    [Senate Hearing 114-366]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 114-366

     BANK CAPITAL AND LIQUIDITY REGULATIONS PART II: INDUSTRY PERSPECTIVES

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

                                    HEARING

                                   before the

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

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 SECOND SESSION

                                       ON

    CONTINUING EXAMINATION OF CAPITAL AND LIQUIDITY REQUIREMENTS APPLICABLE
      TO U.S. BANKS IN ACCORDANCE WITH THE BASEL INITIATIVES AND THE DODD-
    FRANK ACT, FOCUSING ON INDUSTRY PERSPECTIVES OF THE CURRENT CAPITAL AND
     LIQUIDITY REGIME AND THE EFFECTS IT MAY HAVE ON THE BANKING INDUSTRY,
               FINANCIAL STABILITY, AND THE ABILITY TO STIMULATE
                                ECONOMIC GROWTH

                                   __________

                                 JUNE 23, 2016

                                   __________

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

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

                                  __________

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      RICHARD C. SHELBY, Alabama, Chairman

    MIKE CRAPO, Idaho                    SHERROD BROWN, Ohio
    BOB CORKER, Tennessee                JACK REED, Rhode Island
    DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
    PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
    MARK KIRK, Illinois                  JON TESTER, Montana
    DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
    TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
    BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
    TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
    MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
    JERRY MORAN, Kansas

               William D. Duhnke III, Staff Director and Counsel

                     Mark Powden, Democratic Staff Director

                        Dana Wade, Deputy Staff Director

                        Jelena McWilliams, Chief Counsel

                           Beth Zorc, Senior Counsel

                    Shelby Begany, Professional Staff Member

                Laura Swanson, Democratic Deputy Staff Director

                    Graham Steele, Democratic Chief Counsel

                           Dawn Ratliff, Chief Clerk

                          Troy Cornell, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)

                                C O N T E N T S

                                  ----------

                            THURSDAY, JUNE 23, 2016

                                                                       Page

    Opening statement of Chairman Shelby.............................     1

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

                                   WITNESSES

    Rebeca Romero Rainey, Chairman and CEO, Centinel Bank of Taos, on
      behalf of the Independent Community Bankers of America.........     4
        Prepared statement...........................................    28
        Responses to written questions of:
            Senator Sasse............................................    85
    Wayne A. Abernathy, Executive Vice President, Financial
      Institutions Policy and Regulatory Affairs, American Bankers
      Association....................................................     6
        Prepared statement...........................................    32
        Responses to written questions of:
            Senator Sasse............................................    87
    Greg Baer, President, The Clearing House Association, and General
      Counsel, the Clearing House Payments Company...................     7
        Prepared statement...........................................    44
    Jennifer Taub, Professor of Law, Vermont Law School..............     9
        Prepared statement...........................................    75

                  Additional Material Supplied for the Record

    Prepared remarks of Martin J. Gruenberg, Chairman, Federal
      Deposit Insurance Corporation, presented to the Exchequer Club
      in Washington, DC, on June 15, 2016............................    96

                                     (iii)

     BANK CAPITAL AND LIQUIDITY REGULATIONS PART II: INDUSTRY PERSPECTIVES

                                  ----------

                            THURSDAY, JUNE 23, 2016

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:01 a.m., in room SD-538, Dirksen
    Senate Office Building, Hon. Richard Shelby, Chairman of the
    Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The Committee will come to order.
        Today we will continue the Committee's examination of one
    of the most critical areas under its jurisdiction: the
    regulation of the U.S. banking system.
        Recently, we heard from a panel of experts on the
    appropriateness and effects of capital and liquidity rules.
    Their testimony highlighted the complexity of the current
    capital and liquidity regime.
        One witness testified, and I will quote, that `` . . . we
    have introduced all these very complicated rules that tell
    bankers how to, in essence, be a banker.''
        We should be able to agree that regulators should regulate
    banks but not run them. Some believe that every one of the new
    capital and liquidity regulations is needed to guard against
    the next crisis. I worry that such complexity could contribute
    to the next crisis.
        Regulators continue to reference the last financial crisis
    as a justification for rule after rule, without establishing a
    requisite nexus between individual rules and how they will
    prevent the next crisis.
        This has created a vastly complex regulatory system that
    could increase systemic risk, while giving a false sense of
    security that the system is safer than it really is.
        For years, I have urged regulators to implement strong
    capital requirements. I believe strong capital is essential for
    a sound banking system and as a safeguard against taxpayer
    bailouts.
        Many have questioned whether recent capital and liquidity
    rules will actually work during the next crisis. For example,
    will they ensure that liquidity is available when it is needed?
    Or will they jeopardize the financial standing of an otherwise
    healthy bank?
        In addition, no regulator has engaged in a rigorous
    economic analysis to identify the effect of regulations on
    funding and liquidity when a crisis strikes.
        On one hand, regulators stress-test banks annually to
    determine whether the banks can withstand adverse economic
    scenarios. On the other hand, they are unwilling to stress-test
    their own capital and liquidity rules to see whether these
    rules will result in more or less liquidity should a crisis
    occur. We simply do not know if these rules are tailored
    appropriately to both prevent and to handle the next financial
    crisis.
        The purpose of today's hearing is to receive testimony from
    industry representatives. We have asked them to discuss the
    current capital and liquidity regime and the effects it may
    have on the banking industry, financial stability, and the
    ability to stimulate economic growth.
        Senator Brown.

                   STATEMENT OF SENATOR SHERROD BROWN

        Senator Brown. Thank you, Mr. Chairman. I appreciate this
    hearing today. I thank all four of our witnesses for joining
    us. We look forward to your testimony and your answering our
    questions.
        Two weeks ago, we heard academics' views on capital
    regulations, and today we hear the banks' views. It is good we
    are hearing from different perspectives. I appreciate the
    breadth of views here. I hope, though, that we will hear on
    this Committee from representatives of the nearly 9 million
    workers who lost jobs or the 5 million Americans who lost their
    homes to foreclosure during the Great Recession or the millions
    of taxpayers that provided billions of dollars in bailout
    funds. I know this Committee has heard me say this, but my wife
    and I live in ZIP Code 44105 in Cleveland. In the first half of
    2007, that ZIP Code had more foreclosures than any ZIP Code in
    the United States of America. We should be listening to people
    who really paid the worse kind of price for what happened less
    than a decade ago.
        Congress put in place a framework for capital and liquidity
    rules, including stress tests and living wills, to strengthen
    the U.S. banking system. We did this to prevent a repeat of the
    economic devastation that forever changed the lives of millions
    of our fellow Americans.
        The rules were meant to tighten as institutions increase
    their size and complexity and riskiness, and the agencies have
    tailored their rules to banks of varying profiles.
        Last week, the Chair of FDIC, Martin Gruenberg, observed
    that, at the end of 2015, large banks, the largest banks, had
    twice as much Tier 1 capital and liquid assets in proportion to
    their assets as they had entering the crisis--a development we
    all should welcome.
        He concluded the evidence suggests that the reforms put in
    place since the crisis have been largely consistent with, and
    supportive of, the ability of banks to serve the U.S. economy.
        Mr. Chairman, without objection, I would like to submit
    Chair Gruenberg's full remarks for the record of today's
    hearing. Mr. Chairman, without objection? Thank you.
        Chairman Shelby. Thank you.
        Senator Brown. In addition to instituting much needed
    reforms to bank capital, to liquidity, to risk management, and
    other standards, Wall Street reform tailored its approach to
    the regulation of community banks.
        For instance, it carved about 98.4 percent of banks out of
    direct CFPB supervision and limitations on so-called swipe
    fees. Apparently, that is all but four members of the
    Independent Community Bankers of America at the time that Dodd-
    Frank became law. All but four of its members.
        Even more banks were exempted from the changes in the
    treatment of trust-preferred securities under the new capital
    rules. Perhaps most importantly, small banks benefited from a
    change in the FDIC's assessment formula included in Dodd-Frank.
        When the change was implemented in the second quarter of
    2011, small banks' assessments fell by one-third, saving these
    banks over $1 billion. Last year, FDIC announced additional
    changes that will further lower the assessment rates for 93
    percent of small banks.
        Just this past Tuesday, sitting at that table, Federal
    Reserve Chair Janet Yellen indicated that the Fed, the FDIC,
    and the OCC may tailor their rules further, as they use an
    interagency regulatory review process to consider what she
    said, ``a significant simplification of the capital regime for
    . . . community banks.'' Again, something that a number of
    people in this room, I think, would welcome.
        Regulators have tailored rules to provide relief to larger
    banks when appropriate, as both sides of the aisle have asked
    of them. The Fed recently announced plans to alter stress test
    requirements for banks over $50 billion in total assets.
        Despite this reality, many of my colleagues on the other
    side of the aisle have called for dismantling Dodd-Frank--again
    and again and again.
        The Chair of the House Financial Services Committee is
    pushing for Wall Street reform to be, as he said, in a quote
    reminiscent of perhaps 100-plus years ago, ``ripped out by its
    roots and tossed on the trash heap of history.''
        Some have even claimed, despite the solid evidence to the
    contrary, that Wall Street regulations are the cause of, not
    the cure for, financial instability.
        The inconvenient truth is that a financial crisis, brought
    about by reckless deregulation and Wall Street greed--no
    question about that--set off a broader economic crisis that
    helped to contribute to my ZIP Code leading the Nation in
    foreclosures.
        The recovery from that crisis has required a sustained
    period of record low interest rates that have compressed banks'
    profit margins. But that does not make for a compelling hearing
    topic for an agenda that views repealing Dodd-Frank, or many of
    its reforms, as the panacea for all economic issues, real and
    imagined.
        The President of the ICBA, Cam Fine, said it well last
    October:

            Dodd-Frank . . . became the poster child for every regulatory
            ill that has been foisted onto community banks . . . There are
            regulatory burdens that community banks face today that are
            real, but had nothing to do with Dodd-Frank.

        I look forward to a time when we can stop fighting old
    partisan battles. The families living in the low- and moderate-
    income communities that are still struggling to recover deserve
    more of our attention and our energy.
        Thank you, Mr. Chairman.
        Chairman Shelby. This morning, we will receive testimony
    first from Ms. Rebeca Romero Rainey, who is the Chairman and
    Chief Executive of course, of Centinel Bank of Taos. She is
    also the Chairman of the Independent Community Bankers of
    America.
        Next we will hear from someone who is no stranger to this
    Committee, the Honorable Wayne Abernathy, who is the Executive
    Vice President for Financial Institutions Policy and Regulatory
    Affairs at the American Bankers Association.
        Then we will hear from the Honorable Greg Baer, who is the
    President of The Clearing House Association and Executive Vice
    President and General Counsel at The Clearing House Payments
    Company.
        Finally, we will receive testimony from Ms. Jennifer Taub,
    who is Professor of Law at the Vermont Law School.
        We will start with you, Ms. Rainey. All of your written
    testimony will be made part of the hearing record, but you
    proceed as you wish.

     STATEMENT OF REBECA ROMERO RAINEY, CHAIRMAN AND CEO, CENTINEL
    BANK OF TAOS, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF
                                AMERICA

        Ms. Rainey. Chairman Shelby, Ranking Member Brown, and
    Members of the Committee, my name is Rebeca Romero Rainey, and
    I am Chairman and CEO of Centinel Bank of Taos, a $215 million
    asset bank headquartered in Taos, New Mexico. I am a third-
    generation community banker. Centinel Bank was founded by my
    grandfather, Eliu Romero, in 1969. Years earlier, he had been
    denied a loan to finance his startup law practice. That
    experience led him to start a bank that would provide credit
    for all people within our community, and I am proud to carry on
    his legacy.
        I am also Chairman of the Independent Community Bankers of
    America, and I testify today on behalf of the more than 6,000
    community banks we represent. Thank you for convening this
    hearing. Bank capital regulation has the power to promote or to
    stifle community bank lending.
        We believe that changes are urgently needed. In particular,
    ICBA urges this Committee's support for an exemption from Basel
    III capital rule and a return to Basel I for banks with assets
    of less than $50 billion.
        Under Basel III, community bank capital regulation became
    significantly more punitive and complex. Do we really need four
    definitions of regulatory capital, a capital conservation
    buffer, and impossibly complex rules governing capital
    deductions and adjustments?
        At its inception, Basel III was meant to apply only to the
    largest international banks. Applying the rule to community
    banks in a one-size-fits-all manner harms the consumers and
    businesses we serve.
        Aspects of Basel III that are of particular concern
    include: High volatility commercial real estate, or HVCRE;
    complex new reporting requirements; the capital conservation
    buffer; and the punitive treatment of mortgage servicing assets
    and investments in trust preferred securities, or TruPS.
        Basel III's overly broad definition of HVCRE sweeps in too
    many development projects. Taos needs new development--hotels,
    apartments, buildings, shopping centers--to create jobs and
    finally lift us out of the last recession. Basel III risk rates
    HVCRE lending at 150 percent, 50 percent higher than under
    Basel I.
        We want to make every creditworthy loan we possibly can,
    consistent with reasonable capital requirements and safety and
    soundness. But the HVCRE risk rates will force us to make
    difficult tradeoffs in lending to promising development
    projects.
        Another troubling aspect of Basel III is the contribution
    to the page count and complexity of our quarterly call report,
    which had already become a nearly unmanageable burden. Centinel
    Bank's last call report was 93 pages long, and it took 2 \1/2\
    weeks of employee time to prepare it. For this reason, highly
    rated community banks should be allowed to submit a short-form
    call report in the first and third quarters of each year. ICBA
    thanks Senators Moran and Tester for introducing S. 927, which
    would provide for short-form call reports.
        The capital conservation buffer poses a special challenge
    for more than 2,000 community banks organized under Subchapter
    S of the Tax Code, including Centinel Bank. As a passthrough
    entity, we are taxed at the shareholder level. If the capital
    conservation buffer were to prevent us from making
    distributions, our shareholders would be forced to pay its tax
    on their share of the bank's undistributed net income out of
    their own pocket--a prospect that makes it harder for us to
    seek new shareholders. Basel III raises capital levels, but it
    also makes it harder to meet them.
        The punitive capital treatment of mortgage servicing assets
    is driving communities banks out of the servicing business and
    promoting consolidation or, worse, the sale of servicing assets
    to nonbanks, which are not subject to prudential standards.
    Community bank investments in TruPS are being punished by
    similar capital treatment, with a direct impact on their
    lending capacity. For all these reasons, exemption from Basel
    III is a priority for community banks. I seriously doubt that
    my grandfather would have founded Centinel if we had to comply
    with Basel III and other new regulations that exist today.
        We are grateful to Senator Rounds for introducing S. 1816,
    which would exempt banks with assets of less than $50 billion
    from Basel III. In addition, I encourage this Committee to
    consider measures that would help us meet our higher capital
    requirements under the new rule.
        A bill recently passed the House, H.R. 3791, which would
    raise the asset threshold for the Federal Reserve's small bank-
    holding company policy statement from $1 billion to $5 billion.
    This change would provide capital relief to some 415 additional
    bank-holding companies.
        I would like to thank this Committee for raising the
    threshold from $500 million to $1 billion. ICBA has long held
    the position that the threshold should be significantly higher
    to recognize the higher-average asset size of today's community
    bank and thrift-holding companies.
        With that, I will conclude my statement, and thank you
    again for the opportunity to testify. I am happy to take your
    questions.
        Chairman Shelby. Thank you, ma'am.
        Mr. Abernathy.

      STATEMENT OF WAYNE A. ABERNATHY, EXECUTIVE VICE PRESIDENT,
    FINANCIAL INSTITUTIONS POLICY AND REGULATORY AFFAIRS, AMERICAN
                          BANKERS ASSOCIATION

        Mr. Abernathy. Thank you, Chairman Shelby, Senator Brown,
    and Members of the Committee. The American Bankers Association
    represents the breadth and depth of the banking industry from
    the smallest to the largest and all business models.
        Our chief recommendation is that regulators, regulated, and
    the public begin an inquiry into what works. We appreciate the
    Fed starting with stress testing. We are in the eighth year of
    an intensive regulatory reform process. The whole is
    overwhelming for each individual bank, but also a ponderous
    weight upon regulators.
        Increasing regulatory capital is contractionary. Financing
    banks by deposits is expansionary, funding economic activity.
    We need more of the latter.
        Excessive capital rules mean more capital but no additional
    financial service. The largest banks must monitor more than a
    dozen capital dials. Does each have equal supervisory value? If
    not, do those with lesser value steal attention?
        Academic debate pits risk-based capital against leverage
    capital. Bankers and regulators use both. The leverage ratio is
    a risk-blind model, all assets given equal weight.
        Whatever might be said about errors in risk-based, we can
    be certain that the Procrustean simplicity of the leverage
    ratio is always wrong. The 1980s S&L experience demonstrates
    that risk-blind simplicity hides the riskiness of assets until
    they explode, an approach rejected by all regulators and by the
    law.
        Liquidity is dynamic. Financial instruments are liquid
    until they are not. Fannie Mae and Freddie Mac securities once
    seemed so liquid that thought was given to using them for
    monetary policy. The Basel-prescribed liquidity schemes ignore
    liquidity's dynamic nature. They are static, sure to become out
    of date. Like Dorian Gray, they rely on an unchanging picture
    of liquidity while reality changes all around.
        They do not fit U.S. realities. Under the Basel liquidity
    coverage ratio, LCR, banks must assume that financial stress
    will cause a run on deposits. Our banking industry saw an
    influx of deposits by $813 billion during the recession.
        The current structure of the LCR will hasten and deepen
    recession. Banks must concentrate holdings in a narrow list of
    high-quality liquid assets, HQLA, short-term Government
    securities. If there is not enough, what will happen? Panic.
    HQLA will become only one-way liquid. Who will be willing to
    let go of their supply? Those without enough will have trouble
    finding more.
        Basel's other liquidity rule, the net stable funding ratio,
    NSFR, now under comment, lacks a purpose. There is no problem
    that the NSFR would solve that is not already addressed.
        ABA offers the following recommendations:
        In 2014, ABA and bankers associations from every State and
    Puerto Rico asked regulators to recognize that highly
    capitalized banks already meet Basel III standards, without the
    complex calculations.
        Basel III came before the public, Congress, and industry
    far too late. We are still working through Basel problems that
    could have been avoided, including the dangerously narrow HQLA,
    the punitive treatment of mortgage servicing assets, Subchapter
    S banks, and investments in TruPS. Prior to foreign
    negotiations, agencies should involve the public, Congress, and
    industry through publication of an Advance Notice of Proposed
    Rulemaking. This should apply to financial standards whether
    banking, insurance, asset management, or other financial
    products and services. The NSFR should be withdrawn.
        Basel III should grandfather existing TruPS. Under Basel,
    any amount of TruPS above 10 percent of bank equity is treated
    as a loss, regardless of performance. Many hometown banks are
    seeing their capital requirements skyrocket.
        Rules are more complex than they need to be, too complex
    for regulators and regulated alike. The American banking
    industry is eager to engage in the conversation we recommend.
    Supervision and management can be even more effective. That
    will be better for regulators and the regulated, and especially
    for the people whom we all serve.
        Thank you, Mr. Chairman.
        Chairman Shelby. Mr. Baer.

