[Senate Hearing 114-6]
[From the U.S. Government Publishing Office]
S. Hrg. 114-6
EXAMINING THE REGULATORY REGIME FOR REGIONAL BANKS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE IMPACT OF THE EXISTING REGULATORY FRAMEWORK ON REGIONAL
BANKS
__________
MARCH 19, 2015
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
MICHAEL 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
Jelena McWilliams, Chief Counsel
Dana Wade, Deputy Staff Director
Beth Zorc, Senior Counsel
Jack Dunn III, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Graham Steele, Democratic Chief Counsel
Phil Rudd, Democratic Legislative Assistant
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, MARCH 19, 2015
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESSES
Daniel K. Tarullo, Governor, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 32
Responses to written questions of:
Senator Brown............................................ 44
Senator Vitter........................................... 51
Senator Toomey........................................... 53
Thomas J. Curry, Comptroller, Office of the Comptroller of the
Currency....................................................... 5
Prepared statement........................................... 35
Responses to written questions of:
Senator Toomey........................................... 57
Martin J. Gruenberg, Chairman, Federal Deposit Insurance
Corporation.................................................... 7
Prepared statement........................................... 39
Additional Material Supplied for the Record
Systemic Importance Indicators for 33 U.S. Bank Holding
Companies: An Overview of Recent Data, submitted by Chairman
Shelby......................................................... 61
BCBS Systemic Importance Indicators, submitted by Chairman Shelby 68
Tailored Key Elements of Enhanced Prudential Regulation,
submitted by Senator Brown..................................... 69
(iii)
EXAMINING THE REGULATORY REGIME FOR REGIONAL BANKS
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THURSDAY, MARCH 19, 2015
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 C. Shelby, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
This week and next, the Committee will examine the impact
of the existing regulatory framework on regional banks. Today,
we will hear from regulators on the current regulatory
construct and whether it should be imposed on these
institutions.
Regional banks fulfill a critical role in their
communities. They represent what we all recognize as
traditional banking. They, for the most part, take deposits so
that they can provide residential, small business, and
commercial loans. This is the fuel that drives local and
regional economic growth.
Unfortunately, these banks have been placed in a regulatory
framework designed for large institutions because of an
arbitrary asset threshold established by the Dodd-Frank Wall
Street Reform and Consumer Protection Act. The title of the Act
says ``Wall Street,'' but today, we are talking about banks
that call Birmingham, Alabama, and Cincinnati, Ohio, home. The
Dodd-Frank framework subjects all banks with assets of $50
billion or more to enhanced prudential standards, which carry
heightened capital requirements, leverage, liquidity,
concentration limits, short-term debt limits, enhanced
disclosures, risk management, and resolution planning. Five
years after this new regulatory framework was conceived, I
believe it is appropriate today to revisit its suitability for
these particular institutions.
Many experts have expressed concern about an arbitrary $50
billion threshold as an automatic cut-off for systemic risk. I
share their concerns. It has been said that regulators should
not apply macroprudential rules to those institutions that do
not pose macroprudential risk. I could not agree more.
I have also been a proponent of prudent regulation and
strong capital requirements. I believe we must, however,
consider the economic impact of subjecting banks that are not
truly systemically risky to enhanced prudential regulation. I
think we also must ask whether the existing regulatory
framework is the best use of the regulatory resources.
Today, I would like to hear from the witnesses whether the
$50 billion threshold is the appropriate and most accurate way
to determine systemic risk in our banking sector. For example,
a recent paper by the Office of Financial Research examines
broad indicators used by global bank regulators to determine
when a bank is systemically important. In fact, global bank
regulators do not focus strictly on asset size. Rather, they
take a broader view of the bank's total exposures that captures
activities beyond assets.
The Office of Financial Research report takes into account
the bank's size, interconnectedness, complexity, among other
factors, and applies this criteria to regional banks in the
U.S. The results of this analysis show that regional banks
generally pose a small fraction of the risk to the financial
system compared to the largest banks. The report states that
the data set, quote, ``is a significant step in quantifying
specific aspects of systemic importance.''
What this analysis reveals is in stark contrast with the in
or out approach mandated by the $50 billion threshold. Some
supporters of this automatic in or out approach to systemic
risk argue that the regulators can tailor requirements based on
the institution's size. I believe what this argument fails to
take into account is that the law that established this
regulatory framework is very prescriptive on how the regulators
can tailor their regulations.
For example, under the current system, a $51 billion bank
must receive disparate treatment from regulators compared to a
$49 billion bank. This statute, I believe, effectively ties
regulators' hands from taking into account a holistic view
similar to that employed by the Office of Financial Research in
its analysis on systemic risk.
A regulatory system that is too constrictive is not a
system that will allow our banks to thrive or our consumers and
businesses to have access to affordable credit. Moreover, a
system that directs regulators' resources away from issues of
systemic importance raises questions of whether regulators are
adequately focused on protecting the economy and American
taxpayers from the next crisis.
When the Ranking Member and I first met to discuss the
agenda of the 114th Congress, I thought we shared a common
interest that the SIFI threshold was one of a number of topics
on which we should focus. Today, we will begin that effort.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Chairman Shelby, and thank you to
the witnesses today and thank you all for your public service
over the years.
I appreciate the Chairman calling this hearing to examine
the regulation of regional banks. It is an important topic. We
held a hearing last July on a similar topic. Unfortunately, it
seemed to raise more questions than it provided answers. I hope
these next two hearings, this week with the regulators and next
week with banks, will help us to advance the conversation as we
work to ensure that prudential regulations for regional banks,
for midsize banks, are crafted appropriately.
This is a topic that is important to me because I have seen
the effects on a community when a regional bank takes excessive
risks. National City Corporation was a super-regional bank
founded in Cleveland in 1845. It weathered all the bank panics
of the 19th century and the Great Depression of the 20th, but
it no longer exists today. In 2007, National City was the ninth
largest U.S. commercial bank, having $140 billion in assets.
Less than a year later, it had been sold to PNC in Pittsburgh
with the assistance of $7 billion in taxpayer dollars.
National City's downfall is a case study in management
mistakes and regulatory failures. The OCC, for example, allowed
the bank to buy back $3 billion of its own stock in early 2007,
months before its failure. A Federal Reserve witness before my
subcommittee in 2011 called the events at National City, quote,
``a collective failure of imagination by the banks and by the
regulators.''
Even near-failures have costs. Though National City did not
technically fail, 4,000 people lost their jobs, many of them in
my hometown in Cleveland. National City's management and our
regulators failed those workers and communities across my State
and across a number of States.
Congress responded to this and the failures of other
institutions by passing Dodd-Frank and directing agencies to
institute standards like capital and liquidity and risk
management and stress testing to lower the likelihood and the
costs of large bank holding company failures.
In 2010, American Banker wrote that many of the powers in
Title I of Dodd-Frank were not new. They were put there as a
directive from Congress to the regulators to use their
authorities in ways that have teeth. That is why one bank
lobbyist said, ``When the President signed the financial reform
law, that was halftime. The legislators left the field. Now, it
is time for the regulators to take over. We want to see that we
do not over-regulate here,'' unquote.
I agree, we should not over-regulate. So did the authors of
Dodd-Frank. We often hear that a $50 billion bank should not be
treated the same way as JPMorgan Chase. I agree on that, too.
Dodd-Frank did not go as far as I would have liked in some
respects, but in other respects, it struck a pretty good
balance. It called for heightened rules for large bank holding
companies but directed regulators not to take a one-size-fits-
all approach. These rules were not meant to cover just the too-
big-to-fail banks nor just the systemically important banks.
They were meant to cover institutions like National City.
That is why enhanced prudential standards increase in
stringency as institutions grow larger. Regulators have
proposed or implemented different rules that apply to banks
with $50 billion or more in assets, rules that apply to banks
with 250 or more in assets, and rules that apply to banks with
700 or more in assets, the way it should be. Further, the law
allows regulators--and this is key, I believe--the flexibility
to lift the thresholds for some of these standards.
I hope that in the process of these hearings and our
discussions we explore the benefits and the burdens of specific
regulations and whether issues are being caused by the law or
its implementing regulations. Enhanced prudential standards are
important, not just to respond to the last crisis, but also to
prevent the next one. The failure of a single large institution
can create systemic risk, but so can multiple failures of
similar small or medium-size institutions.
The term ``too big to fail'' originated from the failure of
the $40 billion bank Continental Illinois in 1984. In today's
dollars, it would have been a $90 billion bank.
I look forward to hearing our witnesses are using their
authority to tailor their regulations to the institutions and
activities that present the most risk while not becoming
complacent and taking their eyes off of all potential sources
of risk. Our imaginations have failed us more than once when it
comes to anticipating problems. We should make sure we do not
let it happen again.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you.
Without objection, I would like to enter into the record
now the Office of Financial Research Brief 15-01 and the OFR
Table of Systemic Importance Indicators.
Our witnesses today include Governor Daniel Tarullo, a
member of the Board of Governors of the Federal Reserve System,
who is no stranger to this Committee; Comptroller Thomas Curry
of the Office of the Comptroller of the Currency, who is no
stranger, either; and also Martin Gruenberg of the Federal
Deposit Insurance Corporation, who was a longtime staffer here.
Welcome, gentlemen.
Governor, we will start with you.
STATEMENT OF DANIEL K. TARULLO, GOVERNOR, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you very much, Mr. Chairman, Senator
Brown, and other Members of the Committee.
In response to your request for comments on possible
adjustments to statutory thresholds for mandatory application
of certain forms of prudential regulation, let me begin with
three comments.
First, Dodd-Frank's creation of different tiers of
prudential regulation was a very important step forward in
dealing with the problem of too-big-to-fail and larger
institutions. The approach of requiring enhanced prudential
standards for larger, significant institutions is an important
method of promoting financial stability, assuring the
availability of credit for American businesses and households,
and countering moral hazard, while taking into account the
relative costs and benefits of different forms of regulation to
banks of different sizes and scope of activities.
Second, it is worth considering whether the threshold as
applied to smaller institutions within this range might be
adjusted in light of experience to date. As I have said before,
it may be sensible to exempt community banks completely from
certain regulatory requirements where this would reduce
compliance costs with little or no cost to safety or soundness.
It is also worth thinking about some adjustment to the $50
billion threshold in Section 165, a point to which I will
return in a moment.
Third, any possible change in these thresholds should be
limited to specifying the universe of banks for which it is
mandatory that certain regulations apply. It is critical that
the three banking agencies in front of you today retain
discretion to require prudential measures, including things
such as more capital or liquidity, for specific firms or groups
of firms when necessary to ensure the safety and soundness of
those institutions.
Coming back now to the issue of the $50 billion threshold,
let me first note that we have implemented the enhanced
prudential standards requirements in accordance with the
Section 165 criterion of increasing stringency depending on the
systemic importance of the banks as determined through
application of the relevant statutory factors. In essence, we
have created three categories for firms in that group, that
universe of banks of $50 billion or more. So, there is already
a good bit of tiering as we have taken advantage of the
flexibility granted to us.
Now, one might debate whether even the less restrictive
forms of those standards as applied to a $50 billion
institution should be mandatory or just left to supervisory
discretion. But, I would say, in trying to be responsive to the
questions the Committee is asking, that the issue is most
clearly joined with respect to supervisory stress testing. The
incremental supervisory costs for us of doing this entire
universe of banks are significant. The resource demands on the
institutions are substantial. The marginal benefits for safety
and soundness for that group of $50 to $100 billion
institutions seem rather limited. And, finally, our ability to
tailor to these smaller institutions is more constrained in the
context of a supervisory stress test with the three required
scenarios than in those other enhanced prudential standards
areas I was referring to a moment ago.
