutions. This 
report is part of our effort to make our supervision priorities more 
transparent to the boards and management of national banks and Federal 
savings associations. We believe the institutions we supervise can 
better calibrate their own risk management strategies by understanding 
the OCC's supervisory strategies and the emerging risks the agency is 
focused on. The most recent report, published in June of this year, 
presents data on the operating environment, the condition and 
performance of the banking system, and trends in funding, liquidity, 
interest rate risk, and regulatory actions. \3\
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     \3\ http://el.occ/publications/publications-by-type/other-
publications-reports/semiannual-risk-perspective/semiannual-risk-
perspective-spring-2013.pdf
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B. Domestic Collaboration and International Coordination
            Domestic Collaboration
    While the OCC has always sought to coordinate our supervisory 
efforts with other Federal banking agencies, the Dodd-Frank Act has 
made interagency collaboration even more critical. This collaboration 
allows the agencies to contribute their unique expertise and to reduce 
unnecessary duplication.
    Therefore, we have increased our efforts to work with the other 
Federal banking agencies and recently implemented a number of guiding 
principles for interagency coordination with the Board of Governors of 
the Federal Reserve System (FRB) and the Federal Deposit Insurance 
Corporation (FDIC). Thus, for the largest national banks and thrifts, 
examiners are more closely coordinating with the FRB and FDIC to 
develop supervisory strategies that will promote more efficient and 
effective allocation of resources to key priorities and risks, while 
reducing redundant or duplicative supervisory activities. We have also 
invited our prudential regulatory partners to attend meetings of the 
OCC's NRC to share more promptly information about risks.
    The OCC and the other Federal banking agencies also have entered 
into a memorandum of understanding (MOU) with the Bureau of Consumer 
Financial Protection (CFPB) that clarifies how the agencies will 
coordinate their supervisory activities consistent with the Act. The 
objective of the MOU is to minimize unnecessary regulatory burden, 
avoid duplication of effort, and decrease the risk of conflicting 
supervisory directives. The MOU specifically addresses cooperation on 
scheduling examinations and other supervisory activities as well as 
information sharing.
            International Coordination
    The OCC has also been working internationally to coordinate 
supervisory efforts following the financial crisis and the passage of 
the Dodd-Frank Act. The international Basel III agreements incorporated 
many of the lessons relating to bank capital that the global community 
learned from the financial crisis. As members of the Basel Committee on 
Bank Supervision (Basel Committee), the Federal banking agencies had a 
critical role in the development of these enhanced capital standards, 
and the final rule that I approved on July 9th and that is described 
more fully in my testimony reflects many of those key provisions.
    The OCC also has taken a leading role in international discussions 
relating to cross-border resolutions. The OCC is a member of the Basel 
Committee's Cross-Border Bank Resolutions Group and participates in the 
Financial Stability Board's Cross-Border Crisis Management Group. In 
addition, the OCC participates in firm-specific Crisis Management 
Groups and Supervisory Colleges and is engaged with the other U.S. 
banking agencies in developing Cooperation Agreements with foreign 
jurisdictions that will allow for information sharing and coordination 
in future crises affecting large, cross-border financial institutions.
    The OCC is also playing a leading role internationally in improving 
supervisory practices and principles and overseeing the timely, 
consistent, and effective implementation of Basel Committee standards 
around the world.

C. Dodd-Frank OCC Rulemakings
    In response to the Committee's request to discuss the status of the 
rules required by the Dodd-Frank Act, I am pleased to report that all 
of the rules that the OCC has authority to issue independently have 
been completed. This includes rules relating to lending limits (section 
610), stress testing (section 165(i)(2)), the removal of references to 
credit ratings (section 939A), and retail foreign exchange transactions 
(section 742). A summary of each of these rules follows.
            Lending Limits
    The Dodd-Frank Act directly addressed concentrations of credit by 
requiring banks to account for derivatives and securities financing 
transactions under the lending limit rules. Both of these categories of 
instruments contributed to systemic risk during the crisis, in part, 
due to lack of transparency around exposures. Under the National Bank 
Act, the total loans and extensions of credit by a national bank to a 
person outstanding at one time may not exceed 15 percent of the 
unimpaired capital and unimpaired surplus of the bank if the loan is 
not fully secured, plus an additional 10 percent of unimpaired capital 
and unimpaired surplus if the loan is fully secured. Section 610 of the 
Dodd-Frank Act amended the definition of ``loans and extensions of 
credit'' to include any credit exposure to a person arising from a 
derivative transaction, or a repurchase agreement, reverse repurchase 
agreement, securities lending transaction, or securities borrowing 
transaction (collectively, securities financing transactions), between 
a national bank and that person.
    The OCC published a final rule on June 25, 2013. The final rule 
provides significant flexibility for meeting these new requirements, 
particularly for smaller-sized institutions, by offering national banks 
and savings associations three methods for calculating the credit 
exposure of most derivative transactions, a special rule for measuring 
the exposure of credit derivatives, and three methods for calculating 
such exposure for securities financing transactions. These methods vary 
in complexity and permit institutions to adopt compliance alternatives 
that fit their size and risk management requirements, consistent with 
safety and soundness and the goals of the statute. To permit 
institutions the time necessary to conform their operations to the 
amendments implementing section 610, the OCC has extended the temporary 
exception period for the application of these new lending limit rules 
through October 1, 2013.
            Stress Testing
    The use of stress tests during the financial crisis played a 
critical role in restoring confidence in the U.S. banking system, and 
Congress codified further use of stress testing as a regulatory tool 
through several provisions of the Dodd-Frank Act. On October 9, 2012, 
the OCC published a final rule that implements section 165(i) of the 
Dodd-Frank Act, which requires national banks and Federal savings 
associations with total consolidated assets over $10 billion to conduct 
annual stress tests pursuant to regulations prescribed by their 
respective primary financial regulator.
    The final rule defines ``stress test'', establishes methods for the 
conduct of the company-run stress test that must include at least three 
different scenarios (baseline, adverse, and severely adverse), 
establishes the form and content of reporting, and compels covered 
institutions to publish a summary of the results of the stress tests. 
The requirements for these company-run stress tests are separate and 
distinct from the supervisory stress tests, also required under section 
165(i), that are conducted by the FRB. Nevertheless, we believe these 
efforts are complementary, and we are committed to working closely with 
the FRB and the FDIC to coordinate the timing of, and the scenarios 
for, these tests.
    On November 15, 2012, the OCC and other regulators released the 
stress scenarios for the company-run stress tests covering baseline, 
adverse, and severely adverse conditions. Covered institutions with 
more than $50 billion in assets conducted their first stress tests 
under the rule and reported and disclosed the results. The OCC is 
reviewing the results as part of its ongoing supervision of these 
institutions.
            Removal of References to Credit Ratings From OCC 
                    Regulations
    On June 13, 2012, the OCC published a final rule to implement 
section 939A of the Dodd-Frank Act by removing references to credit 
ratings from the OCC's noncapital regulations, including the OCC's 
investment securities regulation, which sets forth the types of 
investment securities that national banks and Federal savings 
associations may purchase, sell, deal in, underwrite, and hold. These 
revisions became effective on January 1, 2013.
    Under prior OCC rules, permissible investment securities generally 
included Treasury securities, agency securities, municipal bonds, and 
other securities rated ``investment grade'' by nationally recognized 
statistical rating organizations such as Moody's, S&P, or Fitch 
Ratings. The OCC's final rule revised the definition of ``investment 
grade'' to remove the reference to credit ratings and replaced it with 
a new non- ratings-based creditworthiness standard. To determine that a 
security is ``investment grade'' under the new standard, a bank must 
perform due diligence necessary to establish: (1) that the risk of 
default by the obligor is low; and (2) that full and timely repayment 
of principal and interest is expected. Generally, securities with good 
to very strong credit quality will meet this standard.
    The OCC recognized that some national banks and Federal savings 
associations needed time to make the adjustments necessary to make 
``investment grade'' determinations under the new standard. Therefore, 
the OCC allowed institutions nearly 6 months to come into compliance 
with the final rule.
    To aid this adjustment process, the OCC also published guidance to 
assist institutions in interpreting the new standard and to clarify the 
steps they can take to demonstrate that they meet their diligence 
requirements when purchasing investment securities and conducting 
ongoing reviews of their investment portfolios.
            Retail Foreign Exchange Transactions
    On July 14, 2011, the OCC published its final retail foreign 
exchange transactions rule (Retail Forex Rule) for national banks and 
Federal branches and agencies of foreign banks. The Retail Forex Rule 
imposes a variety of consumer protections--including margin 
requirements, required disclosures, and business conduct standards--on 
foreign exchange options, futures, and futures-like transactions with 
retail customers (persons that are not eligible contract participants 
under the Commodity Exchange Act). To promote regulatory comparability, 
the OCC worked closely with the Commodity Futures Trading Commission 
(CFTC), Securities Exchange Commission (SEC), FDIC, and FRB in 
developing the Retail Forex Rule and modeled the Retail Forex Rule on 
the CFTC's rule.
    After the transfer of regulatory authority from the Office of 
Thrift Supervision, the OCC updated its Retail Forex Rule to apply to 
Federal savings associations. This interim final rule with request for 
comments was published on September 12, 2011. The OCC also proposed 
last October to update its Retail Forex Rule to incorporate the CFTC's 
and SEC's recent further definition of ``eligible contract 
participant'' and related guidance. The OCC is currently working to 
finalize that proposal.

II. Strengthening Capital and Liquidity
A. Comprehensive Revisions to Capital Rules
    Earlier this week, the OCC joined the other Federal banking 
agencies in issuing comprehensive revisions to the capital rules that 
incorporate changes to the international capital framework published by 
the Basel Committee as well as certain elements of the Dodd-Frank Act 
(domestic capital rules) that we believe will strengthen our Nation's 
financial system by reducing systemic risk and improving the safe and 
sound operation of the banks we regulate. Strong capital standards are 
critical to moderate economic downturns and position the banking system 
to serve as a catalyst for recovery by ensuring that financial 
institutions stand ready to lend throughout the economic cycle.
    The recent financial crisis was marked by significant concerns 
about the riskiness of assets and the ability of bank capital to absorb 
losses. Internationally, the OCC was part of the effort to strengthen 
standards that produced Basel III. The domestic capital rules 
constitute a parallel effort to address the same broad concerns about 
capital and risk. A number of the changes adopted in the domestic 
capital rules complement the capital provisions in the Dodd-Frank Act. 
Importantly, the agencies have calibrated the new standards to reflect 
the nature and complexity of the different institutions they regulate. 
Therefore, although some requirements apply to all national banks and 
Federal savings associations, many requirements will apply only to the 
largest banking organizations that engage in complex or risky 
activities.
    Some of the more significant revisions in the domestic capital 
rules include increasing both the quantity and the quality of capital 
necessary to meet minimum regulatory requirements, enhancing the 
minimum leverage ratio requirements for the largest banks, 
incorporating incentives to clear more derivatives transactions through 
regulated central counterparties, and adding stress assessments into 
many of the risk-based capital requirements. Additionally, the agencies 
issued a proposal that would further increase the leverage ratio 
requirements applicable to the largest, most complex banking 
organizations.
            Increased Quantity and Improved Quality of Required Capital
    The domestic capital rules increase the quantity and improve the 
quality of the capital that national banks and Federal savings 
associations must hold to meet their regulatory requirements. The rule 
does this by narrowing the definition of regulatory capital and raising 
the overall minimum required levels of capital. The rule also 
establishes a new capital measure called Common Equity Tier 1 (CET1). 
This measure includes only the forms of capital that proved to be the 
most reliably loss absorbing during the financial crisis and subsequent 
economic downturn. The domestic capital rules require national banks 
and Federal savings associations to have CET1 capital equal to at least 
4.5 percent of their risk-weighted assets.
    In addition to the regulatory minimums, the domestic capital rules 
apply a capital conservation buffer requirement to all national banks 
and Federal savings associations and a countercyclical capital buffer 
requirement to banking organizations subject to the advanced approaches 
rules (i.e., those with assets in excess of $250 billion or foreign 
exposures of more than $10 billion).
    The capital conservation buffer consists of an additional amount of 
CET1 capital equal to 2.5 percent of a national bank's or Federal 
savings association's risk-weighted assets. \4\ A banking organization 
that fails to hold enough CET1 capital to satisfy the buffer 
requirement will face restrictions on its ability to issue and pay 
dividends and to make discretionary bonus payments. During the recent 
financial crisis and economic downturn, some banking organizations 
continued to pay dividends and substantial discretionary bonuses even 
as their financial condition weakened; the capital conservation buffer 
will limit such practices and force banking organizations to conserve 
capital for periods of economic distress.
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     \4\ Therefore, to meet both the regulatory minimum, plus the 
capital conservation buffer requirement, a bank will have to have CET1 
capital equal to or greater than 7 percent of its total risk-weighted 
assets.
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    The countercyclical capital buffer can be activated in an 
expansionary credit cycle to increase regulatory capital requirements 
during periods of rapid growth. The goal of this requirement is to 
reduce excesses in lending and to protect against the effects of 
weakened underwriting standards. The countercyclical capital buffer 
would increase the capital conservation buffer for advanced approaches 
banking organizations by as much as another 2.5 percent of their risk-
weighted assets.
    A separate surcharge on systemically important banks (the so-called 
SIFI surcharge), which is to be the subject of a separate rulemaking, 
would add another 1 percent to 2.5 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 12 percent 
of their risk-weighted assets, and this level could rise further should 
the systemic footprint of these banks increase.
            Leverage Ratio Capital Requirements
    Under the domestic capital rules, all banking organizations must 
meet a minimum leverage ratio requirement designed to constrain the 
build-up of leverage and reinforce the risk-based requirements with a 
non- risk-based backstop.
    To be considered ``adequately capitalized'' from a leverage ratio 
perspective, all national banks and Federal savings associations must 
have tier 1 capital equal to at least 4 percent of their total on-
balance sheet assets. The minimum ratio for a bank to be ``well 
capitalized'' is 5 percent. Applying both risk-based capital 
requirements and leverage capital requirements is appropriate because 
the two different standards work together to offset potential 
weaknesses and reduce incentives for regulatory capital arbitrage.
    For national banks and Federal savings associations subject to the 
advanced approaches rules, the domestic capital rules add a 
``supplemental leverage ratio'' requirement. The supplemental leverage 
ratio requirement provides that an advanced approaches bank may not be 
considered ``adequately capitalized'' unless it has tier 1 capital 
equal to at least 3 percent of its leverage exposure, which is equal to 
the bank's on-balance sheet assets plus a credit equivalent amount that 
represents the bank's off-balance sheet exposures. Because large 
banking organizations often have large off-balance sheet exposures 
through different kinds of lending commitments, derivatives, and other 
activities, the 3-percent supplemental leverage ratio requirement is 
expected to be a more demanding standard than the current 4-percent 
leverage ratio requirement.
    The OCC, together with the FRB and FDIC, just issued a proposal 
that would substantially increase the minimum supplemental leverage 
ratio requirement applicable to the largest and most complex banking 
organizations. \5\ Under the new supplemental leverage ratio proposal, 
the largest and most systemically important banks would be required to 
maintain an even higher ratio of tier 1 capital to leverage exposure in 
order to be deemed ``well capitalized.'' A higher supplemental leverage 
requirement for such institutions would place additional private 
capital at risk before calling upon the Federal deposit insurance fund 
or the Federal Government's resolution mechanisms. The OCC expects that 
this higher requirement would become the de facto minimum if finalized 
as proposed because large banking organizations generally engage in 
activities that are permitted only for institutions that are well 
capitalized.
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     \5\ The proposal would apply to any U.S. top-tier bank holding 
company (BHC) with at least $700 billion in total consolidated assets 
or at least $10 trillion in assets under custody and any insured 
depository institution subsidiary of such a BHC.
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    The OCC will carefully consider comments received on this proposal 
from all stakeholders.
            Incentives To Clear Derivatives Through Central 
                    Counterparties
    While the domestic capital rules include a number of changes to the 
way banks calculate risk-weighted assets that will improve the risk-
sensitivity of the rules, among the more important provisions from a 
systemic perspective are new requirements that provide strong 
incentives for banks to clear derivatives through regulated central 
counterparties. Under the domestic capital rules, when a national bank 
or Federal savings association clears a derivatives transaction through 
a qualifying central counterparty, the risk-based capital requirement 
applied to the exposure will be substantially lower than the 
requirement that otherwise would apply had the transaction not been 
cleared through the central counterparty.
    Clearing more transactions through regulated central counterparties 
will help improve the safety and soundness of the derivatives market 
through greater netting of exposures, the establishment and enforcement 
of collateral requirements, and by encouraging market transparency.
            Market Risk Capital Requirements
    On August 30, 2012, the OCC published revisions to the market risk 
capital requirements that apply to national banks engaged in 
significant trading activities. The revisions to the market risk 
capital rule substantially increased the overall capital requirements 
applicable to trading activities, in large part by requiring banking 
organizations to incorporate stressed economic conditions into their 
market risk models, adding prudential requirements to improve risk 
management, and adding disclosure requirements that provide 
transparency to market participants with regard to the calculation of a 
bank's market risk capital requirement.
    The revised market risk rule also requires the OCC's prior written 
approval before a banking organization may use a model to calculate its 
market risk capital requirements. The rule requires a national bank to 
notify the OCC if it plans to (1) make a change to an approved model 
that would result in a material change to the bank's risk-weighted 
assets; (2) extend the use of an approved model to a new business line 
or product type; or (3) make any material change to its modeling 
assumptions.
    In addition, the U.S. agencies are participating in the Basel 
Committee's fundamental review of the capital requirements for trading 
positions. In the second half of 2013, the Committee plans to publish a 
proposal for comment based on this review. At that point, the U.S. 
agencies will consider, subject to notice and comment, whether further 
changes in their market risk capital rules are necessary.

B. Enhanced Liquidity Standards
    The maintenance of adequate liquidity is central to the proper 
functioning of financial markets and the banking sector. During the 
financial crisis, a number of banks, including some with adequate 
capital levels, encountered difficulties because they did not 
appropriately manage their liquidity. The stress on the international 
banking system resulted in significant Government actions both globally 
and at home. To address future liquidity shortfalls, the Federal 
banking agencies and the Basel Committee took some immediate and 
initial steps to address liquidity risk management.
    In 2008, the Basel Committee published detailed guidance (Basel 
Liquidity Principles) on the risk management and supervision of 
liquidity risk. In 2010, the Federal banking agencies, the National 
Credit Union Association, and the Conference of State Bank Supervisors 
issued an ``Interagency Policy Statement on Funding and Liquidity Risk 
Management'' (Liquidity Risk Policy Statement) that incorporates 
elements of the Basel Liquidity Principles and includes additional 
liquidity risk management principles previously issued by the agencies. 
The Liquidity Risk Policy Statement describes the process that 
institutions should follow to appropriately identify, measure, monitor, 
and control their funding and liquidity risk. In addition, the 
Liquidity Risk Policy Statement emphasizes the importance of cash flow 
projections, diversified funding sources, stress testing, a cushion of 
liquid assets, and a formal well-developed contingency funding plan as 
primary tools for measuring and managing liquidity risk.
    To complement the Basel Liquidity Principles, in 2010, the Basel 
Committee issued ``Basel III: The Liquidity Coverage Ratio and 
liquidity risk monitoring tools'' (Basel III Liquidity Framework). The 
Basel III Liquidity Framework introduces two explicit minimum liquidity 
ratios--the Liquidity Coverage Ratio and the Net Stable Funding Ratio--
to assist a banking organization in maintaining sufficient liquidity 
during periods of financial distress.
    These ratios are intended to achieve two separate but complementary 
objectives. The Liquidity Coverage Ratio, with a 30-day time horizon, 
addresses short-term resilience by ensuring that a banking organization 
has sufficient high quality liquid resources to offset cash outflows 
under acute short-term stresses. The Net Stable Funding Ratio seeks to 
promote longer-term resilience by creating additional incentives for a 
banking organization to fund its ongoing activities with stable sources 
of funding. Its goal is to limit over reliance on short-term wholesale 
funding during times of robust market liquidity and to encourage better 
assessment of liquidity risk across all on- and off-balance sheet 
items.
    The Basel Committee included a lengthy implementation timeline for 
both ratios to provide regulators the opportunity to conduct further 
analysis and to make changes as necessary. The Federal banking agencies 
are developing a proposed rule to implement the 30-day Liquidity 
Coverage Ratio in the U.S. for large banking organizations, which we 
hope to issue for comment by the end of the year.
    The Basel III Liquidity Framework's standards, once fully 
implemented, will complement overall liquidity risk management 
practices that have been informed and refined by the Liquidity Risk 
Guidance issued in 2010 and the enhanced liquidity standards proposed 
by the FRB, in consultation with the OCC, as part of the heightened 
prudential standards under section 165 of the Dodd-Frank Act.