         STATEMENT OF GREG BAER, PRESIDENT, THE CLEARING HOUSE
     ASSOCIATION, AND GENERAL COUNSEL, THE CLEARING HOUSE PAYMENTS
                                COMPANY

        Mr. Baer. Chairman Shelby, Ranking Member Brown, Members of
    the Committee, my name is Greg Baer, and I am President of The
    Clearing House Association. We are a nonpartisan organization
    that contributes research, analysis, and data to the public
    policy debate. We are owned, along with our sister Payments
    Company, by 24 of the largest banks operating in this country.
        Today I will first describe how core post-crisis reforms
    have made banks more resilient and more resolvable.
        Second, I will describe other reforms, many still pending,
    whose costs appear to greatly exceed their marginal benefit.
        Last, I will provide an overview of some of the cumulative
    effects of these regulations.
        The first core reform is capital regulation. For our 25
    owner banks, Tier 1 common equity has nearly tripled over the
    last 7 years, to over $950 billion.
        As a useful benchmark for just how much capital that is,
    consider the Federal Reserve's CCAR test. Large banks must now
    be able to weather an extraordinary stress, everything from an
    unprecedented 4-percentage-point increase in unemployment over
    four quarters to an 11,000-point loss in the Dow, all while
    continuing to do business as usual.
        A second core reform is liquidity regulation. Under the
    liquidity coverage ratio and other rules, large banks are
    substantially less likely to fall victim to a run now. The FSOC
    recently reported that the largest banks now hold about 30
    percent of their balance sheet in the form of Treasurys, cash,
    and other highly liquid assets, nearly double pre-crisis
    levels.
        A third core reform is resolvability. As detailed in my
    testimony, Title I and Title II of the Dodd-Frank Act are core
    reforms that ensure that any bank can be resolved in a way that
    requires no taxpayer assistance and does not destabilize the
    broader system. And markets understand this change as they are
    pricing bank debt assuming they are fully at risk.
        The Clearing House strongly supports these reforms.
    However, 8 years past the crisis, regulations are still being
    written that have high costs and minimal benefits. These
    include:
        First, the U.S.-only supplemental leverage ratio. Under
    this rule, our banks are holding over $50 billion in capital
    against cash on reserve at the Fed, capital that could be
    deployed to lending. It also has sizable adverse effects on
    capital markets activity and custody services.
        Second, the U.S. G-SIB surcharge, one of many Basel reforms
    where U.S. regulators have dramatically increased requirements
    for U.S. firms only, with significant ramifications in this
    case for capital markets.
        Third, a newly proposed countercyclical capital buffer,
    which would allow the Federal Reserve to raise capital even
    further based on an unproven and largely unexplained
    macroprudential theory.
        Fourth, ring fencing for foreign banks that is diminishing
    their ability to serve U.S. businesses.
        Fifth, another liquidity rule, the net stable funding
    ratio, that appears likely to limit loan growth while
    delivering no marginal benefit.
        Finally, and perhaps most significantly, a whole series of
    pending Basel rules, collectively known as ``Basel IV,'' which
    would rewrite many of the capital rules again, with substantial
    impacts on nearly every aspect of the U.S. economy.
        My written testimony describes these rules and others in
    detail, so let me focus on their cumulative impacts.
        Capital and liquidity rules are shrinking credit
    availability, particularly to small businesses and low- to
    moderate-income consumers. While nonbank alternatives have
    sprung up, they tend to be expensive and will likely prove less
    available in an economic downturn. Whether with payday lenders,
    finance companies, or online lenders, prices charged to
    consumers and businesses are extremely high. This should come
    as no surprise because this is what banks are built to do. Not
    only do banks have access to lower-cost and more durable
    funding, they know the borrower and are better able to price
    the risk.
        In capital markets, bank dealers are exiting businesses.
    Dealer inventory is shrinking, trade sizes are getting smaller,
    and trading is clustering in on-the-run issuance by only the
    largest companies, markets where liquidity is still to be
    found. Small and mid-size firms have less access to capital
    markets and, thus, are more reliant on bank lending, just as it
    is becoming more difficult to obtain.
        Thus, when the next economic or financial crisis comes,
    there is reason for concern that large banks will become a
    systemic Maginot Line, extremely well fortified, all but
    certain to remain intact, but playing little useful role in
    battling risk. We do not know what
    geopolitical shock or asset bubble will cause such a crisis,
    but the chances of its first victims being banks with three
    times the capital they held before the last crisis, with
    plentiful liquidity, appear very low. Rather, shadow lending
    and trading systems that are undiversified, market-funded, and
    unsupervised would seem to be a more likely source of
    flagration and accelerant.
        In short, the current regulatory priority should not be
    reinforcing the Maginot Line with new rules but, rather,
    exploring other sources of risk outside its borders.
        I hope this has been helpful, and I look forward to your
    questions.
        Chairman Shelby. Thank you.
        Professor Taub.

       STATEMENT OF JENNIFER TAUB, PROFESSOR OF LAW, VERMONT LAW
                                 SCHOOL

        Ms. Taub. Chairman Shelby, Ranking Member Brown, and
    distinguished Members of this Committee, thank you for this
    opportunity to testify today. My name is Jennifer Taub. I am a
    professor at Vermont Law School, and formerly I was an
    Associate General Counsel with Fidelity Investments. I offer my
    testimony today solely as an academic and not on behalf of any
    association.
        The title of today's hearing, ``Bank Capital and Liquidity
    Regulation,'' sounds terribly technical, seemingly a topic just
    for the experts. But it is not. Reducing excessive bank
    borrowing through higher capital requirements matters to us
    all.
        Bank capital is much more than just numbers you can count
    up on a balance sheet. Bank capital is what we can count on to
    ensure a more stable financial system that serves the credit
    needs of American families and businesses.
        So what do we mean by capital? Let us say I want to buy a
    small business for $100,000, and I borrow $95,000 from my
    cousin and pay the balance in cash. My equity capital would be
    $5,000, the difference between what I own and what I owe. That
    is a 5-percent leverage ratio.
        If my cousin suddenly demanded the money back, hopefully I
    could sell the business for at least $95,000. If not, I have
    wiped out my capital and would be scrambling for other things
    to sell to fully pay back that loan. That is the downside of
    leverage. But if I can sell the business for $105,000, I have
    doubled my money, the upside of leverage.
        Extending this metaphor, liquidity is about whether I have
    enough cash on hand to fully pay back the loan while I wait a
    bit to try to fetch a better price for that business.
        Similarly, banks borrow money from their depositors and
    other lenders. They use this funding to make loans and to buy
    other assets like derivatives. If their depositors or other
    lenders demand their money back and assets cannot be sold at
    full value, the bank's capital cushion is supposed to absorb
    the difference. If it is too thin, then we, the people, may
    have to bail them out.
        When banks borrow excessively, in good times they gain. In
    bad times we all lose. If banks teeter and topple, lending
    tightens, and the broader economy suffers. We see job losses,
    investment losses, home losses. This is a hard lesson that we
    have learned and forgotten time and time again.
        If we take financial historians seriously, we would
    understand that this time is not and will not ever be
    different. Financial crises share common elements. After an
    asset bubble deflates, thinly capitalized banks that hold
    deflating assets collapse when depositors or other lenders
    withdraw their money. Even good assets cannot be sold at full
    price under stress. This spreads. Government rescues follow
    when leaders realize the collapse of a giant bank could cause
    cascading failures and wider damage.
        We were schooled in this too-big-to-fail problem in 2008.
    Let us recall that the U.S. Government committed many trillions
    of dollars in direct and indirect bailouts to rescue the
    system. Some will assure you this does not matter anymore
    because most of the money was paid back. That is cold comfort
    for the more than 6 million families who lost their homes to
    foreclosure since 2008 and to all of us who are struggling in
    an economy that is just beginning to pick up steam.
        To help ensure that this would never happen again, Dodd-
    Frank was enacted. This law provides regulators with tools to
    rein in excessive borrowing and otherwise help end too-big-to-
    fail. The related rules have made the system safer but not safe
    enough. The current 4-percent leverage ratio is way too low.
    The soon to be required 5 percent for our largest bank-holding
    companies and 6 percent for their insured depositories will
    still be too low.
        So how much capital is enough? Financial economists Anat
    Admati and Martin Hellwig recommend at least 20 percent.
    Together with other leading economists, they have advocated for
    at least 15 percent. This would confer substantial social
    benefits with few social costs.
        This measure should be based on total, nonrisk-weighted
    assets, including certain off-balance-sheet items. While the
    risk-weighted asset approach complements the leverage ratio, it
    is not enough on its own. It is subject to arbitrage and abuse.
        Let us be clear, though. A healthy equity capital cushion
    is necessary but not sufficient. Allowing banks with a mere 10-
    percent leverage ratio a free pass from other crisis prevention
    and intervention rules is misguided. This is but one of the
    many faults with Chairman Hensarling's bill.
        In conclusion, more bank equity capital and better bank
    liquidity means less systemic risk and reduces the cost of
    crises. It makes banks less fragile and more capable of lending
    even after suffering losses.
        Thank you for the opportunity to speak. I look forward to
    your questions.
        Chairman Shelby. Thank you.
        Ms. Rainey, I will start with you. In your testimony, you
    state, and I will quote, ``Applying Basel III to community
    banks in a one-size-fits-all manner harms the consumers and
    businesses that rely on community bank credit.'' Those are your
    words. In particular, you mention that the additional capital
    required for high volatility commercial real estate will, and I
    will quote you again, ``force [you] to make difficult tradeoffs
    in lending to promising development projects'' that will reduce
    credit and harm job creation.
        How will this impact your ability to do business in your
    community going forward? Give us an example.
        Ms. Rainey. An example is the HVCRE capital requirements.
    So as I look at development projects, which I am anxiously
    awaiting coming back to our communities--you see, in Taos, New
    Mexico, we are dependent on tourism. That is what drives our
    market. We are still deep within the throes of a recession. And
    as those projects come into our community, be it hotels,
    restaurants, things that will help provide jobs, resources for
    our community, the additional risk weighting of those loans
    makes it very difficult for us as a smaller organization to
    make that difficult decision to take on that development
    project. And in our small community, there are very few options
    for financing.
        Chairman Shelby. And your bank is a small bank. You said is
    $215 million.
        Ms. Rainey. Yes, sir. We are $215 million.
        Chairman Shelby. OK. Mr. Abernathy, in your testimony you
    state that the application of global standards to the entire
    U.S. banking industry can have a disproportionate and
    unexpected impact on community banks. One example you provide
    is how the Basel III treatment of trust preferred securities is
    causing hometown banks', small banks' capital requirements to
    skyrocket. Explain for the Committee how the Basel III
    treatment of trust preferred securities is negatively impacting
    community banks, and what is the end game here?
        Mr. Abernathy. Thank you, Mr. Chairman. It is a good
    example, this particular case, of how these global rules, when
    you take them and bring them to a particular nation and apply
    them, do not always fit. And Basel is a real good example, that
    and TruPS is one of the ones I like to point to.
        Under the Basel III rules applied to TruPS, the intent of
    Congress, which was to grandfather or hold TruPS investments
    harmless, is undermined because under the Basel III capital
    rules, they would apply a capital charge to anything above 10
    percent of equity in the investments in TruPS. And what they
    require the bank to do is to treat that as if it were a loss
    with no recognition as to how that asset is actually
    performing. That is one of the kind of fixed and Procrustean
    rules that you get from Basel that just does not work with our
    economy.
        Chairman Shelby. How can we work through that, yet make
    sure that the smaller banks have adequate capital? And we want
    good capital, we want strong banks, whether they are large or
    small, right?
        Mr. Abernathy. Yes, absolutely. One of the things that is
    very positive about Basel is that it is requiring that the
    quality of capital be improved. That is a principle that should
    apply to every bank. But where the problems arise is when you
    are looking at the very complicated risk-weighting calculations
    that you have to apply to all of your assets.
        What we have proposed in our testimony, which all of the
    State bankers associations and ABA has proposed to the
    regulators, is that if a bank has, say, twice what Basel could
    ask for in capital, that should be enough of an indication to
    the regulators that that bank is already complying with Basel
    and should not have to go through all the detailed calculations
    to get there.
        What you find is a bank, I am sure, like my colleagues here
    and, frankly, thousands of banks around the country, they are
    sitting on this much capital, they have got to go through the
    Basel calculation, and it says you need only this much, and
    they say, ``What was that all about? Why did we have to go
    through that calculation when in the end you just demonstrate
    that we have twice what we need?''
        They should not have to go through that because it serves
    no beneficial purpose, for regulatory purposes or for the bank.
        Chairman Shelby. But you would agree with me that capital
    is very important to the small banks, medium banks, large
    banks, and so forth. But I would think--and you can correct
    this if I am wrong--that capital for a lot of the community
    banks is harder to raise than it would be for some of the money
    center banks.
        Mr. Abernathy. That is true. Community banks have fewer
    sources or accesses to capital. That is why the TruPS
    instrument was invented back about 10, 15 years ago. What was
    demonstrated is that it does not absorb losses as well as we
    would like, so that was taken off of the table. But it was
    grandfathered so that you are not imposing a new loss and cost
    upon community banks as they adjust. But it is true that
    community banks have fewer sources of capital that they can go
    to.
        Chairman Shelby. Mr. Baer, in your testimony you state, and
    I will quote, ``As regulatory requirements--and, in particular,
    capital and liquidity requirements--become increasingly
    stringent and granular, they . . . effectively drive capital
    allocations.'' Provide a few examples of how regulatory
    requirements are driving capital allocation and explain any
    concerns you may have with this approach. And what does it do
    to the business community, small business and medium size?
        Mr. Baer. Thank you, Mr. Chairman. There are innumerable
    examples. Let me just try to give you a couple.
        One, for example, if you look at the Fed CCAR stress test,
    which is now really the binding constraint for almost all large
    banks, if not all large banks, it contains a FICO cutoff of
    620; that is, although we do not know exactly how the models
    work, certainly those above 620 are treated far better than
    those below 620. So that will necessarily drive bank lending
    decisions, and you will be much better off at 630 than, say,
    610.
        It also does not distinguish between, say, a 620 that has
    been rising for years from the 500s to someone who had a 700 a
    few weeks ago and is now obviously experiencing a credit
    crisis. So in that way, it is displacing bank judgments about
    what are really fine decisions that need to be made.
        I think Ms. Rainey gave another example with respect to
    community banks. They are everywhere. Also within CCAR, there
    is a particularly tough treatment of BBB spreads which will
    affect activity in lending markets. There are examples where
    under CCAR the assumption around unemployment is extremely
    severe, which necessarily puts pressure on loans that are
    subject to greater default rates if, in fact, unemployment
    rises, which are basically loans to folks who do not have
    significant wealth or a steady income.
        Chairman Shelby. Mr. Abernathy, my last question. Earlier
    this week here, Chair Yellen of the Board of Governors of the
    Fed appeared before this Committee, and I asked her whether the
    current effort to review CCAR will result in more meaningful
    tailoring in a way that recognizes the different risk profiles
    of banks. She responded that it was ``very likely'' that
    regional banks would receive an exemption from a part of the
    stress test.
        How can the Fed revise CCAR to appropriately address the
    different risk profiles of banks? Can they do that? I mean,
    banks do have different profiles.
        Mr. Abernathy. They do, absolutely, Mr. Chairman, and that
    is one of the things that we are really very encouraged about
    by Chair Yellen's testimony, that it appears that the Fed is
    engaging in exactly what we are calling for in our testimony, a
    conversation with Congress, with the public, with the industry,
    to look at these different regulatory tools that have been put
    in place and asking, How can we make them better? Tailoring the
    CCAR and the other stress tests is an important way of doing
    that and recognizing that there are a variety of different
    business models.
        If you want your stress test to genuinely stress and test
    particular banks, you need to model it based upon the business
    plan of that particular institution. And it is not just size.
    It is the whole risk portfolio of the particular institution.
    They have authority to do that. We hope they will do that. We
    hope they will do that in conversation with the public,
    Congress, and with industry. I think that will increase the
    likelihood that we will get it right.
        Chairman Shelby. Thank you.
        Senator Brown.
        Senator Brown. Thank you, Mr. Chair.
        Professor Taub, thank you for your clear, understandable
    way of discussing and explaining leverage and risk and
    liquidity and capital. In 2009, when then-Secretary of the
    Treasury Geithner was presenting the framework for Wall Street
    reform to the House Financial Services Committee, our
    counterpart, he said:

            You want capital requirements to be designed so that, given how
            uncertain we are about the future of the world, given how much
            ignorance we fundamentally have about some elements of risk,
            there is a much greater cushion to absorb loss and to save us
            from the consequences of mistaken judgment and uncertainty in
            the world.