That is, even though we do vary some of the qualitative
expectations we have for the smaller banks in the stress test,
the basic application of supervisory scenarios, comparable loss
functions, and other elements of the test create a baseline of
a considerable amount of detail and resource expenditure for
the affected banks. So, I think this is an example of where
things are less susceptible to significant tiering and, thus,
the decision at its root tends to be a bit more of a binary
one, that is, the bank is either in or it is out.
Thank you for your attention, and I would be pleased to
answer any questions you might have.
Chairman Shelby. Thank you.
Mr. Curry.
STATEMENT OF THOMAS J. CURRY, COMPTROLLER, OFFICE OF THE
COMPTROLLER OF THE CURRENCY
Mr. Curry. Chairman Shelby, Ranking Member Brown, and
Members of the Committee, thank you for the opportunity to
discuss the OCC's experience with Section 165 of the Dodd-Frank
Act and our approach to tailoring our regulatory and
supervisory expectations to the size and complexity of the
individual institutions we supervise.
Because the focus of Section 165 as it applies to the
banking sector is on bank holding companies, almost all of the
authorities under this section are assigned to the Federal
Reserve System. The only area in which the OCC has direct
rulemaking authority involves the mandated company-run stress
tests for banks with consolidated assets of more than $10
billion.
To the extent permitted by the statute, we tailored our
requirements to distinguish between those that apply to banks
with assets between $10 and $50 billion in assets and those
with assets in excess of $50 billion. Otherwise, the OCC's role
in Section 165 is limited to a consultive one on matters
affecting national banks.
However, national banks typically comprise a substantial
majority of the assets held by bank holding companies with
consolidated assets of $50 billion or more, and the national
bank is typically the dominant legal entity within each
company. Consequently, I would like to focus my remarks on how
we use our existing supervisory tools that are similar to the
provisions of Section 165 in our prudential oversight of
national banks and Federal savings associations.
It is very important that the OCC retain the ability to
tailor and apply our supervisory and regulatory requirements to
reflect the complexity and risk of individual banks. As my
written testimony describes, we have taken a number of
initiatives to ensure that banks that pose heightened risk to
the financial system are subject to much higher requirements
than those with lower risk profiles. While a bank's asset size
is often a starting point in our assessment of appropriate
standards, it is rarely, if ever, the sole determinant.
For example, while most banks in our midsized portfolio
fall into the $8 billion to $50 billion range, this portfolio
also includes several banks that exceed $50 billion in assets.
These banks have business models, corporate structures, and
risk profiles that are very different from other institutions
in our large bank portfolio, which typically have national or
global operations, complex corporate structures, or extensive
exposures in the wholesale funding and capital markets. This
flexible approach, which considers both size and risk profiles,
allows us to transition and adjust the intensity of our
supervision and our supervisory expectations as a bank's
profile changes.
Our approach of tailoring requirements to different types
of institutions can also be seen in our implementation of
capital, liquidity, and risk management standards for the banks
we supervise. While our standards are separate from the
enhanced prudential standards that the Federal Reserve issues
under Section 165, we believe they are consistent with the
statute's intent and provisions.
For example, the interagency capital requirements
applicable to national banks, including those related to market
and operational risks, and the enhanced leverage ratio
requirements, generally only apply to the largest banks that
have significant trading activities and complex operations. The
capital rules, however, also allow the OCC to require
additional capital based on an individual bank's circumstances,
regardless of its size. This ability to require an individual
bank to maintain capital levels above regulatory minimums is
especially important when we encounter banks that have
significant concentrations in certain loan products or market
segments, and we regularly exercise this discretion.
For our largest banks, generally those over $50 billion in
assets, we have also developed a set of heightened standards
for risk management and corporate governance that reflect the
greater size, complexity, and risk that these institutions
represent. For example, these standards focus on the need for
an engaged board of directors that is capable of providing an
independent perspective and a credible challenge to management.
The standards also address the need for a robust audit function
and a compensation structure that does not encourage excessive
risk taking.
Finally, let me reiterate that there are very considerable
differences not just between community banks and large
institutions, but among the large banks themselves. Our
approach recognizes the differences in size, complexity, and
risk among the large banks and thrifts we supervise and it
ensures that the appropriate degree of supervisory rigor is
targeted to each institution.
Thank you, and I look forward to answering your questions.
Chairman Shelby. Thank you.
Mr. Gruenberg.
STATEMENT OF MARTIN J. GRUENBERG, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Gruenberg. Chairman Shelby, Ranking Member Brown, and
Members of the Committee, I appreciate the opportunity to
testify on the regulatory regime for regional banks.
Section 165 of the Dodd-Frank Act requires enhanced
prudential standards for bank holding companies with total
consolidated assets equal to or greater than $50 billion, while
providing regulatory discretion to tailor standards to the size
and complexity of the companies. The companies that meet the
$50 billion threshold represent a significant portion of the
U.S. banking industry and also represent a diverse set of
business models.
As part of its research on community banks, the FDIC
developed criteria to identify community banks. Based on that
criteria, 93 percent of all FDIC-insured institutions with 13
percent of FDIC-insured institution assets currently meet the
criteria of a community bank. This includes over 6,000
institutions, of which nearly 5,700 have assets under a billion
dollars. By contrast, regional banks are much larger in asset
size than a typical community bank and typically have expanded
branch operations and lending products serving several
metropolitan areas and may do business across several States.
In addition, the Deposit Insurance Fund would face a
substantial loss from the failure of even one of these
institutions.
Section 165 provides the FDIC with explicit
responsibilities in two substantive areas related to prudential
standards: resolution plans and stress testing. In both areas,
the FDIC has tailored requirements to fit the complexity of the
affected institutions.
Resolution plans, or living wills, are an important tool
for facilitating the orderly failure of these firms under the
bankruptcy code. In 2011, the FDIC and the Federal Reserve
jointly issued a final rule implementing the resolution plan
requirements for bank holding companies with assets equal to or
greater than $50 billion in consolidated assets. The agencies
used their statutory discretion to develop a joint resolution
planning rule which recognizes the differences among
institutions and scales the regulatory requirements and
potential burdens to the size and complexity of the
institutions subject to the rule.
For their initial submissions, bank holding companies with
less than $100 billion in total nonbank assets and 85 percent
or more of their assets in an insured depository institution
were generally permitted to submit tailored resolution plans
that simplify the task of creating a living will. Nearly all
the U.S. institutions in this category filed tailored plans.
The joint rule also allows the agencies to modify the frequency
and timing of required resolution plans, which we have done.
The Dodd-Frank Act also requires the Federal banking
agencies to issue regulations requiring financial companies
with more than $10 billion in total consolidated assets to
conduct annual stress tests. The FDIC's stress testing rules,
like those of the other agencies, are tailored to the size of
the institutions, consistent with the expectations under
Section 165 for progressive application of the requirements.
Under the agencies' implementing regulations, organizations in
the $10 to $50 billion asset size range have more time to
conduct the tests and are subject to less extensive information
requirements as compared to larger institutions.
Section 165 establishes the principle that regulatory
standards should be more stringent for the largest
institutions. Certainly, degrees of size, risk, and complexity
exist among the banking organizations subject to 165, but all
are large institutions. Some of the specializations and more
extensive operations of regional banks require elevated risk
controls, risk mitigation, corporate governance, and internal
expertise than what is expected from community banks.
That being said, it is appropriate to take into account the
differences in the size and complexity of large banking
organizations when forming regulatory standards. The agencies
have made appropriate use of the flexibility built into section
165 thus far, and where issues have been raised by industry, we
have tried to be responsive.
However, we do recognize that more could be done. For
example, the statutory language governing stress testing is
more detailed and prescriptive than the statutory language on
other prudential standards, leaving the regulators with less
discretion to tailor the stress testing process. The FDIC would
welcome the opportunity to work with the Committee on language
that would permit greater flexibility in the stress testing
process.
The FDIC also remains open to further discussion on how
best to tailor various enhanced prudential standards and other
regulations and supervisory actions to best address risk
profiles presented by large institutions, including regional
banks.
Mr. Chairman, thank you, and I would be happy to answer any
questions.
Chairman Shelby. I thank all of you.
I want to ask this question--a couple of questions to begin
with to all of you, and I would like a yes or no answer to
these questions. We are going to have a lot of questions.
Should a bank that is systemically risky be regulated like
a bank that is, one?
Two, are there any nonsystemically risky banks currently
being regulated as if they were systemically risky because of
the statutory $50 billion threshold?
Governor, we will start with you.
Mr. Tarullo. Senator, could I ask you to clarify just a bit
the two questions. Is the systemic importance issue----
Chairman Shelby. Let me just ask the question again. Should
a bank that is not systemically risky be regulated like a bank
that is?
Mr. Tarullo. I know you want yes or no, and I am going to
begin by saying no, but I just do want to point out that there
are varieties of systemic riskiness or importance.
Chairman Shelby. I understand. You can elaborate.
Mr. Tarullo. OK.
Chairman Shelby. What about are there any nonsystemically
risky banks currently being regulated as if they were
systemically risky because of the statutory $50 billion
threshold?
Mr. Tarullo. I would say, to a degree, yes, in the stress
testing area.
Chairman Shelby. Yes, basically.
Mr. Curry.
Mr. Curry. I would answer no to the first question, and
potentially yes to the second.
Chairman Shelby. OK.
Mr. Gruenberg.
Mr. Gruenberg. Can you repeat the question, because I want
to be careful----
Chairman Shelby. Yes, I will. Should a bank that is not
systemically risky be regulated like a bank that is? That is
question one. Yes or no?
Mr. Gruenberg. No.
Chairman Shelby. Are any nonsystemically risky banks
currently, to your knowledge, being regulated as if they were
systemically risky because of the $50 billion threshold?
Mr. Gruenberg. As a general matter, from my standpoint, no,
Mr. Chairman.
Chairman Shelby. OK. Another question for all of you. We do
not get this opportunity every day. I mentioned in my opening
statement a recent report by the Office of Financial Research
that examines broad indicators to determine whether a bank is
systemically important. Do you have any concerns with the
methodology described by the OFR report to measure systemic
risk, and do you believe that the automatic $50 billion
threshold is superior to analytic methodology described in the
OFR report to measure systemic risk? Governor.
Mr. Tarullo. Thank you, Mr. Chairman. Here is where this
issue of systemic importance comes in----
Chairman Shelby. Sure.
Mr. Tarullo. ----and there are two ways you can think about
it. One is systemic importance in the sense that high stress or
failure of that particular firm might itself lead to a
financial crisis. So, that is the sort of systemic risk, too-
big-to-fail concern that we are thinking about----
Chairman Shelby. Absolutely.
Mr. Tarullo. ----from 6, 7 years ago.
The second form of systemic importance is, if you just
reverse the syntax, importance to the financial system, and
that is where just the sheer size of an institution, the fact
that it has a big footprint across the country, the fact that
its credit intermediation is important for American businesses
and households, gives it an importance that, for example, does
not attach to a community bank. So, that is where it is
important to take account of those differences.
Now, the OFR report is, to a considerable extent, focused
on the institutions at the very top of the scale, what we have
in our LISCC, Largest Institution Supervision Coordinating
Committee portfolio at the Fed, and the institutions which
internationally have been identified as of global systemic
importance.
Now, there, as I think you all know, we do distinguish,
first off, by segregating that group of eight and have special
requirements applicable to them, and second, even among those
eight, we vary the requirements, for example, in our proposal
on capital surcharges. So, depending on size, complexity,
interconnectedness, and substitutability, the proposed
surcharge may be greater or lesser even among those eight
banks.