III. Financial Stability Oversight Council (FSOC)
    The Dodd-Frank Act established FSOC with the overarching mission to 
identify risks to the financial stability of the United States, promote 
market discipline, and respond to emerging threats to the stability of 
the U.S. financial system. As a member of FSOC, the OCC regularly 
interacts with the other financial regulatory agencies to address these 
types of issues. FSOC enhances the agencies' collective ability to 
fulfill this critical mission by establishing a formal process for the 
agencies to exchange information and to probe and discuss the 
implications of emerging market, industry, and regulatory developments 
for the stability of the financial system. Through the work of its 
committees and staff, FSOC also provides a structured framework and 
metrics for tracking and assessing key trends and potential systemic 
risks.
            Nonbank SIFI Determinations
    In section 113 of the Act, Congress gave FSOC the authority to 
determine that certain nonbank financial companies would be supervised 
by the FRB and subject to heightened prudential standards, after an 
assessment as to whether material financial distress at such companies 
would pose a threat to the financial stability of the United States. In 
accordance with its 2012 final rule and interpretive guidance, FSOC 
voted on June 3, 2013, to issue proposed determinations for three 
nonbank financial companies, and on July 9th, FSOC announced that it 
made a final determination for two of those companies, General Electric 
Capital Corporation, Inc. and American International Group, Inc. The 
third company has requested a hearing. A number of additional 
provisions apply to designated companies. For example, they would 
immediately be subject to the FRB's examination authority, enforcement 
actions under 12 U.S.C. 1818, and assessments by the FRB and the 
Office of Financial Research. FSOC also is considering additional 
nonbank financial companies for proposed determinations.
            FMU Designations
    Title VIII of the Act charges FSOC with the responsibility for 
identifying and designating systemically important financial market 
utilities (FMUs). To process payments and settle securities, 
derivatives, and futures transactions between financial institutions 
safely and efficiently, our financial system relies on certain 
established protocols and intermediaries, including FMUs that operate 
multilateral payment, clearing, or settlement systems among financial 
institutions.
    The Act subjects designated FMUs to heightened supervision by one 
of three agencies: (1) the SEC in the case of securities clearing 
agencies; (2) the CFTC in the case of derivatives clearing 
organizations; and (3) the FRB for all other FMUs (on either a direct 
or back-up basis). FSOC determines whether to designate an FMU as 
systemically important on a case-by-case basis, after assessing the 
FMU's market activities and the effect its failure or disruption would 
have on critical markets, financial institutions, or the broader 
financial system. In accordance with a final rule and interpretive 
guidance issued by the FSOC in July 2011, FSOC designated eight 
entities as systemically important FMUs on July 18, 2012. \6\ FSOC also 
monitors the financial markets and periodically determines whether 
designation status should remain in place for each FMU or whether it 
should designate additional FMUs.
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     \6\ These entities are: The Clearing House Payments Company, 
L.L.C., on the basis of its role as operator of the Clearing House 
Interbank Payments System, CLS Bank International, Chicago Mercantile 
Exchange, Inc., The Depository Trust Company, Fixed Income Clearing 
Corporation, ICE Clear Credit LLC, National Securities Clearing 
Corporation, and The Options Clearing Corporation.
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    Once designated, an FMU is subject to periodic examination by the 
SEC, CFTC, or FRB, as appropriate. Designated FMUs are also subject to 
operating rules promulgated by these agencies and must give their 
supervising agency advance notice of any material changes to their 
operations. Designated FMUs are subject to enforcement proceedings by 
their supervising agency for breach of these requirements, for unsafe 
or unsound practices, or for other violations of law, in accordance 
with 12 U.S.C. 1818(b).
            Other FSOC Authority
    In addition to the authority to designate nonbank financial 
companies and FMUs as systemically important, Congress gave FSOC other 
tools to address systemic risk. For example, under section 120 of the 
Act, FSOC has the authority to recommend that the primary financial 
agencies apply new or heightened standards and safeguards for a 
financial activity or practice conducted by firms under their 
respective jurisdictions should FSOC determine that the conduct of such 
an activity or practice could create or increase the risk of 
significant liquidity, credit, or other problems spreading among 
financial institutions, the U.S. financial markets, or low-income, 
minority, or underserved communities. FSOC exercised this authority on 
November 13, 2012, with respect to money market mutual funds.
    In addition, section 121 of the Act provides that affirmation by 
two-thirds of FSOC is required in those cases where the FRB determines 
that a large, systemically important financial institution poses a 
grave threat to the financial stability of the U.S. such that 
limitations on the company's ability to merge, offer certain products, 
or engage in certain activities are warranted, or if those actions are 
insufficient to mitigate risks, the company should be required to sell 
or otherwise transfer assets or off-balance sheet items to unaffiliated 
entities.

IV. Derivatives--Title VII
    During the financial crisis, the lack of transparency in 
derivatives transactions among dealer banks and between dealer banks 
and their counterparties created uncertainty about whether market 
participants were significantly exposed to the risk of a default by a 
swap counterparty. To address this uncertainty, sections 723 and 763 of 
the Dodd-Frank Act generally require swaps and security-based swaps to 
be cleared through registered derivatives clearing organizations or 
clearing agencies (collectively, clearinghouses) and traded on 
regulated exchanges. Sections 725 and 763 provide the CFTC and SEC 
enhanced authority over their respective clearinghouses in recognition 
that by performing centralized activities, clearinghouses concentrate 
risks and create interdependencies between and among them and their 
participants.
    To further increase transparency and aid financial regulators in 
monitoring and mitigating systemic risk, sections 728, 729, 763, and 
766 establish swap data repositories and require all swaps and 
security-based swaps to be reported to such repositories.
    Pursuant to sections 731 and 763, national banks that are ``swap 
dealers'' must register with the CFTC, and those that are ``securities-
based swap dealers'' must register with the SEC. Banks that must 
register become subject to all of the substantive requirements under 
Title VII for their swap activities. At this time, eight national banks 
have provisionally registered as swap dealers. The OCC has provided 
comments to the CFTC and SEC on rules implementing Title VII when 
consulted in accordance with Title VII.
    Sections 731 and 764 of the Dodd-Frank Act require the OCC, 
together with the FRB, FDIC, Federal Housing Finance Agency, and Farm 
Credit Administration, to impose minimum margin requirements on 
noncleared derivatives for swap dealers and major swap participants 
that are banks. The OCC, together with these other agencies, published 
a proposal on May 11, 2011, to establish minimum margin and capital 
requirements for registered swap dealers, major swap participants, 
security-based swap dealers, and major security-based swap participants 
(swap entities) that are subject to agency supervision. To address 
systemic risk concerns, consistent with the Dodd-Frank Act requirement, 
the agencies proposed to require swap entities to collect margin for 
all uncleared transactions with other swap entities and with financial 
counterparties. However, for low-risk financial counterparties, the 
agencies proposed that a swap entity would not be required to collect 
margin as long as its margin exposure to a particular low-risk 
financial counterparty does not exceed a specific threshold amount of 
margin. Consistent with the minimal risk that derivatives transactions 
with commercial end users pose to the safety and soundness of swap 
entities and the U.S. financial system, the proposal also included a 
margin threshold approach for these end users, with the swap entity 
setting a margin threshold for each commercial end user in light of the 
swap entity's assessment of credit risk of the end user. The proposed 
margin requirements would apply to new, noncleared swaps or security-
based swaps entered into after the proposed rule's effective date.
    Given the global nature of major derivatives markets and 
activities, international harmonization of margin requirements is 
critical, and we are participating in efforts by the Basel Committee on 
Bank Supervision (BCBS) and International Organization of Securities 
Commissions (IOSCO) to address coordinated implementation of margin 
requirements across G20 Nations. The BCBS-IOSCO working group issued a 
consultative document in July of 2012, seeking public feedback on a 
broad policy framework for margin requirements on uncleared swap 
transactions that would be applied on a coordinated and nonduplicative 
basis across international regulatory jurisdictions. We and the other 
U.S. banking agencies and the CFTC re-opened the comment periods on our 
margin proposals to give interested persons additional time to analyze 
those proposals in light of the BCBS-IOSCO consultative framework. The 
banking agencies' comment period closed on November 26, 2012. Many 
commenters focused on the treatment of commercial end users, urging the 
agencies to adopt the exemptive approach suggested by the BCBS-IOSCO 
proposal.
    The BCBS-IOSCO working group published a second consultative paper 
for public comment on February 15, 2013. This paper describes most of 
the guiding principles for the over-the-counter margin regime 
envisioned by the BCBS and IOSCO. The comment period closed on March 
15th of this year, and the BCBS-IOSCO working group continues its 
discussions with its parent committees to finalize a regulatory 
template to guide the participating jurisdictions to a coordinated 
regulatory structure on uncleared swap margin issues. The OCC and the 
other agencies continue to monitor these discussions so that U.S. and 
foreign regulators can coordinate next steps.
    Finally, section 716 of the Dodd-Frank Act prohibits the provision 
of Federal assistance to a national bank swap dealer, \7\ unless the 
dealer limits its swap activities. Specifically, the swap activities 
must be limited to (1) hedging and similar risk mitigating activities; 
and (2) acting as a swaps entity for swaps involving rates or reference 
assets permissible for investment by a national bank under 12 U.S.C. 
Section 24 (Seventh). Credit default swaps are not permissible under 
the second exception unless cleared by a derivatives clearing 
organization or clearing agency as provided in section 716.
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     \7\ In this testimony, ``swap dealer'' refers to both a 
securities-based swap dealer regulated by the SEC and a swap dealer 
regulated by the CFTC.
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    Section 716 also requires the OCC to grant national banks a 
transition period of up to 24 months to comply with the statute 
beginning on July 16, 2013. In establishing the appropriate transition 
period, the statute directs the OCC to consider the potential impact of 
the bank's divestiture or cessation of ``activities that require 
registration as a swaps entity'' on specific statutory factors. 
``Activities that require registration'' include both swap activities 
covered by the prohibition in section 716 as well as those specifically 
excluded from the prohibition and thus allowed within the bank. \8\ 
Further, the statute directs the OCC to consider the impact of 
divestiture or cessation of those swap activities on mortgage lending, 
small business lending, job creation, and capital formation versus the 
potential negative impact on insured depositors and the deposit 
insurance fund of the FDIC. The OCC also may consider other factors as 
appropriate.
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     \8\ Consideration of both covered and excluded swaps, as required 
by the statute, is appropriate if customers request the transfer of all 
swaps to a bank affiliate in order to preserve the netting benefits 
that come from transacting with a single counterparty.
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    Consistent with these statutory mandates, the OCC granted seven 
national banks a 24-month transition period in order to come into 
conformance with the prohibitions without unduly disrupting lending 
activities and other functions the statute required us to consider.
    Because the framework for derivatives is still being formulated 
under Title VII, banks that are covered by section 716 have generally 
not had sufficient clarity to assess how to and where to push out the 
swaps subject to the prohibition. The prudential regulators, CFTC, and 
SEC are still issuing proposed rules, final rules, guidance, and 
exemptive orders to implement Title VII. Although the Title VII 
regulatory structure is still being implemented, section 716 goes into 
effect on July 16, 2013. The transition periods will allow banks to 
develop a transition plan providing for an orderly cessation or 
divestiture of swaps activities based on a more developed Title VII 
regulatory framework.

V. Volcker Rule
    Section 619 of the Dodd-Frank Act is intended to prohibit certain 
high-risk proprietary trading and private fund investment activities of 
banking entities and to limit the systemic risk of such activities. 
Specifically, section 619 prohibits a banking entity from engaging in 
proprietary trading and having ownership interests in, or relationships 
with, a hedge fund or private equity fund, while at the same time 
permitting certain client-oriented financial services that may 
technically fall within the statutory prohibitions.
    On October 11, 2011, the OCC, FDIC, FRB, and the SEC issued 
proposed rules implementing the requirements of section 619. The 
agencies received more than 19,000 comments covering a wide range of 
perspectives on nearly every aspect of the proposed rule. Overall, 
commenters urged the agencies to simplify the final rule, to reduce 
compliance burdens for entities that do not engage in significant 
trading or covered fund activities, and to address unintended 
consequences of the proposed rule. Some commenters urged the agencies 
to adopt a final rule that would set forth fairly prescriptive 
standards and narrowly construed permitted activity exemptions, as they 
believed this would minimize potential loopholes and the possibility of 
evasion. Other commenters urged the agencies to adopt a more flexible, 
principles-based approach in the final rule, as they believed this 
would reduce burden and lessen possible unintended consequences.
    The OCC, together with the other agencies, continues to devote 
significant time and resources to developing final rules consistent 
with the statutory language and with careful consideration to the 
comments we received including, for example, comments on distinguishing 
permissible market-making-related activities from prohibited 
proprietary trading and defining what is a covered fund. To ensure, to 
the extent possible, that the rules implementing section 619 are 
comparable and provide for consistent application, the agencies have 
been regularly consulting with each other and will continue to do so.
    The agencies have made significant progress toward developing a 
final rule that is faithful to the language of section 619 and 
maximizes bank safety and soundness and financial stability at the 
least cost to the liquidity of the financial markets, credit 
availability, and economic growth.

VI. Resolution Authority
    The Dodd-Frank Act contains a number of resolution-related 
provisions that will arm the Federal banking agencies with the 
information and authority to ensure that planning needed for an 
organized resolution of the largest and most systemically significant 
firms is in place.
            Living Wills
    Section 165 of the Act requires the largest bank holding companies 
and FSOC-designated nonbank financial companies to prepare a plan for 
rapid and orderly resolution in the event of material financial 
distress or failure. \9\ While the statute assigns the oversight of 
these companies' resolution planning to the FRB and the FDIC, the OCC's 
experience and expertise as the primary supervisor of the national bank 
subsidiaries of the largest bank holding companies positions us to make 
an important contribution to that work. The three agencies are 
collaborating accordingly. In addition, we expect that the resolution 
plans, particularly as they are developed and are refined over time, 
will provide information that is helpful not only to resolution 
planning but also to our ongoing supervision. An OCC multidisciplinary 
team is currently developing supervisory strategies with respect to the 
use of data underlying the resolution plans.
---------------------------------------------------------------------------
     \9\ A requirement that institutions file resolution plans also had 
been a recommendation of the Basel Committee's Cross-Border Bank 
Resolution Working Group, in which the U.S. banking agencies 
participated. Jurisdictions in addition to the U.S. also are requiring 
institutions to file such plans.
---------------------------------------------------------------------------
            Recovery Planning
    In conjunction with resolution planning, some institutions are also 
preparing recovery plans outlining the steps they would take, as going 
concerns, to remain viable in the case of severe financial pressure. 
Recovery planning is critical to ensuring the resilience of a firm's 
core business lines, critical operations, and material entities. 
Recovery planning as a discipline is integrated with resolution 
planning, capital and liquidity planning, and other aspects of 
financial contingency, crisis management, and business continuity 
planning. The OCC believes that recovery planning must be an integral 
part of institutions' corporate governance structures and processes, be 
subject to independent review, and be effectively supported by 
reporting to the board and its committees. As the primary supervisor 
for national banks and Federal savings associations, the OCC has an 
important interest in how recovery planning is carried out. For this 
reason, the OCC has worked closely with other regulators to provide 
appropriate informal supervisory guidance for recovery planning, and 
further coordination is underway.
            Orderly Liquidation Authority
    In response to the financial crisis, Congress provided to the FDIC 
in Title II of the Dodd-Frank Act the Orderly Liquidation Authority 
(OLA). The OLA's provisions are aimed at addressing two policy goals--
mitigating the systemic risk that is presented when large financial 
firms enter the bankruptcy process, and minimizing the moral hazard 
that arises when investors believe that firms are likely to be granted 
a Government bail-out to save them from bankruptcy and prevent systemic 
problems. The OLA provisions aim to address apparent weaknesses 
inherent in the core features of bankruptcy when resolving systemically 
important financial institutions while minimizing moral hazard. Thus, 
Title II gives the FDIC broad discretion in how it funds the resolution 
process and how it pays out creditors. The FDIC can seek to exercise 
its discretion in a way that will minimize moral hazard. Title II also 
changes the way in which qualified financial contracts (QFC) are 
treated, providing the FDIC with 24 hours to transfer QFCs as compared 
with the bankruptcy process under which QFCs are not subject to a stay.

VII. Dodd-Frank Impact on Community Banks
    The Committee has also requested the OCC to discuss how the Dodd-
Frank Act has affected our regulation of community banks and thrifts. 
The Act is primarily directed toward larger financial institutions, but 
it does broadly amend some laws in ways that affect the entire banking 
sector, including community banks and thrifts.
    The OCC is sensitive to the necessary differences in supervision 
between large banks and community banks, and we are taking steps to 
reduce the burden and expense smaller institutions bear in reviewing 
and implementing new regulatory requirements.
    We believe it is important to assess the potential impact of our 
regulations on smaller-sized institutions and, where the OCC has rule-
making authority under the Dodd-Frank Act, we have tailored our 
regulations to accommodate concerns of community banks and thrifts. For 
example, in the recently released lending limits rule, we provided 
significant additional flexibility for smaller institutions by allowing 
them to use a simple look-up table to calculate particular exposures. 
The companion guidance to our rulemaking to remove credit ratings from 
our investment securities regulations similarly seeks to reduce burden. 
In implementing these provisions of the Act, our goal has been to meet 
the objectives of the statute while recognizing the effectiveness of 
the existing tools and analyses that well-managed community banks and 
thrifts have routinely used to aid their credit analysis and investment 
decisions.
    We have also reexamined the ways in which we explain and organize 
our rulemakings to better help community bankers understand the scope 
and application of the rules to their institutions. For example, the 
recently released domestic capital rules are accompanied by a 12-page 
interagency community bank guide and an OCC-issued 2-page pamphlet that 
helps banks navigate through an otherwise dense and complex rulemaking. 
The pamphlet is attached as Appendix A hereto. We plan to use this or a 
variant of this approach in more of our rulemakings to enable community 
banks and thrifts to more easily determine which provisions apply to 
them and whether they should comment on proposed rulemakings. 
Similarly, in October 2012, we provided guidance to clarify that the 
OCC does not expect community banks to conduct stress tests like those 
required for larger banks (OCC Bulletin 2012-33). As part of our 
outreach activities with community bankers, we also regularly welcome 
input regarding additional ways to improve our communications with 
community banks and thrifts.
    These initiatives are complemented by the efforts of our examiners 
to serve as a resource to the institutions we supervise. We remain 
committed to having our examiners work and live in the same communities 
as the banks they supervise. This allows examiners to develop an in-
depth understanding of the local market and to better anticipate and 
discuss risks with these institutions.
    Most recently, the OCC published a new booklet titled A Common 
Sense Approach to Community Banking. \10\ The booklet is intended in 
part to convey our views about the types of practices that make a 
community bank excel. The booklet reviews topics important to community 
bankers and highlights those time-tested concepts that all financial 
institutions should understand and apply to their business.
---------------------------------------------------------------------------
     \10\ http://el.occ/publications/publications-by-type/other-
publications-reports/common-sense.pdf
---------------------------------------------------------------------------
    We also note that under the Dodd-Frank Act, the CFPB has exclusive 
authority to prescribe regulations administering certain enumerated 
Federal consumer financial laws. With respect to this rule-making 
authority, the CFPB is required to consult with the prudential 
regulators prior to proposing a rule and during the rule-making process 
``regarding consistency with prudential, market, or systemic 
objectives'' administered by the prudential regulators. This 
consultation process provides an avenue for the OCC to make the CFPB 
aware of concerns expressed by all banks, including the community banks 
and thrifts we supervise. The consultation process has enabled the OCC 
to have meaningful input in the CFPB's regulatory process. The OCC has 
taken this responsibility seriously and has provided comment to the 
CFPB. For example, the OCC recently submitted a comment letter to the 
CFPB to express the OCC's views on the CFPB's qualified mortgage 
proposal regarding interpretations on loan originator compensation. The 
CFPB's final rule incorporated these suggestions, and we look forward 
to continuing to provide similar input on issues of concern to our 
banks and thrifts.

VIII. Update on Status of Dodd-Frank Rulemakings
    As discussed earlier, all of the significant rules for which the 
OCC has independent rule writing authority have been completed. The 
joint interagency rule on appraisals for higher-priced mortgage loans 
(section 1471) has also been finalized.
    With respect to other rules that require interagency action that 
are yet to be completed, the OCC is continuing to work cooperatively 
with our colleagues at other agencies. These rules include those 
addressing credit risk retention (section 941), the Volcker Rule 
(section 619), source of strength requirements (section 616(d)), margin 
and capital requirements for covered swap entities (sections 731 and 
764), incentive-based compensation (section 956), automated valuation 
models used to estimate collateral value (section 1473(q)) and 
reporting activities of appraisal management companies (section 
1473(f)(2)). The OCC has committed the necessary resources to these 
efforts, and we remain mindful of the need to complete these rules in 
the near term.

Conclusion
    I appreciate the opportunity to appear before this Committee and to 
update you on the work the OCC has done to address systemic risk 
concerns at our largest institutions. The Dodd-Frank Act contains a 
number of tools to address systemic risk, and it is important that we 
avail ourselves of those tools by completing as quickly as possible the 
outstanding rules. We believe it is essential to supplement the rules 
with an equally vigorous approach to supervision. We look forward to 
keeping the Committee apprised of our progress.

APPENDIX A









        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                      FROM MARY J. MILLER

Q.1. In late 2011, the agencies issued a highly complex and 
lengthy regulatory proposal to implement the Volcker rule. In 
February of this year, Chairman Bernanke testified that while 
regulators have made a lot of progress on the rule, the issues 
slowing the process ``are finding agreement and closure among 
the different agencies . . . .'' When can we expect the final 
rule? What are the reasons for a delay?

A.1. Treasury staff has been actively participating with the 
Federal banking agencies, the SEC, and the CFTC in an ongoing 
interagency process designed to coordinate development of these 
rules since January 2011. This process includes regular 
meetings that serve as constructive forums for the agencies to 
deliberate on key aspects of the rules. This process resulted 
in the issuance of proposed regulations that were substantively 
identical, demonstrating a commitment among the agencies to a 
coordinated approach, and continues as regulators work to 
finalize the rules.
    Regulators are completing their review of the nearly 18,000 
public comments on the proposed rules. Reviewing these comments 
takes time, and it is important for the rule-making agencies to 
get the final product right. As the Financial Stability 
Oversight Council noted in its Volcker Rule study in January 
2011, and as the SEC, the CFTC, and the Federal banking 
agencies noted in their proposed rules to implement the Volcker 
Rule, the challenge inherent in creating a robust 
implementation framework is that certain classes of permitted 
activities--in particular, market making, hedging, 
underwriting, and other transactions on behalf of customers--
often evidence outwardly similar characteristics to prohibited 
proprietary trading, even as they pursue different objectives. 
Additionally, effective implementation of the Volcker Rule 
requires careful attention to differences between types of 
financial markets and asset classes. We take Treasury's role as 
coordinator very seriously and remain committed to working with 
the rule-making agencies to issue substantively identical final 
rules.

