[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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            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.
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    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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