[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
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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__________
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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
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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
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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.
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\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.
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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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