Q.2. In early June, FSOC voted to designate AIG, Prudential 
Financial, and GE Capital as nonbank SIFIs, the first three so 
designated. Some industry observers complained that the 
process, which took nearly 3 years to complete, lacked 
transparency. The FSOC did not even announce the names of the 
firms it had selected; the disclosure came from the firms 
themselves. How should the FSOC designation process be more 
open? How are companies that may be considered for nonbank SIFI 
designation supposed to position themselves vis-a-vis their 
public disclosures and SEC filings if no formal announcement is 
made by FSOC?

A.2. The Council voted on June 3, 2013, to make proposed 
determinations regarding three nonbank financial companies. 
Each of those companies had been notified in 2012 that it was 
under review by the Council and had engaged in extensive 
discussions with staff of the Council members and member 
agencies. Following the proposed determinations, each of the 
companies had an opportunity to request a hearing to contest 
the proposed determination, after which the Council could vote 
to make a final determination. In accordance with the Council's 
interpretive guidance, and due to the preliminary nature of the 
Council's evaluation of a company prior to a final 
determination, the Council does not generally intend to 
publicly announce the name of any nonbank financial company 
under review before the Council makes a final determination. 
Any company notified of a proposed or final determination may 
publicly announce, including in a filing with the SEC, that it 
is under consideration or has been subject to a final 
determination by the Council.
    The Council voted on July 8, 2013, to make final 
determinations regarding American International Group, Inc. and 
General Electric Capital Corporation, Inc. The Council's action 
was publicly announced the following day, when the Council 
issued a press release and posted information on its Web site 
about the determinations along with the basis for each 
determination. Notification was also provided directly to 
Congress, in accordance with Section 112(a)(2)(N)(iv) of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank Act).
    The Council recognizes the importance of a careful and 
transparent process for its determinations, so before engaging 
in company-specific analyses, it prepared and sought public 
comment on its proposed analytic framework and process. This 
public process began in October 2010 with an advance notice of 
proposed rulemaking, which was followed by two separate notices 
of proposed rulemaking and ultimately the issuance of a final 
rule and interpretive guidance in April 2012. The Council's 
final rule and guidance took into account multiple rounds of 
comments from stakeholders and the public.
    The Council is committed to conducting its work in a manner 
that is as transparent as possible, while appropriately 
balancing the need to protect market-sensitive information.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
              SENATOR MENENDEZ FROM MARY J. MILLER

Q.1. Over the last few months, we've seen reports in the press 
of so-called ``regulatory capital trades'', in which regulated 
financial institutions have purchased credit protection (often 
using credit default swaps) from unregulated entities (often 
SPVs, hedge funds, or other entities formed offshore to avoid 
regulation) in order to reduce the amount of capital they need 
to hold against an investment on their books. In effect, these 
trades are transferring risk from regulated institutions that 
are subject to capital requirements to unregulated entities 
that are not subject to capital requirements, and creating 
exposure of the regulated institution to a potential default by 
the unregulated entity.
    If this story sounds familiar, it should--this is 
strikingly similar to what we saw happen with AIG before the 
financial crisis. These trades are transferring risk from 
regulated and supervised financial institutions to unregulated 
corners of the market, where it can build and concentrate 
without monitoring or supervision by regulators.
    The Basel Committee has partly addressed this issue by 
calling for banks to properly account in their capital 
calculations for the costs of credit protection they purchase. 
But does this proposal do enough to address concerns about 
regulatory arbitrage and systemic risk accumulating all over 
again through ``shadow banking''? Are you concerned about these 
``regulatory capital trades'', and what steps are you taking to 
monitor and address these arrangements?

A.1. These types of transactions constitute one of many types 
of transactions that may be designed to reduce banks' 
regulatory capital without reducing the financial loss exposure 
that the applicable capital requirements are designed to 
address. Though it is not a banking regulator, Treasury 
continues to communicate with the banking regulators and other 
financial institution regulators to identify and address risks 
to the financial system that may result from transactions to 
arbitrage the capital requirements and other prudential 
standards designed to protect the financial system.
    Treasury has been and continues to be a strong advocate for 
increasing the resilience of the U.S. and international banking 
systems by significantly increasing the capital held by banks, 
as well as imposing liquidity standards and other enhanced 
prudential standards on the largest banks and financial 
institutions to protect the financial system and the public.
    However, the increased capital requirements of Basel III 
could create incentives for banks to engage in arbitrage 
transactions to reduce their capital costs by entering into 
guarantees and other transactions reducing banks' risk-weighted 
and leverage assets under the Basel standards. Accordingly, 
supervisors need to be vigilant to allow such a reduction in a 
bank's capital requirements only for qualifying guarantees and 
other transactions that provide a legitimate reduction in the 
probability and severity of loss to the bank. Therefore, we 
agree with the Basel Committee's reduction of a bank's capital 
requirements for qualifying transactions shifting the banks' 
risk exposure to a qualifying guarantor or other counterparty. 
But we also believe that ongoing supervisory scrutiny is needed 
to ensure that such reductions in capital requirements are only 
provided when there is an actual transfer of loss exposure to a 
guarantor or counterparty with the capacity and intent to 
provide such loss protection to the bank.
    As recognized by the Basel Committee, in January 2011, the 
Federal Reserve issued a supervisory letter on this issue. The 
banking agencies have supervisory authority over banks and 
savings associations to scrutinize arbitrage transactions. In 
addition, the Federal Reserve similarly has broad supervisory 
authority to deter unsafe and unsound practices by bank holding 
companies and savings and loan holding companies. Furthermore, 
under the Dodd-Frank Act, the Financial Stability Oversight 
Council may designate a nonbank financial company that could 
pose a threat to U.S. financial stability for Federal Reserve 
supervision and enhanced prudential standards. The Dodd-Frank 
Act also tasks the Office of Financial Research with assessing 
emerging threats to U.S. financial stability. Treasury will 
continue its communication with the banking and financial 
regulators with the goal of identifying and addressing 
arbitrage transactions.

Q.2. I asked you about this topic earlier this year, and I want 
to ask about it again because it's still important. In New 
Jersey and across our country, families continue to struggle 
with high debt burdens, particularly mortgage debt. We're 
seeing some improvements, but we still have a lot of work left 
to do. Senator Boxer and I have introduced legislation, the 
Responsible Homeowner Refinancing Act, that would remove 
barriers to refinancing for borrowers with GSE mortgages and a 
history of paying their mortgage on time. This bill would help 
individual families lower their debt burdens and stay in their 
homes, and would help the economy as a whole by strengthening 
demand through consumer deleveraging. Though interest rates 
have recently started to rise to some degree, many families can 
still benefit from refinancing. Can you please comment on the 
importance of continuing our efforts to reduce consumer debt 
burdens and remove barriers to refinancing mortgages to more 
affordable levels?

A.2. The Administration continues to support helping all 
responsible homeowners to have an opportunity to reduce their 
monthly mortgage payments to more affordable levels by 
refinancing, particularly by taking advantage of the current 
low interest rates. As you know, the President has called for 
broad-based access to refinancing for all borrowers who are 
current on their payments, including those who are underwater. 
The Federal Housing Finance Agency (FHFA) recently extended the 
Home Affordable Refinance Program by 2 years to 2015, and 
Treasury is working with FHFA to make sure all eligible 
borrowers can take advantage of this program. An important part 
of this work is a marketing campaign so more borrowers will 
become aware of opportunities to refinance.

Q.3. We know that excessive and misaligned compensation schemes 
provided part of the fuel for the financial crash. In response, 
I worked to include a provision in Dodd-Frank that would 
require publicly listed companies to disclose in their annual 
SEC filings the amount of CEO pay, the amount of the median 
company worker pay, and the ratio of the two. The SEC, so far, 
has been slow to implement this measure. Given the importance 
of providing information to shareholders about executive 
compensation and better align the incentives of corporate 
decision makers with shareholder interests, what is Treasury 
doing, whether through the Financial Stability Oversight 
Council or otherwise, to help the SEC move forward on this 
issue?

A.3. We agree that the provision of the Dodd-Frank Act 
requiring disclosure of CEO pay ratios is a very important 
component in properly aligning the incentives created by 
compensation programs with the interests of shareholders going 
forward. Section 953 of the Dodd-Frank Act gives the SEC sole 
authority to promulgate a rule on this issue. We encourage the 
SEC to promptly issue a rule implementing this provision.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                      FROM MARY J. MILLER

Q.1. A critical element of the proposed new Basel leverage 
ratio is the definition of the denominator (the assets subject 
to the leverage requirement). A denominator definition that 
permits too many bank commitments to remain off the balance 
sheet and uncapitalized could undermine the benefits of a 
higher leverage ratio requirement.
    Have the banking agencies made a quantitative examination 
of the change in bank assets subject to the leverage 
requirement that will be created by the new Basel leverage 
rules?
    Could you please inform us, for the six largest U.S. banks 
and bank holding companies, the approximate amount of total 
assets that would be counted for the denominator of leverage 
capital requirements under the following definitions of assets: 
U.S. GAAP, IFRS accounting, the proposed Basel leverage ratio 
definition.
    What factors are most important in determining the 
difference between GAAP and IFRS accounting and the proposed 
Basel leverage ratio definition? What is the total amount of 
the difference accounted for by: Changes in off-balance sheet 
treatment of credit commitments that are not derivatives 
contracts and changes in derivatives netting and offset rules.
    To the degree possible, please include breakdowns of the 
impact of the relevant sub-changes in each of these areas, as 
well as written explanations of the areas in the Basel leverage 
ratio definition that account for the differences.

A.1. Treasury is not a rule-writing agency for bank regulatory 
capital and has not participated in the development of the 
banking agencies' new supplementary leverage ratio proposal. 
Treasury does not have the data necessary to support an 
analysis as to how particular provisions of the proposal would 
affect bank assets or how certain types of assets would be 
affected under different accounting standards. However, 
Treasury has been and remains supportive of strengthening 
capital standards. Since the crisis, banking regulators have 
completed rules to require large, interconnected financial 
institutions to hold significantly higher levels of capital and 
liquidity. It is important to recognize that the financial 
system is significantly stronger than it was 5 years ago. 
Borrowing is significantly lower, reliance on short-term 
funding is lower, and liquidity positions have already improved 
such that large firms are less vulnerable in the event of a 
downturn. Treasury supports additional efforts by the banking 
regulators to make the system even stronger.

Q.2. The new leverage ratio proposals mandate a leverage ratio 
of 6 percent for large bank subsidiaries, but a lower 5-percent 
ratio for the overall holding company. What policy 
justification is there for this distinction between the bank 
and the holding company?

A.2. Treasury is not a rule-writing agency for bank regulatory 
capital and has not participated in the development of the 
banking agencies' new supplementary leverage ratio proposal.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                      FROM MARY J. MILLER

Q.1. Has your agency done any studies on the costs and benefits 
of allowing banks to book derivatives in depositories?

A.1. In general, Treasury has no authority to regulate bank and 
bank holding company structure or the types of activities that 
are permitted in different parts of banks or bank holding 
companies. However, Treasury believes that it is important that 
depositors are not exposed to the risk of losses from banks due 
to particularly risky activities. To that end, section 716 of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank Act) generally requires a bank holding company to 
move these activities out of its depository institutions and 
into separately capitalized affiliates. In addition, section 
608 of the Dodd-Frank Act strengthens the restrictions on 
transactions between a bank and its affiliates within a bank 
holding company. Section 608 of the Dodd-Frank Act will help 
reduce the possibility that losses associated with derivatives 
do not spread to insured depository institutions.

Q.2. A number of derivatives experts, including Frank Partnoy 
and Satyajit Das, contend that a large percentage of complex 
OTC derivatives, including credit default swaps, are not used 
for commerce but for economically unproductive activities such 
as gaming accounting and tax rules or hiding losses. Have you 
ever taken a large sample of derivatives transactions to see if 
these charges have validity? If the charges are accurate, in 
what ways would you change your views about derivatives 
regulation?

A.2. Prior to passage of the Dodd-Frank Act, OTC derivatives 
markets were characterized by opacity. As a result, Treasury 
worked to include provisions in the Dodd-Frank Act to create 
transparency in these markets by, for example, requiring the 
clearing of most derivatives and the reporting of transaction 
data to regulated swap data repositories (SDRs). Data reported 
to SDRs are accessible to and can be analyzed by the U.S. 
regulators with primary jurisdiction over these markets--namely 
the Commodity Futures Trading Commission (CFTC) and the 
Securities and Exchange Commission (SEC). Moreover, the Dodd-
Frank Act provides the CFTC and the SEC with enhanced anti-
manipulation and enforcement authority to deter and detect 
fraud, manipulation, and other abuses in these markets. The 
CFTC and SEC are working hard to finalize effective rules to 
implement the requirements of the Dodd-Frank Act and promote 
the safety, liquidity, and transparency of these markets, as 
well as to develop systems that allow them to analyze and 
monitor transactions, positions, risk, and abusive conduct.

Q.3. Members of Congress have been told that the Transatlantic 
Trade and Investment Partnership negotiations include 
discussion about ``harmonizing'' domestic financial regulation 
among the parties to the TTIP negotiations. Do the negotiations 
contemplate agreements that would in any way, directly or 
indirectly, limit prudential or financial stability regulation 
of the type adopted in the Dodd-Frank Act regardless of how 
they are described or characterized?

A.3. Financial services are a critical component of the 
transatlantic relationship. In TTIP, as in all our free trade 
agreements, the Administration will seek market access 
commitments for financial services.
    Since the financial crisis, Treasury and U.S. financial 
regulators have been actively engaged on a wide range of 
financial regulatory matters domestically and internationally. 
There is an ongoing robust agenda with ambitious deadlines on 
international regulatory and prudential cooperation in the 
financial sector--both bilaterally and under the auspices of 
the G20 and international standards-setting and other bodies 
such as the Financial Stability Board, the Basel Committee on 
Banking Supervision, and the International Organization of 
Securities Commissions. We expect that work to continue making 
progress alongside the TTIP negotiation.

Q.4. Has FSOC or the Treasury requested that OFR or Treasury 
researchers conduct and publish contemporary quantitative 
estimates of the size and sources of the well-known borrowing 
cost advantages enjoyed by very large banks? If not, why not?

A.4. The Financial Stability Oversight Council (Council) and 
Treasury staff have not prepared or requested from the Office 
of Financial Research estimates of funding costs of very large 
banks, though staff monitor academic and other research on this 
topic.
    The reforms enacted by the Dodd-Frank Act provide 
regulators with critical tools and authorities that we lacked 
before the crisis to resolve large financial firms whose 
failure would have serious adverse effects on financial 
stability. The emergency resolution authority for failing firms 
created under Title II expressly prohibits any bailout by 
taxpayers. We need to keep making progress implementing the 
Dodd-Frank Act to make sure that these and the other Dodd-Frank 
Act reforms are well understood by the public and implemented 
to reduce risks and strengthen the financial system.
    In April 2013, Treasury staff met with representatives from 
the Government Accountability Office regarding its study 
focused on potential funding cost advantages of large financial 
institutions, and we look forward to reading the findings of 
the GAO's report. Treasury will continue to monitor financial 
market indicators, such as bank borrowing costs, to understand 
the impacts of the rules implementing the Dodd-Frank Act, and 
to understand whether these reforms are effective in creating 
incentives for the largest, most complex firms to reduce their 
size and complexity.

Q.5. The FSOC recently designated the first two nonbank 
Systemically Important Financial Institutions (SIFIs), GE 
Capital and AIG.
    Why did it take so long to designate the first two SIFIs? 
Do you anticipate that the pace of designation will accelerate 
in the coming months or years? Why or why not?
    As you know, systemic risk can come not only from very 
large institutions but also come from smaller entities that 
collectively generate high levels of leverage using the 
wholesale funding markets. For example, the recent FSOC annual 
report identified high levels of leverage at mortgage REITs as 
a risk for market disruption. While no single mortgage REIT may 
be large enough to be designated as a SIFI under the current 
rules, collectively the sector can pose risks to financial 
stability. How does the FSOC plan to address this kind of 
problem? Would this kind of issue ever call for the designation 
of a sector, rather than an individual institution, as 
systemically critical?

A.5. The Council has undertaken a careful and transparent 
process for its nonbank financial company determinations, 
including a process that incorporated multiple rounds of public 
comments before issuing a final rule and interpretive guidance 
in April 2012. The Dodd-Frank Act and the Council's rule and 
interpretive guidance require the Council to engage in 
extensive company specific analysis to determine whether a 
company could pose a threat to financial stability and should 
be subject to supervision by the Federal Reserve and enhanced 
prudential standards. It is critically important that the 
Council take the time to get the analysis right, and Council 
staff have worked diligently to complete each stage of the 
process. The Council will continue to evaluate nonbank 
financial companies eligible for Council determinations with 
the same sense of urgency.
    The Dodd-Frank Act provides the Council with various 
authorities to mitigate threats to financial stability. In 
addition to the Council's authority to designate nonbank 
financial companies for supervision by the Federal Reserve and 
enhanced prudential standards, the Council may also designate 
systemically important financial market utilities and payment, 
clearing and settlement activities conducted by financial 
institutions, which thereby become subject to enhanced risk 
management standards and supervision. In addition, the Council 
has authority under section 120 of the Dodd-Frank Act to make 
recommendations to the primary financial regulatory agencies to 
apply new or heightened standards for a financial activity or 
practice that is conducted by bank holding companies or nonbank 
financial companies under their respective jurisdictions. The 
Council may employ its section 120 authority, as it did at the 
end of 2012 in issuing proposed recommendations with respect to 
money market mutual funds, if it determines that the conduct, 
scope, nature, size, scale, concentration, or 
interconnectedness of such activity or practice could create or 
increase the risk of significant liquidity, credit, or other 
problems spreading among bank holding companies and nonbank 
financial companies, financial markets of the United States, or 
low-income, minority, or underserved communities. In addition, 
as noted in your question, the Council's most recent annual 
report--another key tool to highlight potential risks to 
financial stability--included a discussion of the growth of 
agency real estate investment trusts and the potential impact 
of a shock to the sector.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                     FROM DANIEL K. TARULLO

Q.1. In late 2011, the agencies issued a highly complex and 
lengthy regulatory proposal to implement the Volcker rule. In 
February of this year, Chairman Bernanke testified that while 
regulators have made a lot of progress on the rule, the issues 
slowing the process ``are finding agreement and closure among 
the different agencies . . . .'' When can we expect the final 
rule? What are the reasons for a delay?

A.1. The Federal Reserve, OCC, FDIC, SEC, and CFTC, (the 
``Agencies'') issued the final regulations implementing section 
619 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act on December 10, 2013. As you note, in late 2011, 
the Agencies issued the proposed rules. The Agencies received 
over 18,000 comments addressing a wide variety of aspects of 
the proposals and met with many representatives of the public, 
including banking firms, trade associations, and consumer 
advocates, and provide an extended public comment period. The 
Board and the other rule-making agencies carefully reviewed 
those comments and suggestions and the issues they raised in 
light of the statutory provisions in developing the final 
implementing rules.

Q.2. The Wall Street Journal recently reported that certain 
large U.S. banks presented to the FRB a plan to pay for large 
banks' restructuring in the event of a future crisis, proposing 
that each bank hold a combined debt and equity equal to 14 
percent of its risk-weighted assets which would be used to prop 
up any failed bank subsidiary seized by regulators. Is the FRB 
considering such plan as a viable option? Would that plan work 
in lieu of, or in addition to, the resolution mechanism in 
Title II of Dodd-Frank?

A.2. The Federal Reserve supports the progress made by the 
Federal Deposit Insurance Corporation (FDIC) in implementing 
Title II of the Dodd-Frank Act, including the proposed single-
point-of-entry (SPOE) resolution approach. SPOE is designed to 
resolve a systemically important company by insuring that the 
losses are focused on the shareholders and long-term unsecured 
debt holders of the failed firm. It aims to address the 
potential system impact of the failure of the firm by providing 
sufficient capital for critical operating subsidiaries to 
continue to operate by converting long-term debt holders of the 
parent into equity holders of the bridge holding company. Key 
to the ability of the FDIC to execute its SPOE approach under 
Title II is the availability of sufficient amounts of loss 
absorbency capacity (e.g., equity and long-term, unsecured 
debt) at the company. Accordingly, a regulatory requirement 
that the largest, most complex U.S. banking firms maintain a 
minimum amount of outstanding long-term unsecured debt on top 
of their regulatory capital requirements would support the 
FDIC's implementation of the resolution mechanism under Title 
II.

Q.3. Recently the FRB finalized its Basel III capital rules. 
You stated at the Board's public meeting on July 9th that the 
FRB should be ready in the next few months to issue a notice of 
proposed rulemaking concerning the combined amount of equity 
and long-term debt large institutions should maintain in order 
to facilitate orderly resolution in appropriate circumstances. 
How much debt the biggest banks would have to issue or how it 
would be calculated? Would any such proposal give deference to 
suggestions made by large banks to the FRB that they should 
hold combined debt and equity equal to 14 percent of risk-
weighted assets?

A.3. The Federal Reserve continues to develop, in consultation 
with the FDIC, a regulatory proposal that would require the 
most systemic U.S. banking firms to maintain a minimum amount 
of long-term, unsecured debt (i.e., gone-concern loss 
absorbency) to supplement existing equity capital requirements 
(i.e., going concern loss absorbency). Such a proposal should 
improve the resiliency and market discipline of our most 
systemic banking firms and contribute to the ability of the 
FDIC to resolve a firm using its single-point-of-entry 
approach. Calibration is one of the key issues that the Board 
is considering as we develop this proposal.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
            SENATOR MENENDEZ FROM DANIEL K. TARULLO

Q.1. Over the last few months, we've seen reports in the press 
of so-called ``regulatory capital trades'', in which regulated 
financial institutions have purchased credit protection (often 
using credit default swaps) from unregulated entities (often 
SPVs, hedge funds, or other entities formed offshore to avoid 
regulation) in order to reduce the amount of capital they need 
to hold against an investment on their books. In effect, these 
trades are transferring risk from regulated institutions that 
are subject to capital requirements to unregulated entities 
that are not subject to capital requirements, and creating 
exposure of the regulated institution to a potential default by 
the unregulated entity.
    If this story sounds familiar, it should--this is 
strikingly similar to what we saw happen with AIG before the 
financial crisis. These trades are transferring risk from 
regulated and supervised financial institutions to unregulated 
corners of the market, where it can build and concentrate 
without monitoring or supervision by regulators.
    The Basel Committee has partly addressed this issue by 
calling for banks to properly account in their capital 
calculations for the costs of credit protection they purchase. 
But does this proposal do enough to address concerns about 
regulatory arbitrage and systemic risk accumulating all over 
again through ``shadow banking''? Are you concerned about these 
``regulatory capital trades'', and what steps are you taking to 
monitor and address these arrangements?