        We now are 8 years beyond the crisis. There seems to be a
    sense of amnesia setting in, certainly to this Committee, to
    the Senate, and to many in the public. Give me your
    observations on how the arguments around capital have evolved
    from the time of Secretary Geithner's observations.
        Ms. Taub. Senator Brown, thank you for your question. I
    really think that is an elegant statement by Secretary of the
    Treasury Geithner about the importance of equity capital as a
    buffer.
        I do think there has been a kind of selective amnesia that
    has set in. I think memories are good that Washington will be
    here to bail out the banks in the future, and that is why I
    believe there is this extensive lending and forgetting about
    the need to raise
    equity capital requirements.
        If you look back in 2010, we had many folks saying,
    including Alan Greenspan, that the banking system had been
    undercapitalized for years. We have had folks, including Nobel
    Laureate
    Eugene Fama, suggesting dramatically needing increases in
    capital, perhaps up from where we are to 40 to 50 percent. Alan
    Greenspan, in 2013, when he was making a book tour, mentioned
    that perhaps 22 percent capital would be necessary. But here we
    are with just 4 percent waiting for the 5- and 6-percent
    leverage capital ratios to kick in.
        So I think it is a shame that we have not--when there is so
    much bipartisan support on the need for capital buffers, that
    we are still at these low levels at this point.
        Senator Brown. Thank you, Professor Taub.
        This is for all the panelists, and I will start with you,
    Ms. Romero Rainey. Did risk posed by systemic nonbanks play an
    important role in the crisis? And do you find that heightened
    regulation of nonbanks is important, both to protect our
    financial system and to help regulated banks remain
    competitive? So really two questions for each of you, if you
    would answer it fairly quickly. Would nonbanks play a role,
    systemic role in this? And, second, heightened regulation of
    nonbanks, is that important?
        Ms. Rainey. Yeah, I think all entities should be regulated
    for the risks that they pose to the system.
        Senator Brown. OK.
        Mr. Abernathy. Thank you for that question because it goes
    right to the other thing you did earlier, which is put FDIC
    Chairman Gruenberg's recent speech in the record. In that
    speech--and I was there and heard him deliver it--he pointed
    out that the banking industry today makes up only 16 percent of
    the financial services industry. That is the market share of
    the banking industry. Where is the other 84 percent? That is in
    the nonbank world. Can we ignore that and assume that we have
    covered all the risks? The answer is no. We have to look at the
    entire package. Whereas, a lot of the regulatory effort in
    recent days has been on the 16 percent, which I think is
    important, but let us not ignore the rest.
        Senator Brown. Mr. Baer.
        Mr. Baer. I think it is good to remember that AIG, Lehman
    Brothers, Bear Stearns, Countrywide were not banks. No one
    really had thought about the potential systemic impacts of a
    money fund, the reserve fund going bust. So I think it is
    actually quite important, particularly now, to recall how much
    of the financial crisis originated outside and spread through
    the nonbanking system. It gets back to the Maginot Line point I
    was making earlier, which is as we push more and more risk out
    of the banking system, it is a very good time to ask: Where is
    that risk going? How do we feel about that? And how is it being
    regulated?
        Senator Brown. Ms. Taub.
        Ms. Taub. So our concerns about nonbanks or the shadow
    banking system are not new. In 2010, the Federal Reserve Bank
    of New York noted that $16 trillion in liabilities were with
    the shadow banking sector versus $13 trillion with the
    traditional banking sector. And I would also point out that I
    consider Countrywide to be a bank, as it was a thrift-holding
    company.
        But I think some of this attention to nonbanks is a bit
    pretextual. I was just at a hearing at a House Subcommittee a
    few weeks ago, and folks were lobbying for reducing the amount
    of oversight on nonbanks such as private equity funds and hedge
    funds. So I wish we would get our stories together here.
        Senator Brown. Let me follow up with you, Professor Taub.
    We hear the argument a lot that bank regulations will force
    more financial activities to the nonbank sector, the less
    regulated sector. One, tell us whether that is actually
    happening. And, second, what is the best way to prevent that
    kind of migration--to regulate banks less or to regulate other
    activities--to regulate all activities equally?
        Ms. Taub. So in referring to Gruenberg's speech that we
    have been talking about, he noted--and he has--I think the
    third exhibit is a chart showing that the amount of loans in
    the nonbank financial system have been steady, not increasing,
    relative to before. So that is one thing. But I think where we
    can all agree is that if there is a problem in the shadow
    banking system, let us take a look at that. For example, why
    not look at reducing leverage at hedge funds and so on? I am
    all for that.
        Senator Brown. Thank you.
        Mr. Baer, just a yes or no, if you could, to this. Chairman
    Hensarling proposed repealing Title II of Dodd-Frank, as you
    know, which provides for an orderly liquidation authority for
    large financial institutions, and Title VIII, which provides
    for heightened
    regulation of systemically important clearinghouses. Would you
    support repealing either of those?
        Mr. Baer. I will try to do it in more than one word,
    unfortunately, but we support Title II as a credible backstop
    to Title I. We do believe that bankruptcy should always be the
    first option in
    resolving a large bank. But it seems sensible to have a
    fallback plan in the form of Title II.
        Then with respect to Title VIII--and I have to say this a
    little grudgingly because The Clearing House Payments Company
    is actually a designated financial market utility under Title
    VIII, so talking against interest here. But we do believe it is
    appropriate to designate financial market utilities and have
    supervision of them.
        Of course, that should not be the same type of supervision
    as you would get with a bank. It should be tailored to the
    activities and risks of the CCP or whatever the FMU is. Sorry
    for the acronyms. But, yes, we support that.
        Senator Brown. Thank you.
        Last question, Professor Taub. Should we be concerned by
    proposals that use capital requirements as a sort of Trojan
    horse for broad-based deregulation of the industry?
        Ms. Taub. Whenever someone says ``Trojan horse,'' I think
    we should be cautious, yes. I mean, I do think that, as
    Hensarling's bill is trying to do, is to say if there is a 10-
    percent leverage ratio, that should be enough to get out of so
    many of the Dodd-Frank regulations, that is a mistake. As we
    just heard from Mr. Baer, Title II is a really important
    backstop in case--and as you mentioned before, it is very hard
    to predict the future. And so we do need to have this
    possibility in the alternative of a bankruptcy if that
    cannot happen in an orderly fashion to have Title II, for
    example, good supervision is also critical. So I do not think
    that this is, you know, a free pass out of sensible prudential
    regulation.
        Senator Brown. Thank you, Mr. Chairman.
        Chairman Shelby. Senator Scott.
        Senator Scott. Thank you, Mr. Chairman.
        Ms. Rainey, Chair Yellen appeared before our Committee just
    a couple of days ago and stated in the past that, when it comes
    to bank regulation and supervision, one size does not fit all.
    Other Governors at the Federal Reserve have also echoed those
    comments. Community banks have reported major increases in
    their compliance burden since implementation of Dodd-Frank. In
    February of this year, the Fed, FDIC, and the OCC increased the
    number of banks and savings associations eligible for the 18-
    month examination cycle as opposed to the 12-month cycle. Well-
    capitalized and well-managed banks and savings associations
    with less than $1 billion in total assets may be eligible for
    this relief.
        First, how important is the extension of the exam cycle to
    community banks?
        And, second, from your perspective, what are some other
    measures that can be taken to relieve the regulatory burden on
    smaller institutions?
        Ms. Rainey. Thank you, Senator. Yes, as we look at the exam
    cycle, to give you a relevant example, I am preparing for a
    compliance exam right now. We just received our pre-exam
    checklist that is over 30 pages long; there are over 400
    individual questions in my $215 million bank that we are
    preparing for. And this comes about each and every year as we
    are preparing for examination throughout compliance, IT, BSA,
    and safety and soundness--our four different exams that we
    prepare for. So to lengthen the time between exams for well-
    rated, highly capitalized banks I think is very important and
    makes a significant difference.
        I would draw back to the capital rules that we are talking
    about here today to look at an exemption, just in terms of both
    what we are doing to comply with these regulations as well as
    the impact that it has on our lending practices could make huge
    strides in enhancing the environment in which community banks
    operate, making it--streamlining the process in which we are
    able to serve our customers and our communities.
        Senator Scott. Thank you.
        To both Ms. Rainey and Mr. Abernathy, the punitive
    treatment of mortgage servicing assets, could it have led to
    the third consecutive year that we have seen a drop in first-
    time home buyers?
        Mr. Abernathy. I think it certainly has to affect the
    environment within which people take out mortgages and manage
    those mortgages. One of the biggest problems that we see from
    the Basel practice bringing global rules and applying them here
    is you get rules that do not seem to fit the United States, and
    the mortgage servicing assets is a very good example. The
    Europeans do not have that. But we have the relationship where
    the bank has a close relationship with the mortgagee and
    provides the services that are needed and the mortgagee knows
    where to go. We need to preserve that. But because of the rules
    under Basel, a lot of banks have had to sell their mortgage
    servicing to somebody else who really does not know that
    business, they are learning that business, and it is notorious
    how poorly many of those nonbank providers are doing in
    servicing those mortgages.
        Senator Scott. Thank you.
        Ms. Rainey. I agree. I think in times of stress, in good
    times to have a relationship lender that is servicing that
    mortgage, that understands the property in which that
    collateral is located within that community, can work with the
    borrower to understand the requirements, leads ultimately to
    better success for that mortgage, the borrower, and the
    institution.
        Senator Scott. Mr. Abernathy, the LCR creates disincentives
    for banks to accept business deposits. Isn't this at odds with
    the centuries of accepted banking practices accepting deposits
    from customers?
        Mr. Abernathy. Senator, one of the fundamental purposes of
    banking is to receive deposits--from businesses, from
    individuals, families, from governments. And yet the LCR,
    because it is a static assessment of where risk is, has decided
    in the terms that are there--again, a global rule applied here
    in the United States--that for some reason business deposits
    will run in times of stress. Maybe that happened in Europe, but
    in the United States, business deposits came in to banks.
    During the recession over $800 billion of deposits came in to
    banks because they see banks, correctly, as a safe haven. And
    yet banks during the next stress will have to pretend that they
    are going to be losing those deposits, and that makes it harder
    for banks to take in those business deposits when they are
    looking, again, for that safe haven. Where will those people
    go?
        Senator Scott. Thank you, sir. My time is up.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Reed.
        Senator Reed. Thank you very much, Mr. Chairman, and thank
    you, panelists, for your excellent testimony.
        Professor Taub, in your comments you point out a speech by
    Marty Gruenberg indicating that FDIC-insured institutions have
    earned a new record, about $164 billion last year, and almost
    two-thirds of institutions reported higher earnings, which
    might at least raise a question of whether these regulatory
    difficulties not only have not inhibited profitability but in
    some respects might have assisted profitability. Do you have
    any comments on that?
        Ms. Taub. Yes, I mean, that was really impressive. We are
    often hearing complaints about how Dodd-Frank is hurting
    banks--in particular, community banks--and the economy. And yet
    we saw that last year the record profits were $164 billion.
        In addition, what I thought was interesting about that
    speech is that there has been loan growth at community banks of
    8.0 percent, and that exceeds the 6.9 percent compared to--that
    is year-over-year growth, and it exceeds 6.9 percent in terms
    of overall for all banks. So not only are banks overall that
    are FDIC-insured institutions doing better, but in particular,
    the community bank segment is outshining the larger banks.
        Senator Reed. Mr. Baer, from your position have you also
    tracked sort of relatively good profitability numbers in the
    institutions and, also, as Professor Taub points out, loan
    growth, particularly in the community banks, which is critical?
        Mr. Baer. I think it is fair to say----
        Senator Reed. Could you turn your microphone on, please?
        Mr. Baer. I think it is fair to say banks, including the
    large banks who are members of our association, are still quite
    profitable. I think the interesting question for purposes of
    policy is: How are they making those profits? What we are
    seeing, if you follow bank results, is a very large focus on
    reducing expenses. So that has involved laying off tens,
    hundreds of thousands of people. The industry is also
    benefiting from an expense perspective from a massive move
    toward electronification, so fewer branches, fewer tellers,
    more mobile apps on your phone. In the securities business as
    well as, I think, in the retail business, you are seeing a
    great move to doing electronically what used to be done by
    voice or by other means. So, you know, clearly expenses are a
    lot of it.
        And then, you know, with respect to the revenues, banks are
    adjusting, and the question is how you feel about how they are
    adjusting. So they are exiting certain business lines, and I
    would say measure one is principal at-risk market making, which
    under the capital rules, particularly the leverage ratio, has
    become a very expensive and difficult proposition.
        They are moving into other areas. So, for example, private
    wealth management is a terrific business under the capital and
    liquidity rules. It does not require capital, it does not
    require liquidity, and there is not a lot of operational risk.
    So they have migrated, a lot of them, into private wealth
    management. And then the question is just how do you feel about
    that.
        Senator Reed. Just two follow-up questions. One, my
    impression is because of the inherent advantages of
    technological improvements, those cost savings would have been
    adopted by any sensible individual in any case. Is that your
    thought, too?
        Mr. Baer. I agree.
        Senator Reed. And the other issue, too, in the migration
    into these more--away from market-making centers, that is more
    characteristic of the larger banks than community banks. Is
    that fair also?
        Mr. Baer. Well, this really gets to--I mean, the biggest
    difference between the banks I represent and perhaps the ones
    to my right is not, I do not think, really size because the
    risks of making a loan are pretty much the same whether you are
    a large bank making a loan or a small bank. The largest banks
    are really the banks that are doing capital markets activity.
        Senator Reed. Right.
        Mr. Baer. And that is why, for example, a 10-percent
    leverage ratio where you can debate that around an illiquid
    loan, the idea of holding 10 percent capital against a Treasury
    security becomes a lot more problematic. I think that is where
    we see a lot of the issues.
        Senator Reed. But that is more characteristic of larger
    institutions.
        Mr. Baer. Correct.
        Senator Reed. And, Mr. Abernathy, thanks again. You have
    been a constant source of advice and counsel, and we appreciate
    it very much.
        Mr. Abernathy. Thank you.
        Senator Reed. One of the issues that has been brought up is
    that there is migration to some degree--you can question how
    much--into the nonbank arena, which suggests that reinforcing
    the role of FSOC for big institutions because they can declare
    a nonbank institution as systemically risky, and you pointed
    out, I think, or someone on the panel did, let us remember, it
    was Lehman Brothers' failure, Bear Stearns' failure, AIG's
    failure that triggered a lot of the dilemmas here.
        And the other issue, too, is at the commercial level, a lot
    of alternatives to banks fall within the purview of the
    Consumer Financial Protection Bureau, and its role would be
    even more important now if you are describing this migration
    away from banks. Is that fair?
        Mr. Abernathy. Certainly where the migration is with regard
    to retail services, and we are seeing both with retail as well
    as wholesale. Frankly, it is a little bit alarming to the
    banking industry. When I heard the Chairman of the FDIC say the
    banking industry only has 16 percent of the financial market
    these days, representing the banking industry, I am a little
    bit alarmed at that because I believe there are things that
    banks do in terms of staying power and other things that you do
    not get outside of the banking industry. But there are other
    regulatory means of getting to these to some degree. What we
    notice, though, is that the rules, while they apply to
    nonbanks, they seem always to be enforced against banks because
    we have in place a means of enforcement. We have got three
    regulatory agencies that enforce. The nonbanks do not.
        Senator Reed. I appreciate that.
        Finally, thank you, Ms. Rainey, for your testimony. Any
    comments you would like to make from the perspective of a
    community banker with respect to the issues I have raised about
    profitability, lending? Is your lending going up? Hopefully
    your profitability is going up.
        Ms. Rainey. Yes. Well, again, I draw back to the market
    dynamics, and I think as we look at the industry, so much of
    this depends on where the bank is located. We are still in an
    area that is struggling economically. So goes the community, so
    goes the bank, very interdependent.
        You know, something I would maybe add to the comment, as I
    look at the industry as a whole and community banks and our
    future, the lack of de novo charters is very alarming to me in
    an industry where you have no birth, new creation of
    organizations and charters, especially in communities that
    desperately need those services, and I would point to many of
    these capital burdens. And back to our original story, you
    know, looking at what is required to start a bank today in a
    community that desperately needs it, there is unequal treatment
    in terms of the needs of that community and the requirements
    for the bank.
        Senator Reed. Thank you very much. Thank you all very much.
        Chairman Shelby. Senator Moran.
        Senator Moran. Chairman, thank you very much. I thank our
    panel for being here. While profitability is important, the
    ability to continue to exist in business is related to your
    ability to generate a profit. I want to focus on the ability to
    lend, access to credit. I often tell my bankers that, yes, I am
    for you as a banker, I guess. But what I am really for is the
    community in which you serve. And I am worried that for a
    number of reasons, but in significant part the regulatory
    environment is reducing access to credit to people who
    traditionally would be thought of as creditworthy, capable of
    repaying their loan. But because of the fear of not crossing
    the t's and dotting the i's of regulatory burden, good loans
    are not being made. And I would like to know whether my sense
    is accurate and if there is anything that measures that. The
    example that I have often used in visiting with regulators is
    that, again, in a State like ours, community banking is a
    significant component of access to credit. And there are a
    number of bankers who have told me they no longer make a
    residential loan, a home loan, because of the fear of making an
    error or the amount of training and expertise now required to
    understand how to comply with the complexity of those
    regulations. And it just seems so--it is so troublesome to me
    that you would have a bank in a town of 4,000 people that has
    made the conscious decision we are not going to make a loan to
    somebody who wants to buy a home in their hometown and in our
    hometown, not because we do not believe that borrower can pay
    it back, but because we are too worried about the consequences
    of making an error or the expenses associated with having the
    personnel necessary, capably trained to make that loan. Is