So, although one will have a different set of views, maybe,
on exactly what the right set of criteria are, and a lot of
academics and people internationally, people at the Fed, OFR,
have tried to give their own precise formulas, I think all of
those people are engaged in the same exercise, which is to say,
let us identify the systemic importance of those institutions
whose failure would really put the whole system at risk.
Chairman Shelby. Governor, again, do you disagree with the
methodology in the OFR report to measure systemic risk?
Mr. Tarullo. We might have some questions about the
methodology. I know you know this, Mr. Chairman, because you
have heard me on this for 10 years now, but I am very focused
on the vulnerabilities created by short-term wholesale funding
at large capital market institutions, and I, at least my
understanding of the OFR report is it does not weight that as
heavily as I would. But, as I said earlier, I think we are
engaged in the same broader exercise.
Chairman Shelby. Governor, as part of the Financial
Stability Board and the Basel Committee for Banking
Supervision, the Federal Reserve participated in devising what
we call a multifactor approach for assessing the systemic risk
for financial institutions. You are very familiar with this.
Could you briefly explain here this multifactor approach, and
do you believe that this approach is a valid way to determine
systemic risk?
Mr. Tarullo. Yes. I have already alluded to it, but let me
be a bit more specific.
Chairman Shelby. Yes.
Mr. Tarullo. What the Basel Committee did, and the Fed
participated very heavily in this, was to try to construct a
set of indicators, which, as I say, addressed issues like size,
interconnectedness, the degree of cross-border activity----
Chairman Shelby. Uh-huh.
Mr. Tarullo. ----and then to assign some weights to those
factors. Then we took a broad range of large internationally
active banks and ran their characteristics through that
template----
Chairman Shelby. Uh-huh.
Mr. Tarullo. ----to come up with a ranking of institutions
that might be considered of global systemic importance. That
was the basic exercise.
But, again, I just want to emphasize, that effort was
oriented toward the institutions whose failure in and of
themselves might create a domino effect and have a financial
crisis as a result. So, we were trying to do that assessment
for the very significant additional regulations that are
associated with those very largest institutions.
Chairman Shelby. Governor, you are familiar with Secretary
Lew's testimony before the House Financial Services Committee,
I assume, on Tuesday. He said that he is not convinced
legislation, quote, ``is required right now to raise the $50
billion threshold until we determine administrative flexibility
is inadequate.''
My question to you, does either the FSOC or the Federal
Reserve currently have administrative flexibility to raise the
$50 billion threshold with respect to prudential standards in
Section 165? It is my understanding that is statutory.
Mr. Tarullo. That is statutory, and the FSOC has authority
to raise some but not others.
Chairman Shelby. Not that.
Mr. Tarullo. And not stress testing, right.
Chairman Shelby. Thank you.
Senator Brown.
Senator Brown. This chart to the witnesses' right, and all
my colleagues should have a copy at their desks, highlights
significant tailoring of enhanced prudential standards by the
regulators for bank holding companies above $50 billion in
total assets. This is an easier yes or on question than the two
directed from the Chair. Just to each of you, if you would just
say yes or no, does this look accurate to you?
Mr. Tarullo. No, it does not, Senator.
Senator Brown. Why is that?
Mr. Tarullo. Well, there are at least two reasons I see,
looking at it quickly. I do not quite know where the $700
billion category came from. We have breaks for statutory and
supervisory reasons at 1, 10, 50, 250, and then the LISCC
portfolio, but this other one, they may have inferred it from
some other things, but it is not one of our categories. Also, I
do not see single counterparty credit limits up there, either.
There may be others.
Senator Brown. Mr. Curry.
Mr. Curry. I think, generally, it is correct, Senator. I
believe the $700 billion figure may reflect the cut-off in the
enhanced supplemental leverage ratio.
Senator Brown. Mr. Gruenberg.
Mr. Gruenberg. Senator, since the enhanced prudential
standards are, in significant measure, a bank holding company
set of standards under the Fed, I think I would probably defer
to Governor Tarullo on the evaluation of this particular chart.
Senator Brown. OK. Let us get back to that. Let me go in a
slightly different direction.
Governor Tarullo and Chairman Gruenberg observed the
statute allows for tailoring. You have said that. But, there
are practical challenges to tailoring stress tests. Governor
Tarullo said the supervisory benefits of stress testing for
banks around $50 or $60 or $70 billion are relatively modest.
Chairman Gruenberg alluded to this when he discussed capital
and liquidity, but Section 165 also includes some standards
that are central to preserving safety and soundness and
financial stability.
And, questions for all of you, again, start with you,
Governor Tarullo. How concerned should we be by proposals that
would limit your agency's longstanding authority to preserve
safety and soundness and financial stability of all bank
holding companies, regardless of size? And, let us go down,
starting with you.
Mr. Tarullo. Very concerned, Senator. That is why I
included that as one of my introductory points, that it has
been a longstanding practice of the three agencies in front of
you, as validated by Congress, let me see, 32 years ago, that
the Federal banking agencies have discretion to apply
specifically stronger expectations for particularly banks or a
group of banks that pose safety and soundness risk. Any
constraint upon that would be highly problematic.
Senator Brown. Mr. Curry.
Mr. Curry. I would agree with Governor Tarullo. The items
that are in Section 165 really are tools, longstanding tools,
established tools that the supervisors have used. So, any
direct or, by implication, limitation on our ability to use
those tools on a selective basis would be problematic.
Senator Brown. Mr. Gruenberg.
Mr. Gruenberg. Senator, I agree with the points made by
Governor Tarullo and Comptroller Curry, and it goes to, to me,
an important issue, as to what the purpose of these enhanced
prudential standards are. As I read them, they basically
preserve the underlying prudential authorities that the
agencies have had and are basically saying to the agencies, for
institutions over a certain size, they may present particular
risk to the financial system. They are basically telling the
regulators to pay attention and, if necessary, impose more
stringent standards. I think that is the purpose and that is,
in significant measure, the value. But, I think the premise was
that the underlying prudential authorities that we had would be
preserved, and I think that is probably for us the threshold
issue here.
Senator Brown. Thank you.
One financial sector analyst's note about this hearing said
that raising the $50 billion threshold, and I quote, ``would
open the door to more freedom for banks to distribute capital
to shareholders in the form of buy-backs and dividends and
would pave the way to more M&A activity as banks worry less
about crossing the $50 billion threshold designation.''
Should we be giving a priority, then, to dividends and buy-
backs and consolidation at the expense of financial stability?
And, I will start with Mr. Gruenberg this time.
Mr. Gruenberg. No, Senator.
Senator Brown. Mr. Curry.
Mr. Curry. No.
Mr. Tarullo. So, Senator, obviously not. I mean, that is
not what motivates it. I think what should motivate it is the
question of how much safety and soundness benefit do we get out
of this particular approach, which is the stress testing. I
think that as you saw by looking at the stress test results
this year, in fact the smaller regional banks are very well
capitalized. So, it is really just a question of the
expenditure of resources and how much safety and soundness
benefit you get for that.
Senator Brown. Mr. Gruenberg, one more question, if I
could. The failure of the $30 billion thrift IndyMac, a
traditional lender under $50 billion in assets, cost the FDIC
fund about $12 billion. What did their failure mean for the
market and for the DIF and which enhanced prudential
regulations would help mitigate those effects in the future for
a bank that size?
Mr. Gruenberg. It is a good question, Senator. As you know,
IndyMac was the most costly failure during this recent crisis
to the Deposit Insurance Fund, and, I think, may have been the
most costly failure the Fund has ever experienced for a single
institution. And, it presented significant resolution
challenges, because, frankly, the institution was in such bad
shape that there was no available acquirer for it. We had to
establish a bridge company to manage it over a period of
several months to have an orderly wind-down, which is one of
the reasons for the cost of the failure.
And, it certainly had consequences. It was a California
institution, and it had consequences for the community and
region in which it operated. It is fair to say, given the
fragile financial environment generally at the time, it may
have had broader impacts in terms of perceptions about the
vulnerability of the mortgage market.
The point is that an institution even of that size could
have, certainly, significant consequences for the Deposit
Insurance Fund and considerations for the financial system more
broadly. Among the provisions of Dodd-Frank, of the enhanced
prudential standards, the stress test is the one provision that
would have applied, and in retrospect, had they had stress
testing as well as a risk committee for the institution, I
would argue that a stress test for that institution and a risk
committee would not have had value for that institution.
Senator Brown. Thank you.
Chairman Shelby. Senator Heller.
Senator Heller. Mr. Chairman, thank you, and thanks for
holding this hearing on regional banks.
I also want to thank the banking agencies for being here,
also, for taking time and listening to our concerns.
Before I get started with my questions, I would like to
find out where that chart came from. Maybe I would ask the
Ranking Member----
Chairman Shelby. The source of it.
Senator Heller. ----what is the source of this chart?
Chairman Shelby. Senator Brown, I think he is directing
this question to you.
Senator Brown. I am sorry. Yes. It came from Better
Markets.
Chairman Shelby. From what, now?
Senator Brown. Better Markets.
Chairman Shelby. It does not have where it came from.
Senator Brown. I apologize for it not showing that.
Senator Heller. I mean, it is unusual to have a chart that
is passed around that has no validity.
Senator Brown. Well, it has got lots of validity. I
apologize for----
Senator Heller. Well, the banking agencies themselves said
it had no validity to it.
Senator Brown. Well, they had--we had talked to the Fed
about this and we----
Senator Heller. I just hope it is not the practice of
this----
Senator Brown. Well, I----
Senator Heller. ----this Committee to pass around charts
that have no validity----
Senator Brown. ----do not think it has----
Senator Heller. ----nor does it have any source connected
to it.
Chairman Shelby. It is not the practice of the Committee.
We generally--I have never known anything that did not have a
source on it.
Senator Brown. OK. I apologize for not putting the source
on it. It was--there were some slight problems with it, but not
major problems with it. I apologize for that.
Senator Heller. All right.
Governor, can you explain to me, based on current
standards, the difference in the risk of a $49 billion bank and
a $50 billion bank? Why is a $49 billion bank less risky than a
$50 billion bank?
Mr. Tarullo. Well, Senator, obviously, the risk of a
particular institution is going to depend substantially on the
underwriting practices and quality of capital of that
particular institution. I think if you are getting at the
question of why a threshold at $50 billion, I mean, to a
considerable extent lines do have to be drawn. And, so, with
respect to, as Comptroller Curry was explaining, the
supervisory portfolios that we all have, we do have these asset
thresholds to make sure that we are not requiring community
banks to do more than makes sense for them to do with their
limited portfolios.
And, so, you draw a line at some point that seems sensible,
but there is not always in supervisory practice a radical
difference. There is a gradation of differences in what the
expectations are. There are some things that do vary when you
cut across a line that has been established in the statutory
sense, like $50 billion. But, let me just say----
Senator Heller. Governor, let me ask you a question----
Mr. Tarullo. Yes.
Senator Heller. ----because I do not have a lot of time.
You floated the idea of raising that to $100 billion.
Mr. Tarullo. Mm-hmm.
Senator Heller. Do you endorse that?
Mr. Tarullo. I endorse it in the sense that with stress
testing, in particular, I think that is the one area where the
administrative flexibility we have got seems not to allow us to
do something that we think is a win-win on all sides.
Senator Heller. Do you think risk matters or size? Which
matters more, measuring risk or the size of the capital----
Mr. Tarullo. Well, the two interact with one another,
obviously, because the riskiness associated--the larger the
institution, a given quantum of riskiness associated with that
institution's portfolio will translate into a greater or lesser
impact on the community and on the country. So, you really have
to take the two things together.