A.1. The Federal Reserve is concerned about and is monitoring 
the migration of risk from the regulated banking system to the 
shadow banking system, particularly in light of incentives for 
such migration that may be created by its ongoing 
implementation of a significantly stricter regulatory regime 
for banking organizations. The Federal Reserve also addresses 
risks posed by derivative and other transactions between 
banking organizations and unregulated financial entities in a 
number of ways, including through the recently revised capital 
rules, its supervisory assessment of capital adequacy, and 
other supervisory monitoring.
    The final rule approved by the Board earlier this year that 
revised its regulatory capital rules (the final rule) increases 
the capital requirements for the largest, most complex banking 
organizations' exposures to unregulated financial institutions 
such as hedge funds and financial special purpose vehicles. \1\ 
The Federal Reserve also assesses banking organizations' 
overall capital adequacy through the supervisory process. For 
bank holding companies with total assets of at least $50 
billion, this includes annually reviewing the company's capital 
plan, which contains a discussion of how the bank holding 
company will maintain capital commensurate with its risks under 
expected and stressful conditions. This analysis incorporates 
the effectiveness of regulatory capital trades in mitigating a 
banking organization's risks under stressful conditions.
---------------------------------------------------------------------------
     \1\ See, 12 CFR 217.131.
---------------------------------------------------------------------------
    In general, the Federal Reserve views a firm's engagement 
in risk-reducing transactions as a sound risk management 
practice. However, the final rule's risk-based capital 
framework may not fully capture the residual risks that a firm 
faces with respect to regulatory capital trades.
    Thus, when evaluating capital adequacy, including in the 
context of the Board's annual Comprehensive Capital Analysis 
and Review, supervisory staff evaluates whether a firm holds 
sufficient capital in addition to its minimum regulatory 
capital requirements to cover the risks associated with such 
transactions. The Federal Reserve further expects a firm that 
engages in risk transfer transactions to be able to demonstrate 
that it reflects any potential risks of such transactions in 
its internal assessment of capital adequacy and that it 
maintains sufficient capital to address such risks.
    In January 2011, the Federal Reserve issued guidance 
regarding risk transference in Supervision and Regulation 
Letter 11-1, entitled ``Impact of High-Cost Credit Protection 
Transactions on the Assessment of Capital Adequacy'' (SR 11-1). 
\2\ This guidance emphasized that supervisors would scrutinize 
transactions with high premiums and fees, but with a 
questionable degree of risk transference. In particular, the 
guidance stated that high-cost credit protection transactions 
would be taken into account in the supervisory assessment of a 
banking organization's capital adequacy, and in certain cases, 
the Board may determine that a transaction should not be 
recognized as a guarantee for risk-based capital purposes. This 
guidance was issued in response to potential regulatory 
arbitrage transactions involving little risk transference, and 
continues to be used in the supervisory evaluation of the 
capital adequacy of banking organizations. In particular cases, 
the Board may determine that a transaction should not receive, 
or only partially receive, favorable risk-based capital 
treatment based on an assessment of the risks retained by a 
firm. In addition, as a member of the Basel Committee, the 
Federal Reserve is participating in the ongoing effort to 
appropriately address the risks posed by these transactions 
through international standards.
---------------------------------------------------------------------------
     \2\ See: http://fedweb.frb.gov/fedweb/bsr/srltrs/sr1101.pdf.
---------------------------------------------------------------------------
    With respect to monitoring the migration of risk from the 
regulated banking system to the shadow banking system, in 
recent years the Federal Reserve has greatly increased the 
resources it devotes to financial system monitoring. It has 
also taken a more systematic and intensive approach, led by its 
Office of Financial Stability Policy and Research and drawing 
on substantial resources from across the Federal Reserve 
System. This monitoring informs the policy decisions of the 
Federal Reserve as well as our work with other agencies. The 
Federal Reserve also has brought these issues to the attention 
of the Financial Stability Board (FSB), which currently has 
five major projects underway focusing on potential systemic 
risks associated with shadow banking. These include projects 
considering regulatory initiatives to mitigate the spill-over 
effect between the regular banking system and the shadow 
banking system; reduce the susceptibility of money market funds 
to runs; assess and align the incentives associated with 
securitization; dampen risks and procyclical incentives 
associated with securities financing transactions such as repos 
and securities lending that may exacerbate funding strains in 
times of market stress; and assess and mitigate systemic risks 
posed by other shadow banking entities and activities. This 
past August the FSB issued a policy framework for addressing 
shadow banking risks in securities lending and repos, \3\ as 
well as a policy framework for strengthening the oversight and 
regulation of shadow banking entities. \4\
---------------------------------------------------------------------------
     \3\ See: http://www.financialstabilityboard.org/publications/
r_130829b.pdf.
     \4\ See: http://www.financialstabilityboard.org/publications/
r_130829c.pdf.
---------------------------------------------------------------------------
    The Federal Reserve will continue to monitor shadow banking 
and risk transfer and will consider further policy actions as 
necessary to address emerging risks.

Q.2. In New Jersey and across our country, families continue to 
struggle with high debt burdens, particularly mortgage debt. 
We're seeing some improvements, but we still have a lot of work 
left to do. Senator Boxer and I have introduced legislation, 
the Responsible Homeowner Refinancing Act, that would remove 
barriers to refinancing for borrowers with GSE mortgages and a 
history of paying their mortgage on time. This bill would help 
individual families lower their debt burdens and stay in their 
homes, and would help the economy as a whole by strengthening 
demand through consumer deleveraging. Though interest rates 
have recently started to rise to some degree, many families can 
still benefit from refinancing. Can you please comment on the 
importance of continuing our efforts to reduce consumer debt 
burdens and remove barriers to refinancing mortgages to more 
affordable levels?

A.2. I share your concern about the effect of high levels of 
debt and debt payments on household well-being and the economy. 
Although many homeowners have benefited from the low level of 
mortgage rates by refinancing their mortgages, other homeowners 
have been precluded from doing so by tight underwriting 
standards, negative equity in their homes, a fall in income, or 
high refinancing fees. The Home Affordable Refinance Program 
and the National Mortgage Settlement have facilitated 
refinancing for many of these borrowers. Borrowers who face 
obstacles to refinancing and are not eligible for these 
programs, however, continue to struggle.
    Mortgage refinancing lowers household debt payments and 
increases the funds available for other purposes. The decrease 
in debt payments can help relieve the strains on financially 
stressed borrowers, and so reduce the probability of default on 
mortgages or other obligations. Many borrowers may also react 
to their decrease in debt payments by increasing their 
spending, thereby probably boosting the economy, on net.

Q.3. I held a hearing earlier this year in the Housing 
Subcommittee examining the botched independent foreclosure 
review process and related settlement. At the time, the GAO 
issued a report that looked at some of the problems that 
occurred and outlined a set of ``lessons learned.'' In 
particular, the GAO recommended that the OCC and the Fed 
improve oversight of sampling and consistency, apply lessons in 
planning and monitoring to activities under the consent order 
and continuing reviews, and implement a communication strategy 
to keep stakeholders informed. I'm concerned, however, by 
recent reports suggesting that some of the same problems we saw 
before are continuing to occur. Are you familiar with the GAO's 
recommendations, and what steps has the Fed taken to implement 
them? In your own reviews of the process, what other changes 
have you identified and made?

A.3. On March 26, 2013, the Government Accountability Office 
(GAO) issued a report titled ``FORECLOSURE REVIEW: Lessons 
Learned Could Enhance Continuing Reviews and Activities Under 
Amended Consent Orders'', (GAO-13-277). This report included 
three recommendations addressed to the Federal Reserve Board 
(Board) and the Office of the Comptroller of the Currency 
(OCC). Consistent with our basic objective of continuous 
improvement, the Federal Reserve has taken measures to address 
all of the recommended actions and to improve oversight based 
on our own experience. Examples of measures we have taken are 
provided below.
    The GAO's first recommendation is for the agencies to 
improve oversight of sampling methodologies and mechanisms to 
centrally monitor consistency, such as assessment of the 
implications of inconsistencies on remediation results for 
borrowers in the remaining foreclosure reviews. The agreements 
in principle reached earlier this year between the Board, the 
OCC, and 15 of the 16 servicers subject to Consent Orders 
replaced the Independent Foreclosure Review (IFR) requirements 
of those enforcement actions with a new program of payments to 
covered borrowers, thereby eliminating the sampling requirement 
for the 15 firms. \5\ Only one firm, One West Bank, FSB, 
continues to conduct an IFR. One West Bank, FSB, is regulated 
by the OCC. With respect to assuring consistency of outcomes, 
the Federal Reserve and the OCC continue to coordinate closely 
to ensure that the guidance we provide is consistent.
---------------------------------------------------------------------------
     \5\ Agreements in principle with 13 of the servicers were 
announced in January 2013. The agreements were memorialized in 
amendments to the Consent Orders which were published on February 28, 
2013. On July 26, 2013, the Board announced a similar amendment to the 
Board's Consent Order against GMAC Mortgage, and on August 23, 2013, 
the OCC announced that it reached an agreement in principal with 
EverBank, which ultimately will be memorialized in an amendment to the 
OCC's Consent Order against that bank.
---------------------------------------------------------------------------
    The GAO's second recommendation is that the agencies 
identify and apply lessons learned from the foreclosure review 
process, such as enhancing planning and monitoring activities 
to achieve goals, as the agencies develop and implement the 
activities under the amendments to the Consent Orders. The 
Federal Reserve, in coordination with the OCC, significantly 
expanded its planning and monitoring efforts during the course 
of the IFR and continues to devote resources to planning and 
monitoring the implementation of the remaining requirements of 
the amendments to the Consent Orders. With respect to the cash 
payments to borrowers and foreclosure prevention assistance 
requirements of those amendments in particular, the agencies 
have taken several steps to enhance their planning and 
monitoring. Among other things, the agencies have instituted 
status calls as frequently as daily with the paying agent, Rust 
Consulting, Inc., to keep the agencies abreast of developments 
and potential issues with respect to payments to borrowers. The 
agencies have also worked in close collaboration on a template 
to be used by all servicers in reporting on their activities to 
fulfill their foreclosure prevention obligations under the 
amendments to the Consent Orders. Similarly, the Federal 
Reserve has devoted resources to advanced planning with respect 
to public reporting on the IFR where it continues, and on 
implementation of the remaining amendments to the consent 
orders.
    The GAO's third recommendation is focused on the 
development of a communication strategy to regularly inform 
borrowers and the public about the processes, status, and 
results of the activities under the amendments to the Consent 
Orders and continuing foreclosure reviews. The agencies have 
taken a number of steps to ensure that borrowers are aware of 
the amendments to the Consent Orders. For example, the agencies 
have:

    Met with and sought feedback from community groups, 
        housing counseling organizations, and other interested 
        stakeholders, and incorporated that feedback into 
        communications to borrowers about the amendments to the 
        Consent Orders, including a postcard for the paying 
        agent, Rust Consulting, Inc., to mail to borrowers 
        whose servicers are parties to the amendments to the 
        Consent Orders to alert borrowers that they would be 
        receiving a payment. The agencies received valuable 
        input that helped improve readability;

    Developed a letter to accompany payments to 
        borrowers whose servicers are parties to the amendments 
        to the Consent Orders. This letter contains an 
        explanation about why the borrower is receiving a 
        payment, along with instructions for cashing the check, 
        a statement that the borrower is not required to 
        execute a waiver of any legal claims they may have 
        against their servicer as a condition for receiving 
        payment, and other important disclosures;

    Presented a webinar on March 13, 2013, directed at 
        community groups, housing counselors and other 
        interested members of the public to explain the 
        provisions of the amendments to the Consent Orders;

    Presented a webinar on April 30, 2013, for 
        NeighborWorks America and its member organizations to 
        explain the provisions of the amendments to the Consent 
        Orders; and

    Issued several press releases related to the 
        amendments to the Consent Orders and made publicly 
        available on their Web sites information about how cash 
        payment amounts were determined, the numbers of 
        borrowers falling into the various payment categories, 
        and the schedule for mailing checks to borrowers whose 
        servicers participated in the agreements in principle. 
        \6\
---------------------------------------------------------------------------
     \6\ When available, the Board intends to make similar information 
available to borrowers whose mortgages were serviced by GMAC Mortgage, 
which only recently agreed to make payments to all such borrowers in 
lieu of the IFR.

    In addition, the Federal Reserve is regularly updating its 
Web site with the number and dollar value of checks to 
borrowers whose servicers are parties to the amendments to the 
consent orders that have been deposited or cashed. The Federal 
Reserve and the OCC have also committed to providing public 
reports that detail the implementation of the amendments to the 
consent orders. We anticipate the reports will include 
available details about the direct relief and other assistance 
provided to homeowners, as well as information about the 
findings of reviews where complete, number of requests for 
review, costs associated with the reviews, and the status of 
the other corrective activities directed by the enforcement 
actions. We are in the process of analyzing this information at 
this time and, as suggested above, are taking steps to 
determine how this information may be best presented to the 
public.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                     FROM DANIEL K. TARULLO

Q.1. A critical element of the proposed new Basel leverage 
ratio is the definition of the denominator (the assets subject 
to the leverage requirement). A denominator definition that 
permits too many bank commitments to remain off the balance 
sheet and uncapitalized could undermine the benefits of a 
higher leverage ratio requirement.
    Have the banking agencies made a quantitative examination 
of the change in bank assets subject to the leverage 
requirement that will be created by the new Basel leverage 
rules?
    Could you please inform us, for the six largest U.S. banks 
and bank holding companies, the approximate amount of total 
assets that would be counted for the denominator of leverage 
capital requirements under the following definitions of assets: 
U.S. GAAP, IFRS accounting, and the proposed Basel leverage 
ratio definition.
    What factors are most important in determining the 
difference between GAAP and IFRS accounting and the proposed 
Basel leverage ratio definition? What is the total amount of 
the difference accounted for by: Changes in off-balance sheet 
treatment of credit commitments that are not derivatives 
contracts and changes in derivatives netting and offset rules.
    To the degree possible, please include breakdowns of the 
impact of the relevant sub-changes in each of these areas, as 
well as written explanations of the areas in the Basel leverage 
ratio definition that account for the differences.

A.1. In January 2014, the Basel Committee on Banking 
Supervision (the BCBS) issued a revised international leverage 
ratio standard (the revised BCBS standard) that replaces the 
standard issued in December 2010. The denominator of the 
leverage ratio (total exposure) continues to include on-balance 
sheet assets and off-balance sheet exposures, including 
unfunded commitments, guarantees, derivative exposures, and 
securities financing transactions.
    Compared to the December 2010 standard, under the revised 
BCBS standard, certain off-balance sheet items will be included 
in the total exposure using the same credit conversion factors 
as those used in the standardized approach to risk-based 
capital, with one exception. To ensure that all unfunded 
commitments are included in the total exposure, unconditionally 
cancelable commitments (e.g., credit card lines) will receive a 
credit conversion factor of 10 percent rather than the zero 
percent specified in the standardized approach to risk-based 
capital. While the revised BCBS standard reduces exposure 
amounts for certain off-balance sheet items that received a 
100-percent credit conversion factor under the 2010 standard, 
the revised BCBS standard increases exposure amounts for 
securities financing transactions and written credit 
derivatives, as discussed further below, and also clarifies the 
treatment of cash variation margin in derivatives transactions.
    The denominator of the BCBS standard, total exposure, is 
the same irrespective of whether a banking organization uses 
U.S. GAAP or IFRS. While there are some differences between 
U.S. GAAP and IFRS in the amount of balance-sheet netting 
permitted for derivatives and securities financing 
transactions, the revised BCBS standard would neutralize these 
differences by requiring all banking organizations to treat 
such exposures in a consistent manner. For example, U.S. GAAP 
permits netting of derivatives and related cash variation 
margin if the transactions are covered by qualifying master 
netting agreements and certain other criteria are met. However, 
the IFRS netting criteria are more restrictive than U.S. GAAP, 
and therefore, allow less balance-sheet netting. The revised 
BCBS standard clarifies that, regardless of the accounting 
standard used, a bank may net both derivatives and related cash 
variation margin if certain criteria are met. This will result 
in institutions that use U.S. GAAP and institutions that use 
IFRS reporting similar values for these exposures.
    The revised BCBS standard also includes an additional 
exposure amount for written credit derivatives. These would be 
included in the total exposure at their notional amount, a 
treatment that exists in neither U.S. GAAP nor IFRS, both of 
which use mark-to-market value as the basis for reporting. The 
inclusion of the notional amount of written credit protection, 
offset to some degree by bought credit protection in the same 
name of equal or greater maturity, results in a significant 
amount of added exposure to the denominator relative to the 
2010 standard for the largest U.S. banks.
    U.S. GAAP and IFRS have some differences with regard to the 
extent to which a bank can offset assets and liabilities in 
securities financing transactions with the same counterparty 
but a recent change in IFRS made the accounting of these 
transactions similar to U.S. GAAP. The revised BCBS standard 
permits limited netting for securities financing transactions 
if certain criteria are met, similar to both accounting 
frameworks. Compared to the 2010 standard, the revised BCBS 
standard would increase the exposure amount for securities 
financing transactions that is included in the total exposure 
while maintaining equivalence across U.S. GAAP and IFRS 
reporters. There are no other significant accounting 
differences between U.S. GAAP and IFRS that would impact the 
amount of institutions' total exposure.
    The U.S. Federal banking agencies are participating in 
ongoing international discussions and a confidential 
quantitative impact study analysis of the revised BCBS 
standard. The U.S. agencies are also examining the potential 
impact of the revised BCBS standard on U.S. banking 
organizations. Since U.S. institutions report financial data 
based on U.S. GAAP, it would be imprecise to try to estimate 
the amount of the U.S. banking organizations' total assets 
under IFRS. If the total exposure is calculated under the 
revised BCBS standard but no netting is permitted for 
derivatives and securities financing transactions, the total 
exposure for the six largest U.S. bank holding companies would 
increase by a percentage ranging between 1 percent and 15 
percent, depending on the banking organization's business 
model. On average, total exposure would increase by 
approximately 9 percent for these institutions, if netting is 
not permitted for derivatives and securities financing 
transactions.

Q.2. The new leverage ratio proposals mandate a leverage ratio 
of 6 percent for large bank subsidiaries, but a lower 5-percent 
ratio for the overall holding company. What policy 
justification is there for this distinction between the bank 
and the holding company?

A.2. Under the final and interim final capital rules issued by 
the agencies in 2013 (2013 capital rule), certain large 
depository institutions and bank holding companies to which the 
advanced approaches requirements are applicable are subject to 
a minimum supplementary leverage ratio of 3 percent. \1\ On 
July 9, 2013, the Federal banking agencies proposed to 
implement enhanced supplementary leverage ratio standards that 
would apply to bank holding companies with total consolidated 
assets of more than $700 billion or assets under custody of 
more than $10 trillion (covered BHCs), as well as their insured 
depository institution subsidiaries. \2\ Under this proposal, 
in order to avoid limitations on distributions and 
discretionary bonus payments, covered BHCs would need to hold a 
leverage buffer of tier 1 capital in an amount greater than 2 
percent of its total leverage exposure, in addition to the 
minimum supplementary leverage ratio requirement of 3 percent. 
This proposed buffer standard is similar to the capital 
conservation buffer for the risk-based capital ratios in the 
final capital rule. \3\ Under the proposal, insured depository 
institution subsidiaries of covered BHCs would be subject to a 
6-percent supplementary leverage ratio to be well-capitalized 
under the prompt corrective action framework. \4\
---------------------------------------------------------------------------
     \1\ Advanced approaches requirements generally apply to an 
institution with consolidated total assets on its most recent year-end 
regulatory report equal to $250 billion or more, or consolidated total 
on-balance sheet foreign exposure on its most recent year-end 
regulatory report equal to $10 billion or more. See also, 78 FR 62018 
(October 11, 2013) available at http://www.gpo.gov/fdsys/pkg/FR-2013-
10-ll/pdf/2013-21653.pdf.
     \2\ See, 78 FR 51101 (August 20, 2013) available at http://
www.gpo.gov/fdsys/pkg/FR-2013-08-20/pdf/2013-20143.pdf.
     \3\ See, section 11 of the 2013 capital rule.
     \4\ In order to be ``adequately capitalized'' under the prompt 
corrective action framework in the 2013 capital rule, these insured 
depository institutions must meet the 3-percent minimum supplementary 
leverage ratio requirement.
---------------------------------------------------------------------------
    As explained in the proposal, the agencies calibrated the 
proposed standards so that they would remain in an effective 
complementary relationship with the strengthened risk-based 
capital standards included in the 2013 capital rule. By setting 
the minimum supplementary leverage ratio plus leverage buffer 
at 5 percent for covered BHCs, and the well-capitalized 
threshold for insured depository institution subsidiaries of 
covered BHCs at 6 percent, the proposal is structurally 
consistent with the current relationship between the leverage 
ratio requirements applicable to insured depository 
institutions and BHCs under section 10 of the 2013 capital 
rule. Under that provision, insured depository institution 
subsidiaries must maintain at least a 5-percent leverage ratio 
to be well-capitalized for prompt corrective action purposes, 
whereas BHCs must maintain a minimum 4-percent leverage ratio 
under separate BHC regulations.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                     FROM DANIEL K. TARULLO

Q.1. Has your agency done any studies on the costs and benefits 
of allowing banks to book derivatives in depositories?