    there something to what--are my fears founded? I guess in a
    broader sense is there empirical evidence about lack of access
    to credit related to the regulatory environment?
        Mr. Baer. Senator, I mean, I think there are any number of
    examples of where regulation is having a measurable and clear
    effect in these areas. So, for example, with regard to
    residential mortgages, high-risk weights for prime mortgages
    have really taken prime mortgages off most--at least large--and
    I think small bank balance sheets because you just cannot earn
    back that capital. Jumbo loans are still there, but not prime.
        Another example that I think is a good one because it shows
    how a very technical rule can have a very big economic effect
    is the liquidity coverage ratio, which I will have to say
    actually we at The Clearing House have a lot of sympathy for
    the liquidity coverage ratio and believe it is generally a good
    idea--the NSFR less so, but the LCR, yes. But the LCR has an
    outflow assumption with regard to commitments, that is, lines
    of credit to businesses.
        The experience in the crisis was that the outflow
    assumptions--or the outflow experience was about 10 percent. In
    other words, they drew down about 10 percent. They did not look
    at this as crisis liquidity in the crisis. They used it for
    day-to-day operations. The LCR says that you have to assume 30-
    percent outflow, so three times what we saw in the crisis. What
    that has resulted in is banks of very different sizes all
    having to pull back on those loans or price them low.
        So, similarly, custody banks are also affected by that,
    sort of a little off your topic, but because when they are
    asked by asset managers to have a line of credit to fund a
    redemption, because they do not want to have to hold cash to
    fund a redemption, again, the custody banks are giving the same
    answer to an asset manager that a small- or a mid-size banker
    is giving to a borrower, which is under the LCR we are
    constrained here.
        Senator Moran. Yes, sir?
        Mr. Abernathy. Senator, if I may, and I would echo the
    comments made by Mr. Baer. What we hear from our community
    bankers in Kansas and other parts of the country, if you ask
    them where is the growth in your employment, they will say,
    well, we are hiring more people to do compliance. How much do
    those compliance people interact with real customers? Well, not
    at all. And so you have seen more and more bank resources being
    applied to people who in essence work for the regulators, do
    not work for the customers.
        Why is that important with regard to lending? A number of
    borrowers will come to the bank, but really what gets the
    economy going is when the banker goes to the customer and says,
    ``Charlie, your business is doing really well. Have you thought
    about opening up an office across town?'' He says, ``Well, I do
    not know. How would I do that?'' ``Well, let us talk about how
    we could finance that.''
        There are fewer people available to do that, and a lot of
    these rules make it harder for that banker to have that
    conversation because now he has got to be scratching his head,
    and wondering, if I do that loan to Charlie, how is that going
    to affect my risk-based capital rules and how am I going to
    particularly balance all of those sorts of other regulatory
    requirements. It makes it much more complex and I think more
    difficult.
        Ms. Rainey. Specifically, coming from a rural community
    where no two properties are exactly alike, it has become very
    difficult for us. We will portfolio most of the mortgages that
    we make because we simply do not have secondary market options.
    They do not fulfill the appraisal requirements. We found out
    from our secondary market provider they will no longer accept
    manufactured homes. So, yes, we are seeing a lack of
    availability.
        I am proud to say that in our community bank we continue to
    make residential mortgages because we are the source for
    mortgages in our community. We will roll up our sleeves, and we
    will get the job done. That job, though, has become incredibly
    complex and punitive for the smallest error that is made not
    because we are trying to take advantage of a customer, it is a
    simple human error; but the results and the impact to the
    organization have become much more significant and are not
    proportionate for the type of errors that we are making.
        So, yes, cost is significantly increased. It has become
    harder, and there are fewer options for rural communities to
    have access to credit.
        Senator Moran. Thank you for the answer to my question, and
    I would just add that a part of this is also the need for a
    growing economy. A part of this is also the need for a growing
    economy. In a broader sense, your ability to make loans
    determines whether or not GDP grows at this rate or a higher
    rate. And our country desperately needs more opportunity for
    more people, and access to credit is a significant component of
    whether we are going to achieve that desired goal.
        Mr. Chairman, thank you very much.
        Chairman Shelby. Senator Warren.
        Senator Warren. Thank you, Mr. Chairman, and thank you all
    for being here today.
        Earlier this month, Congressman Hensarling, the Republican
    Chairman of the House Financial Services Committee, provided a
    summary of a new bill that would repeal many of the financial
    reforms that Congress put in place after the 2008 crisis. In a
    hearing 2 weeks ago, I said that when it was introduced, the
    bill should be called ``the Wet Kiss for Wall Street Act.'' Now
    that we have seen more details about the bill, I realize that I
    was wrong. It should be called ``the Big Wet Kiss for Wall
    Street Act.''
        At the earlier hearing, I focused on some of the provisions
    in this proposal that would increase the chances of another
    taxpayer bailout, provisions that would make it harder to
    identify systemic risks and move quickly to address them.
        Today, though, I want to focus on the bill's assault on the
    Consumer Financial Protection Bureau. According to the latest
    detailed summary of this bill, it will go after the fundamental
    structure of the CFPB, cut back on its authority to protect
    consumers, and weaken or repeal rules that the CFPB has already
    proposed. One provision would replace the current single-
    director model of the CFPB with a five-member commission like
    the five-member SEC.
        Now, Professor Taub, you are a close observer of both the
    CFPB and the SEC. What do you think would happen to the CFPB if
    it adopted the SEC's leadership structure?
        Ms. Taub. Senator Warren, I think if the CFPB went from a
    single-director model to a five-member commission model, it
    would be substantially weakened and slowed down, and that I
    think is the whole point of Hensarling's proposal. In
    HousingWire, in June, I just read a report from a research
    group called Compass Point, and they predicted that if this
    were to happen, if it moved to the five-member commission, this
    already elongated rulemaking timeline would be extended,
    probably doubled, and that also enforcement would go down by 75
    percent.
        Senator Warren. Wow. OK. So gum up the works, reduce
    enforcement here. You know, by the way, Chairman Hensarling has
    gone out of his way to claim that his bill does not have the
    support of Wall Street and the big banks. But I would point out
    that the American Bankers Association, which represents the big
    banks, has made it a priority for years to weaken the CFPB by
    making exactly the change that Congressman Hensarling proposes.
    I really do wonder who Congressman Hensarling thinks he is
    fooling here.
        Another provision in the bill would revoke the authority in
    Dodd-Frank that allows the CFPB to restrict the use of forced
    arbitration clauses in credit card and checking accounts.
    Professor Taub, as you know, Congress directed the consumer
    agency to conduct a study about the impact of forced
    arbitration clauses, and the agency did exactly that. It did a
    3-year study, and it found that those clauses are extremely
    harmful to consumers who have been cheated by banks.
        Now, under the explicit authority from Congress as part of
    Dodd-Frank, the CFPB has issued a proposed rule to restrict the
    use of these clauses. How do you think consumers would be
    affected if this rule is eliminated, as Congressman Hensarling
    wants?
        Ms. Taub. I think that they would be deeply harmed. These
    pre-dispute arbitration provisions, or what you are calling
    ``forced arbitration provisions,'' deprive consumers of their
    legal rights under Federal and State law. And as it happens, I
    did sign on to a comment letter with about 200 other law
    professors and scholars in support of the CFPB's rule because I
    think, you know, the status quo currently unfairly limits legal
    rights and remedies for millions of consumers.
        Senator Warren. Thank you. You know, Chairman Hensarling
    has tried to dress this bill up as some kind of get-tough-on-
    Wall-Street, pro-consumer effort. But on every front, whether
    it is reducing systemic risk, preventing another taxpayer
    bailout, protecting consumers, the bill's proposals come
    straight off the Wall Street wish list. These are the kinds of
    ideas that may attract very generous donations from Wall
    Street. That is what a ``big wet kiss'' is all about. But I
    know that the American people will not be fooled.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Cotton.
        Senator Cotton. Thank you, Mr. Chairman. Thank you all for
    taking the time to testify today.
        Like Senator Scott, I have some serious concerns about
    mortgage servicing assets, but I understand that Ms. Rainey and
    Mr. Abernathy addressed those fully with Senator Scott, and I
    just want to associate myself with his comments and with some
    of his concerns.
        I would like to turn to a second topic, unrelated, about
    capital requirements and their impact on the global sanctions
    regime. Mr. Baer, you might be best situated to discuss this
    matter. Recently, Fed Governors Daniel Tarullo and Jerome
    Powell in separate public comments have said that the central
    bank would probably decide to require eight of the largest U.S.
    banks to maintain more equity capital to pass the central
    bank's annual stress tests. Do you think the Federal Reserve
    has fully accounted for what higher capital requirements could
    mean for the United States' ability to enforce sanctions
    through the global financial system if large U.S.-based
    institutions are cutting operations or withdrawing from certain
    markets overseas because of the costs imposed by these new
    actions?
        Mr. Baer. Thank you, Senator. We at The Clearing House
    actually are quite focused on how effectual the AML OFAC regime
    is currently. We have seen, as you are alluding to, a large de-
    risking globally by U.S. and actually by U.K. and other banks
    as well, simply because if you do a risk-and-reward analysis,
    the risks of banking the wrong person under a strict liability
    sort of enforcement environment and where the penalties can be
    extremely high can really never be recouped by anything you
    could charge a customer like that.
        There have been serious, I think, costs from that,
    including, you know, we have talked to folks in the development
    area who believe that there are countries that need banking
    services around the world but are having U.S. and other banks
    withdraw from those services. We have heard from people in
    diplomacy and national defense expressing concerns about the
    ability of the United States to exert influence in those
    countries. And we have also heard from law enforcement and
    national security that it is a tough issue in the sense that
    you want to kick bad people out of the system, but you also
    want to observe bad people in the system. And so to the extent
    that U.S. banks are not doing that business abroad, that
    effectively blinds us to the ability to spot wrongdoing and
    potential terrorist financing, for example.
        I think capital could play a role in that in the sense
    that, you know, for example, a G-SIB surcharge punishes cross-
    jurisdictional exposures, so one of the five factors that
    influence a large bank's charge is its dealings with those
    abroad, although that is really, I would confess, on the
    wholesale side, less on the retail side. Most of the largest
    banks are not really doing much of a U.S.--of a consumer retail
    business abroad. They are really managing their businesses
    through correspondent accounts. And so the de-risking that is
    taking place with the largest banks I think primarily is
    cutting off correspondents and large corporate borrowers. But,
    again, that is having a whole host of, I think, unintended
    consequences. And I will give credit to the Treasury Department
    and others who I think are actually quite focused on this issue
    at this point.
        Senator Cotton. So you do think that Treasury and some of
    the other agencies or departments in the Government who might
    have a stake in this decision as it affects our ability to
    implement and enforce global sanctions are weighing in with the
    Federal Reserve?
        Mr. Baer. I think they are weighing in. I think one of the
    core problems in this area, though, is sort of the incentives
    of those involved. For a bank regulatory agency, they are not
    sort of confronted day to day with concerns about development
    or national defense or diplomacy. I think they are, I think
    rightly, worried, you know, what will the reputational
    implications for the bank or for them be if the bank banks the
    wrong person.
        So they have a very strong, one might say, perverse
    incentive to favor de-risking. That is why I think you saw this
    sort of unusual spectacle of the Secretary of State going over
    to London to lobby U.K. banks to continue banking Iranian
    accounts. And I think, you know, whether you think they should
    or they should not, the reason he was doing that was reflective
    of, you know, the fact that banks are quite reluctant to do
    anything that might eventually result in a sanction for them.
        Senator Cotton. I think they are understandably reluctant,
    and I think ``spectacle'' is an appropriate word to use for
    these circumstances.
        Would any of the other panelists care to weigh in? I know
    that may be a little outside your bailiwick, but we would be
    happy to hear from you as well.
        Mr. Abernathy. Certainly, Senator, if I could just briefly,
    and certainly echo what Mr. Baer has said. One of the biggest
    challenges we have as a bank, one of these causes of de-risking
    is not only are banks required to understand their customers,
    but now they are being required by rules to take on
    responsibility for their customer's customer based upon
    information that they really do not have access to, and yet
    they get sanctioned for what a customer's customer is doing.
    And that is causing a number of banks to say, ``I just do not
    make enough money in this line of business to be able to carry
    that huge regulatory risk, and so I am just getting out of this
    business.'' That affects banks of all sizes, and it affects not
    only international but domestic banks as well.
        Senator Cotton. Thank you all.
        Chairman Shelby. Senator Heitkamp.
        Senator Heitkamp. Mr. Chairman, thank you so much.
        I want to talk about call reports, and most of my comments
    are going to really focus on the impact of all of these rules
    on small financial institutions. And so I want to begin by
    saying there is little doubt that clear and consistent capital
    and liquidity requirements are an essential part of a strong
    banking system. I think that is something we can all agree on,
    and it is absolutely the best line of defense against future
    bailouts. But small businesses and small banks, like the
    majority of banks in my State, have great concerns about the
    complex reporting requirements referenced in Ms. Rainey's
    testimony, and particularly because they are costly, time-
    consuming, and confusing, especially for smaller institutions
        When you take that into account with the variety of other
    rules and regulations that small banks are now implementing
    that are unrelated to Basel, the fact that the smaller banks do
    not have time and resources to coordinate and implement these
    rules.
        And so I guess I am going to ask you, Ms. Taub, what is
    your reaction to the small bank concerns about the increased
    reporting requirements? And is there a path forward, as you see
    it, to address what I believe is legitimate concerns?
        Ms. Taub. Thank you for the question. The way I would like
    to respond to it is to talk about that issue of amnesia again.
    I take a different lesson than Mr. Abernathy does about the
    savings and loan crisis. He said--and as you know, that was
    small and regional banks that were affected. He suggested that
    the lesson of that crisis was that net worth or, you know,
    leverage did not really hold up. But that is actually not what
    happened there. The savings and loans faced an interest rate
    shock. Then they were facing competition for deposits for money
    market funds. And as a result of that, they managed to achieve
    massive deregulation for the asset side of their balance sheet.
    And, in fact, it was because they were struggling in that
    environment that they got special accounting treatment. Instead
    of GAAP, it was called ``RAP,'' and they were able to kind of
    monkey with their net worth.
        So I would point out that it is not just large banks that
    can cause massive crises that result in taxpayer-funded
    bailouts, but also correlated bad practices at small
    institutions.
        Senator Heitkamp. I think it would be a little bit of an
    exaggeration to say the savings and loan crisis had the same
    consequences and result as the crisis in 2008.
        Ms. Rainey, can you give us some feedback on your
    relationships with financial regulators, whether you believe
    that generally there is a level of responsiveness to a lot of
    the concerns that I hear from my local community bankers? And
    what can we do to enhance that dialogue?
        Ms. Rainey. Thank you. Yes, I feel--and I have had the
    opportunity to work, whether it is on advisory councils or
    committees, to engage in conversation, and I think those have
    been productive. I think as we talk about some of the specific
    examples here today, whether it is call report reform or some
    of the pieces within the Basel rules, this exemption for
    community banks, so much of it also requires legislative
    action. And so I think in a best-case scenario, to be able to
    move forward in these dialogues both with the regulators as
    well with Congress to feel how we make some of these things
    happen and avail all tools possible to provide a best-case
    scenario.
        Senator Heitkamp. Another issue that frequently comes up is
    the issue of distributions from Subchapter S and taxability of
    those distributions or the lack of distributions but still
    incurring a tax liability, which can put quite a strain on a
    small organization, certainly on a small community family-owned
    bank. Can you walk me through how that requirement will be
    phased over the next few years, see what major risks all of
    that provides to community banks, and offer maybe some
    suggestion on how we can be more responsive to the legitimate
    concerns of the Subchapter S issue?
        Ms. Rainey. This is a significant and very personal issue
    for us. Now, while I would hope to never find myself in a
    situation like that, the pure fact that our shareholders, a
    family-owned organization, would be responsible for the
    earnings of the organization and to pay the amount of tax is
    very concerning. And I would draw your attention to an example
    of C corporation banks. Even if they were in a scenario below
    the well-capitalized limits, they would still be able to pay
    the taxes on the income of the organization. So why would we
    create a different scenario purely for Sub S organizations?
        And so as we look at this, I think there is a simple
    solution in that we allow, even if we were in that capital
    conservation buffer period, the opportunity for the bank to
    distribute up to 40 percent of its earnings to pay the
    associated tax and allow for those shareholders to take care of
    the liability.
        Senator Heitkamp. So not avoiding the liability but making
    sure that the assets are there rather than personal assets to
    pay for profitability of the bank.
        I am out of time. I will submit the rest of my questions
    for the record.
        Chairman Shelby. Senator Brown.
        Senator Brown. Thank you, Mr. Chairman. Just a couple
    comments before the end of the hearing.
        Again, thank you all for being here. It seems there are
    some areas of disagreement but also some areas of agreement. I
    thank all four of you for that. We want to ensure, especially,
    Ms. Romero Rainey, we want to ensure that community banks have
    appropriate rules. That is why in the past year and a half
    Congress has passed 10 provisions into law benefiting community
    banks. The regulators have said publicly that as part of the
    EGRPRA process they are considering changes to call reports, a
    simpler capital regime for small banks, and adjustments in the
    asset thresholds for real estate appraisals. The FDIC has made
    changes that will make it easier to start new banks, an
    important concern I hear from both the ABA and the community
    bankers.
        We have taken action and there is more potential action
    coming on capital rules. ICBA said it well last year in support
    of the Fed's capital surcharge rules on the larger banks, of
    course, that:

            Enhanced supervision of these systemically important financial
            institutions together with the significant capital surcharge
            will provide more stability to our financial system and
            discourage SIFIs from becoming even larger and more
            interconnected.

        So I think there is broad agreement we have made progress.
    There is also clearly the belief that our job is not yet done.
        Professor Taub is right when she urges to take bold action
    to continue raising capital for the largest and the most
    complex institutions.
        Thank you so much.
        Chairman Shelby. Thank you.
        I want to thank all the panelists today. I think it has
    been a good hearing. We appreciate your input, and we
    appreciate your views to keep the markets going. Thank you.
        The hearing is adjourned.
        [Whereupon, at 11:23 a.m., the hearing was adjourned.]
        [Prepared statements, responses to written questions, and
    additional material supplied for the record follow:]
                   PREPARED STATEMENT OF REBECA ROMERO RAINEY
                    Chairman and CEO, Centinel Bank of Taos
           on behalf of the Independent Community Bankers of America
                                 June 23, 2016
    Opening
        Chairman Shelby, Ranking Member Brown, and Members of the
    Committee, my name is Rebeca Romero Rainey, and I am Chairman and CEO
    of Centinel Bank of Taos, a $215 million asset bank with 48 employees
    headquartered in Taos, New Mexico. I'm a third generation community
    banker. Centinel was founded by my grandfather, Eliu E. Romero, in 1969
    after he was denied a loan to finance his startup law practice. I'm
    proud to carry on his legacy of service to our community by providing
    access to credit on an equitable basis to all responsible borrowers.
        I am also Chairman of the Independent Community Bankers of America
    (ICBA), and I testify today on behalf of the more than 6,000 community
    banks we represent. Thank you for convening this hearing on bank
    capital and liquidity regulation. A great deal is at stake in these
    regulations. They have the power to promote or to stifle community bank
    lending, and can make or break a community. It is critically important
    that we get them right.
        Changes are urgently needed to community bank capital regulation.
    In particular, ICBA urges the support of this Committee for an
    exemption from Basel III for banks with assets of less than $50
    billion. More on that later in this statement.
        At the outset, I would like to thank the Members of this Committee
    for your leadership in securing inclusion of community bank regulatory
    relief in the FAST Act, which was signed into law last December. FAST
    Act relief includes expansion of the exam cycle for highly rated banks,
    broadening of accommodations under the CFPB's ``ability to repay''
    rule, the long-sought elimination of annual privacy notices when a bank
    has not changed its privacy policies, and other important provisions.
    We encourage this Committee to build on that record by enacting
    additional regulatory relief measures for community banks.
        I would also like to thank the Members of this Committee who
    contacted the bank regulators during their consideration of the Basel
    III rule to express their concern about the impact of the rule on
    community banks. Your influence was critical to securing notable
    improvements in the final rule, though, as explained below, the rule
    continues to pose a significant threat to consumers and small
    businesses seeking credit.
    Basel III
        With the implementation of the Basel III Capital Rule, which began
    in 2015, bank capital regulation became significantly more complex and
    punitive, especially for community banks. Do we really need four
    definitions of regulatory capital, plus a capital conservation buffer,
    and complex rules governing capital deductions and adjustments? More
    fundamentally, why does the rule apply to community banks at all?
        At its inception, Basel III was meant to apply only to the largest,
    interconnected, internationally active and systemically important
    institutions. Community banks, with their simple capital structures and
    conservative funding and lending practices, have nothing in common with
    these larger institutions.
        Applying Basel III to community banks in a one-size-fits-all manner
    harms the consumers and businesses that rely on community bank credit.
    The impact will be especially harsh in small communities and rural
    areas not served by larger institutions. This is why 17,000 community
    bankers signed a petition calling for an exemption from Basel III for
    community banks.
        Aspects of Basel III that are of particular concern for Centinel
    Bank and other community banks include:
    High Volatility Commercial Real Estate (HVCRE)
        My community of Taos has yet to fully recover from the last
    recession and continues to experience high unemployment. New
    development projects would create jobs in construction and related
    services, which would in turn boost consumer spending and create
    additional jobs. These projects might include hotels, apartment
    buildings, shopping centers, hospitals, or other commercial projects--
    important sources of employment in themselves after construction has
    been completed.
        Unfortunately, such projects would be defined as high volatility
    commercial real estate (HVCRE) under Basel III--unless the borrower can
    contribute at origination 15 percent of the projected appraised value
    of the project upon its completion in cash or readily marketable
    assets. The borrower must also commit to tying up that capital for the
    life of the project. HVCRE loans are subject to punitive risk weighting
    for the determination of regulatory capital: 150 percent compared to
    100 percent before Basel III. I now have to allocate 50 percent more
    capital in order to finance a loan that my community desperately needs.
        The HVCRE rule sweeps in too many creditworthy developers who are
    well established in our local business community, developers who
    exercise due diligence in planning projects with manageable risk but
    simply do not have the resources to tie up a 15 percent cash
    contribution for the life of a multi-year construction project. Such a
    developer might have an equity stake in land that will serve as the
    site of a project. But, under the HVCRE rule, any appreciated value of
    land equity does not count toward the required 15 percent contribution.
        At Centinel Bank, we want to make every creditworthy loan that we
    possibly can--consistent with reasonable capital requirements and
    safety and soundness--to ensure the prosperity of our community and the
    long-term viability of the bank. The HVCRE rule will force us to make
    difficult tradeoffs in lending to promising development projects. The
    result will be reduced credit availability and higher costs for
    potentially job-creating projects. Rural communities will be
    particularly hard hit. While urban and suburban communities have access
    to nonbank options for project finance--lenders and investors not
    subject to regulatory capital requirements--communities such as mine
    rely almost exclusively on community bank credit. Subjecting community
    banks to punitive capital treatment for HVCRE lending will hobble the
    economic recovery in Taos, New Mexico, and in thousands of communities
    across the country.
        ICBA is grateful to Members of Congress who have written to the
    heads of the banking regulatory agencies to express their concerns
    about the impact of the HVCRE rule.
    Introduced Legislation
        ICBA strongly supports the Community Bank Access to Capital Act (S.
    1816), sponsored by Committee Member Senator Mike Rounds and Senator
    Roy Blunt, which would, among other provisions, direct the bank
    regulatory agencies to issue a regulation exempting community banks
    with assets of less than $50 billion from Basel III.
    Complex New Reporting Requirements
        Another troubling aspect of Basel III is its contribution to the
    volume and complexity of our quarterly call report--which had already
    become a nearly unmanageable burden. Today's call report consists of 80
    pages of forms and more than 670 pages of instructions, with one new
    schedule alone taking up 134 pages. Centinel Bank's last call report
    was 93 pages long and its preparation consumed 2 \1/2\ weeks of full-
    time equivalent hours. That's over a month of FTE hours each year. This
    is unfortunately typical of the staff burden the call report imposes on
    a community bank.
        It hasn't always been this way. The call report is so named because
    it used to be called in by phone. Unfortunately, the report has grown
    since that time out of all proportion to its value in monitoring safety
    and soundness, and Basel III has only amplified it growth. As recently
    as 2006, before Basel III, the call report instructions were 45 pages
    long, roughly half of what they are now.
        Only a fraction of the information collected is actually useful to
    regulators in monitoring safety and soundness and conducting monetary
    policy. The 80 pages of forms contain extremely granular data such as
    the quarterly change in loan balances on owner-occupied commercial real
    estate. Whatever negligible value there is for the regulators in
    obtaining this type of detail is dwarfed by the expense and the staff
    hours dedicated to collecting it. To put things in perspective,
    consider this contrast: the largest, multi-billion-dollar credit unions
    filed a less than 30-page call report in the first quarter of 2016.
    Surely, regulators can supervise community banks with significantly
    less paperwork burden than they currently demand.
        In September 2014, nearly 15,000 community bankers representing 40
    percent of all community banks nationwide signed an ICBA petition to
    the regulatory agencies calling for more streamlined quarterly call
    report filings.
        ICBA's recent Community Bank Call Report Burden Survey empirically
    demonstrates this problem. Eighty-six percent of survey respondents
    said the total cost of preparing the quarterly call report has
    increased over the last 10 years.\1\ Thirty percent said it had
    increased significantly. A typical $500 million asset community bank
    spends close to 300 hours a year of senior level, highly compensated
    staff time on the quarterly call report.
    ---------------------------------------------------------------------------
        \1\ 2014 ICBA Community Bank Call Report Burden Survey. http://
    www.icba.org/docs/default-source/icba/news-documents/press-release/
    2015/2014callreportsurveyresults.pdf?sfvrsn=2.
    ---------------------------------------------------------------------------
        For this reason, ICBA is calling on the agencies to allow highly
    rated community banks to submit a short form call report in the first
    and third quarters of each year. A full call report would be filed at
    mid-year and at year-end. The short form would contain essential data
    required by regulators to conduct offsite monitoring, including income,
    loan growth, changes in loan loss reserves, and capital position. In
    the recent survey noted above, community bank respondents
    overwhelmingly agreed that instituting a short-form call report in
    certain quarters would provide a great deal of regulatory relief.
    Seventy-two percent of respondents indicated the relief would be
    substantial.
    Introduced Legislation
        A number of bills introduced in the House and Senate would provide
    for short form call reports, notably the Clear Plus Act (S. 927),
    introduced by Senators Jerry Moran and Jon Tester.
    The Capital Conservation Buffer and Subchapter S Community Banks
        In addition to establishing higher minimum capital ratios and new
    risk weights, Basel III also establishes a capital conservation buffer
    of 2  \1/2\ percent. Banks that do not exceed the buffer face
    restrictions on dividends and discretionary bonuses.
        The capital conservation buffer is a concern for all banks, but it
    poses a special challenge for the more than 2,000 community banks--one-
    third of all community banks--organized under Subchapter S of the tax
    code, including Centinel Bank.
        Subchapter S banks are ``pass through'' entities, taxed at the
    shareholder level. Shareholders are responsible for paying taxes on
    their pro rata of the bank's net income, whether that income is
    distributed or not. When a Subchapter S bank falls short of the capital
    conservation buffer and is restricted in full or in part from making
    distributions, shareholders are required to pay taxes on the bank's net
    income out of their own pockets. Investors expect returns on their
    investments, or at least deductible losses. What they do not expect is
    an unfunded tax bill in year when their investment had positive net
    income.
        This possibility makes it significantly more difficult for a
    subchapter S bank to solicit new shareholders or to raise additional
    capital from existing shareholders. While FDIC and the Federal Reserve
    have stated that they would consider waiving dividend restrictions on a
    case-by-case basis, this is hardly reassuring to current or potential
    investors. A better solution is needed, such as a community bank
    exemption from Basel III, or at a minimum, a provision to allow a
    distribution of at least 40 percent of a Subchapter S bank's net
    income, regardless of the capital conservation buffer. This would
    ensure that a bank can distribute at least enough to cover its
    shareholders' taxes.
    Capital Treatment of Mortgage Servicing Assets
        The punitive new capital provisions of Basel III pose a real threat
    to community bank mortgage servicing. ICBA believes it is critical to
    retain and promote the role of community banks in mortgage servicing
    and to adopt policies that will deter further consolidation of that
    industry. Community banks thrive on their reputation for customer focus
    and local commitment. Their involvement in mortgage servicing promotes
    industry competition and deters future abuses and avoidable
    foreclosures such as those that impeded the housing recovery and led to
    the national mortgage settlement. Despite this, the Basel III mortgage
    servicing asset (MSA) provisions seem to be designed to drive community
    banks from the mortgage servicing business.
        Basel III provides that the value of mortgage servicing assets
    (MSAs) that exceed 10 percent of a bank's common equity tier 1 capital
    must be deducted directly from its regulatory capital.\2\ In addition,
    MSAs that are below the 10 percent threshold must be risk weighted at
    250 percent once Basel III is fully phased in. Expressed in terms of
    capital ratios, MSAs shrink the numerator or capital (when they exceed
    the 10 percent threshold) and inflate the denominator or assets,
    resulting in a lower regulatory capital ratio. As if this were not
    enough, there's a third limitation on MSAs: When MSAs combined with
    deferred tax assets and investments in the common stock of
    unconsolidated financial institutions exceed 15 percent of common
    equity tier 1 capital, the excess must also be directly deducted from
    regulatory capital. Many banks that do not exceed that 10 percent MSA
    threshold are caught by the 15 percent combined threshold.
    ---------------------------------------------------------------------------
        \2\ MSAs represent the future value of servicing mortgage loans
    owned by third parties.
    ---------------------------------------------------------------------------
        The Basel III rule is a drastic change from the previous rule which
    allowed a bank to hold MSAs up to 100 percent of tier 1 capital (and
    broader measure of capital) and risk weight MSAs at 100 percent. Any
    change in policy with such a broad adverse impact should have been
    clearly supported by data and analysis. But regulators offered no data
    or empirical analysis whatsoever to suggest that MSAs destabilized
    banks during the recent financial crisis.
    Introduced Legislation
        ICBA supports bills introduced in the House and Senate that would
    require the Federal banking agencies to study the impact of the Basel
    III capital treatment of mortgage servicing assets, including Chairman
    Shelby's Financial Regulatory Improvement Act (S. 1484).
    Capital Treatment of TruPS Investments
        ICBA urges this Committee to support capital relief for community
    banks, many of them rural-based, that invested in trust preferred
    securities (TruPS) issued by other community banks. Under the Basel III
    rule, these investments are subject to the same punitive capital
    treatment as MSAs: TruPS investments that exceed 10 percent of a bank's
    common equity tier 1 capital must be deducted directly from its
    regulatory capital. A capital deduction for their TruPS investments
    will directly reduce their capacity to provide credit in their
    communities.
        Basel III provides an exemption for community banks that issued
    TruPS prior to May 19, 2010: These banks continue to count the proceeds
    of their TruPS issuances as Tier 1 capital. A comparable exemption
    should be provided to community banks that invested in TruPS. Parity
    between issuers and investors in the same securities will create a more
    equitable outcome and will provide a direct benefit to the communities
    they serve.
    Disincentive for De Novo Charters
        I ask you to consider the cumulative impact of the Basel III
    capital rule, numerous additional bank regulations that have gone into
    effect in recent years, and others that are in statute but have not yet
    been implemented. The complexity and volume of new regulation is a
    strong disincentive for de novo bank charters. I doubt that Centinel
    Bank or many other community banks would have been chartered if they
    had been faced with the daunting regulatory cost and complexity that
    exists today.
        The FDIC has approved only two applicants for deposit insurance in
    the past 4 years, a dramatic shift from many years of de novo bank
    formation averaging over 170 per year. Community bank consolidation,
    coupled with the dearth of new charters, will leave many communities
    without a local bank or access to local credit. I urge this Committee
    to consider legislation that will incentivize much needed de novo bank
    formation.
    Other Proposals That Would Support Community Bank Capital

    Modernize the Federal Reserve's Small Bank Holding Company Policy
            Statement
        Addressing the punitive capital regulation of Basel III is a
    priority for community banks. Short of an outright exemption for
    community banks, or at least targeted
    relief, from Basel III, I encourage this Committee to consider measures
    that would help us to meet our higher capital requirements under the
    new rule and better serve our customers and communities.
        ICBA supports legislation that would raise the consolidated assets
    threshold for the Federal Reserve's Small Banking Holding Company
    Policy Statement (Policy Statement) from $1 billion to $5 billion. I
    would like to thank the Members of this Committee for their efforts and
    leadership in the adoption of legislation at the end of the 113th
    Congress, which raised the Policy Statement asset threshold from $500
    million to $1 billion. That change has provided relief for nearly 650
    bank and thrift-holding companies.
        ICBA has long held the position that the threshold should be
    significantly higher to recognize the higher average asset size of
    today's community banks and bank and thrift-holding companies.
    Approximately 415 additional bank-holding companies would obtain
    capital relief if the Policy Statement were raised to $5 billion.
        The Policy Statement is a set of capital guidelines with the force
    of law that allows qualifying holding companies to raise and carry more
    debt than larger holding companies and potentially downstream the
    proceeds to their subsidiary banks. The Policy Statement plays an
    important role in capital formation for smaller bank and thrift-holding
    companies that have limited access to equity markets. A higher
    threshold will help more community banks meet their higher capital
    requirements under Basel III.
        The Policy Statement contains safeguards to ensure that it will not
    unduly increase institutional risk. These include limits on outstanding
    debt and on off-balance sheet activities (including securitization), a
    ban on nonbanking activities that involve significant leverage,
    limitations on dividends, and a requirement that each depository
    institution subsidiary of a small bank-holding company remain well
    capitalized.
    Introduced Legislation
        ICBA is very pleased that H.R. 3791, which would raise the Policy
    Statement threshold to $5 billion, passed the House in April of this
    year. The bill is sponsored by Rep. Mia Love.
    New Capital Options for Mutual Banks
        ICBA supports the creation of a new capital option to strengthen
    the long-term viability of mutual banks. Mutual banks should be
    authorized to issue Mutual Capital Certificates that would qualify as
    Tier 1 common equity capital.
        Mutual institutions were established and are maintained for the
    benefit of their communities, depositors and borrowers. They are well-
    run financial institutions that provide local service and investment to
    improve the quality of life in their local communities. In addition,
    mutual community banks are among the safest and soundest financial
    institutions. They remained strong during the financial crisis and
    continued to provide financial services to their customers.
    Introduced Legislation
        The Mutual Bank Capital Opportunity Act of 2015 (H.R. 1661),
    sponsored by Rep. Keith Rothfus, would authorize Mutual Capital
    Certificates as described above.
    Closing
        ICBA thanks this Committee for convening this important hearing and
    for the opportunity to present the views of the community banking
    industry.
        As I stated at the outset, capital regulation has the power to make
    or break credit availability in thousands of rural communities and
    small towns across America such as Taos, New Mexico. We urge this
    Committee to support changes that will support vital community bank
    lending.
                                     ______