Senator Heller. You mentioned in your testimony that there
was a lot of cost in these stress tests, a lot of stress to the
agencies, obviously, quite a bit for the banks themselves. Is
there a better way? Is there a better way that the Feds could
be more transparent, perhaps communicate better to these
regional banks as to what your expectations are?
Mr. Tarullo. Oh, I think we have got a substantial back and
forth with the community banks--excuse me, the regional banks.
We have frequent meetings at the supervisory level before,
during, and after the stress tests. With respect to this group,
the $50 to $100 billion group, we have met with them on several
occasions and will again once the supervisory letters go out to
try to, to the degree we can, to tailor things to make the
expectations a little clearer. So, sure, there is always more
that can be done.
Senator Heller. Just one more follow-up question, or just
one last question. Do you think it is necessary to have a new
living will every year if there are no material changes in a
bank's organization?
Mr. Tarullo. Well, you do not necessarily have to have a
new one every year, and as Chairman Gruenberg was noting, we do
have a gradated set of requirements. I think for the largest
institutions, it is almost inevitable that there are going to
be changes that one wants to take into account on an annual
basis, just the same way we update stress tests and we update
other things.
Senator Heller. Governor, thank you.
Mr. Chairman, thank you.
Chairman Shelby. Senator Warren.
Senator Warren. Thank you, Mr. Chairman. Thank you all for
being here.
I agree with Ranking Member Brown, that while certain
regional banks may pose different risks than the too big to
fail banks, that Dodd-Frank already gives the Fed a great deal
of discretion to tailor its regulation and supervision to
account for these differences. Where there is discretion, I do
not think Congress should take away that discretion from the
Fed and simply exempt certain large regional banks from
increased Fed scrutiny. That is a recipe for missing the
buildup of excessive risk in the financial system and it
reflects the kind of ``let the banks run free'' mindset that
created the last financial crisis. I just do not want to go
there again.
Now, we have heard a lot today about ways to roll back
Dodd-Frank, but surely there are areas where we need to
strengthen Dodd-Frank to address new concerns or to address old
problems that were previously overlooked.
Governor Tarullo, are there specific steps that you think
Congress should take to strengthen or complement Dodd-Frank?
Mr. Tarullo. Well, Senator, there are certainly discrete
areas that would be worthy of consideration. Let me mention
one, which probably many of you read about in connection with
the commodities issues that have been looked at by this
Committee.
You know, there is a provision, Section 4(o), of the Bank
Holding Company Act which exempts two institutions,
essentially, from the restrictions on commodities activities
that are generally applicable to bank holding companies. This
resulted from an anticipatory grandfathering clause in the
Gramm-Leach-Bliley Act. It basically said, if any institution
becomes a bank holding company at some point in the future,
they can continue to engage in all the commodities activities
they have been engaging in, and as all of you know, two such
entities did become bank holding companies as a result of the
crisis.
So, right now, those two firms are, by statute, allowed to
engage in the extraction and transportation of potentially
highly combustible materials with substantial risks associated
with them. I think it would be very much worth considering
treating those two firms the way we treat all other bank
holding companies.
Another thing that certainly occurred to me when I was back
teaching banking law was that the structure of civil money
penalties that we have right now puts dollar limits on those
civil money penalties that are basically on a daily basis, you
know, for each day that you can find the violation, and there
are two issues there.
One, the caps had to be set by the Congress with smaller
banks in mind, obviously. So, the caps, particularly that
middle tier cap, is really quite low. I think it is $37,000 a
day for certain forms of safety and soundness problems where
there was a recklessness associated with it. And, as you can
imagine, that does not allow for the kind of penalty that would
have an impact on a much larger institution. So, that is one
issue.
A second related issue is it is not quite clear to me why a
thing should be calibrated on the number of days that the
violation was in place as opposed to the relative seriousness
of it.
So, Senator, if the Committee was thinking in terms of
discrete changes on all sides, I think it would be worth
revisiting that so that our civil money penalty authority is
effective for very large institutions.
Senator Warren. Thank you very much, Governor Tarullo. I
hope that the Chairman will be looking into concerns about the
banks taking on more risks by speculating in commodities like
aluminum and gold and oil, and also about increasing civil
money penalty caps as two more ways to try to reduce risk in
the system.
Since the day Dodd-Frank was enacted, banks have been
looking for ways to chip away at it, roll it back. But, if
anything, the last 5 years have shown that we need to
strengthen our financial reforms. The too big to fail banks
have grown bigger than ever and banks take on new kinds of
risks every day. Just last summer, the Fed and the FDIC
declared that if any one of 11 banks started to falter, they
would require a taxpayer bailout to avoid bringing down the
entire financial system. If Congress thinks enough time has
passed to reopen Dodd-Frank, then we should consider ways to
protect taxpayers and the economy, not grant give-aways that
further tilt the playing field toward the bigger banks and make
our financial system less safe.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you.
Senator Rounds.
Senator Rounds. Thank you, Mr. Chairman.
I do not think there is a single community in the United
States today that can consider themselves to have an
opportunity to grow unless they have access to capital, to be
able to borrow money, to be able to magnify what they could
otherwise do with the resources at hand. We have got about 300
towns, small towns, in South Dakota. On a day-to-day basis,
they are impacted by the availability of their small town banks
to be able to loan money.
If you look at what has happened since Dodd-Frank, there is
a continued concern expressed in many rural communities about
the additional cost of compliance, and that cost of compliance,
while it has been laid out because of a failure, I am not so
sure that the failure has occurred in the banks that serve many
of our small and regional communities. And, yet, we still talk
about the need to identify a particular $50 billion number as
the right number.
I am just curious, when you take a look at it, and in this
particular case, Governor, I would like to start with you,
there is clearly a need to consider the impact to the economy
with the availability of credit versus the need to protect the
financial system that we have in place today. What is the
impact--and you see this, you have discussed it regularly--how
is the growth in our economy going based upon the ability of
communities throughout the United States to access credit, and
is it being impacted by the reduction in the availability of
credit based upon the need for more capital at the bank level?
Mr. Tarullo. Senator, it is obviously always a difficult
matter to disentangle all the causes of a particular
phenomenon, but I would say that at this juncture, the areas in
which credit intermediation has seemed a bit sluggish probably
have as much to do with demand for credit, meaning the relative
amount of growth in the economy, growth in wages, which
produces consumer demand, and the lingering effects of the
crisis and the Great Recession, which caused many households
and businesses to have to repair their own balance sheets where
they had a lot of debt.
I think, actually, the efforts that the three agencies in
front of you have made to boost the capital of all of our banks
will, over time, provide a much sounder basis for providing
that credit intermediation because they are going to be strong
and stable institutions.
Marty was referring earlier to an institution that got
itself in so much trouble that it was not able to provide that
credit intermediation long before the FDIC had to shut it down.
They had already reduced their activities. So, I think in that
sense, we are headed in the right direction.
The compliance cost issue that you note is a real one,
though, for the community banks, in particular. That is why I
advocated that the Congress adjust some of the limits on us in
raising our small bank holding company exception, and I was
delighted that you acted as quickly as you did in doing so.
And, we will continue to look for ways to reduce compliance
burden on smaller institutions that, again, just is not worth
it for the safety and soundness benefits. I think we are all
looking to try to do that.
Senator Rounds. Gentlemen.
Mr. Curry. Let me just elaborate on the cost and trying to
eliminate some unnecessary burden on community banks. That has
really been a focus of the three agencies, particularly in the
EGRPRA context that we are currently engaged in, where we are
actually reviewing rules and regulations and statutes to see
whether there is an undue or unnecessary burden, particularly
on the community bank sector.
From a supervisory standpoint, we are constantly looking at
our community bank division at the OCC, and how we can do a
better job in supervising and being less intrusive and creating
additional direct and indirect burden reductions for small
community banks, particularly in rural areas.
We are also looking at how can we offer a means of reducing
the costs for necessary regulatory burden. The OCC issued a
white paper on the opportunities for collaboration. We think
that may be particularly helpful for smaller institutions that
can share a compliance officer, share some of those costs that
necessary regulation may be imposing upon them.
Senator Rounds. Sir.
Mr. Gruenberg. Senator, briefly, two points. One, the FDIC
issues a quarterly banking profile every 3 months on the
condition of the industry. The industry has been gradually
improving now for several years and community banks'
performance in particular has been improving. The banking
industry, generally, and community banks in particular have
made efforts over these last several years to strengthen their
capital and liquidity. We actually believe that they are well-
positioned to take advantage of expanding credit demand and
credit opportunities. Hopefully, if we get some increased lift
from the economy, our banks should be well-positioned to
respond to that.
On the community bank side, though, I think there is, as
has been mentioned by my colleagues, particular reason to take
a look at regulatory burden and ways we can simplify and reduce
costs for community banks to better enable them to respond to
the credit demands from their communities. We are undertaking
this EGRPRA process, which is really a comprehensive review of
this. I do think there are going to be a number of ways that we
are going to be able to come forward to suggest reducing
regulatory costs, particularly for smaller institutions.
Senator Rounds. Thank you.
Mr. Chairman, I know my time has expired. I would just make
the point that as we talk about the regulations involved in
these banks and where they go, the one thing that seems to be
lacking is a discussion about the impact, the economic impact
on the entire economy, the whole thing, with whether or not
when these banks can provide the necessary capital to
businesses and individuals across the entire program of rural
and urban areas. I think that should be an integral part of any
discussion that we have about the regulation on these
institutions.
Chairman Shelby. The Senator is absolutely right. This is
going to be part of the discussion and should be part of your
concern, all three regulators, the impact on the economy,
everything.
Senator Scott.
Senator Scott. Thank you, Mr. Chairman.
Good morning to the panel. Thank you for taking the time to
have this conversation. Mr. Chairman, thank you for holding
this hearing, very important hearing----
Chairman Shelby. I apologize for skipping you, Senator
Menendez.
Senator Scott. ----about the adequacy of the current asset
threshold for considering a bank to be a systemically important
financial institution.
For me, as I translate it into what I think is important
for my constituents back at home in South Carolina, this is
really about the cost and the availability of small loans and
consumer credit at home in South Carolina. Many of my
constituents are served by a number of regional banks because
they can travel throughout the State or the region and have
access to banking services and ATMs. So, it is really a simple
process for most of my constituents.
A regional bank, for my constituents, is a community bank
with simple operations that simply expanded its footprint. We
are not talking about the Wall Street banks. We are talking
about banks that serve South Carolina that did not--did not--
contribute to the financial crisis.
We have heard a lot of conversation today already about the
$50 billion threshold, whether it is necessary and if it by
itself is important for us to consider using that. I think
Senator Heller asked a question about $49 billion versus $50
billion, what is the difference in the business operations, and
your question had a lot to do with complexity and
interconnectivity, it sounded like to me.
I personally would consider no asset threshold and
designation on a case by case basis in a process that uses
objective risk data and gives a bank clear notice of what it
can do to choose or not to choose to be a SIFI. If objective
criteria were used, I think many banks would amend their
behavior to avoid SIFI-land, so to speak. They would be able to
choose whether to become less risky on their own or allow the
regulators to make that decision.
Governor Tarullo, I appreciate the Fed's efforts to date to
tailor supervision, but I think they are no substitute for
raising the $50 billion threshold. Some supervision stress
testing, in particular, has certain fixed compliance costs at a
bank. The big banks can weather these costs more easily than
smaller regional banks that serve my constituents, as I have
described earlier. So, these fixed compliance costs become like
a regressive tax to my folks in South Carolina. You referred to
the cost as considerable challenge in your testimony, and that
regressive tax is passed right on to everyday South
Carolinians.
In light of this outcome, do you believe that the $50
billion asset threshold for prudential standards and stress
testing is too low, and my second question is, has the Fed done
any cost-benefit analysis on the stress test requirement for
banks right around that $50 billion bubble, as Senator Heller
talked about earlier?