A.1. Banks book derivatives in a variety of legal entities. A 
number of different factors can affect a bank's booking 
practices such as regulatory factors, customer preference, and 
funding costs. We have not conducted a study that specifically 
quantifies potential costs and benefits of booking derivatives 
in depositories.

Q.2. A number of derivatives experts, including Frank Partnoy 
and Satyajit Das, contend that a large percentage of complex 
OTC derivatives, including credit default swaps, are not used 
for commerce but for economically unproductive activities such 
as gaming accounting and tax rules or hiding losses. Have you 
ever taken a large sample of derivatives transactions to see if 
these charges have validity? If the charges are accurate, in 
what ways would you change your views about derivatives 
regulation?

A.2. The Board has access to several data sources on derivative 
transactions entered into by bank holding companies. These data 
are informative about the size and nature of the derivative 
exposures but are not informative about the motivation behind 
such transactions. Moreover, bank holding companies play a 
significant intermediation role in the derivatives market. The 
specific motivation of counterparties such as asset managers, 
insurance companies, and nonfinancial corporates that engage in 
derivative transactions with bank holding companies cannot be 
determined from these data as it is not possible to observe any 
of the other economic exposures or considerations that motivate 
the derivative transactions themselves.

Q.3. Treasury Lew recently stated, ``if we get to the end of 
this year and we cannot with an honest straight face say that 
we have ended Too Big To Fail, we're going to have to look at 
other options.'' Do you agree?

A.3. Since 2008, the United States and the international 
regulatory community have made meaningful progress on policy 
reforms to reduce the moral hazard and other risks associated 
with financial firms perceived to be too big to fail. In broad 
terms, these reforms seek to eliminate too-big-to-fail in two 
ways: (1) by reducing the probability of failure of systemic 
financial firms through stronger capital and liquidity 
requirements and heightened supervision, and (2) by reducing 
the systemic impact on the broader system of the failure of 
such a firm, including by improving the resolvability of 
systemic financial firms. In the United States, the U.S. 
banking agencies have implemented the Basel III capital rules 
and are working actively on implementing the Basel III 
liquidity rules. The Federal Reserve has established a robust 
stress testing framework for large banking organizations and 
has created a Large Institution Supervision Coordinating 
Committee to strengthen the supervision of the most systemic 
U.S. financial firms. The Federal Reserve also is in the 
process of implementing a broad set of enhanced prudential 
standards and early remediation requirements for large U.S. 
bank holding companies and foreign banks with U.S. operations.
    The United States has made substantial progress since the 
crisis in improving the resolvability of systemic financial 
firms. The core areas of progress include (i) adoption and 
implementation of statutory resolution powers, (ii) adoption 
and implementation of resolution planning requirements, (iii) 
increased international coordination efforts, and (iv) the 
foreign bank regulatory requirements proposed by the Federal 
Reserve. The Federal Reserve supports the progress made by the 
FDIC in implementing Title II of the Dodd-Frank Act, including, 
by developing the single-point-of-entry (SPOE) approach to 
resolution of a systemic financial firm. Developing an approach 
to resolutions under Title II, such as SPOE, represents an 
important step toward ending the market perception that any 
U.S. financial firm is too big or too complex to be allowed to 
fail. More work remains to be done to maximize the prospects 
for an orderly resolution of a systemic financial firm, but we 
have made much progress in the past few years.
    Despite this considerable progress in addressing too-big-
to-fail, we have not yet adequately addressed all the 
vulnerabilities that developed in our financial system in the 
decades preceding the crisis. As I have noted, I believe that 
more is needed, particularly in addressing the residual risks 
posed by short-term wholesale funding markets, which have the 
continuing potential to aggravate the too-big-to-fail problem.

Q.4. The agencies have proposed increasing the leverage ratio 
for very large bank holding companies to 5 percent, and for 
depositories to 6 percent. These ``supplementary'' ratios are 
calculated using U.S. GAAP accounting measures. This means that 
total on-balance-sheet assets include only the net value of 
derivatives positions. If derivatives were accounted for under 
IFRS, which limits derivatives netting, then their total assets 
would be substantially higher. (See, for example, the analysis 
of the quantitative impact of different accounting rules done 
by ISDA: at http://www2.isda.org/functional-areas/research/
studies/.)
    Does the proposed increase in the leverage ratio do more 
than bring the U.S. leverage requirement roughly into line with 
the 3-percent leverage ratio that will be applied by EU 
regulators to all banks?
    Should the GAAP/IFRS difference and implications be 
detailed and addressed in the rulemakings? If not, why not?
    Have you compared the proposed leverage ratios to the 
losses experienced by banking institutions during the financial 
crisis?
    Why is there a distinction between the leverage ratio for 
bank holding companies and depositories?

A.4. The recent proposal to establish enhanced leverage ratio 
standards for the largest, most complex bank holding companies 
(covered BHCs) and their subsidiary insured depository 
institutions (IDIs) builds on the 3-percent minimum 
supplementary leverage ratio requirement (minimum supplementary 
leverage ratio) that the Federal banking agencies established 
earlier this year in the final rule that revised regulatory 
capital standards. The minimum supplementary leverage ratio 
implements the leverage ratio adopted by the Basel Committee on 
Banking Supervision (the BCBS) (the Basel III leverage ratio) 
for banking organizations subject to the agencies' advanced 
approaches risk-based capital rules.
    The minimum supplementary leverage ratio is a measure of 
tier 1 capital (the numerator) to total leverage exposure (the 
denominator), which includes both on-balance sheet assets and 
off-balance sheet exposures. The BCBS designed the total 
leverage exposure measure so that it could be calculated in a 
comparable manner across jurisdictions, adjusting for any 
differences in accounting standards. In June 2013, the BCBS 
proposed modifications to the calculation of total leverage 
exposure that would further standardize and clarify the 
calculation of exposure amounts for derivatives and securities 
financing transactions. The agencies are continuing to work 
with the BCBS to assess the Basel III leverage ratio, including 
its calibration and design, and will consider making changes to 
the supplementary leverage ratio as the BCBS revises the Basel 
III leverage ratio.
    Because the minimum supplementary leverage ratio already 
mitigates to a large extent the differences in accounting 
standards, the agencies' proposed enhanced supplementary 
leverage ratio standards would generally be more stringent than 
the international standard because they would require covered 
BHCs to hold 5-percent tier 1 capital to total leverage 
exposure in order to avoid limits on capital distributions and 
discretionary executive bonus payments. The proposed enhanced 
supplementary leverage ratio standards would also require 
subsidiary IDIs of covered BHCs to hold 6-percent tier 1 
capital to total leverage exposure in order to be ``well 
capitalized'' under the Prompt Corrective Action (PCA) 
framework. These proposed enhanced standards for covered BHCs 
are consistent with section 165 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, which requires the Board to 
establish enhanced capital standards for large bank holding 
companies that increase in stringency based on the risk they 
pose to the U.S. financial system.
    The agencies have taken into account various factors in 
developing the enhanced leverage ratio standards, including the 
amounts of regulatory capital held by financial institutions 
during the crisis and the complementary nature of the risk-
based and leverage capital ratios. Based on the agencies' 
analysis, approximately half of the covered BHCs in 2006 would 
have met or exceeded a 3-percent minimum supplementary leverage 
ratio at the end of 2006, and the other half would have been 
close to meeting this requirement. This suggests that the 
minimum requirement would not have placed a significant 
constraint on the pre-crisis buildup of leverage at the largest 
institutions. The agencies believe that there could be benefits 
to financial stability and reduced costs to the deposit 
insurance fund by requiring the largest, most complex banking 
organizations to meet the enhanced leverage ratio standards. To 
enhance the safety and soundness of these most systemically 
important banking organizations, the risk-based and leverage 
capital requirements should work together so that each standard 
can offset potential weaknesses of the other.
    Further, to maintain an effective complementary 
relationship of both regulatory capital standards, the agencies 
believe that enhanced leverage ratio standards should be more 
closely calibrated to the strengthened risk-based capital 
standards and the enhanced PCA standards included in the 2013 
capital rule. The proposed calibration for covered BHCs and 
their IDIs is structurally consistent with the current 
relationship between the leverage ratio requirements applicable 
to IDIs and BHCs under section 10 of the 2013 capital rule, 
under which IDIs must maintain a 5-percent generally applicable 
leverage ratio to be well capitalized for PCA purposes, whereas 
BHCs must maintain a minimum 4-percent generally applicable 
leverage ratio under separate BHC regulations. The agencies' 
proposal specifically seeks feedback on the appropriateness of 
the proposed calibration.
    The agencies are currently reviewing public comments on 
this and all other aspects of the enhanced leverage ratio 
standards proposal and will take into account all the comments 
received in any final rulemaking.

Q.5. Under 12 U.S.C. 1818(e), Federal banking agencies may 
remove ``institution-affiliated parties'' from participation in 
the affairs of an insured depository when they directly or 
indirectly violate banking laws or regulations. Were officers 
or directors of any bank that was party to the mortgage 
servicer settlements removed because they directly or 
indirectly participated in the violations that led to the 
settlements? If no officer or director was removed, can you 
explain why?

A.5. The Federal Reserve has not issued prohibition orders 
against officers or directors at the banking organizations 
subject to mortgage servicing related enforcement actions for 
the conduct that led to those actions. The Federal Reserve and 
other Federal banking agencies have statutory authority to 
remove and prohibit insiders from participating in the banking 
industry, but in doing so must meet the high standard 
established by Congress. To prohibit an individual from 
participating in the banking industry under 12 U.S.C. 1818(e), 
the Federal Reserve must prove not only that the individual 
engaged in an unsafe or unsound practice, breach of fiduciary 
duty or violation of law, but also that this misconduct 
resulted in losses or other harm to the institution or gains to 
the individual, and involved personal dishonesty, or willful or 
continuing disregard for safety and soundness. 12 U.S.C. 
1818(e)(1). Decisions on whether to initiate actions to ban 
individuals from banking are based on whether each of these 
statutory criteria are met with respect to the conduct of a 
particular institution-affiliated party based on the individual 
factual record relating to a particular case.
    The Federal Reserve has required the servicers it regulates 
to implement action plans to correct the servicing and 
foreclosure deficiencies that led to the enforcement actions 
against the servicers. We are in the process of validating the 
servicers' compliance with these plans. If conduct that meets 
the statutory criteria for a prohibition is uncovered, we will 
take appropriate action against the individuals involved.

Q.6. How do you audit large bank IT systems to determine 
potential systemic risk?

A.6. The Federal Reserve has taken a number of steps to 
strengthen its ongoing supervision of the largest, most complex 
banking firms as a result of lessons learned from the financial 
crisis. Most importantly, we established the Large Institution 
Supervision Coordinating Committee (LISCC), to ensure that 
large institution supervision is more centralized; involves 
regular, simultaneous, horizontal (cross-firm) supervisory 
exercises; and is more interdisciplinary than it has been in 
the past. The committee includes senior Federal Reserve staff 
from the research, legal, and other divisions at the Board, and 
from the markets and payment systems groups at the Federal 
Reserve Bank of New York, as well as senior bank supervisors 
from the Board and relevant reserve banks. To date, the LISCC 
has developed and administered a number of horizontal 
supervisory exercises, notably the capital stress tests and 
related comprehensive capital reviews of the Nation's largest 
bank holding companies, and is now extending its activities to 
coordinate other supervisory processes more effectively.
    The largest banking institutions also are subject to 
continuous supervision by the Federal Reserve that includes 
resident teams of on-site examiners. This level of supervisory 
oversight incorporates review of internal management reports, 
periodic meetings with the personnel responsible for managing 
and controlling the risks of the firm, and additional discovery 
and targeted examinations of the firm's activities. Discovery 
reviews are conducted when a new business line or product is 
released, the firm's operating environment changes, or gaps 
exist in supervisors' understanding of the financial 
institution's risk profile. Targeted reviews are conducted to 
more closely analyze a specific risk area, determine the 
quality of internal risk assessments, and evaluate mitigating 
controls.
    Additionally, enhanced continuous monitoring (ECM) focuses 
on information security, business resilience, project 
management, and key initiatives related to core settlement and 
clearing activities. The ECM approach is used to develop 
supervisory assessments at systemically important financial 
institutions and financial market utilities. Federal Reserve 
supervisors also leverage interagency examination reports and 
internal and third-party audit reports. Supervisors select 
examination strategies based on a bank's risk profile and 
historical risk management capabilities.
    Throughout the year, examiners gather information from 
individual firms and evaluate this information for common 
trends or concerns that may pose a systemic risk to the 
financial system. When emerging threats or concerns are deemed 
material, supervision staff and management conduct a focused 
review across a number of banks to obtain more detailed 
information for additional analysis.
    Increased reliance on technology service providers and 
interconnectivity with other banks and entities has significant 
implications for the identification and management of systemic 
risk. Technology advances and cost pressures have driven banks 
to consolidate core processing systems and to initiate projects 
to deliver services more efficiently. Supervision staff and 
management monitor IT risks, such as information security, 
cybersecurity, and operations resiliency, at large banks and 
adjust supervisory efforts based upon evolving threats.

Q.7. The U.S. Chamber of Commerce has called for a trade review 
of the Volcker Rule, alleging that the rule violates trade 
agreements. Has your agency done any legal analysis of whether 
pending or prior trade pacts would vitiate its ability to 
impose higher capital requirements on SIFIs?

A.7. It is well recognized that the Basel Capital Accords 
establish minimum capital standards for internationally active 
banking organizations. National supervisors are free to require 
higher capital for their organizations than the Basel minimum 
standards. None of this would violate any trade obligations of 
the United States. Pending and prior trade agreements impose 
certain obligations on the United States relating to foreign 
financial institutions, including financial institutions that 
are designated as SIFIs. Relevant obligations include 
permitting market access and applying national treatment and 
most-favored-Nation treatment to foreign financial institutions 
subject to the Board's jurisdiction. Board staff does not 
believe that imposing higher capital requirements on financial 
institutions that are SIFIs would violate any of those trade 
obligations. Moreover, even if any of those trade obligations 
were implicated by higher capital requirements, all relevant 
trade agreements permit the United States to adopt or maintain 
measures for prudential reasons. Staff believes the imposition 
of higher capital requirements to assure the safety and 
soundness of banking organizations is the exemplary case of a 
prudential measure. Accordingly, Board staff does not believe 
U.S. trade agreements relating to financial services would 
vitiate the ability of the United States to impose higher 
capital requirements on financial institutions that are SIFIs.

Q.8. Has your agency performed any studies or prepared any 
estimates of the profit subsidy banks derive from carrying 
derivatives in depositories?

A.8. We have not attempted to quantify the earnings impact of 
moving positions out of the depository institution. It is 
difficult to estimate the subsidy associated with bank 
engagement in derivatives activities because of the 
heterogeneity of the different firms and their derivatives 
businesses. One challenge to an analysis of this sort is that 
some firms that hold derivatives outside of the depository 
institution have self-funding derivatives business, and thus do 
not require additional funding to meet collateral requirements. 
In other words, collateral collected is sufficient to meet 
collateral posting needs. Another challenge is that some 
clients prefer facing the depository institution, and it would 
be difficult for us to predict how clients would respond to not 
having this as an option.

Q.9. Certain aspects of the U.S. payments system lag 
international standards by a substantial margin. For example, 
the U.S. still uses magnetic strip technology for credit and 
debit cards, while in Europe, Asia, and even emerging markets 
like South Africa, more secure chip cards (smart cards) have 
been widely used since the late 1990s. South Africa has also 
used cards for paying unbanked laborers starting in the 1990s, 
and at much lower fee levels than American banks charge. Can 
you explain how a less advanced country with much smaller banks 
can run an apparently more efficient payment system than the 
U.S.?

A.9. The United States has established infrastructure that 
supports several ubiquitous payment systems, including wire, 
ACH, check, and card payments. The U.S. payments system 
provides a solid foundation for payment services; however, some 
of these systems are not universally fast or efficient from an 
end user perspective by today's standards. The challenge for 
the payment industry is to provide a payment system for the 
future that combines the valued attributes of existing payment 
methods--convenience, safety, and universal reach at low cost 
to the end user--with new technology that enables faster 
processing and enhanced convenience. In deciding how to 
accomplish this in the United States, stakeholders are not 
starting from an undeveloped payment environment like some 
other economies that have adopted new payment technologies in 
the last 10 to 20 years.
    Industry stakeholders have made substantial capital 
investments over many decades into the existing payment system, 
and closely analyze the costs and benefits of investment 
proposals. For example, whether smart card technology will 
yield positive net societal benefits in the United States is an 
open issue with payment experts on both sides of the debate. 
Smart card technology was introduced in some countries largely 
to reduce counterfeit fraud. Implementation in the United 
States, however, would require significant changes to an 
established payment infrastructure that would cost stakeholders 
billions of dollars, would not necessarily improve efficiency, 
and would not address ``card not present'' fraud in mail, 
telephone, and Internet transactions. On the other hand, as 
other countries embed smart card technology into their payment 
infrastructure, U.S. card holders may increasingly experience 
challenges with using their magnetic-stripe cards outside the 
United States. Nevertheless, several major card networks have 
taken steps to implement smart card technology in the United 
States over the next several years.
    Nearly all stakeholders are willing to work toward a more 
efficient payments system, and agree that improvements are 
necessary and appropriate in some cases. However, views on what 
constitutes a more efficient system and what risks within that 
system are appropriate vary across the payment industry, which 
includes over ten thousand depository institutions, operators, 
processors, service providers, and end users.

Q.10. In your testimony, you emphasized the risks created by 
short-term funding markets. In this context, you stated that 
you felt regulators should consider: ``possible additional 
steps in areas such as securities financing transactions to 
address the potential for runs in short-term funding regardless 
of whether the borrower is a large regulated institution.''
    Has the Federal Reserve investigated the extent to which 
systemic risks in short-term funding markets may be created by 
institutions that are not currently prudentially regulated by 
the Federal Government? Is the data currently available to the 
Federal Reserve (including through its participation in FSOC) 
adequate to answer this question?
    Do you believe that serious systemic risks may be created 
by institutions that are not currently prudentially regulated 
but participate heavily in short term funding markets? If so, 
what steps are you taking to coordinate with other agencies 
such as the SEC and with the FSOC to address these risks?

A.10. As the experience of the financial crisis shows, large 
portfolios of assets can be funded with short maturity 
liabilities entirely outside of the regulated banking industry; 
indeed, in some cases without any explicit support from any 
institution, whether regulated or not. Measures taken since the 
crisis, including those by banking regulators who have taken 
concrete steps to require that financial institutions hold 
capital and liquidity against the risks stemming from off-
balance sheet activities, have contributed to the disappearance 
of some of the most pernicious structures engaging in such 
maturity transformation during the pre-crisis period. But it is 
also clear that there is potential over time for new structural 
and transactional forms to emerge, particularly as regulation 
of the core banking system become more comprehensive and 
effective.
    Thus the Federal Reserve is acutely focused on the role 
that a variety of institutions and markets play in providing 
short-term funding, whether or not they are prudentially 
regulated by a Federal agency. We are actively gathering 
relevant information in a variety of ways. On September 19, 
2013, the Federal Reserve proposed collecting highly granular 
data on the liquidity positions of large complex financial 
institutions, including information on securities financing, 
repurchase agreements and securities financing transactions 
with a host of bank and nonbank counterparties. We sought 
public comment on these collections and look forward to 
finalizing them soon. (Proposed collections FR 2052a and FR 
2052b; for more information see http://www.federalreserve.gov/
reportforms/formsreview/FR2052a_FR2052b_ 20130919_ifr.pdf.)
    As part of its work with the FSOC, the Federal Reserve has 
obtained information on the liquidity positions of a number of 
large, complex nonbank financial institutions. Indeed, the 
FSOC' s bases for designating American International Group, 
Inc., General Electric Capital Corporation, Inc., and 
Prudential Financial, Inc. as systemically important nonbank 
financial companies referenced inter alia their reliance on a 
variety of nondeposit funding sources that could be withdrawn 
by investors, potentially putting pressure on the institutions 
to rapidly liquidate large portfolios of assets.
    We are committed to continuing our efforts to gather 
information on potential pressure points in short-term funding 
markets and to address them. We will continue to work with 
other relevant agencies, including other members of the FSOC, 
to put in place structural reforms to reduce the likelihood and 
magnitude of runs.
    In that vein, I and others at the Federal Reserve have 
highlighted the continuing systemic vulnerabilities posed by 
MMFs, which are susceptible to destabilizing runs. We continue 
to engage through the FSOC with the SEC and other agencies with 
the goal of enhancing the resilience of these vehicles, which 
are important to households and businesses as well as short-
term funding markets.

Q.11. In your response to Chairman Johnson's question regarding 
the regulatory treatment of insurance companies, you stated 
that insurance companies tended to hold long-term liabilities 
and that there was ``not a way to accelerate the run of that 
funding.'' Although this is true for many insurance 
liabilities, insurance companies do sell products whose 
liabilities are closely linked to returns in the broader 
financial sector. These include financial guarantee products, 
insurance products with redemption features, and variable 
annuities that include guarantees. Has the Federal Reserve 
examined the magnitude of these activities in the insurance 
sector and their potential for creating systemic risk? What 
have been the results of this examination?