                    PREPARED STATEMENT OF WAYNE A. ABERNATHY
    Executive Vice President, Financial Institutions Policy and Regulatory
                     Affairs, American Bankers Association
                                 June 23, 2016
        Chairman Shelby, Ranking Member Brown, Members of the Senate
    Banking Committee, thank you for this opportunity to discuss key issues
    of capital and liquidity in bank supervision and operations. My name is
    Wayne Abernathy, Executive Vice President for Financial Institutions
    Policy and Regulatory Affairs at the American Bankers Association
    (ABA). The American Bankers Association represents the breadth and
    depth of the banking industry, from the smallest bank to the largest
    bank, comprehending all of the industry's business models. Capital and
    liquidity are important to each of these banks.
        Capital and liquidity are two of the key indicators on which bank
    examiners focus and rate banks as part of the supervisory CAMELS system
    (Capital, Assets, Management, Earnings, Liquidity, and Sensitivity to
    market risk). It is hard to overestimate the significance of getting
    capital and liquidity management right.
        This is a timely hearing. We welcome it. We recommend that
    financial regulators, institutions regulated, and the public served
    begin to take up the questions--in an orderly, considered, and
    comprehensive way--as to what works, what does not work as expected,
    and what can be improved. We envision that this can and should be done
    in the nonpartisan fashion that has long been the tradition of
    successful bank supervision in the United States. We offer our comments
    within that context.
        As we meet today, the team of global specialists in Basel,
    Switzerland, are deliberating yet another dozen or more detailed
    financial regulatory projects, some new, some part of yet another round
    of adjustments to earlier Basel global regulatory prescriptions. Much
    like previous Basel projects, neither the American public nor the U.S.
    Congress have been effectively involved in these Basel deliberations.
    It is getting increasingly difficult to discern either what their goals
    are or what value the developing Basel projects have to bring to the
    U.S. supervisory program.
        The latest Basel project for which proposed U.S. implementing
    regulations are currently pending for comment, is actually one of
    Basel's older--begun some 7 years ago: the Net Stable Funding Ratio
    (NSFR). The NSFR is a good example of a Basel global prescription for
    which it is hard to find a valid purpose in the U.S. supervisory
    program not already amply covered by other regulations and tools,
    several of which have been put in place since the Basel specialists
    began their work on the NSFR in 2009. I will discuss the NSFR more at
    length later in this statement.
        We are now in the eighth year of an intensive and extensive
    financial regulatory reform process. Subjects have included projects
    affecting capital, liquidity, risk management, stress testing, failure
    resolution, business processes, compensation, loan-loss reserves, as
    well as rules and standards for specific product lines, such as
    mortgages and derivatives. Final regulations, guidelines, and policies
    have been implemented in all of these areas, with only a few pieces
    remaining to be applied. In this latter group are rules on Total Loss
    Absorbing Capacity, executive compensation, as well as counterparty
    credit limits. These reforms have been accomplished through tens of
    thousands of pages of regulations and millions of pages of bank
    compliance reports to their financial supervisors.
        All taken together, with the experience of several years of
    application of the new regulatory regimes, and the publication of the
    full body of new standards nearing completion, we believe that this is
    an appropriate point for a review of how it all is working. In the
    press of reform, each measure has been created and implemented with
    less than the usual deliberation, and with imperfect reference to the
    other pieces. It is not credible to assume that each rule and
    regulation, many of which implement global schemes developed on distant
    shores for conditions that little prevail in the United States, is
    immune to improvement.
        It is no criticism of the purpose of any of the reform measures to
    ask how each is working and to inquire into how all the pieces are
    working together. The whole substance is not only overwhelming for each
    individual bank, but we have to believe that it is an awesome weight
    resting upon the bank regulators who have to supervise how all of the
    affected banks are applying each and all of the rules. We propose for
    consideration that there are ways to reduce complexity for banks and
    supervisors that will result in improved application of the regulatory
    principles involved. We need to begin that conversation. If not, we may
    find ourselves with a regulatory program that in practice is too
    complex to realize the supervisory success to which we all aspire.
    GETTING CAPITAL AND LIQUIDITY RIGHT
        Today's focus on capital and liquidity brings to the fore factors
    that affect banks throughout their operations. They also have profound
    impact on the overall economy. Getting capital and liquidity right is
    important for local, State, and national economic growth and
    prosperity, because they affect both the amount of financial services
    banks can provide and the form that those services take. Economic
    growth and prosperity, by the way, are the business of banking. Banks
    prosper as their customers and communities do. Banks devote a lot of
    time and attention to capital and liquidity management because of their
    impact on growth and prosperity.
        Since the trough of the recession, the U.S. banking industry as a
    whole has increased equity capital by more than half a trillion
    dollars. By the end of 2008, the low point of the financial crisis,
    industry equity capital had receded to $1.30 trillion, from a high
    point in March of 2008 of $1.36 trillion. At the end of the first
    quarter this year, bank equity capital had reached a record $1.84
    trillion. Other measures of bank capital are comparably elevated,
    whether risk-based capital measures or risk-blind capital measures like
    the leverage ratio. Bank liquidity profiles and resources have been
    similarly augmented.
        For U.S. banks, the fundamentals of safety are strong. But are they
    getting so strong that they are jeopardizing bank soundness? By
    soundness, I refer to other CAMELS measures, such as earnings and
    assets. Can a bank have too much capital, and, if so, what are the
    consequences? Without sustained and strong earnings, no amount of
    capital and liquidity will eventually be enough. Excessive limitations
    on assets mean limiting the financial services that banks are chartered
    by Government to provide. There is a balance here, and how to get that
    balance right is an important matter for policymakers and industry to
    consider. It is not academic.
    CAPITAL IDEAS
        We offer a few thoughts for that consideration.
    Efficiency of Capital
        After the trough of the recession, while the banking industry was
    building its capital by half a trillion dollars, bank assets--the
    banking industry's share of the economy--remained flat for several
    years and then grew by $2.4 trillion. That growth is good and valuable,
    supporting broader economic growth and millions of jobs. But could
    there have been more? The new, additional capital has been, at least in
    the short run, relatively less efficient than normal in generating
    economic growth. The ratio of new capital to new asset growth has been
    just shy of one-to-five, each new dollar of capital supporting just
    under five dollars of new loans, leases, and other bank investments. At
    the trough of the recession, the $1.3 trillion of bank capital
    supported $13.8 trillion of loans, leases, and other bank assets and
    investments; that is to say that one dollar of capital supported almost
    9 \1/2\ dollars of loans, leases, and bank investments. Encouragingly,
    the latest results from the banking industry suggest asset growth
    related to capital moving in a direction toward historical norms. Is
    that a development for policymakers to arrest or to encourage?
    Contractionary Effects
        Increasing regulatory capital is contractionary. As we learn in the
    basics of money and banking, most of the money in a modern economy is
    generated by means of the banking system, through the process of banks
    taking in deposits and making loans. The Federal Reserve may create
    dollars, but depositors take those dollars and put them into banks.
    Depositors treat their deposit balances as part of the money supply.
    Banks lend those deposits back into the economy, which funds are used
    as money by the borrower for economic activity and which find their way
    back into banks as more deposits, again increasing the money supply,
    when they are lent yet again. It has been said that modern banking is
    the process of allowing the same dollar to be used and reused by
    several different people. Financing banks by deposits is expansionary,
    funding economic activity. Adequate capital supports that process as a
    base of confidence and a platform from which to take a chance on
    borrowers.
        But raising capital standards is contractionary, because it takes
    dollars out of the system. Investors do not treat their capital
    investments as money. They do not use their capital investments to buy
    groceries, purchase furniture, go on vacation, or do the millions of
    other things for which deposited money is used.
        That is not to diminish the importance and value of capital as a
    foundation on which banks are able to build and manage their
    activities, including that important function of converting deposits
    into loans and yet more deposits. While adequate capital allows a bank
    to expand its activities, excessive capital requirements mean pulling
    even more money out of circulation to provide the same amount of
    financial services, more capital to do the same amount of financial
    work. How much capital is really needed, and how do we know?
    A Cacophony of Capital Measures
        As a result of the variety of new prudential regulations in recent
    years, we have multiplied the ways in which we evaluate and measure
    bank capital. The largest banks are required to monitor more than a
    dozen capital dials, including the Standardized Common Equity Risk-
    Based Ratio, the Standardized Tier 1 Risk-Based Ratio, the Standardized
    Total Risk-Based Ratio, the Advanced Approaches Common Equity Risk-
    Based Ratio, the Advanced Approaches Tier 1 Risk-Based Ratio, the
    Advanced Approaches Total Risk-Based Ratio, the Leverage Ratio, and the
    Supplemental Leverage Ratio, among others. To this are added less-well
    defined but more demanding regulatory capital expectations under annual
    stress tests, such as the Comprehensive Capital Analysis and Review
    (CCAR), and a number of capital buffers, including the Capital
    Conservation Buffer and the Basel capital surcharge for Global
    Systemically Important Banks (GSIBs).
        Surely a case can be made for each measure of capital and the
    information it provides, or that measure would not have been created
    and imposed. Do we really need all of them, however? Do so many
    measures of capital each have equal supervisory value? If they do not,
    do those measures with lesser supervisory value take some element of
    attention away from those whose supervisory value is greater, perhaps
    even vital? Would we improve the effectiveness of supervision if we
    identified and focused on those measures that provide the most value to
    prudential supervision? Is now a good time to be asking these
    questions?
    Risk-Based and Leverage Capital
        There is a purely academic debate that pits risk-based capital
    measures against leverage capital measures. In reality, bankers and
    regulators use both to evaluate the capital condition of banks. Risk-
    based capital measures have been criticized for being overly complex,
    subject to manipulation, and prone to error. All of these criticisms
    have elements of validity. Current Basel III--and other--capital
    measures are excessively complex, requiring calculations of details
    that exceed the supervisory value yielded. They do not have to be that
    way. Measuring capital according to risk can be simpler and still
    provide enough recognition of variation in asset quality to be a
    valuable aid to capital management and supervision. Excessive
    complexity may facilitate manipulation, which is an argument for
    simplifying the risk measures, not eliminating them. It is easy to
    point to errors in the risk-based measures, most of which derive from
    excessive complexity (that presume too fine and precise the degree of
    risk predictability) and from the static nature of the risk-based
    measures, inadequately recognizing the dynamic nature of asset risk.
        Similarly strong criticisms can be justly applied to risk-blind
    capital measures such as the leverage ratio. Both risk-based and
    leverage measures of capital are models. While acknowledging some
    degree of model error in risk-based capital, it should be understood
    that the leverage ratio is a model, too, one that assumes that all bank
    assets present equal risk. Whatever might be said about the likelihood
    of errors in risk-based measures, we can be certain that the simplicity
    of the leverage ratio means that it is always wrong. Unless a bank
    holds only one asset, its portfolio will contain assets with a variety
    of risks. The 1980s experience with the savings and loan industry
    demonstrates that this risk-blind simplicity can be manipulated by the
    unscrupulous to hide the riskiness of assets until the accumulation of
    risk becomes explosive. The risk-blind capital system that prevailed at
    that time allowed numerous institutions to run amok and contribute to
    the destruction of the Federal Savings and Loan Insurance Corporation,
    which had no measure of the degree of risk building up in the
    institutions whose deposits it insured.
        A more sound capital management and supervisory program makes
    appropriate use of both risk-based and leverage capital measures, an
    approach adopted by all U.S. banking regulators and mandated by statute
    in the wake of the S&L crisis. Risk-weighting of bank assets is indeed
    imprecise, but it is an art that has shown valuable progress over the
    years. It avoids the proven dangers of treating all risks the same
    (under which safer banks are required to hold too much capital, and
    unsafe banks may be able to pass with too little). To counteract the
    model risks of risk-based capital systems, however, as well as to
    ensure capital for risks that are either unknown or unknowable, a
    foundation of leverage capital is merited. That is the structure that
    regulators and bankers rely upon today. It is demonstrably superior to
    reliance on either risk-based or risk-blind measures alone. Inasmuch as
    risks are dynamic, there is room for consideration of the right balance
    and improvements.
    LIQUIDITY POINTS
    Liquidity Is More Perishable than the Rules
        Financial instruments are liquid until they are not. There is no
    class of financial instruments that has not had liquidity issues.
    Fannie Mae and Freddie Mac securities were once thought so liquid that
    serious consideration was given to using them as a monetary policy
    substitute for U.S. Treasuries, should the latter disappear as a
    consequence of prolonged budget surpluses. The budget surpluses did not
    last, and neither did the liquidity value of Fannie and Freddie
    financial instruments. The perceived reliability and liquidity of
    mortgage-backed securities helped fuel the mortgage/housing bubble. The
    insolvency problems of the Greek Government have reminded investors
    that sovereign instruments can become very risky. Even U.S. Treasury
    securities are subject to significant market losses in the event of an
    increase in interest rates, a problem made more acute by the Federal
    Reserve's prolonged suppression of interest levels, exposing Treasury
    investors to pronounced market losses from relatively minor upward
    movements in rates.
        Unfortunately, the Basel-prescribed liquidity schemes implemented
    or proposed for implementation in the United States ignore the dynamic
    nature of liquidity. They are based upon static measures, financial
    snapshots of current liquidity conditions hardened into virtually
    perpetual standards. Are there supervisory and management methods to
    evaluate liquidity more dynamically?
    HQLA, Concentration, and One-Way Liquidity
        The Basel Liquidity Coverage Ratio (LCR), and U.S. implementing
    regulations, are intended to ensure that banks maintain enough
    liquidity to meet their needs for 30 days in a stressed environment.
    This basic prudential liquidity purpose is one that the banking
    industry supports. Liquidity, the ability to engage in transactions in
    a timely fashion and at reasonable cost, is essential to banking. Like
    oil in a car engine, without enough the engine soon locks up and ceases
    to operate.
        Liquidity management, therefore, has been a perennial focus of bank
    management and regulatory supervision, part of the CAMELS evaluation
    for all banks, as I mentioned above. The LCR was promoted as an effort
    to standardize liquidity supervision for larger banks according to
    global rules applied locally. Kept at a level of focus on central
    principles of liquidity management, the global LCR standards could have
    been useful. Unfortunately, the Basel experts went well beyond that,
    into micromanaging liquidity supervision. Liquidity problems are all
    about panic, and panic is a local, idiosyncratic matter. It is affected
    by local laws, national financial structures, even by local customs and
    attitudes. Some of these globally determined details do not fit
    realities in the United States very well, impacting the markets in
    which all of our banks operate.
        For example, under the LCR, U.S. banks are required to assume that
    during a recession or financial stress banks will suffer a significant
    run on deposits. Maybe that was the experience in Europe or other
    places the Basel experts call home. The U.S. experience has been more
    generally the opposite. During the recent recession, our banking
    industry saw an influx of domestic deposits, by $813 billion from
    immediately before the start of the recession in December 2007 until
    its official end in June 2009, as bank customers looked to banks as a
    safe haven to place their money. Yet, under the LCR, U.S. banks are
    forced to pretend, and engage in liquidity management that assumes a
    fictitious major run off in business deposits. Large banks are
    encouraged by the LCR to increase their gathering of retail deposits,
    in competition with community banks. That is worse than wasteful, as it
    distorts markets and distracts bankers and regulators from a better
    focus on what are more realistic challenges to liquidity in the U.S.
    environment.
        That is not the worst problem. The current structure of the LCR is
    excessively pro-cyclical, likely to hasten and deepen recession. The
    LCR requires banks to concentrate holdings in a static and narrowly
    defined list of what are called ``High Quality Liquid Assets'' (HQLA).
    The definition is basically short-term Government securities, with a
    smattering of highly rated corporate debt (deeply discounted).
    Recently the Federal Reserve added some municipal securities to the
    definition of HQLA (also deeply discounted), a move not yet echoed by
    the FDIC or the Office of the Comptroller of the Currency.
        If during a time of stress there is not enough HQLA to meet
    liquidity needs, what will happen? Panic. The LCR makes specific
    minimum ratios of bank holdings of High Quality Liquid Assets
    mandatory. What appears liquid today, however, will likely become only
    one-way liquid in a recession or even the approach to recession. In
    prosperous times, short-term Treasuries are easy to buy and to sell. In
    times of stress, who will be willing to let go of their supply? Those
    that have a supply cannot be sure how much regulators will want them to
    hold as recession unfolds. Those that do not have enough will have
    trouble finding it.
        If they cannot get needed HQLA, they will be forced to halt any
    expansion of loans and may even need to shed business in order to keep
    the mandated ratio of their assets in line with whatever amount of HQLA
    that they are able to find. Moreover, as noted earlier, U.S. banks
    typically see an influx of deposits during times of stress, which
    deposits will be difficult for a bank to accommodate if it is unable to
    acquire the additional supporting HQLA required by compliance with the
    LCR (see further discussion, below).
        Bear in mind that, at the same time, other regulations will be
    driving financial actors to acquire and hold these same short-term
    Treasuries for other mandatory purposes. Recent money market mutual
    fund rules allow at-par pricing and redemptions only for funds that
    invest in Government securities, and these same Government securities
    are the primary asset recognized by regulations mandating collateral
    for swaps transactions.
        With many sources of demand, HQLA will become scarce when financial
    storm clouds gather. That scarcity will affect economic activity,
    accelerating the slide toward recession, and sharpening a recession
    once begun. Does the static definition of HQLA miss assets that can
    have important liquidity value under certain circumstances? Is it wise
    to fix in regulation the assumption that Government securities will
    always be highly liquid under all conditions?
    Where Will the Depositors Go?
        Banks like to receive deposits and put them to work. A core
    function of banking is the reception of deposits from individuals,
    businesses, and government entities. We question the wisdom of
    liquidity regulations (the LCR) and capital rules (particularly the
    leverage ratio) that discourage banks from taking in deposits and that
    make it harder for banks to put those deposits to work.
        In particular, these regulations disadvantage business deposits and
    deposits from municipal governments. The LCR assumes, opposite to U.S.
    experience, that significant amounts of business deposits will move out
    of banks during periods of stress. With municipal deposits, the LCR in
    effect imposes a double charge. Municipal deposits are required by most
    State laws to be collateralized, however the LCR will require banks to
    apply additional HQLA if the State-approved collateral does not meet
    the LCR's narrow definition of ``highly liquid.'' Is it appropriate
    regulatory policy to discourage banks from accommodating business
    deposits and municipal
    deposits, particularly in times of economic trouble? Do we no longer
    want banks to perform this traditional function?
        To this are added punitive capital rules. These deposits are
    steered into high levels of HQLA, which, if a bank can get the HQLA,
    provide very low returns to the bank. In the second of a one-two punch,
    the leverage capital ratio assesses to banks the same capital charge
    applied to assets with higher returns. Under given market conditions--
    such as those prevailing today--the earnings on the HQLA may barely, if
    at all, cover the bank's costs in taking in these deposits. The market
    conditions that prevail in a recession are likely to be even worse.
        The result has already been that some banks have had to refuse
    deposits and/or charge some businesses fees for holding large deposits.
    In times of financial stress or even a recession, the supply of
    deposits seeking a safe haven in banks will likely be elevated
    (contrary to the regulatory assumptions of the LCR), opportunities to
    invest those deposits will wane, while bank earnings will be under
    increased pressure. In short, the new rules compromise the traditional
    practice of banks to accommodate deposits that they cannot readily use.
    Where will these depositors go? And what further strain will that place
    on economic activity? We believe that these are consequences, though
    already materializing, that neither banks nor policymakers intended. We
    need to address these dangers sooner than later.
    NSFR: Static, Complex, and Plowing an Already Seeded Field
        Much of what has been said about the problems with the LCR also
    applies to Basel's other liquidity prescription, the Net Stable Funding
    Ratio (NSFR), for which the U.S. implementing regulations were recently
    published for comment. The NSFR imposes static measures on dynamic
    activity, and by an order of magnitude the NSFR is more complex than
    the LCR. Moreover, the NSFR lacks a purpose. There is no problem that
    the NSFR would solve that is not amply addressed by other prudential
    regulatory regimes already in operation.
        The NSFR requires banks to evaluate their assets according to a
    complex framework of static risk weightings. At the same time, the rule
    would require banks to assess their funding sources by another complex
    set of risk weightings. Then the banks have to compare the two and see
    what they get. These asset and funding risk weightings, and the
    regulatory costs that the NSFR would impose, will guide the direction
    of banking services, rewarding banks for some assets and funding
    sources, penalizing them for others.
        Not only does that increase regulatory allocation of funding, but
    the risk measures are sure to become swiftly out of date.
    Unfortunately, like Dorian Gray, the NSFR relies upon an unchanging
    picture of liquidity while reality changes all around. The liquidity of
    any asset or liability is subject to variation. The NSFR is not. Based
    upon the Basel experts' judgment of conditions with which they are
    familiar, the NSFR would harden risk weightings into regulation and
    impose them on the future, regardless of what the future may bring.
        One of the key themes in the NSFR scheme, is that the maturity of
    an asset should be more closely matched to the duration of its funding
    source. To the Basel experts, this may sound like a good idea. It
    misses, however, one of the important economic roles of banking:
    maturity transformation. The U.S. banking industry takes in trillions
    of dollars of very short-term funds--deposits and other short-term
    debt--which customers take comfort in knowing that they can withdraw as
    needed. Banks take those funds and lend them out for longer periods,
    much of them for years. The longer maturities of the loans make houses,
    cars, and educations more affordable for families by letting them pay
    over a longer period. Businesses borrow in terms of years to allow the
    acquisition of plant and equipment, the development of business
    activities and other projects, most of which take time to generate
    revenues.
        Banks manage the risks involved in the difference between those
    needs. That is what banks do. The NSFR is hostile to that banking
    function. It rewards maturity matching, meaning that banks under the
    operation of the NSFR will be encouraged to lengthen the time that
    people commit their funds to banks while shortening the maturities of
    loans.
        The banking industry objects, the NSFR being neither in the
    interests of savers, borrowers, or banks. If finalized as proposed, the
    NSFR will mean less funding from depositors and fewer loans. We ask
    whether that is what policymakers intend.
        That is not to deny the risk in managing largely short-term
    liabilities funding longer-term assets. Banks constantly monitor their
    supply of deposits and other sources of funds, just as they do the
    conditions of their borrowers. Evaluating how banks perform these
    duties is one of the central jobs of bank examination.
        It has also been the focus of a number of additional regulatory
    programs put in place over the 7 years that the Basel experts have been
    working on the NSFR. The various regulatory stress tests put bank
    funding sources and assets through rigorously negative, and dynamic,
    scenarios to see how they stand up. Weaknesses are identified and
    addressed. In addition to the LCR, which assumes a severe stress,
    regulators have developed and apply a Comprehensive Liquidity
    Assessment and Review (CLAR) to the largest banks, that annually
    evaluates current and anticipated future liquidity conditions on a
    dynamic basis. In addition, under form FR-2052a the largest banks daily
    report their liquidity positions, with monthly reporting for other
    banks having more than $50 billion in assets. The Federal Reserve's
    form FR-2052b is employed to monitor liquidity in banks with more than
    $10 billion in assets but less than $50 billion.
        In short, the NSFR would plow ground that has already been seeded
    by more effective, appropriate, and dynamic measures of short- and
    long-term liquidity. Can we apply finite supervisory and management
    resources and attention to more fruitful prudential tasks?
    RECOMMENDATIONS
        Consistent with these principles and observations, ABA offers the
    following recommendations.
    Highly Capitalized Banks and Basel III
        In an overly complex way, Basel III capital rules require banks to
    hold adequate levels of high quality capital--capital with a
    demonstrable capacity for absorbing losses. As implemented by U.S.
    regulators, the final Basel III rules have been in some valuable ways
    tailored to bank conditions and business models. More can be done.
        On September 15, 2014, the American Bankers Association and State
    bankers associations from every State and Puerto Rico sent a letter to
    the banking regulators recommending an additional element of tailoring.
    This recommendation stems from the recognition that a number of banks,
    primarily community banks, already hold high levels of capital.
    Recognizing that reality, our recommendation would not require any
    changes to law or to substance of the Basel III regulations. It would
    provide relief to thousands of banks, primarily community banks that
    are already holding levels of capital far and above what Basel III
    requires. (A copy of the associations' letter is attached to this
    testimony.)
        The recommendation is simple. We recommend that bank regulators
    recognize that highly capitalized banks, namely any bank that holds
    approximately twice the level of capital expected by Basel III, be
    presumed to be in compliance with the Basel III standards without
    having to go through the complex--and unnecessary--Basel calculations.
    If you consider Basel risk-based standards, that would be approximately
    14 percent risk-based capital; or if you consider the U.S. leverage
    ratio, that would be about 10 percent. We urge that the regulators
    employ tools already used by banks to identify these highly capitalized
    banks, rather than create a new onerous process to identify banks that
    would get relief from another onerous process.
        For banks with that much capital, the Basel calculations would be a
    fruitless exercise, invariably discovering that the bank's capital
    levels were already far and above what the Basel rules would require.
    This recommendation would not have application to banks subject to the
    Advanced Approaches, since that process by definition involves a more
    detailed level of scrutiny.
        We have had several discussions with bank regulators regarding this
    proposal and have found significant interest. We ask for timely
    implementation of this important step that would provide important
    burden relief while fully realizing the purpose of the Basel III
    capital regime.
    Transparency and Due Process for International Financial Standards
        The development and implementation of Basel III capital and
    liquidity standards was a painful process for all involved. It did not
    need to be that way. The public, the Congress, the broader U.S. banking
    industry were brought into the process too late, long after regulatory
    consensus was hardened, key concepts and formats already developed, and
    international deals reached.
        Moreover, U.S. regulators participated in the international
    discussions with needlessly limited knowledge as to how the Basel plans
    would affect U.S. institutions, markets, and the overall economy. By
    the time that implementing regulations were proposed, U.S. regulators
    considered themselves committed to the global Basel plan and were
    reluctant to make more than minor adjustments.
        We are still working our way through problems that could have been
    avoided if addressed at earlier stages in the process and had the
    regulators been equipped with more knowledge and public input. Examples
    would include the static and dangerously narrow band of HQLA, the
    punitive treatment of mortgage servicing assets (that resulted in the
    shedding of mortgage servicing from banks to nonbank parties whose
    lower-quality service has been the subject of notoriety, regulatory
    inquiry, and borrower discomfiture), penalty treatment for investors in
    banks organized under subchapter S rules (whereby investors in
    Subchapter S banks that are subject to dividend restrictions to rebuild
    capital, find themselves paying taxes on dividends never received), and
    harsh treatment of investments in Trust Preferred securities, TruPS
    (contrary to congressional intent that existing TruPS investments be
    allowed to wind down without further regulatory penalties).
        ABA recommends that financial regulators adopt or Congress mandate
    the following administrative practice: prior to the initiation of such
    international negotiations on financial standards, the U.S. agencies
    concerned should involve the public, the Congress, and affected
    industry through the publication of an Advance Notice of Proposed
    Rulemaking (ANPR). We believe that the ANPR should address and invite
    comment on the following items, among other pertinent matters----