Mr. Tarullo. Senator, what I have been trying to suggest is
that with respect to those banks around that size, it is what I
described as a win-win situation because this is not a case in
which we have to tradeoff some safety and soundness benefits
against compliance costs. I think this is a case in which, for
a $50 or $60 or $70 billion bank, our normal supervisory
processes, the capital requirements that we have all put in
place, the examinations that one of our three agencies does,
will provide adequate protection for that kind of institution.
So, that is where I think the nub of the issue is.
I do want to say, I certainly agree with you on the issue
of relative amount of burden for smaller and regional banks,
and I would just supplement that by saying that, again, we do
want all banks to be safe and sound, because when the economy
turns down and the balance sheets of all banks look worse, as
they always do, because they have to reserve more, some loans
go into nonperforming status, we want to make sure that every
one of those banks is in a position to continue to lend to the
businesses and the households that are still going to need
credit. And that is why we want them to have these buffers, to
protect the Deposit Insurance Fund, but also to make sure that
they are viable institutions.
The bigger they get, just sheerly in asset terms--when you
have a $300, $350, $400 billion bank, think how many States
that bank's operations cover, how many households and
businesses are dependent on that bank being able to provide the
credit. So, that is the other thing to keep in mind, but it
does not detract from any of the points that you made.
Senator Scott. I think you make a very good point there,
sir. I will tell you, though, that having been in business for
myself for a long time, about 15 years, the fact of the matter
is that the market changes. The business cycles change. The
threat and the challenges to a business changes. And, so, the
business itself should go through the process of, as we call in
this hearing, the living wills--should go through the process
of understanding and appreciating it, the risk that they have
to their consumers, as well.
I think the question that we are really talking about has
more to do with SIFIs. So, it is, in fact, economically on the
Nation as a whole, and what those thresholds should be.
I do appreciate the fact that you and I both see the fact
that smaller banks that have very consistent profiles of risk--
the question that I would have for you is, if those banks--
should those banks go through an annual testing, or should they
be every other year? Would you recommend it or suggest that if
the banking business model does not change, that the costly
annual reporting should be the same or not?
Mr. Tarullo. Well, there may be a couple of different
issues there. In terms of the stress testing, if one is going
to be in the stress testing, it does make sense to do it
annually. The systems have to be in place year-round no matter
what. The cost is spread over the course of the year.
Resolution plans, some other things, may be susceptible to
going biannual rather than annual. But, I think on the stress
testing itself, as I said, it is probably more of a binary
decision. You are either in or you are out.
Senator Scott. Thank you.
Chairman Shelby. Thank you.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
You know, from my perspective, regional and midsized banks
are different from the smallest community banks and credit
unions, and the largest, as well, most complex financial
companies. During the crisis, we saw how institutions like
Countrywide, Washington Mutual, IndyMac, that were outside the
largest view, but not considered small, could impose stress on
the financial system and costs on taxpayers. At the same time,
midsized and regional banks generally have different
structures, activities, risk profiles from the largest
institutions.
So, I recognize, as someone who sat here during that whole
period of time and was part of the Wall Street reform
legislation, that no legislation is perfect, and the Wall
Street Reform Act is no exception. As stockholders and our
regulators gain experience with the rules, I think we can and
should look for ways to improve the law. We should be open to
calibration, however, in both directions, areas where
protections may need to be strengthened and areas where the law
may need careful tailoring to reduce costs of compliance and
unintended consequences.
As the Committee considers whether to make changes to the
Wall Street reform law, a law that many on this Committee
fought and bled for, I hope we can strike the right balance
between reducing compliance costs without undermining
regulatory objectives. That would give business sufficient
freedom to operate, but at the same time ensure strong
protections for taxpayers, consumers, and investors.
And, as our economy continues to recover and parties get
through the initial costs of complying with the new rules, I
also hope we can distinguish between the impacts of new
regulations as opposed to other external factors that may be
affecting access to credit or business performance. For me,
that is the framework in which I come to these hearings and
these issues with.
So, with that as my objectives in mind, I have a few
questions for our witnesses, who I appreciate both your service
and your testimony here today.
Let me ask the three of you, you discussed in your
testimony some of the steps your agencies have taken to tailor
regulation and supervision for banks and bank holding companies
within the enhanced prudential standards regime based on the
different types of risks and challenges they present. And,
while it is true that a bank does not have to engage in
derivatives or complicated trading operations to create risk
for taxpayers on the financial system--making bad loans can be
enough, obviously--the appropriate supervisory tools may be
different if a bank has a relatively simple organizational
structure and transparent activities.
Can you discuss how your agencies take into account factors
such as organizational structure and activities when making
decisions about how to tailor your regulatory and supervisory
standards.
Mr. Curry. I think we do, and the particular area that I
would like to focus on is what our expectations are for risk
management. There, we are taking a very tailored approach to
that individual institution. We are looking at their ability to
identify the level of risks inherent in their business lines,
what types of mechanisms do they have in place to detect and to
address those issues and to basically have a strong,
independent, credible risk management function that is
buttressed by an equally strong audit function and strong
corporate governance. That is a highly tailored view, basically
focusing in on the structure of the institution, and by its
very nature is tailored.
Mr. Tarullo. Yes, Senator. I would endorse what Tom just
said, and let me just add that I think this is probably true
for all three of our agencies. I know it is true in ours, which
is to say when you think about what supervisory portfolio a
bank belongs in, the asset amount is the starting point, but if
you see a smaller institution that is engaged in derivatives
activities to a substantial degree, we will change the kind of
supervision that we do with that institution and hold them to
different kinds of risk management standards.
But, by the same token, we do not want to say, OK, so all
banks at $50 billion have to meet these supervisory
expectations, because, in many instances, the risk is just not
present in any significant degree.
The point all three of us were making in our testimony, is
that in our regulation, by definition, something we do, we put
in place, those are the rules people have to abide by. Our
supervision, which is the important supplement to that
regulation, is where I think we all exercise a lot of
discretion in the kinds of expectations based on not just group
but individual firm profiles, as well.
Senator Menendez. So, when we have a, well, I will call it
private panel, I think it is next week, they would say that
they feel that they are----
Mr. Tarullo. Oh, I suspect----
Senator Menendez. ----supervised in a way that is tailored
in accordance with their realities of their organization and
their functions?
Mr. Tarullo. I suspect a large number of bankers will think
that we all pay a bit too much attention to them, but I think
that is what you all want us to do, actually, is to be paying
attention. I think when they can identify areas in which
efficiencies can be gained through the supervisory process, not
undermining our supervisory and regulatory ends of safety and
soundness, I think we are certainly very receptive to those,
and that is what we will continue to do.
Senator Menendez. Well, let me ask----
Mr. Tarullo. I cannot guarantee you that banks are going to
come and say they think we are just fine.
[Laughter.]
Senator Menendez. I did not expect that, either.
Let me, if I may, Mr. Chairman, just follow up in a
different--a follow-on question. As the Committee considers
proposals to change financial stability measures, it is
important, in my view, to distinguish between those that are
aimed to reduce costs or prevent unintended consequences, which
I would be inclined to support, and those that would create
opportunities to evade or roll back fundamental protections.
Very clearly, not every proposal, I think, will be pure in
its motives, but there are areas where improvement is possible
without undermining core regulatory objectives or
effectiveness. For example, are there ways to harmonize
reporting requirements or streamline reporting based on the
type of activities an institution is engaged in?
Mr. Tarullo. There are, and we are thinking about some of
them, part of them through the FFIEC, the Council that all
three of us belong to, some of them we are doing with bank
holding companies reporting to the Fed. The only thing I will
point out there, Senator, is that there sometimes is a bit of a
tradeoff, which is to say if we get more information, that
sometimes allows us to have fewer examinations. And, if the
bank is giving us regular information in a broad swath of
areas, our supervisors can sit in a particular Reserve Bank and
do an assessment which does not require them to go out, do the
onsite, which takes up a lot more of the bank's resources. So,
sometimes the net supervisory burden can be reduced a little
bit paradoxically through providing more information.
Having said that, we are looking for ways to streamline all
the reporting.
Senator Menendez. Mr. Gruenberg.
Mr. Gruenberg. Senator, there has been a particular focus
through the FFIEC on the call reports and ways we may be able
to identify to reduce reporting burden while still providing
the information necessary to carry out supervision. I think
there may be other opportunities.
Just to come back to your previous question on the
resolution plans or living wills, we have really made an
effort, particularly for those institutions under $100 billion,
are to focus 165 plans on the nonbank, the holding company
operations. For those under $100 billion, it is really the bank
that is the principal activity of the institution. We have
provided tailored plans for that universe of institutions that
really simplifies the reporting and planning obligation, and
almost all the institutions under $100 billion have taken
advantage of that tailored plan opportunity.
Senator Menendez. Thank you, Mr. Chair. Thank you for your
answers. I just hope you will remain open to looking at all of
those possibilities, because I think there is a desire by many
of us to see that happen.
Thank you, Mr. Chairman.
Chairman Shelby. I am going to recognize Senator Cotton,
and then Senator Cotton, I believe that Senator Scott would
want you to yield to him for a quick question.
Senator Scott. Just a quick question.
Chairman Shelby. I will recognize you, and then it is up to
you to yield, if you so choose.
Senator Cotton. I would be happy to yield to Senator Scott.
Senator Scott. No pressure. Thank you, sir.
Governor Tarullo, just one final thought and question for
you. It is possible that a regional bank with $51 billion in
assets could offer traditional simple banking services abroad
as a service to its U.S. customers who travel. I would like
your thoughts, please, as to whether the $10 billion in foreign
exposure threshold for advance approaches regulation should
remain a strict asset size test or whether it, too, should be
based on factors that better predict systemic risk.
Mr. Tarullo. If you have a $50 billion bank that has $10
billion in international activity, that does not look like an
oversized community bank. That is going to be a different kind
of banking institution. My sense is that the $10 billion in
foreign activity has worked pretty well in identifying a
relatively small number of institutions that do pose different
kinds of risks than a bank with a similar size balance sheet,
almost all of whose activities are domestic.
Senator Scott. Thank you. Thank you, sir.
Chairman Shelby. Senator Cotton.
Senator Cotton. Thank you.
I will note that since Senator Scott and I share an
apartment building and my wife is due with our first child in 5
weeks, I am going to take that as a return favor for one night
of babysitting.
[Laughter.]
Senator Scott. For the sake of your child, I would say no.
Senator Cotton. That is a fair point.
[Laughter.]
Senator Cotton. So, thank you, Mr. Chairman, thank you,
gentlemen, for appearing before us today.
When you consider the automatic SIFI threshold as a
somewhat arbitrary number, but we have to draw arbitrary
numbers in the law all the time, at $50 billion, you could
imagine that it is also going to be diminishing in a way that
monetary thresholds do but nonmonetaries do not because of
inflation or expanding economy. The same could also be the case
for other Dodd-Frank thresholds. And, I would just like to go
down the line, if we could, and ask if you would support
indexing thresholds in Dodd-Frank to inflation, to real GDP
growth, or to any other kind of economic measure.
Mr. Tarullo. It is probably worth considering, Senator, but
as the very last clause of your question suggested, it may not
be as straightforward a matter to think what you would index it
to. You know, would you index it to inflation, to GDP, to the
total size of institutions, to concentration. So, I think it is
worth thinking about, but my instinct is that inflation
probably would not be the right thing to index it to.
Senator Cotton. Do you have an instinct on what would be?
Mr. Tarullo. If there were one, it would be GDP, but I
would want to think about that a little bit more.