A.11. There is a range of opinions on the question of the 
extent to which insurance companies pose a systemic risk. 
Ultimately, the Financial Stability Oversight Council (FSOC) is 
charged under the Dodd-Frank Act with making firm-specific 
determinations regarding the systemic risk posed by a nonbank 
financial firm, including an insurance company. For these FSOC 
determinations, the question of systemic risk in the insurance 
sector has to be answered within the context of a specific firm 
and an evaluation of its size, product mix, activities, 
interconnectedness with other financial companies, and other 
factors set forth in the Dodd-Frank Act and FSOC guidance.
    Generally speaking, traditional insurance companies tend to 
have lower levels of leverage and liquidity risk, and engage in 
less maturity transformation, relative to banking firms. 
However, it is also true that many insurance companies, 
particularly life insurers, have progressively moved toward 
investment products that more closely resemble banking products 
(e.g., annuities, guaranteed investment contracts, and other 
investment products that have withdrawal features and/or 
guarantee a minimum market return). In addition, some insurance 
companies have become active participants in the financial 
markets, including the same securities lending and financing 
markets relied on by banking and securities firms. These 
activities have introduced into the operations of some 
insurance companies an increasing level of liability liquidity, 
financial risk and interconnectedness with the financial 
system.

Q.12. In your testimony, you stated that ``The Section 716 
[swaps push out] rule is done.'' The Federal Reserve released a 
rule in June governing temporary (2-year) extensions to the 
deadline for compliance with Section 716 for both U.S. and 
foreign banking organizations, but I was not aware of any 
proposed rule or guidance issued by the banking agencies 
concerning how to come into full compliance with all the 
requirements of Section 716.
    By stating that the Section 716 rule is done, did you 
intend to indicate that Section 716 is self-enforcing in 
statute and no additional rulemaking is necessary for the final 
post-extension deadline of 2015? If not, when do you plan to 
issue guidance to banking organizations concerning full 
compliance with Section 716?
    Has the Federal Reserve begun any process of working with 
banks to determine that they will be fully prepared to comply 
with Section 716 by the end of any extension period?

A.12. Section 716's prohibition will come into effect on July 
16, 2015, for most affected entities. The statute is self-
effectuating and does not require the Board to issue 
implementing regulations or guidance. During the transition 
period, the Board will work with banking organizations to 
facilitate their compliance with section 716 and will consider 
whether further guidance is appropriate.

Q.13. How many firms are engaged in trading of physical 
commodities using the authority under section 4(o) in 12 U.S.C. 
1843? How does the Federal Reserve track this activity?

A.13. Two firms are engaged in trading of physical commodities 
using the authority under section 4(o) of the Bank Holding 
Company Act (12 U.S.C. 1843(o)). As part of its ongoing work 
supervising bank holding companies, Federal Reserve staff seeks 
to understand the full range of commodities activities 
currently conducted by these companies, assess their risk 
management practices for these activities, and assess the 
potential impact of commodities activities on their financial 
condition. The supervisory oversight includes review of 
internal management reports, periodic meetings with the 
personnel responsible for managing and controlling the risks of 
the firm's commodities activities, and targeted examinations of 
those activities.

Q.14. Why hasn't the Federal Reserve mandated real-time check 
clearing for domestic transactions?

A.14. Over the past decade, the payment industry has undergone 
an almost complete transition from paper-based to electronic 
check clearing. For example, in 2005, approximately 5 percent 
of checks sent to Reserve Banks for collection were cleared 
electronically while today over 99.95 percent of checks sent to 
Reserve Banks for collection are in electronic form. This 
transition has greatly reduced the time and cost of check 
clearing. In addition, banks have introduced innovations to end 
users allowing the electronic capture and deposit of checks 
remotely, increasing convenience of the check instrument. It is 
unclear, however, that the additional efficiencies that could 
be gained with real-time check clearing would justify the cost 
of the required changes to the check clearing system.
    The payment industry is evaluating opportunities to improve 
the speed of payment clearance and settlement but generally 
with respect to other payment instruments. On September 10, the 
Federal Reserve Banks issued for public consultation a paper 
(www.FedPaymentslmprovement.org) discussing the Federal 
Reserve's vision for improving the speed and efficiency of the 
U.S. retail payments system on an end-to-end basis while 
maintaining payment system safety. The paper identifies key 
gaps and opportunities in the U.S. payment system and desired 
outcomes that close these gaps and capture these opportunities. 
One desired outcome calls for ubiquitous electronic solution(s) 
for making retail payments whereby funds are debited from the 
payer and credited to the recipient on a near-real-time basis. 
The paper requests industry feedback on several potential ways 
to achieve a near-real-time retail payment system, including a 
separate wire transfer-like system, enhancements to the 
automated clearing house system, modifications to debit card 
networks, or development of an entirely new payment system.
    The paper invites payment-industry and end-user input on 
the gaps, opportunities, and desired outcomes articulated in 
the paper as well as potential strategies and tactics to shape 
the future of the U.S. payment system. The Federal Reserve 
plans to consider this input as it assesses how to best foster 
improvements that advance the speed, efficiency, and security 
of the Nation's payments system.

Q.15. Can the Fed use access to Fedwire or other payment 
systems as a mechanism for promoting soundness of firms that 
rely on the Fed's ``lender of the last resort'' dollar 
facilities?

A.15. The promotion of safe and sound financial institutions is 
the foremost objective of financial regulation. The Federal 
Reserve and the other banking regulators have a broad range of 
supervisory and regulatory authorities designed to assess and 
promote the soundness of depository institutions. These 
authorities include the ability to compel corrective actions 
through a variety of escalating enforcement mechanisms.
    The Reserve Banks' provision of accounts and payment 
services to depository institutions occurs in the context of 
this larger U.S. regulatory and supervisory framework for 
depository institutions. In particular, the Federal Reserve has 
a well-developed set of policies and a framework for monitoring 
the financial condition of depository institutions that 
maintain accounts at the Reserve Banks in order to limit risks 
to the Reserve Banks. Such monitoring incorporates supervisory 
reports and capitalization data, among other information. These 
policies also provide for placing progressively more 
restrictive conditions on a depository institution's use of 
Reserve Bank payment services as its financial condition 
deteriorates. For example, a depository institution may be 
required to post collateral, maintain certain minimum balances, 
pre-fund certain payment transactions, or be limited in the 
services it may access. These potential limitations on access 
to the payment system for depository institutions along with 
supervisory measures provide a strong incentive for 
depositories to avoid a significant deterioration in their 
financial condition.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                    FROM MARTIN J. GRUENBERG

Q.1. In late 2011, the agencies issued a highly complex and 
lengthy regulatory proposal to implement the Volcker rule. In 
February of this year, Chairman Bernanke testified that while 
regulators have made a lot of progress on the rule, the issues 
slowing the process ``are finding agreement and closure among 
the different agencies . . . .'' When can we expect the final 
rule? What are the reasons for a delay?

A.1. The Volcker Rule rulemaking involves the bank regulatory 
agencies, the Securities and Exchange Commission, and the 
Commodity Futures Trading Commission (the agencies). The 
agencies received more than 18,000 comment letters on the 
Volcker Rule proposal, including hundreds that were very 
detailed and highly technical. We are committed to carefully 
considering all views expressed during the comment process as 
we finalize the rule. The agencies are striving to have the 
rule completed by year end 2013.

Q.2. Your agencies published a short guide for smaller, less 
complex institutions so they can understand and implement the 
final Basel III rule. Both of your agencies, together with the 
FRB, took additional steps to analyze and mitigate the burden 
of the proposed rule on community banks before promulgating 
final rules. What steps is your agency taking to ensure that 
its bank examiners and regional office staff properly interpret 
and apply the Basel III regime for community banks versus 
larger banks?

A.2. Internally, the FDIC is holding training sessions for 
examination and other key supervisory staff on the interim 
final capital rule. To date, we have trained regional 
specialists who serve as points of contact on Basel III in our 
six regional offices (New York, Atlanta, Dallas, Kansas City, 
Chicago, and San Francisco) and hosted a training conference 
call with capital markets subject matter experts in our field 
office locations. We have established an internal Web site for 
FDIC examiners and staff where we are providing critical 
information and training materials on Basel III.
    The information on our public Web site includes the 
interagency community bank guide, an expanded community bank 
guide developed by the FDIC, and instructional videos. We held 
outreach sessions for bankers in our six regional offices in 
August, and the FDIC hosted a national call on August 15, 2013, 
to review common questions on the interim final rule raised 
during outreach sessions. The national call was advertised to 
financial institutions during outreach sessions and through a 
Financial Institution Letter and to FDIC examination and 
supervisory staff through a global email.
    Formal assessment of FDIC examiner training is underway to 
ensure the curriculum sufficiently reflects the new interim 
final capital rule. On an interagency basis, the FDIC 
participates on the Federal Financial Institutions Examination 
Council (FFIEC) course development teams, and the FFIEC is 
reviewing training updates that will be required to reflect and 
educate examination staff on the new capital rules.

Q.3. On July 9th the FDIC board approved the Basel III rules on 
interim basis and, together with the FRB and the OCC, issued a 
proposed rule to increase the leverage ratio for the eight 
largest banking organizations beyond the Basel III levels. 
Should banks below the $700 billion threshold worry about the 
trickle-down effect of the proposed approach?

A.3. The proposed enhanced supplementary leverage ratio would 
apply to banking organizations with $700 billion or more in 
total consolidated assets or $10 trillion or more in assets 
under management. It was intentionally focused on the eight 
most systemically significant financial institutions and not on 
smaller or less complex institutions that do not present the 
same degree of systemic risk.

Q.4. The FDIC's proposal calls for a supplementary leverage 
ratio of 5 percent for large bank holding companies and 6 
percent for the banks that are owned by those holding 
companies. The rules proposed by the FDIC would apply to 8 
largest U.S. banks and exceed standards set by the Basel III 
international accord. Are European regulators considering 
similar requirements for large EU-based banks since most of the 
10 largest banks in the world are based out of Europe? If 
European regulators are not considering similar standards for 
their large banks, what effect would FDIC's proposal have on 
the competitiveness of the U.S. banks abroad?

A.4. While Basel III establishes an international leverage 
ratio for the first time, there is no indication at this time 
that other jurisdictions would propose leverage standards 
beyond the minimum provided in the Accord. However, U.S. banks 
have long been subject to prompt corrective action standards 
that include minimum requirements based on a leverage ratio, 
while European banks until now have not been subject to such 
requirements. Historically, U.S. banks have fared very well 
relative to their European counterparts despite (or perhaps 
because of) being subject to higher capital standards. The 
financial crisis in Europe has been exacerbated in large part 
due to weakness in the banking sector. As such, we believe a 
strongly capitalized banking sector will benefit banking 
organizations and the economy.

Q.5. Institutions with nonbank assets greater than $250 billion 
filed their resolution plans last year and must now provide a 
second, more comprehensive version of the living will by 
October 1st. How can we know that these living wills will work 
in the first place? What are top three significant obstacles 
identified by regulators in the first round of living wills 
that warrant additional scrutiny?

A.5. Under the framework of the ``Dodd-Frank Wall Street Reform 
and Consumer Protection Act'' (Dodd-Frank Act), bankruptcy is 
the preferred option in the event of the failure of a 
Systemically Important Financial Institution (SIFI). To make 
this objective achievable, Title I of the Dodd-Frank Act 
requires that all bank holding companies with total 
consolidated assets of $50 billion or more, and nonbank 
financial companies that the Financial Stability Oversight 
Council (FSOC) determines could pose a threat to the financial 
stability of the United States, prepare resolution plans, or 
``living wills,'' to demonstrate how the company could be 
resolved in a rapid and orderly manner under the Bankruptcy 
Code.
    The FDIC and the Federal Reserve (the Agencies) review the 
165(d) plans and may jointly find that a plan is not credible 
or would not facilitate an orderly resolution under the 
Bankruptcy Code. If a plan is found to be deficient and 
adequate revisions are not made, the FDIC and the Federal 
Reserve may jointly impose more stringent capital, leverage, or 
liquidity requirements, or restrictions on growth, activities, 
or operations of the company, including its subsidiaries. If a 
company does not comply with these requirements within 2 years, 
the FDIC and the Federal Reserve, in consultation with the 
FSOC, can order the company to divest assets or operations to 
facilitate an orderly resolution under the Bankruptcy Code.
    Eleven companies submitted initial resolution plans in 
2012. Following the review of the initial resolution plans, the 
Agencies provided additional Guidance to companies to assist in 
the preparation of their 2013 resolution plan submissions. The 
Agencies extended the filing date to October 1, 2013, to give 
the firms additional time to address the Guidance.
    The Agencies will be evaluating how each resolution plan 
addresses a set of benchmarks outlined in the Guidance that 
pose the key impediments to an orderly resolution. The 
benchmarks are as follows:

    Multiple Competing Insolvencies: Multiple 
        jurisdictions, with the possibility of different 
        insolvency frameworks, raise the risk of discontinuity 
        of critical operations and uncertain outcomes.

    Global Cooperation: The risk that lack of 
        cooperation could lead to ring-fencing of assets or 
        other outcomes that could exacerbate financial 
        instability in the United States and/or loss of 
        franchise value, as well as uncertainty in the markets.

    Operations and Interconnectedness: The risk that 
        services provided by an affiliate or third party might 
        be interrupted, or access to payment and clearing 
        capabilities might be lost.

    Counterparty Actions: The risk that counterparty 
        actions may create operational challenges for the 
        company, leading to systemic market disruption or 
        financial instability in the United States.

    Funding and Liquidity: The risk of insufficient 
        liquidity to maintain critical operations arising from 
        increased margin requirements, acceleration, 
        termination, inability to roll over short term 
        borrowings, default interest rate obligations, loss of 
        access to alternative sources of credit, and/or 
        additional expenses of restructuring.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
           SENATOR MENENDEZ FROM MARTIN J. GRUENBERG

Q.1. Over the last few months, we've seen reports in the press 
of so-called ``regulatory capital trades'', in which regulated 
financial institutions have purchased credit protection (often 
using credit default swaps) from unregulated entities (often 
SPVs, hedge funds, or other entities formed offshore to avoid 
regulation) in order to reduce the amount of capital they need 
to hold against an investment on their books. In effect, these 
trades are transferring risk from regulated institutions that 
are subject to capital requirements to unregulated entities 
that are not subject to capital requirements, and creating 
exposure of the regulated institution to a potential default by 
the unregulated entity.
    If this story sounds familiar, it should--this is 
strikingly similar to what we saw happen with AIG before the 
financial crisis. These trades are transferring risk from 
regulated and supervised financial institutions to unregulated 
corners of the market, where it can build and concentrate 
without monitoring or supervision by regulators.
    The Basel Committee has partly addressed this issue by 
calling for banks to properly account in their capital 
calculations for the costs of credit protection they purchase. 
But does this proposal do enough to address concerns about 
regulatory arbitrage and systemic risk accumulating all over 
again through ``shadow banking''? Are you concerned about these 
``regulatory capital trades'', and what steps are you taking to 
monitor and address these arrangements?

A.1. The FDIC does not condone ``regulatory capital trades'' 
that mask a bank's risk position and result in an overly 
optimistic portrayal of its underlying capital strength. Our 
examiners are aware of the issue and will scrutinize such 
activities during on-site examinations.
    In March, 2013, the Basel Committee issued a consultative 
paper titled ``Recognizing the Cost of Credit Protection 
Purchased'', which proposes changes in regulatory capital rules 
intended to address some of these concerns. In addition, other 
regulatory initiatives will help mitigate risk concerns 
associated with these trades. For example, many of these 
``regulatory capital trades'' are conducted via over-the-
counter derivatives. Going forward, these trades will be 
subject to margin requirements as well as heightened capital 
standards.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                    FROM MARTIN J. GRUENBERG

Q.1. A critical element of the proposed new Basel leverage 
ratio is the definition of the denominator (the assets subject 
to the leverage requirement). A denominator definition that 
permits too many bank commitments to remain off the balance 
sheet and uncapitalized could undermine the benefits of a 
higher leverage ratio requirement.
    Have the banking agencies made a quantitative examination 
of the change in bank assets subject to the leverage 
requirement that will be created by the new Basel leverage 
rules?
    Could you please inform us, for the six largest U.S. banks 
and bank holding companies, the approximate amount of total 
assets that would be counted for the denominator of leverage 
capital requirements under the following definitions of assets: 
U.S. GAAP, IFRS accounting, and the proposed Basel leverage 
ratio definition?
    What factors are most important in determining the 
difference between GAAP and IFRS accounting and the proposed 
Basel leverage ratio definition? What is the total amount of 
the difference accounted for by: Changes in off-balance sheet 
treatment of credit commitments that are not derivatives 
contracts and changes in derivatives netting and offset rules?
    To the degree possible, please include breakdowns of the 
impact of the relevant sub-changes in each of these areas, as 
well as written explanations of the areas in the Basel leverage 
ratio definition that account for the differences.

A.1. The banking agencies have analyzed the quantitative impact 
of the leverage ratio proposal. A discussion of this analysis 
is included in the Enhanced Supplementary Leverage Ratio notice 
of proposed rulemaking. In summary, our analysis indicates 
that, on average, the proposed supplementary leverage ratio 
denominator would be 1.43 times larger than total assets 
reported in the denominator of the longstanding U.S. leverage 
ratio, which is based upon U.S. GAAP.
    According to Federal Reserve regulatory reporting data (FR 
Y-9C), which are calculated in accordance with U.S. GAAP, the 
largest holding companies reported total assets of: $2.2 
trillion for JPMorgan; $2.1 trillion for Bank of America; $1.8 
trillion for Citigroup; $1.3 trillion for Wells Fargo; $0.9 
trillion for Goldman Sachs; and $0.7 trillion for Morgan 
Stanley. These and other U.S. institutions are not required to 
report total assets under International Financial Reporting 
Standards (IFRS). Accordingly, we are unable to provide the 
quantitative estimates of GAAP-IFRS differences requested in 
your letter. In general terms, however, an important difference 
between the two frameworks, especially from the perspective of 
financial institutions active in derivatives, is that while 
both frameworks allow netting of derivatives under certain 
circumstances, in the case of IFRS, those circumstances are 
more limited.
    It is important to note that the leverage ratio included in 
the Basel III agreement is calculated in a manner that is not 
dependent on a particular bank's accounting framework. The 
Basel agreement follows principles more similar to U.S. GAAP in 
certain areas (e.g., derivatives netting) and more similar to 
IFRS in other areas (e.g., the treatment of certain 
collateral). For example, the proposed supplementary leverage 
ratio denominator follows the U.S. GAAP approach for netting 
derivatives and securities lending and borrowing transactions. 
However, the proposed supplementary leverage ratio denominator 
includes several add-ons that are not part of U.S. GAAP or 
IFRS: (1) a potential future-exposure amount for derivatives; 
(2) off-balance sheet commitments; and (3) 10 percent of 
unconditionally cancelable commitments (e.g., unused credit 
card lines).

Q.2. The new leverage ratio proposals mandate a leverage ratio 
of 6 percent for large bank subsidiaries, but a lower 5-percent 
ratio for the overall holding company. What policy 
justification is there for this distinction between the bank 
and the holding company?

A.2. These levels are structurally consistent with the current 
relationship between the generally applicable leverage ratio 
requirements for insured depository institutions (IDIs) and 
bank holding companies (BHCs). Under the existing rules, IDIs 
must maintain a 5-percent generally applicable leverage ratio 
to be well capitalized for prompt corrective action (PCA) 
purposes, whereas BHCs must maintain a minimum 4-percent 
generally applicable leverage ratio under separate BHC 
regulations. The new standards are more stringent than the 
current 5-percent well-capitalized standard under PCA with 
respect to the generally applicable leverage ratio due to the 
higher calibration and inclusion of additional items in the 
denominator.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                    FROM MARTIN J. GRUENBERG

Q.1. Has your agency done any studies on the costs and benefits 
of allowing banks to book derivatives in depositories?

A.1. Experience has shown that certain types of derivatives can 
be used to improve risk management while other types of 
derivatives activity appear to have elevated risks within banks 
or the financial system as a whole. For example, interest rate 
swaps have been used for more than a decade to help 
institutions manage interest rate risk as part of their asset 
liability management process. On the other hand, banks' credit 
default swaps activity has sometimes had the effect not of 
hedging risk but of elevating risk, both to individual 
institutions and the financial system. For example, large banks 
experienced significant losses on credit derivatives in 2007 
and 2008; these procyclical losses appear to have amplified 
rather than hedged the risks facing these institutions at the 
time (see also the Table provided in the response to Question 
11).

Q.2. A number of derivatives experts, including Frank Partnoy 
and Satyajit Das, contend that a large percentage of complex 
OTC derivatives, including credit default swaps, are not used 
for commerce but for economically unproductive activities such 
as gaming accounting and tax rules or hiding losses. Have you 
ever taken a large sample of derivatives transactions to see if 
these charges have validity? If the charges are accurate, in 
what ways would you change your views about derivatives 
regulation?

A.2. Derivatives markets are undergoing major reforms as the 
result of domestic regulations and international mandates. The 
``Dodd-Frank Wall Street Reform and Consumer Protection Act'' 
(Dodd-Frank Act) requires significant reforms of derivatives 
activities. For example, under the Dodd-Frank Act certain 
derivatives must be cleared, margin will have to be exchanged 
between derivatives counterparties, certain derivatives (such 
as uncleared credit default swaps that are not hedging risk) 
will be pushed out of IDIs, and the Volcker Rule will limit 
proprietary trading in derivatives positions. These reforms are 
designed to manage systemic risk and should reduce the 
incentives to use derivatives to support unproductive 
activities such as those described by certain derivatives 
experts.

Q.3. Treasury Lew recently stated, ``if we get to the end of 
this year and we cannot with an honest straight face say that 
we have ended Too Big To Fail, we're going to have to look at 
other options.'' Do you agree?