        The issues or problems to be addressed by international
            standards;

        The nature of the standards being considered for
            application in the United States or affecting U.S. citizens or
            businesses;

        The various options likely to be considered; and,

        The anticipated impact of such options on U.S. persons,
            businesses, and the economy overall.

        We believe that this requirement should apply to internationally
    developed financial standards in general, whether affecting banking,
    insurance, securities, derivatives, or other financial products and
    services.
        This would not be an unusual procedure. Regulators often rely upon
    ANPRs to gather information prior to developing regulatory proposals.
    Negotiation of international trade agreements normally begins with
    significant public consultation and congressional involvement. The
    Basel II capital negotiations involved significant public consultation,
    improving the approach, providing greater tailoring of application, and
    collectively enhancing our understanding of risk based capital
    measures. It is true that the consultations resulted in a pause in
    potential U.S. implementation of Basel II, but with hindsight it is
    fair to describe that delay as salutary, since the recession did not
    catch U.S. banks in the midst of major capital restructuring. The U.S.
    banking industry entered the recession with a strong capital position
    that supported continued lending throughout most of 2008, and which
    industry net capital levels were only mildly impacted in the latter
    half of that year. Not only would the public and industry be more
    informed and Congress more involved in major financial policymaking
    with advance public notice, but the regulators themselves would be
    operating from a stronger base of information in the international
    discussions.
    The NSFR: Already Done That
        The NSFR, discussed above, is at best an outdated proposal that has
    since been overcome by other and better regulatory structures. ABA
    recommends that the proposed rule be withdrawn. U.S. regulators should,
    in fact, find that the purposes--if not the formalities--of the
    international standard have already been achieved in the United States
    by other liquidity supervisory and management regimes put in place
    while the NSFR standard was in development.
    TruPS and Basel III
        Prior to the recent recession it was believed, with regulatory
    concurrence, that trust preferred securities (TruPS) could serve as an
    additional and valuable source of capital, particularly for community
    banks. The recession demonstrated that while that might be true in the
    case of an individual troubled bank, TruPS had little loss-absorbing
    capacity when the entire banking sector was under strain.
        In the enactment of the Dodd-Frank Act, Congress took two major
    steps with regard to TruPS and capital. The first was to end the future
    use of TruPS as capital. The second, to prevent unnecessary harm to the
    existing issuances and holdings of TruPS by community banks, was to
    hold existing TruPS harmless, letting them run off as they matured. The
    regulators tested this congressional purpose in the initial Volcker
    Rule regulation but subsequently revised their rule to carry out
    Congress' hold-harmless intentions. Unfortunately, in the Basel III
    implementing regulations, TruPS are targeted for punitive treatment.
    ABA recommends that Congress' hold-harmless approach to existing TruPS
    be applied in the Basel III regulations as well.
        Most international regulatory standards, such as those developed by
    the Basel Committee, are at least initially announced as being designed
    for internationally active banks. When U.S. regulators choose to expand
    the reach of these global
    standards to the entire banking industry--as they did with Basel III--
    the rules can have a disproportionate and unexpected impact on
    community banks.
        TruPS instruments previously qualified as regulatory capital for
    the issuing holding company, and are securities in which a number of
    banks invested in good faith. Some smaller institutions accessed the
    market for these securities by pooling their issuances with those of
    other community banks.
        Under the pre-Basel III capital regime, most pooled TruPS were
    assigned a capital requirement based on the credit quality of the pool,
    using a ratings-based approach. Under Basel III implementing
    regulations, however, the U.S. regulators treat any amount of TruPS
    investments above 10 percent of a bank's common equity as a loss,
    deducted from regulatory capital regardless of actual performance. As a
    result of the Basel III treatment, many hometown banks with TRuPS in
    their investment portfolios are seeing their capital requirements for
    their TruPS investments skyrocket.
        This treatment of TruPS is inconsistent with the intent of Section
    171(b)(4)(C) of the Dodd-Frank Act, which holds harmless existing TruPS
    investments. That congressional intent was eventually reaffirmed by the
    banking regulators when they backed away from an initial provision of
    the final Volcker Rule regulation that required banks to divest their
    trust preferred securities holdings, forcing thousands of otherwise
    healthy community banks to consider selling these assets at fire sale
    prices. About a month later, the banking agencies issued an interim
    final rule providing relief to banks that had invested in TruPS, citing
    congressional intent to hold harmless existing investments in the TruPS
    market. The Basel III capital deduction operates in a contrary
    direction, strongly encouraging the very divestiture treatment of TruPS
    investments that was overturned in the 2014 interim final Volcker Rule.
        It is not clear why the regulators weighted Congressional intent so
    lightly, but it is clear that the Basel III treatment should be
    revisited if congressional intent is to be preserved and existing
    investments in TruPS indeed held harmless.
    SUMMARY
        The capital and liquidity positions of the banking industry are
    strong. The task list of prudential regulatory reform is approaching
    completion. Some reforms have been in place for several years, some are
    more recently in place, while a few remain to be finalized. Meanwhile,
    more and sustained economic growth are needed. The regulatory
    operations have been taking place on a living patient, whether you
    refer to the banking industry, the customers served, or the economy
    overall. We believe that the time is opportune to have a conversation
    involving all concerned about how all of this is working. What has been
    effective? What can be more effective? Are there provisions that are
    not working as expected or intended? We have offered several issues
    that we hope will be, and need to be, part of that consideration,
    particularly with regard to capital and liquidity.
        The rules are complex, we suggest more complex than they need to be
    to achieve their important prudential purposes, too complex for
    regulators and regulated alike. We believe that appropriate and well-
    considered simplification--with an eye always fixed on accomplishing
    the purposes of the prudential rules--can enhance both supervision and
    management. Part of that simplification should include further
    tailoring of these regulations to the various business models of our
    very diverse
    banking industry.
        In that context, we offer four specific recommendations, in
    addition to the issues and questions that we have raised:

      1.  Banks that are holding high levels of capital should be
            recognized as already meeting Basel III capital standards,
            without having to go through the complex Basel III
            calculations.

      2.  Prior to the initiation of international negotiations on
            financial standards, the U.S. agencies concerned should involve
            the public, the Congress, and affected industry through the
            publication of an Advance Notice of Proposed Rulemaking (ANPR).

      3.  U.S. regulators should withdraw the proposed rules implementing
            the Basel NSFR liquidity regime, having no purpose that is not
            already met by existing liquidity supervisory programs and
            tools.

      4.  The treatment of TruPS under Basel capital rules should hold
            existing TruPS issuances and investments harmless, as was the
            intent of the Congress in the Dodd-Frank Act, and followed by
            the banking regulators with regard to implementation of the
            Volcker Rule.

        The American banking industry is eager to engage in the
    conversation that we have recommended. Supervision and bank management
    can be rendered even more effective, which will be better for
    regulators and the regulated, and for the people whom we all serve.
    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

      RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM REBECA
                             ROMERO RAINEY

    Q.1. I'd like to discuss contingent convertible capital
    instruments, commonly known as CoCo bonds.

       LWhat lessons can be drawn from Europe's experience
            with CoCo bonds?

       LDo you believe CoCo bonds can uniquely help a firm
            withstand significant financial distress? If so, how?

       LHow should Federal regulators treat CoCo bonds?

    A.1. ICBA has no position on contingent convertible capital
    instruments.

    Q.2. I'd like to ask about Federal Reserve Governor Powell
    testimony at the April 14, 2016, Senate Banking Committee that
    ``some reduction in market liquidity is a cost worth paying in
    helping to make the overall financial system significantly
    safer.''

       LIs there also a risk that reducing liquidity in the
            marketplace also makes the marketplace unsafe?

       LIf so, how should regulators discern the difference
            between an unsafe reduction in liquidity and a safe
            reduction in liquidity?

    A.2. ICBA believes that market liquidity is critical to
    averting future financial crises. While ICBA has no position on
    the post-crisis regulation of the fixed-income markets, which
    is the context of Governor Powell's comment, we believe that
    reduced liquidity could make the marketplace unsafe. As part of
    a cost-benefit analysis of proposed regulations, which ICBA
    believes should be mandated by statute, regulators should
    attempt to quantify any anticipated reduction in liquidity and
    weigh that against the anticipated benefits of the regulation.
        ICBA generally supports the Federal agencies' liquidity
    coverage ratio (LCR) rule which requires the largest and most
    internationally active financial institutions that pose the
    most risk to our financial system to maintain a stock of ``high
    quality liquid assets'' (HQLAs) to meet unanticipated cash-flow
    demands. However, ICBA is concerned about the unintended
    consequences of several provisions of the LCR rule. These
    concerns include (i) the impact on the housing market of
    excluding Fannie Mae and Freddie Mac securities from the Level
    1 definition of HQLA; (ii) the impact on municipal finance of
    the exclusion of municipal securities from the definition of
    HQLA; and (iii) the high outflow rate assigned to reciprocal
    brokered deposits despite their full FDIC insurance and the
    inconsistent treatment of reciprocal brokered deposits that
    originate with wholesale customers (40 percent outflow rate)
    and with retail customers (10 percent outflow rate). A high
    outflow rate means that banks have to hold more liquid assets
    against them. ICBA's January 30, 2014, comment letter on the
    LCR proposal describes our position in greater detail.

    Q.3. I'd like to ask about the various capital requirements
    that have been imposed after the 2008 financial crisis.

       LHave Federal regulators sufficiently studied the
            cumulative impact--including on liquidity in the
            marketplace--of these various changes?

       LIf not, how should Federal regulators resolve this
            issue? For example, some have called to delay the
            imposition of new financial rules and regulations, to
            facilitate a broader study of these issues.

    A.3. ICBA is deeply concerned about the impact of the Basel III
    capital rule on community banks and advocates for an exemption
    for banks with assets of less than $50 billion so that these
    banks may continue using the Basel I capital rules. In my
    testimony, I noted four aspects of Basel III that are of
    particular concern: (i) the risk weighting of loans that are
    classified as high volatility commercial real estate (HVCRE);
    (ii) the complexity the rule adds to the quarterly call report;
    (iii) the capital conservation buffer, especially its impact on
    Subchapter S community banks such as mine; and (iv) the
    punitive capital treatment of mortgage servicing assets. ICBA's
    concerns are detailed in my written statement. We do not
    believe the regulators sufficiently studied the cumulative
    impact of these changes before finalizing the rule.

    Q.4. I'd like to discuss stress tests.

       LHow should policymakers balance the tension between
            providing more transparency and guidance to regulated
            entities about how to pass a stress test, and concerns
            that to do so would allow regulated entities to
            allegedly ``game'' these processes?

       LDo stress tests accurately depict how a firm would
            perform during a financial crisis, when taking into
            account ``systemic'' considerations? If not, what
            should be done, if anything, to improve their accuracy?

    A.4. ICBA supports a full exemption from stress test
    requirements for nonsystemically important financial
    institutions (non-SIFIs). ICBA has no position on the
    appropriate level of transparency and guidance or the accuracy
    of SIFI stress tests.

    Q.5. I'd like to ask about House Financial Services Chairman
    Hensarling's legislation, the Financial CHOICE Act, which--in
    part--would allow banks to opt-out of various regulatory
    requirements, in exchange for meeting a 10 percent leverage
    ratio that is essentially the formulation required by the
    current Supplemental Leverage Ratio.

       LWhat are the most persuasive arguments for and
            against relying upon a leverage ratio as a significant
            means of reducing systemic risk in the financial
            system?

       LUnder this legislation, is the 10 percent leverage
            ratio the right level? If not, where should
            policymakers set the level at?

       LWhat evidence do you find or would you find to be
            the most persuasive in discerning the proper capital
            levels under this proposal?

       LIf the leverage ratio was set at the right level,
            do you find merit in eliminating a significant portion
            of other regulatory requirements, as with the Financial
            CHOICE Act? Are there any regulations that you would
            omit beyond those covered by the Financial CHOICE Act?

       LWhat impact would this proposal have on liquidity
            in the marketplace?

    A.5. The Financial CHOICE Act has not been introduced. ICBA is
    studying Chairman Hensarling's discussion draft. We strongly
    support the community bank regulatory relief included in the
    draft proposal.
                                    ------

     RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM WAYNE A.
                               ABERNATHY

    Q.1.a. I'd like to discuss contingent convertible capital
    instruments, commonly known as CoCo bonds.
        What lessons can be drawn from Europe's experience with
    CoCo bonds?

    A.1.a. CoCo bonds, intended (particularly in Europe) to provide
    an alternative to immediate resolution of troubled or insolvent
    financial institutions, present significant practical problems
    that make their contribution to financial stability highly
    questionable and likely counterproductive. As the Bank for
    International Settlements has noted, designing triggers for the
    conversion of CoCo bonds into bank equity is highly complex.
    Triggers based on formulas, asset value tests, and similar
    measures are subject to problems of market opacity, potential
    manipulation, inconsistencies in application of accounting
    standards, and uncertainties when regulators exercise
    supervisory tools in relation to troubled institutions.
    Furthermore, in some structures the trigger is based on the
    institution's current market capitalization, which may be
    drastically affected by circumstances other than the condition
    of the institution itself, e.g., general equity market
    conditions. Other structures rely on regulators' discretionary
    decisionmaking to trigger conversion. This approach introduces
    risk of inconsistent treatment of troubled financial
    institutions. All of these uncertainties and opportunities for
    arbitrary--or at least discretionary--regulatory action
    undermine market discipline. Indeed, these factors can also
    undermine market acceptability of the bonds, threatening the
    market's appetite for such instruments, which negative
    perception could become acute in times of general market
    stress. Resultant shortages of investors in CoCos, in turn,
    could accelerate retrenchment by banks unable to obtain
    regulatorily mandated supplies to support growth or even
    maintain current asset levels, hastening or intensifying
    financial recession.

    Q.1.b. Do you believe CoCo bonds can uniquely help a firm
    withstand significant financial distress? If so, how?

    A.1.b. The potential flaws in the mechanisms described above
    suggest that CoCo bonds would create more uncertainty and
    unintended adverse effects than benefits for financial
    stability. Furthermore, the recent experience of European
    financial institutions that had issued CoCo bonds, the prices
    of which fluctuated dramatically based on confusion about the
    mechanics of the structures, offers no reassurance that these
    instruments are beneficial. Indeed, they suggest a limited
    availability of funds via CoCo bonds in good times and threaten
    a severe scarcity in times of stress, potentially rendering a
    bank unable to maintain regulatorily mandated levels of CoCo
    bonds and an impossibility of selling more to investors in
    order to support any expansion of lending related to economic
    recovery.