Senator Cotton. OK. Mr. Curry.
Mr. Curry. I think indexing has some opportunities, as
Governor Tarullo mentioned. But, again, I think the theme in
our testimony is that we think that the asset threshold is one
consideration in determining whether or not an institution is
systemically significant or of heightened supervisory concern.
There is a balance, I think, between the activities that the
bank is engaged in and other factors that have to be
considered, as well.
Mr. Gruenberg. Senator, I think, conceptually, it is worth
thinking about, and in some sense is hard to argue against,
although the methodology may raise issues. On the other side of
that, the clarity of having a clear threshold without adjusting
it, in particular if there are sensitivities--because when you
have a threshold, there are always going to be institutions on
both sides of it. Having a clear threshold is clear and
transparent and understood and may have some value.
I do think the key issue goes to providing some flexibility
for the agencies, if you are going to set a threshold, to
differentiate among firms that may be above the threshold,
because wherever the threshold is, there are clearly going to
be distinctions. Even if additional scrutiny is warranted, you
want an ability to distinguish among the institutions to apply
the appropriate standards.
Senator Cotton. OK. Governor Tarullo, I was not here in
September. I was in the House, on the Financial Services
Committee. But, in your opening statement to this Committee
last September, you had said, quote, ``There could also be some
benefit from some statutory changes. One would be to raise the
current $50 billion asset threshold that determines which banks
are in the systemic category,'' end quote. Just 2 days ago, in
front of my old colleagues on the House Financial Services
Committee, Secretary Lew said that he opposes raising that
threshold.
Did Secretary Lew or any other administration official take
issue with your statement in front of the Financial Services
Committee last fall?
Mr. Tarullo. Not directly to me, no, and I have not read
the transcript of what Secretary Lew said. I read the press
accounts of it. I think he was pointing to the discretion, the
administrative flexibility that we do have. What I have been
particularly focused on is the stress testing threshold.
Senator Cotton. When he says, not directly to you,
indirectly to----
Mr. Tarullo. Well, he is saying----
Senator Cotton. ----anyone on your team, or----
Mr. Tarullo. No. Whatever he may be saying publicly, yes.
That is----
Senator Cotton. OK. Thank you. I will yield back the
balance of my time.
Chairman Shelby. Governor Tarullo, conceptually, would you
support the redrawing of the threshold lines, but with the
discretion remaining with the regulator to decide whether a
particular institution is systemic or not? In other words, you
would keep that power.
Mr. Tarullo. Again, Senator, so long as we have the
understanding that systemic is broader than just the failure of
that institution bringing down the financial system.
Chairman Shelby. Oh, yes.
Mr. Tarullo. I think that is when the thinking of the
threshold makes some sense. The two qualifications, again, are,
one, and I think you just said this, that our discretion should
under no circumstances be removed to do more, and second, this
has not come up in the hearing today, but just so that we
remind ourselves of what is important for the Congress to do.
What the Congress has done following each financial crisis
that we have had in the country, whether it was Latin American
debt crisis in the early 1980s----
Chairman Shelby. Sure.
Mr. Tarullo. ----late 1980s, S&Ls, Congress has stepped in
and tried to adjust the behavior of the regulators and, in some
sense, made some things mandatory. Prompt corrective action--
and you were there, Senator to help with that--prompt
corrective action made sure that we all had to take action when
capital fell below a certain standard because of what happened
in the S&L crisis.
In Dodd-Frank, what the Congress said was there are some
areas where we think the regulators should be required to take
action. That is, they want to take some discretion out of our
hands and say, you must have this kind of regulation. I think
that is a sound idea. The only issue, to me, is really around
those midsized regionals with the stress testing.
Chairman Shelby. Mr. Curry, in September of last year, you
were quoted in an American Banker article as saying, quote, and
I am going to read it to you, ``Fifty billion dollars was a
demarcation at the time, but it does not necessarily mean you
are engaged in that activity that the rules are trying to
target. The better approach is to use an asset figure as a
first screen and give discretion to the supervisors based on
the risk in their business plan and operations. It is just too
easy to say, this is the cut-off. I am a little leery of just a
bright line.'' Do you stand by your words?
Mr. Curry. Yes, Senator.
Chairman Shelby. Thank you.
Mr. Curry. I do think that is the approach that we have
consistently applied at the OCC. Thank you.
Chairman Shelby. Well, I do not think anybody up here has
even, I hope, not even alluded to weakening your power to
regulate. You have got to do that. We are just trying to give
some relief where we think maybe it is--you could still
intervene in a dangerous situation. And, if you do your job,
you will. You will know, would you not, Governor? If you do
your job as a regulator, you are going to know what banks are
doing.
Mr. Tarullo. I hope so.
Chairman Shelby. Yes. Do you agree with that, Mr. Curry?
Mr. Curry. Yes.
Chairman Shelby. Senator Warren mentioned a minute ago that
two banks were grandfathered in in the legislation. Of course,
that is politics. We know that. And, they are still in the
commodities business. Does that--could that pose a risk to
the--systemic risk to the banking system? Governor.
Mr. Tarullo. So, I think it is----
Chairman Shelby. Could it?
Mr. Tarullo. You need to understand what Section 4(o)
permits.
Chairman Shelby. Uh-huh.
Mr. Tarullo. What Section 4(o) permits is not just, for
example, taking title to physical commodities, the part of
trading----
Chairman Shelby. Sure.
Mr. Tarullo. It would allow the banks, for example, to own
oil tankers, to own copper mines, to own extractive industries
themselves. And, I think the issue here for you and for us is
that with some of these activities, which certainly seem
substantially to breach the wall between banking and commerce,
they are the sort of things that are very hard to get a risk
management handle on----
Chairman Shelby. Oh, yes.
Mr. Tarullo. ----as a banking regulator. When you are
talking about oil spills or you are talking about collapses of
mines, it is very different from----
Chairman Shelby. You would have to regulate commerce, in a
way.
Mr. Tarullo. That has been my concern, Senator.
Chairman Shelby. Uh-huh. But, you only have two banks that
can do that.
Mr. Tarullo. That is correct.
Chairman Shelby. And the others, no matter how big or how
powerful or how well run, they could not do that.
Mr. Tarullo. That is correct.
Chairman Shelby. OK. Senator Brown, do you have any more
questions?
Senator Brown. Thank you. A couple more questions. Thank
you, Mr. Chairman.
Thank you for your comments about the commodities. We did a
couple of hearings about that last year. I appreciate the Fed's
engagement in that, and those were done some years ago, and
those two institutions became bank holding companies, which
changed all that. But, the comment you made about risk, oil
tankers and others, to the safety and soundness--I mean, to the
financial stability of the system is really important, so thank
you for that comment.
Comptroller Curry, a question for you. We have talked both
privately and publicly about the culture and environment of the
banks and how banks pretty clearly over the years paid less
attention to risk than they do now, partly because of
regulators, partly because we maybe have a more independent OCC
now, partly because of your insistence in discussions with them
about a risk officer. We hear complaints, though, from banks
about the time that their management and their board members
dedicate to compliance issues and risk management. As we have
discussed institutions tend not to like business lines that do
not bring in revenue, understandably.
Talk to us for a moment about the value to institutions and
to the public of having more management and board time spent on
risk management.
Mr. Curry. Thank you for raising the subject, Senator. We
think it is critical in terms of having an internal framework
that identifies risks and takes appropriate steps to mitigate
those risks. We also think it implicates corporate governance.
You need to have a board that is capable and willing to
interject and to challenge management. So, we pay close
attention to the dynamic between the board and operating
management to make sure that there is a healthy risk culture.
Another area that we have emphasized is improving the
stature of the Chief Risk Officer of an organization and their
ability to help guide the decision making at the organization.
At the OCC, we have promulgated heightened standards that
apply to the largest banks in our portfolio that mandates an
appropriately robust risk management system for those
institutions. And, it also has enforcement mechanisms tied into
it so that it has teeth.
In terms of culture, it is really important, and this is
something we look at in the context of risk management, is
making sure that management of the organization establishes and
enforces standards of conduct, that the failure to do so can
result in significant financial and reputational losses to the
institution.
Senator Brown. Thank you. And, stature, the risk officer's
stature, I assume, implies everything from compensation to seat
at the table, the background with a company, to all the things
that make that person one among equals in decision making at
the highest levels of all kinds of banks, correct?
Mr. Curry. Exactly, and that is what we are looking at from
a corporate governance standpoint.
Senator Brown. Thank you.
Governor Tarullo, I have been concerned about banks'
ability to calculate their own internal risk weights and use
that to game their capital ratios. It is a bit like a professor
letting her students grade their own tests. Last week, you
released the latest round of bank stress tests. Once again, the
largest banks' internal loss projections were significantly
rosier than the Fed's calculations. The industry complains this
makes the tests a black box, of sorts. It seems they want the
Fed to provide them with the answer key for the stress test.
Talk about the value of the Fed's projections. Why should
we continue to rely on the independent evaluations?
Mr. Tarullo. OK. So, a couple of things there, Senator.
First, I like the conclusion, which is you should continue to
rely on our evaluations, because the evaluations we do are,
first off, consistent. Second, they include an appropriate
conservativism, I think, which is thinking on behalf of the
country about what could happen under unlikely but still
plausible adverse scenarios.
I think some of the reasons why you see those gaps between
our assessment and some of the other banks vary, and some of
those reasons are some cause for concern and others are less
cause for concern. If you see the gap and it is because, for
example, as you know, we do not allow the assumption in our
stress test that banks would stop paying dividends and stop
making share repurchases even during a stress period. That
experience that we all went through in 2007 and 2008 was one
that we all took to heart, and so when we do our very
conservative assumptions, we assume that the banks will do what
some of them did in 2007 and 2008, which is continue to
distribute capital.
In their own idiosyncratic stress testing, banks sometimes
do not do that, and it would be, believe me, a sensible thing
for the bank to do, to cut back on its capital distribution.
So, if that is a reason for variance, that is not of great
concern to us because we put it in the supervisory test, but
they have got to test for other purposes.
When we see problems that result from the inability of a
bank to understand its own risks, to aggregate the data, that
is when we are concerned and that is why we will come forth
with supervisory action.
So, the reason why you want to look at our tests is
because, obviously, we do not have an interest in shifting the
loss parameters to help a particular bank's balance sheet,
because we do it in a way that is comparable for everybody. We
review it and we subject what we are doing to the review of
outside experts. We try to improve it every year, and I believe
it really has become a critical supervisory instrument for us,
for the bank's own self-assessment, for the ability of outside
analysts and investors to understand banks, and ultimately for
all of you to keep watch on us.
Senator Brown. Thank you.
If I could have one more question, Mr. Chairman.
Chairman Shelby. Go ahead.
Senator Brown. And, each of you give brief answers to this,
if you would. Some have suggested the advanced approach regime
is out of date and should only apply to the global,
systemically important banks. Do you all continue to support
the current advanced approaches regime? Mr. Gruenberg, start
with you, a brief answer, and just go right to left.
Mr. Gruenberg. Yes, Senator.
Senator Brown. Yes. OK.
Mr. Curry.
Mr. Curry. Yes.
Mr. Tarullo. I do, Senator.
Senator Brown. OK. Thanks. Thank you.
Chairman Shelby. Senator Rounds.
Senator Rounds. Mr. Chairman, thank you.
I have got to go back into this a little bit. Very seldom
do we have an opportunity to have a group like this in front of
us and not at least delve a little bit into the causal effects
that we see in the economy today. I think some of the numbers
that I had seen over a period of years was that since 2009,
there has been an increase in employment in the financial
services area of about 300,000 individuals throughout the
United States, which would seem to be a positive thing, and
which normally would suggest economic growth, and yet the vast
majority of those 300,000, if my numbers are correct, were in
the areas of compliance, which most individuals would suggest
is not an indication of economic growth but one of costs
directly back into the financial services sector.