A.3. Effectively addressing ``Too-Big-To-Fail'' will require 
regulators to implement a broad range of reforms. These include 
additional capital requirements, enhanced prudential 
supervision, the reforms of derivatives regulation described in 
the answer to the previous question, the resolution planning 
procedures under Title I of the Dodd-Frank Act and the orderly 
liquidation authorities in Title II of the Act. While we have 
made significant progress on many of these reforms, there is 
still work to do to finalize some of them and some will require 
ongoing attention in the years to come.
    The FDIC has devoted significant effort and resources to 
carrying out our new authorities under Titles I and II. The 
living will requirements of Title I of Dodd-Frank Act and the 
resolution authority of Title II of the Act are critical 
components to addressing ``Too-Big-To-Fail.'' These provisions 
are intended to allow for these firms to fail and be resolved 
in a rapid and orderly manner, without systemic disruption. 
Implementation of these provisions will impose accountability 
on systemically important financial institutions by permitting 
the removal of culpable management and imposing losses on 
shareholders and creditors of a failed company, without risk to 
taxpayers.
    The FDIC expects to continue to make significant progress 
on key elements of addressing ``Too-Big-To-Fail'' before the 
end of the year. For example, the revised resolution plans for 
the largest, most complex financial institutions were submitted 
on October 1, 2013, and will be subject to review under the 
standards of the Dodd-Frank Act. Determination of appropriate 
actions to be taken will be considered by the FDIC and the 
Federal Reserve. In addition, the FDIC expects to release a 
description of the FDIC's strategy for handling the orderly 
liquidation of a systemically important financial institution 
for public comment by the end of the year. Also, the FDIC will 
be engaged in ongoing discussions with our international 
counterparts about planning and coordination regarding the 
failure of a large institution with international operations.

Q.4. The agencies have proposed increasing the leverage ratio 
for very large bank holding companies to 5 percent, and for 
depositories to 6 percent. These ``supplementary'' ratios are 
calculated using U.S. GAAP accounting measures. This means that 
total on-balance-sheet assets include only the net value of 
derivatives positions. If derivatives were accounted for under 
IFRS, which limits derivatives netting, then their total assets 
would be substantially higher. (See, for example, the analysis 
of the quantitative impact of different accounting rules done 
by ISDA: at http://www2.isda.org/functional-areas/research/
studies/.)
    Does the proposed increase in the leverage ratio do more 
than bring the U.S. leverage requirement roughly into line with 
the 3-percent leverage ratio that will be applied by EU 
regulators to all banks?

A.4. The Basel Committee's agreement on the leverage ratio 
includes a definition of the leverage ratio denominator that is 
independent of a bank's accounting framework. Therefore, a bank 
that calculates a leverage ratio under the Basel agreement will 
obtain the same result regardless of the accounting framework 
it uses for reporting purposes. Thus, the recently proposed 
U.S. leverage requirements for large, systemically important 
institutions are, in fact, significantly more stringent than 
the international 3-percent standard, irrespective of the 
accounting framework. If European Union regulators adopt the 3-
percent leverage ratio agreed upon by the Basel Committee, they 
will likely do so according to the Basel Committee's agreement, 
which (consistent with U.S. GAAP and, in many circumstances, 
IFRS) records derivative positions on a net basis.

Q.5. Should the GAAP/IFRS difference and implications be 
detailed and addressed in the rulemakings? If not, why not?

A.5. The proposed rule focused on the numerical value of the 
supplementary leverage ratio, thereby maintaining continuity 
with the definition of that ratio in the revised capital rules 
the agencies published in July 2013. The measurement of 
derivatives exposure is an important issue that the agencies 
continue to analyze with the Basel Committee. The Basel 
Committee recently issued a consultative paper that proposes 
changes to the measure of exposure used in the international 
leverage ratio framework, including for derivatives. As noted 
in the proposed rule, if the Basel Committee finalizes changes 
to the leverage exposure measure, the agencies would consider 
the appropriateness of such changes for purposes of U.S. 
regulation.

Q.6. Have you compared the proposed leverage ratios to the 
losses experienced by banking institutions during the financial 
crisis?

A.6. As noted in the preamble to the proposed rule, the 
agencies' analysis suggests that the 3-percent supplementary 
leverage ratio standard would not have materially constrained 
leverage had it been in effect during the years leading up to 
the crisis. This suggests that the 3-percent leverage standard 
is an insufficient safeguard. With the proposed 6-percent 
supplementary leverage ratio for covered insured banks, the 
increase in stringency of the leverage standards for these 
institutions would be similar to the increase in stringency of 
their risk-based capital requirements in the revised capital 
rules published in July 2013.

Q.7. Why is there a distinction between the leverage ratio for 
bank holding companies and depositories?

A.7. The one percentage point difference in the proposed rule 
between the supplementary leverage requirements for banks and 
bank holding companies is structurally similar to the current 
generally applicable leverage requirements, which also 
incorporate a one percentage point difference between insured 
banks and bank holding companies.

Q.8. Under 12 U.S.C. 1818(e), Federal banking agencies may 
remove ``institution-affiliated parties'' from participation in 
the affairs of an insured depository when they directly or 
indirectly violate banking laws or regulations. Were officers 
or directors of any bank that was party to the mortgage 
servicer settlements removed because they directly or 
indirectly participated in the violations that led to the 
settlements? If no officer or director was removed, can you 
explain why?

A.8. The October 2010 announcement by Ally Financial, Inc. 
(AFI) (the parent of Ally Bank (Midvale, Utah), Residential 
Capital, LLC (ResCap) and GMAC Mortgage, LLC) that certain of 
its subsidiaries (ResCap and GMAC Mortgage) had engaged in 
certain foreclosure practices, now commonly referred to as 
``robo-signing,'' prompted the FDIC's review of the mortgage 
servicing practices and procedures of GMAC Mortgage, an 
affiliate of Ally Bank. The Federal Reserve Bank of Chicago 
joined the FDIC's review of GMAC Mortgage. The Federal banking 
agencies subsequently initiated a horizontal review of the 
Nation's 14 largest mortgage servicers. The Department of 
Justice (DOJ) and a task force of the State Attorneys General 
conducted a parallel review of these practices. As a result of 
these reviews, the Federal banking agencies entered into 
Consent Orders with the entities they supervised and the DOJ 
and State AGs entered into Consent Judgments with many of these 
same entities.
    The FDIC is the primary Federal supervisor of Ally Bank. 
Ally Bank, like many other depository institutions, engages 
third parties to perform mortgage servicing. The horizontal 
review of the major servicers determined that they had engaged 
in unsafe and unsound mortgage servicing practices, and the 
FDIC determined that Ally Bank had failed to properly supervise 
and adequately oversee its third party servicers. Accordingly, 
the FDIC ordered Ally Bank to take corrective action to rectify 
its oversight deficiencies. The required corrective action is 
detailed in the Consent Order entered into by AFI, ResCap, GMAC 
Mortgage and Ally Bank with the Board of Governors of the 
Federal Reserve System and the FDIC. The effect of this Order 
is to require the bank to ensure that its affiliated servicer 
takes corrective measures to fully address the deficiencies 
identified in the interagency review. Both the bank and its 
affiliates have made substantial progress in complying with the 
requirements of the Consent Order. However, the facts regarding 
Ally Bank and its institution affiliated parties documented 
during the horizontal review were not sufficient to satisfy the 
misconduct, effect and culpability statutory standards required 
to support any removal and prohibition action under Section 
8(e).

Q.9. How do you audit large bank IT systems to determine 
potential systemic risk?

A.9. Where the FDIC is the primary Federal regulator of a large 
institution, FDIC examiners conduct information technology (IT) 
and operations risk management examinations to assess the 
effectiveness of a bank's IT risk identification, measurement, 
and mitigation practices. IT and operations risk management 
examinations are conducted concurrently with safety and 
soundness examinations. At the conclusion of an examination, 
the bank is assigned a composite rating that reflects the 
results of the IT and operations risk management evaluation 
(which assesses the effectiveness of the audit, management, 
development and acquisition, and support and delivery 
components). The composite rating is based on a scale of 1 to 
5, with 1 representing the highest rating and least degree of 
supervisory concern and with 5 representing the lowest rating 
and highest degree of supervisory concern. The higher degree of 
supervisory concern, the more frequently the institution is 
examined. In addition to full-scope examinations, FDIC 
examiners may conduct interim visitations to assess whether the 
bank is addressing deficiencies noted in the most recent full-
scope examination.
    The Federal Financial Institutions Examination Council 
publishes an IT Examination Handbook that addresses topics such 
as Information Security, Supervision of Technology Service 
Providers, and Business Continuity Planning. The Handbook 
describes specific IT risks and includes examination procedures 
used to assess a bank's compliance with Federal laws, 
regulations, and supervisory guidance. The procedures in the 
Handbook are more granular for larger, more complex banks. For 
example, the Information Security and Business Continuity 
Planning examination procedures are structured as Tier I and 
Tier II. Tier II procedures are targeted at larger, more 
complex institutions and are more in-depth.
    Where the FDIC is not the primary Federal regulator, FDIC 
examiners and specialists monitor potential risks associated 
with information technology systems' capabilities and controls 
at such firms through ongoing interaction with the primary 
Federal regulator and other regulators of such institutions. 
This ongoing interaction includes obtaining continuous feeds of 
supervisory findings from other regulators and internal risk 
reporting from the institutions as well as working on-site at 
the firms alongside the other regulators, including direct 
participation in certain supervisory reviews and activities. 
The FDIC also obtains information about an institution's 
management information systems through the review of 
institution-prepared resolution plans at both the consolidated 
level and at individual large banks within the organization. 
Such activities allow the FDIC to develop an independent 
assessment of the risk profile of such institutions and 
determine whether appropriate corrective actions are being 
taken to reduce unreasonable risk.

Q.10. The U.S. Chamber of Commerce has called for a trade 
review of the Volcker Rule, alleging that the rule violates 
trade agreements. Has your agency done any legal analysis of 
whether pending or prior trade pacts would vitiate its ability 
to impose higher capital requirements on SIFIs?

A.10. We are not aware of any trade agreements that diminish 
our statutory authority to impose higher capital requirements 
on SIFIs, either through a rulemaking or by order on a case-by-
case basis. The Federal banking agencies have considerable 
discretion to impose capital requirements under the prompt 
corrective action (PCA) requirements of section 38 of the 
Federal Deposit Insurance Act, the International Lending 
Supervision Act, as well as various provisions of the Dodd-
Frank Act (including sections 165 and 171). Historically, the 
risk-based and leverage capital requirements have served as the 
basis for determining an institution's capital category under 
PCA.

Q.11. Has your agency performed any studies or prepared any 
estimates of the profit subsidy banks derive from carrying 
derivatives in depositories?

A.11. We have not attempted to directly estimate the profit 
subsidy from derivatives activities in IDIs. However, the 
revenue generated from derivatives activities in IDIs is 
publicly disclosed. The following table is based on the Office 
of the Comptroller's latest quarterly derivatives report:


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                      FROM THOMAS J. CURRY

Q.1. In late 2011, the agencies issued a highly complex and 
lengthy regulatory proposal to implement the Volcker rule. In 
February of this year, Chairman Bernanke testified that while 
regulators have made a lot of progress on the rule, the issues 
slowing the process ``are finding agreement and closure among 
the different agencies . . . .'' When can we expect the final 
rule? What are the reasons for a delay?

A.1. The agencies have targeted year-end 2013 for issuance of a 
final rule, and we have made considerable progress toward 
achieving that goal. Work on the Volcker rule has required 
continuing review and careful analysis of the over 19,000 
comments submitted during the rule-making process, drafting 
rule text and an explanatory preamble that addresses the 
substantive comments received, and regular interagency 
consultations to ensure the agencies' rules are comparable and 
provide for consistent application. The time and resources that 
the agencies have spent on developing a final rule reflect the 
complexity of the issues, the level of detail and variety in 
the concerns discussed by the commenters, and the care taken to 
consider and evaluate the approaches available to address those 
concerns.

Q.2. Your agencies published a short guide for smaller, less 
complex institutions so they can understand and implement the 
final Basel III rule. Both of your agencies, together with the 
FRB, took additional steps to analyze and mitigate the burden 
of the proposed rule on community banks before promulgating 
final rules. What steps is your agency taking to ensure that 
its bank examiners and regional office staff properly interpret 
and apply the Basel III regime for community banks versus 
larger banks?

A.2. In addition to the Community Bank Guide and the Quick 
Reference Guide, OCC is preparing a presentation to convey a 
consistent message on the changes most relevant to community 
banks. This presentation will be used in field offices 
throughout the country to familiarize examiners with the 
capital changes, support consistent interpretation and 
application of the rules by examiners, and to facilitate 
meetings with bank and thrift management in discussing the 
changes. The presentation will also be available on our 
dedicated Web site for national banks and Federal savings 
associations (BankNet). In addition, OCC conducts ongoing 
national and local outreach to discuss current topics and 
issues. The capital changes will be an ongoing topic in the 
months to come. Institutions are always encouraged to contact 
their local Assistant Deputy Comptroller with any questions or 
topics they would like to discuss and OCC Portfolio Managers 
conduct quarterly monitoring calls with each national bank and 
Federal savings association. These calls are another avenue to 
discuss implementation.
    Finally, the final rule includes a lengthy transition 
period before smaller banks must comply with the new standards. 
All but the largest, most complex banking organizations will 
have until the beginning of 2015 before the first elements of 
the new capital framework come into effect. In addition, banks 
will be granted a lengthy phase-in period such that all 
elements of the new framework will not be in place until 2019.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
             SENATOR MENENDEZ FROM THOMAS J. CURRY

Q.1. Over the last few months, we've seen reports in the press 
of so-called ``regulatory capital trades'', in which regulated 
financial institutions have purchased credit protection (often 
using credit default swaps) from unregulated entities (often 
SPVs, hedge funds, or other entities formed offshore to avoid 
regulation) in order to reduce the amount of capital they need 
to hold against an investment on their books. In effect, these 
trades are transferring risk from regulated institutions that 
are subject to capital requirements to unregulated entities 
that are not subject to capital requirements, and creating 
exposure of the regulated institution to a potential default by 
the unregulated entity.
    If this story sounds familiar, it should--this is 
strikingly similar to what we saw happen with AIG before the 
financial crisis. These trades are transferring risk from 
regulated and supervised financial institutions to unregulated 
corners of the market, where it can build and concentrate 
without monitoring or supervision by regulators.
    The Basel Committee has partly addressed this issue by 
calling for banks to properly account in their capital 
calculations for the costs of credit protection they purchase. 
But does this proposal do enough to address concerns about 
regulatory arbitrage and systemic risk accumulating all over 
again through ``shadow banking''? Are you concerned about these 
``regulatory capital trades'', and what steps are you taking to 
monitor and address these arrangements?

A.1. We believe that concerns with the types of trades you 
describe have been reduced for a number of reasons, reflecting 
lessons learned from the recent financial crisis. The OCC 
carefully scrutinizes the credit risk transfer transactions 
from a supervisory perspective and limits the ability of banks 
to recognize regulatory capital benefits from such transactions 
unless risks have truly been transferred to a third party. In 
addition, risk transfer transactions with nonbanks are now 
almost always collateralized by cash posted by the counterparty 
dealer or nonbank investor. These counterparties have real 
money at risk, which helps to ensure that the end-investor 
bears the actual risks of any losses, and makes it less likely 
that the risks will flow back to the banking system or lead to 
contagion concerns. In the absence of cash or other high-
quality collateral, our standards require banks to hold more 
capital. The application of the proposed swap margin rules, 
which would require financial counterparties to credit 
derivative transactions to post both initial and variation 
margin, would further reduce the risk of nonperformance of 
protection providers, thereby further ensuring that these 
transactions legitimately transfer risk.

Q.2. I held a hearing earlier this year in the Housing 
Subcommittee examining the botched independent foreclosure 
review process and related settlement. At the time, the GAO 
issued a report that looked at some of the problems that 
occurred and outlined a set of ``lessons learned.'' In 
particular, the GAO recommended that the OCC and the Fed 
improve oversight of sampling and consistency, apply lessons in 
planning and monitoring to activities under the consent order 
and continuing reviews, and implement a communication strategy 
to keep stakeholders informed. I'm concerned, however, by 
recent reports suggesting that some of the same problems we saw 
before are continuing to occur. Are you familiar with the GAO's 
recommendations, and what steps has the OCC taken to implement 
them? In your own reviews of the process, what other changes 
have you identified and made?

A.2. The OCC received the GAO's draft report on March 13, 2013. 
As I described in a letter to the Committee on Homeland 
Security and Governmental Affairs Ranking Member Coburn dated 
June 7, 2013, the OCC has the following actions underway in 
response to the recommendations in the GAO report.
    First, to improve oversight of sampling methodologies and 
mechanisms to centrally monitor consistency in the remaining 
foreclosure reviews, our examination and economics staff have 
been working closely with the independent consultants engaged 
in the remaining reviews to ensure sampling approaches are 
consistent and conform to OCC guidance. Second, we have 
identified and applied lessons from the foreclosure review 
process--such as enhancing planning and monitoring activities 
to achieve goals--to our activities under the amended consent 
orders. We enhanced our centralized planning, monitoring and 
tracking of activities associated with the amended consent 
orders to help ensure we meet our goals in a timely and 
consistent manner. For example, we put into place an expanded 
post-settlement foreclosure consent order project plan, and we 
created an examination plan each resident team will use to test 
compliance with all articles of the consent orders. Goal-
oriented results are reported to me and other OCC senior 
management weekly. Finally, GAO recommended that we implement a 
communication strategy to keep stakeholders informed. We are 
following a communication strategy that makes use of methods we 
have found to be most effective with various audiences--direct 
outreach to affected borrowers, webinars for counselors and 
consumer groups, and updates to our Web site. We publish weekly 
updates on our Web site on the number of borrowers who have 
cashed or deposited checks and other news on the independent 
foreclosure review. Through these updates, we have also issued 
reminders to borrowers on the process for presenting checks and 
we have provided notice to financial institutions on the 
process for validating and accepting checks. We are currently 
planning the content and timing of additional public reports to 
inform stakeholders about the IFR Payment Agreements, the 
status of reviews for servicers who did not join the 
agreements, and servicer compliance with other articles of the 
original foreclosure-related consent orders.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                      FROM THOMAS J. CURRY

Q.1. A critical element of the proposed new Basel leverage 
ratio is the definition of the denominator (the assets subject 
to the leverage requirement). A denominator definition that 
permits too many bank commitments to remain off the balance 
sheet and uncapitalized could undermine the benefits of a 
higher leverage ratio requirement.
    Have the banking agencies made a quantitative examination 
of the change in bank assets subject to the leverage 
requirement that will be created by the new Basel leverage 
rules?

A.1. The Basel III supplementary leverage ratio (Basel leverage 
ratio) uses a much more inclusive definition of exposure than 
does the existing generally applicable leverage ratio 
denominator. Specifically, unlike the current generally 
applicable leverage ratio, which ignores all off-balance sheet 
exposures, the Basel leverage ratio, in most cases, includes 
the full notional amount of such exposures (for example, most 
loan commitments and letters of credit). Based on the agencies' 
analysis in the leverage ratio proposed rule, the denominator 
of the Basel leverage ratio, on average, is roughly 40 percent 
greater than the current generally applicable leverage ratio. 
This analysis is based on a group of the largest U.S. banks as 
of the third quarter of 2012.

Q.2. Could you please inform us, for the six largest U.S. banks 
and bank holding companies, the approximate amount of total 
assets that would be counted for the denominator of leverage 
capital requirements under the following definitions of assets: 
U.S. GAAP, IFRS accounting, and the proposed Basel leverage 
ratio definition.

A.2. U.S. GAAP--The Basel III framework attempts to account for 
differences between IFRS and U.S. GAAP for purposes of 
calculating the Basel leverage ratio. As a result, the 
denominator of the ratio (i.e., the measure of exposure amount) 
is fairly independent of the accounting regime that a bank uses 
for reporting purposes. See the table below for a comparison of 
assets as measured by GAAP and the estimated exposure that 
would be used for the Basel leverage ratio for the six largest 
U.S. bank holding companies, in aggregate.
    IFRS accounting--U.S. bank holding companies do not report, 
on a consolidated basis, under an IFRS accounting framework and 
therefore, such data are not readily available. As noted 
earlier, the balance sheet total assets figure under IFRS is 
not being used as the denominator for the Basel leverage ratio.
    The proposed Basel leverage ratio definition--The table 
below provides a comparison of GAAP total assets and estimates 
of the total exposure, as reported in the Comprehensive Capital 
Analysis and Review for the third quarter of 2012, for the six 
largest U.S. bank holding companies.



Q.3. What factors are most important in determining the 
difference between GAAP and IFRS accounting and the proposed 
Basel leverage ratio definition? What is the total amount of 
the difference accounted for by: Changes in off-balance sheet 
treatment of credit commitments that are not derivatives 
contracts and changes in derivatives netting and offset rules.
    To the degree possible, please include breakdowns of the 
impact of the relevant sub-changes in each of these areas, as 
well as written explanations of the areas in the Basel leverage 
ratio definition that account for the differences.

A.3. For financial reporting purposes, there can be significant 
differences between the total assets of an entity calculated 
under U.S. GAAP and IFRS. Specifically, the offsetting 
requirements (i.e., when a reporting entity has the right to 
offset the value of a financial asset with the value of a 
financial liability in the statement of financial position) 
account for the single largest quantitative difference between 
statements of financial position prepared under U.S. GAAP and 
under IFRS. Under IFRS, an entity can only offset a financial 
asset and a financial liability when there is both an 
unconditional right of offset and an intention to settle net. 
Under U.S. GAAP, entities are allowed to offset derivatives, as 
well as related cash collateral, and certain repurchase 
agreement balances subject to master netting agreements, 
including when net settlement is contingent upon default or is 
not intended. There are also minor quantitative differences due 
to the treatment of off-balance sheet commitments under the 
different accounting regimes.
    In developing the Basel leverage ratio, the Basel Committee 
recognized the important accounting differences, particularly 
with respect to the treatment of derivatives, and employed an 
approach to neutralize accounting differences within the Basel 
leverage ratio. As a result, the denominator of the Basel 
leverage ratio is calculated under a regulatory framework, 
minimizing the impact of a reporting entity's accounting 
regime. Although a side-by-side comparison has not been 
performed for the calculation of the total exposure of the six 
largest U.S. banks under U.S. GAAP, IFRS, and the Basel 
leverage ratio definition (due to the fact that U.S. 
institutions do not report under IFRS), qualitatively, the 
Basel leverage ratio allows for more lenient netting rules than 
IFRS but stricter netting than U.S. GAAP. Therefore, it could 
be expected that the total exposure under the Basel leverage 
ratio would be somewhere between the two but closer to a U.S. 
GAAP amount. The Basel Committee is continuing to refine the 
Basel leverage ratio definition and recently issued a 
consultative paper on further enhancements. \1\
---------------------------------------------------------------------------
     \1\ ``Revised Basel III Leverage Ratio Framework and Disclosure 
Requirements'', at http://www.bis.org/press/p130626.htm.