    Q.1.c. How should Federal regulators treat CoCo bonds?

    A.1.c. Federal regulators should bear in mind two
    considerations. First, some internationally active financial
    institutions with U.S. operations are regulated in
    jurisdictions that require or encourage CoCo issuance. If and
    when U.S. regulators are faced with resolution of one of these
    organizations, they will have to consider the impact of
    outstanding CoCo bonds on the U.S. operations, including any
    possible support this source of capital could offer to U.S.
    operations or, alternatively, the potential for ring-fencing
    and support offered to foreign operations but not to those in
    the United States. At a minimum, for each affected
    organization, U.S. regulators must understand the structure of
    the specific CoCo issuance(s) involved, how the bonds will
    behave in the circumstances, and the likely approach of foreign
    resolution authorities.
        Second, Federal regulators have proposed a requirement for
    ``total loss absorbing capacity'' (TLAC), to be issued by the
    largest systemically important financial institutions. TLAC is
    intended to provide a capital injection when an institution's
    top-tier entity becomes insolvent. Though the industry has
    pointed out a number of problems and uncertainties with the
    proposal which the Federal Reserve must address, a modified
    TLAC proposal would likely be superior to CoCo bonds in at
    least this key respect: the equity conversion would take place
    in the context of a legal proceeding in which credit or claims,
    at least those at the top-tier entity, could be finally
    resolved under due legal process and with some degree of
    predictability, rather than as a mitigating step that could
    still be overwhelmed by adverse market conditions and
    regulatory judgment. Also, though initiation of resolution
    proceedings may involve some elements of regulatory discretion,
    there are detailed standards for both agency review and
    potentially judicial review of agency action. Those standards,
    already in place through legislation, contrast markedly with
    the questions that regulatory discretion and even arbitrariness
    present in the structure involving CoCo bonds and their
    triggers.

    Q.2.a. I'd like to ask about Federal Reserve Governor Powell
    testimony at the April 14, 2016, Senate Banking Committee that
    ``some reduction in market liquidity is a cost worth paying in
    helping to make the overall financial system significantly
    safer.''
        Is there also a risk that reducing liquidity in the
    marketplace also makes the marketplace unsafe?

    A.2.a. Yes, decidedly so, and that is a risk that needs to be
    taken very seriously. We do not have to reject the purposes of
    measures of prudential supervision to inquire whether they can
    be improved so as to operate better, and whether unintended
    consequences can be addressed. A market that is less liquid is
    one that is more fragile. Unless we are seeking the stability
    of the grave, we need rules and regulations that can
    accommodate the dynamics of living markets. As one of our
    member institutions described, market liquidity is the market's
    ability to function--to have buyers and sellers transact
    without causing sharp price moves. Can we have too much of that
    kind of liquidity, that is, better functioning markets? We do
    not believe so. Regulations that drive legitimate participants
    from the market, or significantly reduce their levels of
    participation, impair the liquidity and stability of the market
    place, compromising the ability of markets to perform their
    functions, increasing volatility and raising the chances of
    stressed markets seizing up for lack of ready participants.
        Historically, banking organizations have provided liquidity
    to financial markets by acting as market makers, providing and
    encouraging the liquid operations of markets. This liquidity
    provision serves an important role in the depth and functioning
    of the financial markets that support so much other economic
    activity. Capital rules, such as a poorly designed and
    excessive leverage ratio, however, discourage market making in
    certain markets, such as those for Treasuries and corporate
    debt. In response, banking organizations are significantly
    decreasing or even exiting these and related activities,
    changing the structure of certain markets and making them less
    liquid and more volatile. We have recently heard that these
    measures are making it too expensive for some banks to take in
    business deposits, a key banking function. Where will those
    deposits go, and how does their departure from banking make the
    financial system more stable?
        As another example, liquidity regulations such as the
    Basel-inspired Liquidity Coverage Ratio (LCR) mandate that
    banking organizations hold fixed ratios of ``high quality
    liquid assets'' (HQLA), dangerously limited to largely one
    asset class, Treasury securities. These rules, which govern how
    banks fund themselves and their customers' activities, are
    exacerbating the current dislocations in the Treasury market by
    taking significant portions of Treasuries out of circulation
    and significantly increasing demand for those that are traded.
    Further distorting the Treasury market are new rules raising
    collateral requirements for derivatives transactions,
    increasing demand for these same Treasury securities also
    demanded for use as HQLA. Under current market conditions while
    the economy is expanding, the stresses in the supply and
    liquidity of Treasury securities can be more potential than
    seen. But when economic conditions become more troubled, a lack
    of market liquidity will become acute, as those who hold HQLA
    will be reluctant to let go of their supplies, and those who
    need such Treasury securities--either for HQLA purposes or to
    use as collateral--will have difficulty finding supplies to
    meet their needs. The safety of the financial markets will
    become significantly tested in such times of stress. Liquidity
    of the instruments defined in regulation as HQLA may become
    only one-way liquid, easy to sell but hard to buy.
        Robust capital and liquidity are essential to bank safety
    and soundness. Proper calibration of the rules that govern
    capital and liquidity is essential for local, State, and
    national economic growth and prosperity. Banking organizations
    are essential economic actors, whose balance sheets reflect
    both individual business strategies and, in aggregate, economic
    decisions made across the products and services the banking
    industry provides to the U.S. economy and markets. It is
    imperative, then, that policymakers understand how the set of
    regulations applied to banking organizations affects U.S.
    financial markets and the economy. A stable and healthy economy
    needs access to financial products and services made available
    through smoothly operating markets.

    Q.2.b. If so, how should regulators discern the difference
    between an unsafe reduction in liquidity and a safe reduction
    in liquidity?

    A.2.b. For reasons described above, regulations that drive
    legitimate participants from the markets, or result in
    significantly curbing their activities, reduce the safety of
    the markets. This is not to countenance fraud, manipulation,
    and other forms of theft and dishonesty in the market place.
    Market liquidity is in fact enhanced to the degree that such
    illegal actors and their practices are removed from the
    markets. The concept of ``safe reduction in liquidity'' is a
    dangerous contradiction, however. The smoother the markets
    operate, the better. Introducing potholes, detours, and
    barriers into the function of the markets does not render them
    safer.

    Q.3.a. I'd like to ask about the various capital requirements
    that have been imposed after the 2008 financial crisis.
        Have Federal regulators sufficiently studied the cumulative
    impact--including on liquidity in the marketplace--of these
    various changes?

    A.3.a. No, at least not yet. The banking agencies have not
    sufficiently studied the cumulative impact of various changes
    to the regulatory capital standards (or of other related
    prudential standards such as liquidity, resolution planning,
    stress testing, and risk management). Following the 2008
    financial crisis the banking agencies issued various regulatory
    capital amendments, such as Basel III, heightened leverage
    ratio standards for large banks, and raised risk-based capital
    standards for large banks, among others. Each of these
    rulemakings contained minimal analysis of the impact, scant
    reference to the interaction with other regulatory standards,
    and in some cases analysis was provided only after the public
    comment period closed.
        Internationally, the Basel Committee has issued a flood of
    recent proposals and final standards that, given their extent
    and impact, can best be named ``Basel IV.'' Each of these
    proposals appears to have been developed in a silo, and ABA is
    very concerned that the Basel Committee lacks ability and
    incentive to evaluate the cumulative impact of the changes in
    an effective and transparent way. While the Basel Committee
    does conduct limited Quantitative Impact Studies (QIS) for
    individual proposals, the Committee does not seem to be able to
    connect the dots of the variety of prudential standards and how
    they interact.
        We would emphasize that, when thinking about the cumulative
    impact of capital rules, it is also important to consider
    standards beyond the regulatory capital standards and their
    interplay in the economy. For example, heightened leverage
    ratio standards--which measure all assets as if they posed
    identical risk--offer incentives to banks to hold less liquid
    assets, which of course runs against the purpose of the
    liquidity framework. There are many other examples, such as the
    effect of capital and liquidity rules together to punish banks
    for holding deposits.

    Q.3.b. If not, how should Federal regulators resolve this
    issue? For example, some have called to delay the imposition of
    new financial rules and regulations, to facilitate a broader
    study of these issues.

    A.3.b. We urge the regulators to begin a process of reviewing
    the significant prudential regulations to see how they can be
    simplified. We believe that the regulatory program of recent
    years has become too complex for regulator and regulated alike.
    In fact, we believe that the purposes of each can be enhanced
    by a review focused on what is actually needed. That
    simplification naturally leads to and facilitates a
    consideration of the interaction of the various rules. A
    reduction in the intricacy of these rules will improve their
    worth as supervisory tools for regulators and management tools
    for banks. With regard to capital rules, we would recommend
    asking which standards--indeed, which elements of the
    standards--provide the most supervisory and management value.
    Those of lesser value--not to say no value--should be
    considered for setting aside so as not to distract supervisory
    and management attention from standards that offer the most
    benefit.
        As it relates to development of international standards,
    the regulatory agencies should conduct empirical studies of the
    impact on the U.S. banking system, with a focus on bank
    customers and the economy, that would result from the adoption
    of proposed international standards that are being considered
    for domestic implementation. While the Basel QIS process can be
    informative, that process is limited to a few banks and does
    not take into account U.S.-specific laws that might affect how
    a standard is implemented.
        In order to support U.S. rulemaking efforts based on
    international standards, ABA believes that the banking agencies
    should conduct empirical cumulative impact studies as part of
    Advanced Notice of Proposed Rulemakings before a proposal is
    issued, as I discuss in my testimony. The results of the study
    would notify the public of the analyses underlying key elements
    of the agencies' determinations as is required under the
    Administrative Procedure Act and would allow the public to help
    identify the cumulative impact.

    Q.4.a. I'd like to discuss stress tests. How should
    policymakers balance the tension between providing more
    transparency and guidance to regulated entities about how to
    pass a stress test, and concerns that to do so would allow
    regulated entities to allegedly ``game'' these processes?

    A.4.a. Surprise is not an appropriate component of bank
    supervision. The very concept of bank supervision is based upon
    the principle of allowing banks to know clearly what is
    expected of them and supervising on that basis. Unfortunately,
    the excessive regulatory secrecy surrounding the preparation
    and administration of stress testing is itself suggestive of
    supervisory ``gaming.'' Policy makers need not and should not
    compromise legal certainty in an effort to test banks'
    resilience. Besides basic fairness, wisdom and good governance
    argue that those subject to a law must have the means of
    knowing what is required. Anything less is arbitrary and
    fertile for opportunities for abuse. Unfortunately, the stress
    testing regime is a secretive process that allows the Federal
    Reserve to adjust capital performance expectations without
    public discussion and oversight.
        There certainly can be value in table-top ``what-if ''
    exercises, conducted jointly by banks and supervisors, to
    evaluate how both would respond to unexpected financial shocks,
    and learn from such hypothetical training drills. It is quite
    another matter to convert this approach into fully armed bank
    supervision, applying on the basis of surprise hypotheticals
    financial penalties that directly and materially affect banks,
    their investors, and the ability of banks to serve their
    customers. Under the current practice, with standards developed
    and hidden from public view, if a bank falls short in these
    stress tests severe and immediate penalties are assessed. In
    fact, the opaque stress testing standard has evolved to where
    it overshadows the regulatory capital standards that have been
    developed through the public and transparent process, subject
    to notice and comment under the Administrative Procedure Act.
    Serious questions of due process and wise supervision are
    raised. This secretive component in developing stress tests
    erodes public confidence in the supervisory process.
        Regulations, stress tests, and other valuable supervisory
    tools should be so designed and administered as to promote
    safety and soundness. The standards of safety and soundness
    should not be shrouded in mystery. Safety and soundness rules
    should be sufficiently certain, clear, and well-known so that
    they provide those subject to them with the ability to conform
    their conduct. That is the desired result of a well-constructed
    program of bank
    supervision.

    Q.4.b. Do stress tests accurately depict how a firm would
    perform during a financial crisis, when taking into account
    ``systemic'' considerations? If not, what should be done, if
    anything, to improve their accuracy?

    A.4.b. No, not adequately. Stress test results are dependent on
    the plausibility of the scenarios. We believe that the
    scenarios have tended to be unrealistic, posing hypothetical
    economic and financial conditions far more severe than what can
    be reasonably expected. That might be tolerable if it were a
    question of whether a bank could endure such harsh scenarios.
    We note and appreciate how well banks have stood up under such
    harsh tests. The tests, however, become unreasonable when a
    bank's performance against such unrealities is used to govern a
    bank's actual activities vis-a-vis its customers and investors.
    Stress tests have been based on hypothetical scenarios and have
    relied upon a vast number of uncertain assumptions. Such stress
    tests can be useful in helping develop a bank's risk management
    systems and examining their tolerances, but that usefulness
    should not be confused with ``accuracy'' and applied to the
    real world services provided to customers and the earnings due
    to investors.
        By definition, ``accuracy'' is not achievable in the stress
    tests, because that would require predicting the future.
    Moreover, if banks, regulators, and other market participants
    ever become convinced that a stress test is ``accurate,'' that
    would likely lead to over-reliance on the stress test modeling.
    ``Effectiveness'' in meeting the purposes of identifying issues
    and concerns for appropriate attention is a much better
    standard of measure, and effectiveness calls for a closer tie
    to reality understood by those being tested.

    Q.5.a. I'd like to ask about House Financial Services Chairman
    Hensarling's legislation, the Financial CHOICE Act, which--in
    part--would allow banks to opt-out of various regulatory
    requirements, in exchange for meeting a 10 percent leverage
    ratio that is essentially the formulation required by the
    current Supplemental Leverage Ratio.
        What are the most persuasive arguments for and against
    relying upon a leverage ratio as a significant means of
    reducing systemic risk in the financial system?

    A.5.a. The leverage ratio has an important place in bank
    supervision, compensating for shortcomings in risk-based
    capital models and for risks that either cannot be measured or
    are unknown. It should be remembered, however, that the
    leverage ratio incorporates its own very obvious shortcomings,
    namely that it assumes that all assets carry the same risk all
    the time. That, of course, is a fiction, albeit a useful
    fiction as a backstop for the limitations of risk-based capital
    measures. Very wisely, the current supervisory capital program
    in the United States is one that relies upon a risk-based
    capital program with a leverage ratio backstop. That is the
    basic structure under which U.S. banks operate today, as
    required by statute.
        That said, the draft legislation does not eliminate risk-
    based capital measures. As we understand it, the proposal
    offers an option. When a bank is extremely highly capitalized,
    the draft legislation would provide a simpler leverage ratio
    measure for calculating capital on the assumption, presumably,
    that at such high levels risk-based tests would be likely to be
    met.

    Q.5.b. Under this legislation, is the 10 percent leverage ratio
    the right level? If not, where should policymakers set the
    level at?

    A.5.b. Our primary concern is not with the level but with the
    calculation method. The draft legislation uses a complex
    calculation designed by the Basel Committee and used by large
    internationally active banks. As such, we believe it could be
    unnecessarily burdensome for community banks. We believe that a
    measure more appropriate for community banks for these purposes
    would be a leverage ratio based on United States Generally
    Accepted Accounting Principles (U.S. GAAP).

    Q.5.c. What evidence do you find or would you find to be the
    most persuasive in discerning the proper capital levels under
    this proposal?

    A.5.c. Any number that is chosen by law or regulation will be
    artificial, at best an approximation. Markets, however, tend to
    be more flexible. There is a natural tradeoff, when considering
    capital levels, between the two different types of investors in
    banks.
    Some invest in banks by taking equity positions, basically by
    providing capital. Others invest in banks by lending to banks,
    such as depositors and holders of a bank's bonds and other debt
    instruments. The first group is compensated by the profits of
    the bank, which are subject to variation. The latter group is
    compensated by the stated terms of the interest rates applied
    to the debt.
        It can be seen that there is a tension between the two. As
    capital requirements are raised, the profits per dollar of
    equity invested are reduced (spreading any given earnings among
    more units of investment), and capital investors may become
    harder to find, looking for better returns elsewhere. But
    raising capital levels increases confidence for those lending
    to the bank that the terms of the loans will be met, while
    reducing capital can make investors in debt harder to find or
    lead them to demand higher interest rates. Markets, if left to
    themselves, will balance those competing investor demands,
    consistent with the risk profile of the bank.
        That is to say that, identifying a capital level set by
    governmental fiat is inherently difficult and likely to be
    inconsistent with the levels that markets may set. The
    questions that need to be asked, that can only be answered with
    imprecision, is at what level of capital will debt investors be
    unconcerned with regulatory standards that are waived (assuming
    that those regulatory standards add value to the performance of
    the bank), and will equity investors still invest in the bank
    at that level of dilution of their return on capital? The
    optimal answers to those questions are likely to vary by
    institutions and over time.

    Q.5.d. If the leverage ratio was set at the right level, do you
    find merit in eliminating a significant portion of other
    regulatory requirements, as with the Financial CHOICE Act? Are
    there any regulations that you would omit beyond those covered
    by the Financial CHOICE Act?

    A.5.d. The relevant question in examining any regulation is
    whether the regulation adds value. We would measure that value
    by the degree to which the regulation facilitates the ability
    of banks to serve their customers. Any regulation that inhibits
    the ability of banks to serve their customers needs to be
    revised or discarded.
        We believe that this question should be applied to a review
    of regulations frequently, and that no regulation should be
    exempt from it. For example, we believe that the significant
    number of prudential regulations applied from the Dodd-Frank
    Act and those pursuant to global standards developed in Basel
    are generally far too complex for the good that they do. That
    is why in my testimony ABA urges that each of these regulations
    be subject to a public review and discussion as to how each can
    be simplified, which, in our view, will actually result in
    better supervision and achievement of the purposes of each
    regulation. That review would, in turn, serve the goal of
    facilitating the ability of banks to serve their customers, the
    reason why each bank in America was given a Government charter.
        That process cannot be concluded in a day, and it has to
    start somewhere. We appreciate the selection of regulations
    that have been identified for review and reform in the CHOICE
    Act.

    Q.5.e. What impact would this proposal have on liquidity in the
    marketplace?

    A.5.e. As currently drafted, we do not anticipate any negative
    impact on liquidity. We are eager to work with the authors in
    the House as well as with those in the Senate working on
    regulatory relief measures to realize the intent of legislators
    to improve liquidity and the functioning of the financial
    marketplace. We believe that such efforts can achieve both
    better liquidity and better
    supervision.

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