If my numbers are correct, and if I am wrong, I would have
you correct me, but if those numbers are correct, it seems to
me that we add a burden within the financial services industry,
we add an additional cost to all of those businesses and
individuals that would need those services, because they are
going to get passed on.
But, second of all, and there is a second part that it
seems that we sometimes do not look at, and that is the
regulatory impact on the economy itself. Governor, I am
curious, because the Federal Reserve clearly has recognized
that even after a time in which we had a significant slowdown
in the economy, our expectation would be that there would be an
increased period of economic activity, and yet over the last 4
or 5, 6 years, the Fed has continued to maintain a very
inexpensive money policy, seemingly because there is the need
to make this economy start to move.
Any possibility that the cause and effect of this is the
Dodd-Frank Act and the impact that it has had on the
availability of capital because of the regulatory environment
that financial institutions find themselves in today?
Mr. Tarullo. So, Senator, let me just begin by saying that
you did not really ask a question about monetary policy, but we
are still in our blackout period, so I am not going to comment
on the monetary policy.
Senator Rounds. OK.
Mr. Tarullo. Happy to comment on the regulatory issue, and
let me begin with the compliance point. And, here again, I want
to really draw a distinction between compliance function at a
community bank and compliance function at those largest
institutions, and I am going to do it, if you will bear with me
a bit, with an anecdote.
Back in 2009 at the height of the crisis, when we were
conducting the first set of stress tests, we sent out in
February a request for data to, at that time, the 19 largest
financial institutions in the country. Some of those
institutions more or less immediately were able to get back to
us and say, here is the data, and it proved to be pretty
accurate. Most took a while and then eventually gave us
something that was more or less accurate. And, some of them,
after a number of days, were still unable to put together an
accurate picture of what their risks actually were.
The lesson I drew from that is that the inattention to risk
management, which is the most important compliance function for
the safety and soundness of institutions, had led to a
situation in which the banks did not really know their own
risks, much less allow us to do the job that Chairman Shelby
just indicated we need to do, which is to go in and make sure
we understand those risks.
I understand that there has been a big run-up in the number
of people devoted to compliance at these institutions, at the
big institutions, and I do not know whether the precise numbers
are what we need, but I do know we needed a lot more attention
to that.
Now, on the other end of the spectrum, I am concerned when
I hear stories like the following, which is a community
banker--I think he was about a $2 billion bank--and he said,
``You know, we thought we would merge. We did merge with a bank
just about our size. We thought that in doing so we would get
some benefits of some modest economies of scale, serving a
slightly bigger area while retaining the same business model.''
And, then, he sort of shook his head and he said, ``So, our
examiner comes in and says to us, `Well, you are twice as big
now. You should add a second compliance officer.' '' That was
what he was trying to avoid, and I have a lot of sympathy for
that. I do have a lot of sympathy for that.
Tom mentioned the EGRPRA process. I think that is where our
efforts are really focused, because the size of the portfolios
of those community banks are sufficiently small that they
cannot amortize those costs very well. But, this is, again,
where I really do want to draw a distinction between the most
complex institutions with heavy capital market activities, on
the one hand, and the small bank, as Senator Scott was saying,
in Columbia or Charleston or Orangeburg, that has a very
limited base of assets.
Senator Rounds. I think in many cases, on the smaller
banks, they feel as if their examiners are looking at them
saying a lot of the things are coming downstream to them that
are being applied to the larger banks.
Mr. Tarullo. The trickle down? The supervisory trickle-down
effect?
Senator Rounds. I had a similar discussion with a small
town banker who literally said, ``Look, I cannot do home loans
anymore. I just cannot do the compliance.'' And, when you start
to see that in small communities in places like South Dakota,
these are not the folks that were involved in any of the
problems to begin with, and yet they are the ones that are
feeling the impact of this regulatory activity.
Thank you, sir. Thank you.
Chairman Shelby. I am looking at the systemic importance
indicators reported by large U.S. bank holding companies, $5
billion or more, and if you look at the methodology in the OFR
report--this is part of it, we have referred to it--to measure
systemic risk, the table here shows those two banks that we
were talking about that were grandfathered in as being
significantly more systemically risky than the regional banks
to our system. Do you think that the methodology that the OFR
report works here? Do you have a comment?
Mr. Tarullo. Senator, here, I would say the Basel Committee
methodology, the Fed methodology for our SIFI surcharge, and
the OFR methodology would all agree with that proposition.
Chairman Shelby. OK. Thank you.
Do you disagree with that?
Mr. Curry. No.
Mr. Gruenberg. No, Mr. Chairman.
Chairman Shelby. Thank you. I think we all basically agree
here, we want banks that are healthy, that are strong,
capitalized, well regulated, well managed, because without
that, the economy, as Senator Rounds alluded to, it is all tied
into our economy, the ability to access capital. Everybody--
you, as regulators, know this. So, let us hope we can work
together and try to give some relief here. Although Dodd-Frank
was legislation, no legislation is perfect. Even Senator
Menendez referred to that. Maybe we can work together. I hope
so.
This concludes the hearing.
[Whereupon, at 11:39 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF DANIEL K. TARULLO
Governor, Board of Governors of the Federal Reserve System
March 19, 2015
Chairman Shelby, Ranking Member Brown, and other Members of the
Committee, I appreciate the opportunity to testify on the threshold in
section 165 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) for application of enhanced prudential
standards to bank holding companies. In my testimony this morning I
will try to provide, from a regulator's perspective, some context for
the Committee's consideration of this subject by explaining how the
Federal Reserve has differentially implemented prudential regulations
based on the size, scope, and range of activities of banking
organizations, as well as how we have organized our supervisory
portfolios. In both our supervisory and regulatory practices, we are
pursuing a tiered approach to prudential oversight.
Regulatory Differentiation in the Dodd-Frank Act
Traditionally, statutes creating prudential regulatory requirements
or authorities generally took what might be termed a unitary approach.
That is, the statutes simply made a particular requirement or authority
applicable to banks or banking organizations generally, with few clear
distinctions based on the characteristics of the regulated entities.
The Federal banking agencies did adopt some regulations with
requirements that applied only to larger institutions. And, as I will
describe a bit later, through supervisory practice they administered
some statutory requirements differently based on the size of banks and
the scope of their activities. But the starting point was a more or
less similar set of statutory requirements.
The Dodd-Frank Act explicitly broke with this traditional approach
by creating prudential requirements that vary with the size or systemic
importance of banking organizations. Of particular importance is the
Dodd-Frank Act emphasis on financial stability, both in markets
generally and with respect to the largest financial firms, which had
been associated with market perceptions that they were too big to fail.
The law created some new authorities for financial regulators and
instructed regulators to use authorities they already had to put in
place regulations to contain systemic risk. As to regulations
applicable to individual firms, the Dodd-Frank Act creates thresholds
for various prudential regulations at asset sizes of $1 billion, $10
billion, and $50 billion. Of special note is that section 165 of the
Dodd-Frank Act requires the Federal Reserve to establish enhanced
prudential standards for bank holding companies with total assets of
$50 billion or more and other financial firms designated as
systemically important by the Financial Stability Oversight Council.
Among other areas, these standards include capital, liquidity, risk
management, resolution planning, and single-counterparty credit limits.
Of particular significance is the section 165 requirement that these
enhanced standards increase in stringency depending on the size,
interconnectedness, role in credit intermediation, and other factors
specified in the law. In addition to these enhanced, graduated
standards, section 165 requires that firms with greater than $50
billion in assets be subject to annual supervisory stress tests.
The Federal Reserve has implemented the section 165 requirement of
graduated stringency for enhanced prudential standards by creating what
are, in effect, three categories within the universe of banking
organizations with $50 billion or more in assets. As required by
statute, all firms within this universe are subject to basic enhanced
standards. Firms with assets of between $50 billion and $250 billion
are subject only to these basic enhanced standards. Firms with at least
$250 billion in assets or $10 billion in on-balance-sheet foreign
assets are also subject to more stringent requirements, including the
advanced approaches risk-based capital requirements, the supplementary
leverage ratio, the countercyclical capital buffer, and the fullscope
liquidity coverage ratio.
Finally, the eight U.S. bank holding companies that have been
designated as global systemically important banking organizations will
be subject to an additional set of regulatory requirements. An enhanced
supplementary leverage ratio, equally applicable to all eight firms,
has already been adopted. We are also working on two requirements that
will vary in stringency even among these eight firms, based on their
relative systemic importance. One is the set of risk-based capital
surcharges for which we issued a notice of proposed rulemaking late
last year. The other, on which we anticipate issuing a notice of
proposed rulemaking in the coming months, is a long-term debt
requirement designed to support effective orderly resolution processes.
In sum, the stringency of the Federal Reserve's prudential
regulations increases in proportion to the systemic importance of the
banking organizations. With this tiered approach to regulation, the
Federal Reserve aims not only to achieve the Dodd-Frank Act goal of
mitigating risks to U.S. financial stability, but to do so in a manner
that limits regulatory costs and the expenditure of supervisory
resources where not needed to promote safety, soundness, and financial
stability.
Tiered Regulatory and Supervisory Experience
The Federal Reserve also takes a tiered approach to supervision. We
organize the firms we supervise into portfolios based predominately,
although not exclusively, on asset size. We have four such groups: (1)
community banking organizations, which are generally those with $10
billion or less in total assets; (2) regional banking organizations,
which have total assets between $10 billion and $50 billion; (3) large
banking organizations, which have total assets over $50 billion but are
not among the largest and most complex banking organizations; and (4)
firms overseen by the Large Institution Supervision Coordinating
Committee (LISCC), which are the largest and most complex banking
organizations. \1\
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\1\ For more information on the LISCC, see http://
federalreserve.gov/bankinforeg/large-institution-supervision.htm.
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As with tiered regulation, our tiered supervision is intended to
take into account differences in business models, risks, relative
regulatory burdens, and other salient considerations. Where specific
regulatory goals for the different portfolios vary, the supervisory
programs reflect those differences. And even where the goals are
similar across portfolios, supervisory programs should nevertheless
take account of the differences among the firms in the four portfolios.
In general, we shape our supervisory expectations for each portfolio by
considering the increase in safety and soundness that we are likely to
achieve through a specific practice or requirement, in light of the
regulatory costs for the banking organizations in the portfolio and the
impact that the stress or failure of those institutions would likely
have on credit intermediation, the deposit insurance fund, and
financial stability.
So, for example, there are heightened expectations with regard to
corporate governance for large banking organizations that are not
applied to regional or community banking organizations. Among other
areas, the Federal Reserve expects the boards of directors of these
larger firms to set direction and oversight for revenue and profit
generation, risk management, and control functions; to ensure that
senior management has the expertise and level of involvement required
to manage core business lines, critical operations, banking offices,
and other material entities; and to maintain a corporate culture that
emphasizes the importance of compliance with laws, regulation, and
consumer protection. While strong corporate governance is important at
all banking organizations, it is vital at large banking organizations,
given that their systems and operations are typically much broader and
more complex than those of the smaller-scale and more localized
regional and community banking organizations.
While asset size is the principal determinant of the general
supervisory program for a banking organization, other factors are taken
into account as appropriate. For example, if a regional banking
organization were to become involved in activities typically undertaken
only by larger banking organizations, we might add to that firm's
supervision an expectation or practice drawn from the large banking
organization portfolio. Moreover, in determining which banking
organizations belong in the LISCC portfolio, the Federal Reserve has
focused on the risks to the financial system posed by individual
firms--size has not been the dispositive factor. For example, three
large banking organizations are not in that portfolio, even though they
have larger balance sheets than the processing- and custody-focused
bank holding companies that are in the LISCC portfolio. The stress or
failure of these large, essentially regional banking organizations
could have a serious effect on credit intermediation across a
significant part of the country and, in some situations of generalized
stress, might have consequences for the financial system as a whole.