Q.4. The new leverage ratio proposals mandate a leverage ratio 
of 6 percent for large bank subsidiaries, but a lower 5-percent 
ratio for the overall holding company. What policy 
justification is there for this distinction between the bank 
---------------------------------------------------------------------------
and the holding company?

A.4. This dichotomy arises because Prompt Corrective Action 
(PCA) requirements, and therefore well-capitalized standards 
under PCA, apply only at the bank level, and not at the holding 
company level.
    The proposal is structurally consistent with the current 
relationship between the generally applicable leverage ratio 
requirements for banks and holding companies under existing 
regulatory standards. Under existing capital standards, all 
banks must maintain a 5-percent generally applicable leverage 
ratio to be well capitalized for PCA purposes, whereas holding 
companies must maintain a minimum 4-percent generally 
applicable leverage ratio.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                      FROM THOMAS J. CURRY

Q.1. Has your agency done any studies on the costs and benefits 
of allowing banks to book derivatives in depositories?

A.1. The OCC has not conducted a formal, comprehensive, ``cost 
benefit analysis'' of allowing banks to book derivatives in 
depositories. However, the OCC has assessed, and made public, 
the risks and rewards of trading activities, including those 
involving derivatives, since 1995 through the OCC's ``Quarterly 
Report on Bank Trading and Derivatives Activities''. Further, a 
qualitative assessment of costs and benefits is an integral 
part of the OCC's consideration of the legal permissibility of 
new derivatives products. Moreover, the OCC is currently 
reviewing, as required under Section 620 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, the types of 
derivatives activities permissible for national banks and their 
associated risks. Finally, the OCC observes that there is a 
positive correlation between loan loss provisions and trading 
revenues (much of which is in derivatives) at the largest 
trading banks. This means that when loss provisions are high, 
and therefore bank earnings are under pressure, trading 
revenues also tend to be high. That positive relationship 
between provisions and trading revenues helps to diversify the 
net income of these largest firms.

Q.2. A number of derivatives experts, including Frank Partnoy 
and Satyajit Das, contend that a large percentage of complex 
OTC derivatives, including credit default swaps, are not used 
for commerce but for economically unproductive activities such 
as gaming accounting and tax rules or hiding losses. Have you 
ever taken a large sample of derivatives transactions to see if 
these charges have validity? If the charges are accurate, in 
what ways would you change your views about derivatives 
regulation?

A.2. Examiners in the large dealer banks do routinely perform 
transaction testing of complex derivatives trades to assess 
compliance with the interagency guidance on Complex Structured 
Finance Transactions (CSFTs). \1\ They typically select 
transactions for testing based on a review of transaction 
summaries and selecting those that appear to indicate the 
higher risks addressed in the CSFT guidance.
---------------------------------------------------------------------------
     \1\ OCC Bulletin 2007-1, January 5, 2007.
---------------------------------------------------------------------------
    The CSFT guidance cautions banks that if due diligence 
efforts indicate that participation in a particular CSFT would 
create significant legal or reputational risks, bank management 
should take steps to address those risks. Such steps may 
include either declining to participate in the transaction, or 
conditioning its participation upon the receipt of 
representations or assurances from the customer that reasonably 
address the heightened legal or reputational risks presented by 
the transaction. If the bank determines that a transaction 
presents unacceptable risk, or would result in a violation of 
applicable laws, regulations, or accounting principles, the 
bank should decline to participate in the transaction.
    Examples of CSFTs that often pose elevated risks and thus 
covered by the CSFT guidance include transactions that:

    Lack economic substance or business purpose;

    Are designed or used primarily for questionable 
        accounting, regulatory, or tax objectives, particularly 
        when the transactions are executed at year-end or at 
        the end of a reporting period for the customer;

    Raise concerns that the client will report or 
        disclose the transaction in its public filings or 
        financial statements in a manner that is materially 
        misleading or inconsistent with the substance of the 
        transaction or with applicable regulatory or accounting 
        requirements;

    Involve circular transfers of risk (either between 
        the financial institution and the customer or between 
        the customer and other related parties) that lack 
        economic substance or business purpose;

    Involve oral or undocumented agreements that, when 
        taken into account, would have a material impact on the 
        regulatory, tax, or accounting treatment of the related 
        transaction, or the client's disclosure obligations;

    Have material economic terms that are inconsistent 
        with market norms (e.g., deep ``in the money'' options 
        or historic rate rollovers); or

    Provide the financial institution with compensation 
        that appears substantially disproportionate to the 
        services provided or investment made by the financial 
        institution or to the credit, market, or operational 
        risk assumed by the institution.

    Field examiners performing CSFT reviews specifically 
inquire about trade purpose. They report that the purpose of 
most complex transactions is either to lock in a profit, hedge 
a risk, or make an investment. Further transactional testing, 
which examiners perform to test compliance with the CSFT 
guidance, has not revealed that a large percentage of complex 
OTC derivatives involve gaming accounting and tax rules or 
hiding losses. With respect to tax issues, it is common for 
banks to require tax department personnel to approve all CSFTs 
as part of any complex/nonstandard trade or new product 
approval. This procedure ensures that individuals with 
appropriate tax knowledge and sensitivity to reputation risk 
issues are comfortable with the bank's assumption of higher 
risks on these transactions.

Q.3. Treasury Lew recently stated, ``if we get to the end of 
this year and we cannot with an honest straight face say that 
we have ended Too Big To Fail, we're going to have to look at 
other options.'' Do you agree?

A.3. I agree with the Secretary and others that we need to end 
the perception that some financial institutions are ``too big 
to fail.'' I also believe that the significant financial and 
structural reforms that the Dodd-Frank Act and the regulators 
are putting into place will significantly enhance the 
resiliency of large financial institutions and, should they 
develop problems, provide mechanisms to resolve them in an 
orderly manner without expense to the American taxpayer. These 
actions, which I discussed more fully in my written statement, 
include:

    Significantly tougher capital requirements that 
        raise both the level and quality of capital large 
        banking organizations must hold. The revised capital 
        standards that we recently issued increase both the 
        quantity and quality of capital necessary to meet 
        minimum regulatory requirements and enhance the minimum 
        leverage ratio requirements for the largest banks. The 
        rule also mandates that all institutions maintain a 
        buffer of additional common equity, and restricts 
        payment of dividends and bonuses if that buffer falls 
        below 2.5 percent. In addition, for large banks and 
        thrifts, the rule established a countercyclical buffer 
        that can be activated during upswings in the credit 
        cycle to protect against excessive lending. A 
        forthcoming rulemaking will propose a so-called ``SIFI-
        surcharge'' that would apply to the largest, most 
        systemically important financial institutions. With 
        these additional requirements, the largest U.S. banks 
        could be required to hold Tier 1 common equity equal to 
        as much as 12 percent of their risk-adjusted assets 
        during upswings in the credit cycle.

    To further strengthen the capital base of systemically 
        important financial institutions and to provide 
        additional safeguards against excessive leverage at 
        those firms, the OCC, the Federal Reserve Board and the 
        FDIC also recently issued a proposed rulemaking that 
        would substantially increase their minimum supplemental 
        leverage ratio requirements. A higher supplemental 
        leverage requirement will place additional private 
        capital at risk before the Federal deposit insurance 
        fund and the Federal Government's resolution mechanisms 
        would be called upon, and reduce the likelihood of 
        economic disruptions caused by problems at these 
        institutions. By providing a larger capital cushion, it 
        would reduce the likelihood of resolutions, and would 
        allow regulators more time to tailor resolution efforts 
        in the event those are needed.

    Explicit liquidity requirements on the amount of 
        short- and longer-term liquid assets that the largest 
        banks must hold to cover potential outflows and to fund 
        their balance sheet structure. As noted in my written 
        statement, the Basel Committee's Liquidity Framework 
        introduces two explicit minimum liquidity ratios--the 
        Liquidity Coverage Ratio and the Net Stable Funding 
        Ratio--to help ensure banking organizations maintain 
        sufficient liquidity during periods of financial 
        stress. The OCC, Federal Reserve, and FDIC are 
        developing a proposed rule to implement the Liquidity 
        Coverage Ratio in the U.S. for large banking 
        organizations, which we hope to issue for comment by 
        the end of this year.

    Heightened expectations for stronger corporate 
        governance and more stringent risk management. At the 
        OCC, we've told the large banks we oversee that we are 
        holding them to a higher standard than other banks and 
        will insist that their entire risk management regime--
        from the culture at the top, to all of their systems--
        be strong. Our efforts for strong corporate governance 
        and risk management complement and reinforce the 
        heightened prudential standards that Dodd-Frank 
        mandated for banks over $50 billion and that the FRB is 
        implementing. Moreover, I have instructed my staff to 
        develop an approach for incorporating our heightened 
        expectations into our rulebook. This would formalize 
        our standards and enhance our toolkit for applying and 
        enforcing them.

    Dodd-Frank Resolution Authorities. The orderly 
        resolution provisions of Dodd-Frank and the creation of 
        FSOC provide important new mechanisms for regulatory 
        coordination and for resolving large institutions. The 
        living wills process will provide an important 
        mechanism for the regulators to assess whether the 
        various legal structures used by the largest banks are 
        an impediment for effective supervision and, if needed 
        orderly resolution. Likewise, the Orderly Liquidation 
        Authority under Title II provides the FDIC with tools 
        to use when resolving systemically important financial 
        institutions while minimizing moral hazard.

    Other provisions of Dodd-Frank will fundamentally alter how 
and where various financial activities and risk taking can be 
conducted--chief among these are the Volcker rule prohibitions 
on proprietary trading, the risk retention rules that will 
require bank securitizers to have ``skin in the game,'' the 
swap margin and central counterparty and clearing provisions, 
and the incentive compensation rules.
    Combined, these represent profound and far sweeping 
regulatory changes that should significantly enhance the 
overall resiliency of our financial system. I believe we need 
to fully implement these changes before we start to alter the 
regime set forth in Dodd-Frank.

Q.4. The agencies have proposed increasing the leverage ratio 
for very large bank holding companies to 5 percent, and for 
depositories to 6 percent. These ``supplementary'' ratios are 
calculated using U.S. GAAP accounting measures. This means that 
total on-balance-sheet assets include only the net value of 
derivatives positions. If derivatives were accounted for under 
IFRS, which limits derivatives netting, then their total assets 
would be substantially higher. (See, for example, the analysis 
of the quantitative impact of different accounting rules done 
by ISDA: at http://www2.isda.org/functional-areas/research/
studies/.)
    Does the proposed increase in the leverage ratio do more 
than bring the U.S. leverage requirement roughly into line with 
the 3-percent leverage ratio that will be applied by EU 
regulators to all banks?

A.4. Yes. The proposed Basel leverage ratio levels would use 
the same metric applied internationally at a 3-percent level 
and would apply higher requirements for the largest banks to be 
considered well capitalized under Prompt Corrective Action and 
for their holding companies to avoid capital distribution 
constraints.
    The Basel leverage ratio was developed with the 
understanding that accounting regimes vary greatly in their 
degree of asset recognition. The measure attempts to neutralize 
these differences by placing all banks, regardless of the 
accounting regime under which they report, onto a level playing 
field. Therefore, the accounting differences under U.S. GAAP 
and IFRS were not the motivating factor for proposing higher 
Basel leverage ratio levels for the largest U.S. institutions. 
Rather, the motivation was to enhance the safety and soundness 
of these institutions and to ensure that the relative 
calibration of the Basel leverage ratio is aligned with the 
higher risk-based ratios that are part of the recently 
finalized regulatory capital rules.
    While the proposed Basel leverage ratio levels are above 
the agreed-upon international standards, applying higher 
standards to U.S. institutions is consistent with Basel 
standards, which are intended to serve as minimum requirements. 
Several other countries have also proposed or implemented 
higher capital standards than those agreed to under the Basel 
III framework.

Q.5. Should the GAAP/IFRS difference and implications be 
detailed and addressed in the rulemakings? If not, why not?

A.5. As noted above, the calculation of the Basel leverage 
ratio is designed to be largely independent of the accounting 
regime a bank uses. In other words, the Basel leverage ratio 
should be largely independent of whether a bank is using a U.S. 
GAAP-based or IFRS-based accounting regime. Therefore, the need 
to address differences between U.S. GAAP and IFRS is minimized.

Q.6. Have you compared the proposed leverage ratios to the 
losses experienced by banking institutions during the financial 
crisis?

A.6. We have compared the stringency of the leverage ratio 
requirement to the stressed environment banks experienced from 
the financial crisis. An estimated one-half of the covered bank 
holding companies would have met or exceeded a 3-percent 
minimum supplementary leverage ratio at the end of 2006, and 
the other half were quite close to the minimum. This suggests 
that a minimum requirement of 3 percent would not have placed a 
significant constraint on the precrisis buildup of leverage. 
Based on experience during the financial crisis, the agencies 
believe that there could be benefits to financial stability and 
reduced costs to the deposit insurance fund by requiring these 
banking organizations to meet a well-capitalized standard or 
capital buffer in addition to the 3-percent minimum 
supplementary leverage ratio requirement and is a primary 
reason why we have proposed such a higher standard for the 
largest institutions.
    We considered many other factors in calibrating the 
enhanced supplementary leverage ratio standards, including the 
complementary nature of leverage capital requirements and risk-
based capital requirements as well as the potential complexity 
and burden of additional leverage standards. We also think it 
is important that leverage capital requirements are not viewed 
in isolation. From a safety-and-soundness perspective, each 
type of requirement-leverage and risk-based-offsets potential 
weaknesses of the other, and the two sets of requirements 
working together are more effective than either would be in 
isolation. In this regard, the proposal more closely aligns the 
stringency of the leverage and risk-based standards so that 
neither ratio is binding at all times. Closely aligned 
standards not only minimize the degree to which banks can 
actively manage risk-weighted assets before they would breach 
the leverage requirements, but also minimize the incentive for 
banks to take on additional risk before they would breach risk-
weighted requirements. Finally, in weighing the burden of 
imposing higher leverage standards against the benefits to 
financial stability the agencies considered the potential 
effects on credit availability. The agencies are seeking 
comment on all aspects of the proposal, including the proposed 
calibration of the leverage standards.

Q.7. Why is there a distinction between the leverage ratio for 
bank holding companies and depositories?

A.7. This dichotomy arises because Prompt Corrective Action 
(PCA) requirements, and therefore well-capitalized standards 
under PCA, apply only at the bank level, and not at the holding 
company level.
    The proposal is structurally consistent with the current 
relationship between the generally applicable leverage ratio 
requirements for banks and holding companies under existing 
regulatory standards. Under existing capital standards, all 
banks must maintain a 5-percent generally applicable leverage 
ratio to be well capitalized for PCA purposes, whereas holding 
companies must maintain a minimum 4-percent generally 
applicable leverage ratio.

Q.8. Under 12 U.S.C. 1818(e), Federal banking agencies may 
remove ``institution-affiliated parties'' from participation in 
the affairs of an insured depository when they directly or 
indirectly violate banking laws or regulations. Were officers 
or directors of any bank that was party to the mortgage 
servicer settlements removed because they directly or 
indirectly participated in the violations that led to the 
settlements? If no officer or director was removed, can you 
explain why?

A.8. No officers or directors of the participating servicers 
have been removed pursuant to 12 U.S.C. 1818(e). The amendments 
to the foreclosure consent orders do not provide for any 
release of OCC enforcement actions against officers, directors 
and/or employees of the servicers that were parties to the 
mortgage servicer settlements. The OCC considers enforcement 
actions against individuals and where there is evidence of 
individual wrongdoing that meets the legal standards under 
1818(e), removal and prohibition actions are pursued.

Q.9. How do you audit large bank IT systems to determine 
potential systemic risk?

A.9. The OCC examines large bank IT systems as part of regular, 
ongoing examination activities to determine potential systemic 
risk. This enables the OCC to maintain an ongoing program of 
risk assessment, monitoring, and communications with bank 
management and directors. Examiners assigned to large 
institutions include Bank Information Technology (BIT) 
examiners with a thorough knowledge and understanding of BIT 
risks, examination activities, emerging technologies, industry-
effective practices, BIT-related laws, regulations, and 
guidance.
    BIT examiners focus on risk issues inherent in automated 
information systems, including: management of technology 
resources (whether in-house or outsourced); integrity of 
automated information (i.e., reliability of data and protection 
from unauthorized change); availability of automated 
information (i.e., adequacy of business resumption and 
contingency planning); and confidentiality of information 
(i.e., protection from accidental or inadvertent disclosure). 
BIT examiners assess institutions against standards and 
guidelines established in FFIEC and OCC handbooks and 
issuances, as well as applicable laws and regulations.
    Risk issues identified through examination activities are 
evaluated as potential systemic risks. The OCC assesses the 
systemic nature of identified risk issues through multiple 
forums and communication channels. Depending on the nature of 
the risk issue, examiners communicate and discuss the risk 
issues with Examiners-in-Charge, examiners in other 
disciplines, peer network groups, large bank lead experts, OCC 
senior management, OCC policy staff and/or other regulatory 
agencies.

Q.10. The U.S. Chamber of Commerce has called for a trade 
review of the Volcker Rule, alleging that the rule violates 
trade agreements. Has your agency done any legal analysis of 
whether pending or prior trade pacts would vitiate its ability 
to impose higher capital requirements on SIFIs?

A.10. The question is best directed to the Federal Reserve 
Board, which has authority to impose capital requirements on 
SIFIs. SIFIs are BHCs with $50 billion or more in total assets 
and nonbank companies designated by the FSOC. The OCC lacks the 
authority to impose capital requirements on such entities.

Q.11. Certain aspects of the U.S. payments system lag 
international standards by a substantial margin. For example, 
the U.S. still uses magnetic strip technology for credit and 
debit cards, while in Europe, Asia, and even emerging markets 
like South Africa, more secure chip cards (smart cards) have 
been widely used since the late 1990s. South Africa has also 
used cards for paying unbanked laborers starting in the 1990s, 
and at much lower fee levels than American banks charge. Can 
you explain how a less advanced country with much smaller banks 
can run an apparently more efficient payment system than the 
United States?

A.11. The U.S. payments system is a complex ecosystem. Cards 
are only one of the vehicles used for making payments and 
technology is constantly evolving to introduce new forms of 
payment services. For example, both banks and technology 
companies are introducing mobile payment systems that allow 
payments to be delivered and authenticated via mobile devices. 
Technologies exist that allow small businesses to accept 
existing magnetic strip cards with their mobile phones or 
tablets. In addition, consumers can read and store Quick 
Response (QR) codes \2\ on their mobile phones for payments. It 
is unclear what technology will dominate in the future, and 
like today, many may coexist.
---------------------------------------------------------------------------
     \2\ A two-dimensional bar code that is widely used to provide easy 
access to information through a smart phone.
---------------------------------------------------------------------------
    The card world itself is a multilayered environment 
comprised of banks that are issuers, bankcard companies, bank 
and nonbank processors and acquirers, and retailers. Most of 
the U.S. card market was developed around the magnetic strip 
technology. Banks can and do issue smart cards to consumers and 
corporate clients--primarily for frequent travelers, but for 
this technology to be fully functional, other changes are 
needed: ATMs must be equipped to accept the embedded computer 
chip in the ``smart cards'' and merchants must have point of 
sale (POS) devices that will accept the cards. Independent 
sales organizations, merchants, and banks must work together to 
ensure that all the necessary hardware functions with the new 
cards.
    The major credit card companies are taking steps to 
facilitate the migration to ``smart cards.'' Specifically, 
Visa, MasterCard, American Express, and Discover plan to phase 
in smart cards that use EMV (Eurocard, MasterCard, Visa) 
technology in the U.S. market over the next few years. The EMV 
migration plans all have similar incentives and timelines 
designed to encourage migration by processors, acquirers, and 
retailers by October 2015. In the interim, we fully expect that 
these two technologies will coexist. Bankcard companies are 
eager to adopt EMV technology because of the reduction in fraud 
at the POS. However, EMV does not solve all fraud and security-
related issues. For example, these standards do not prevent 
``card not present'' fraud. In addition, EMV has been 
``broken.'' British researchers from Cambridge University 
cracked the card in 2012, claiming that fraudsters can 
penetrate EMV chip cards through certain ATMs and payment 
terminals. \3\
---------------------------------------------------------------------------
     \3\ A loose thread in the technology's standard gives them an 
opening, according to these researchers. As part of the EMV standard, 
ATMs or payment terminals must provide an authentication number that is 
nonrepeating. However, some machines provide numbers that simply 
increase by the same amount for every transaction. That could allow 
hackers to predict an authentication number, steal the card's 
information, and create a cloned card, the report said.
---------------------------------------------------------------------------
    Fees associated with payment technologies are affected by 
centralization, Government involvement, and regulation, as well 
as the complexity of the payments ecosystem such that looking 
at a single fee can be misleading. In many emerging Nations, 
the financial infrastructure is just being developed and thus 
can rely on newer and less costly (nonpaper intensive) 
technologies versus more established systems such as the U.S. 
where a variety of technologies must be supported. As a result, 
the fee structures for banks operating in those countries do 
not need to support a more complex ecosystem. In many less 
developed countries Government support and sponsorship of 
organizations like the mobile network operators also have 
helped reduce the cost to the consumer. In fact, U.S. bankcard 
companies are working with foreign Governments to develop their 
payment systems and therefore lessen the cost of development 
within those countries.