However, we judge that the functions of the two processing- and
custody-focused LISCC firms implicate systemic concerns to a greater
extent than the substantial balance sheets of the larger regionals.
The Role of Statutory Thresholds
As I hope by now is apparent, the Federal Reserve has done
considerable work to tailor our supervision of banking organizations by
reference to their size, business model, and systemic importance.
Similarly, using the statutory discretion granted us, and frequently in
cooperation with other regulatory agencies, we have also tailored the
application of certain statutory requirements to different groups of
banks. The question of statutory thresholds is thus a fairly narrow
one: Does a threshold specify a cut-off point that is appropriate for
mandatory application of a particular regulatory requirement, taking
into account whatever discretion is given to the implementing
regulatory agencies?
In answering this question, it is first worth noting the case for
establishing such statutory thresholds. In the past, Congress has at
times not simply given the banking agencies authority to engage in a
particular form of prudential regulation, but has required that they do
so. Capital regulation and prompt correction action are two examples.
Not coincidentally, I think, congressional action followed banking
crises that revealed possible shortcomings in the regulatory and
supervisory structures that had existed preceding the crisis. In
requiring certain kinds of prudential regulation, Congress was in
effect protecting against memories of those problems fading and the
consequent possibility of supervisory relaxation, which might allow for
a recurrence of similar banking problems in the future.
The creation of mandatory thresholds for certain enhanced
prudential standards is an important advance in the traditional
congressional role of specifying a set of mandatory regulations. This
statutory structure recognizes the substantially divergent risks
presented to the economy and the financial system by the potential
stress or failure of banking organizations of different sizes and with
different activities, while preserving considerable discretion for the
banking agencies in implementing those regulations. Here again,
statutory enactment of mandatory measures for banking organizations of
a certain size or systemic importance serves as a form of safeguard
against the erosion of prudential oversight that could occur were
predominant reliance to be placed on the details of firm-specific
supervision, which are sometimes hard for the public to discern.
Removal or change of such thresholds, as with generally applicable
prudential requirements, will thus require congressional action and an
occasion for considered public debate on the merits of such change.
Experience to date, however, suggests that there are some statutory
thresholds that might bear reexamination. One pertains to the
applicability of some Dodd-Frank Act provisions to community banks. For
example, the Volcker rule and the incentive compensation requirements
of section 956 of the Dodd-Frank Act are directed at concerns generally
present only with larger institutions, but the Volcker rule by its
terms applies to all banking organizations, and the incentive
compensation provisions apply by their terms to all banking
organizations with $1 billion or more in assets. The banking agencies
have done their best to tailor the application of these rules to
smaller banks and, indeed, to make clear the limited extent to which
they should affect those banks. However, some compliance effort on
these rules is still needed at community banks. Raising the asset
threshold for these two requirements to $10 billion would eliminate
this compliance burden, the cost of which is probably not worth
whatever incremental prudential benefits might be gained at these small
banks. Even in the relatively unusual circumstance in which a practice
at a smaller bank might raise safety and soundness concerns, the
supervisory process would remain available to rectify any problems.
The second threshold that is worth discussing is the $50 billion
level established by section 165 of the Dodd-Frank Act. As noted
earlier, the import of this threshold is to require enhanced prudential
standards and supervisory stress testing for banking organizations
whose assets exceed that amount. As also noted, the Federal Reserve has
tailored those standards in accordance with the increasing stringency
requirement of section 165, so that they are more flexible for
institutions closer to the $50 billion threshold and most demanding for
the eight firms of global systemic importance. It has been somewhat
more difficult to customize supervisory stress testing. While some
elements of the test, such as the market shock and single-counterparty
default scenarios, are applied only to larger firms, the basic
requirements for the aggregation and reporting of data conforming to
our supervisory model and for firms to run our scenarios through their
own models do entail substantial expenditures of out-of-pocket and
human resources. This can be a considerable challenge for a $60 billion
or $70 billion bank. On the other side of the ledger, while we do
derive some supervisory benefits from inclusion of these banks toward
the lower end of the range in the supervisory stress tests, those
benefits are relatively modest, and we believe we could probably
realize them through other supervisory means.
These are the factors that lay behind my suggestion last year that
it might be worth thinking about the level of this threshold, which I
understand to be a purpose of today's hearing. That said, I want to
emphasize a few points. First, consideration of potential increases in
the threshold for mandatory prudential measures should not remove the
discretion of the banking agencies to require additional measures--
including such things as more capital or liquidity--for specific firms
or groups of firms in appropriate circumstances. That is, while it is
sensible to limit mandatory measures for classes of firms where most
banks in that class are unlikely to present a particular kind of risk,
it would be very ill-advised to preclude supervisors from requiring
such measures of firms where that risk may become more of a concern.
Second, any consideration of raising the threshold to take account
of the factors I mentioned earlier should not extend to removal of the
application of enhanced standards and other rules to the largest
banking organizations. As senators and regulators have discussed many
times before in this Committee, the tasks of combating the reality and
the perception of too big to fail, and of vulnerabilities in broader
financial markets, are crucial and ongoing.
Conclusion
The innovation in the Dodd-Frank Act that requires tiered
regulation is central to our shared goals of protecting financial
stability and ensuring the availability of credit. Smaller banks do not
pose risks to financial stability, though they can suffer collateral
damage when stress builds throughout the financial system. And, while
enhanced prudential standards are important to ensure that larger banks
can continue to provide credit even in periods of stress, some of those
same enhancements could actually inhibit credit extension by rendering
the reasonable business models of middle-sized and smaller banks
unprofitable. The Federal Reserve will continue to use statutory
authorities to calibrate our regulation and supervision to the risks
posed by the different classes of banks, avoiding a one-size-fits-all
approach. We and, I believe, many others are committed to the dual
goals of protecting systemic stability and fostering the efficient
intermediation of credit by the overwhelming majority of American banks
that do not pose systemic or far-reaching risks.
Thank you. I would be pleased to take any questions you may have.
______
PREPARED STATEMENT OF THOMAS J. CURRY
Comptroller, Office of the Comptroller of the Currency
March 19, 2015
Introduction
Chairman Shelby, Ranking Member Brown, and Members of the
Committee, thank you for the opportunity to discuss the Office of the
Comptroller of the Currency's (OCC) experience with, and views on,
section 165 of the Dodd-Frank Act and the OCC's approach to tailoring
our regulatory and supervisory expectations, especially with respect to
regional banks, which include banks in the OCC's midsize program and
many of those in our large bank program. Because the focus of section
165, as it applies to the banking sector, is on bank holding companies,
almost all of the authorities under this section are assigned to the
Board of Governors of the Federal Reserve System (Federal Reserve). The
OCC's only direct rulemaking authority under section 165 is with
respect to the company-run stress test requirements under section
165(i)(2). Otherwise, the OCC's role in section 165 is limited to a
consultative one on matters affecting national banks. Nonetheless, the
provisions of section 165 are extremely important to the OCC and our
supervisory programs as national banks typically comprise a substantial
majority of the assets held by bank holding companies with consolidated
assets of $50 billion or more. Indeed, the national bank is typically
the dominant legal entity within each company. Consequently, the
provisions of section 165 have a significant effect on national banks
and our supervisory oversight of those institutions.
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Statement Required by 12 U.S.C. 250: The views expressed herein
are those of the Office of the Comptroller of the Currency and do not
necessarily represent the views of the President.
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My testimony today provides a brief overview of the key provisions
of section 165 as they apply to bank holding companies. I then describe
how the OCC's supervisory and regulatory tools complement and support
the objectives of these provisions. As I will discuss, the OCC believes
that the supervisory areas addressed in section 165 for which the
Federal Reserve is required to develop prudential standards are
fundamental to safe and sound banking and are essential elements of our
ongoing supervision of national banks and Federal savings should
reflect the complexity and risk of a bank's activities. This is why the
OCC has tailored its supervisory programs into three distinct
portfolios--community banks, midsize banks, and large banks. It is also
why the OCC seeks to tailor the application of our supervisory
standards and expectations to the size and complexity of each
individual bank. In some areas, such as capital standards, we do this
by setting explicit regulatory minimums that apply to all banks. We
then augment these minimums with additional requirements for the
largest banks that reflect the complexity and risk of their operations
and their interconnections with the broader financial market. In other
areas, such as corporate governance, while our approach is more
qualitative, we have higher expectations and apply higher standards as
the complexity, risk, and scale of banks' operations increase. The OCC
believes this flexibility to tailor supervisory and regulatory
requirements to reflect our assessment of the risk of individual banks
promotes an effective and efficient supervisory regime while minimizing
undue burden.
As the Committee considers and evaluates the effectiveness of
section 165 and the banks that are affected by its provisions, I would
stress two points. First, I believe it is essential for the OCC to
retain the ability to tailor and apply our supervisory and regulatory
requirements to reflect the complexity and risk of individual banks. We
believe our risk-based supervisory approach is consistent with the
tailored application that Congress provided for in section 165. While a
bank's asset size is often a starting point in our assessment of
appropriate standards, it is rarely, if ever, the sole determinant. For
this reason, we would be concerned with any proposal that would inhibit
our ability to apply specific regulatory or supervisory tools to an
individual bank or group of banks. We need access to these tools should
we, through our supervision, determine that they are needed to address
a bank or a group of banks' risk. Second, although the OCC in our role
as the primary supervisor of national banks. We would be happy to work
with the Committee should the Committee determine that changes are
needed to make the application of section 165 more effective and
efficient.
Overview of Key Section 165 Standards and Requirements for Bank Holding
Companies
Section 165(a) of the Dodd-Frank Act authorizes the Federal Reserve
on its own or pursuant to recommendations from the Financial Stability
Oversight Council (FSOC) to establish certain heightened prudential
standards for bank holding companies with total consolidated assets
equal to or greater than $50 billion. Standards are required for five
areas: (1) leverage and risk-based capital; (2) liquidity; (3) overall
risk management; (4) resolution plan and credit exposures; and (5)
concentration limits. The Federal Reserve is given discretionary
authority to establish standards for: (1) contingent capital; (2)
enhanced public disclosures; (3) short-term debt limits; and (4) any
other prudential standards that the Federal Reserve, on its own or
pursuant to a recommendation by the FSOC, determines are appropriate.
Section 165 directs that the standards should be more stringent
than those required for bank holding companies that do not present
similar risks to the financial stability of the United States (and
thus, are not covered by section 165), and that the standards should
increase in stringency, based on various qualitative risk factors. It
also permits the standards to be tailored to individual or groups of
banking organizations based on their capital structure, riskiness,
complexity, financial activities, size, and any other risk-related
factors that the Federal Reserve deems appropriate. Finally, section
165 permits the Federal Reserve, pursuant to a standards related to the
discretionary standards, listed above, and for the resolution plans and
credit exposure reports.
Section 165 has two provisions that use a lower asset threshold
than is used for the other prudential standards. These are the stress
testing requirements in section 165(i) and the risk committee
requirements in section 165(h). Under section 165(i), all banks and
other financial companies (not just bank holding companies) with assets
above $10 billion are required annually to conduct and publicly report
the results of stress tests using scenarios developed by their primary
Federal financial regulator. Section 165(h) requires publicly traded
bank holding companies with assets of $10 billion or more to establish
risk committees.
The Complementary Nature of Section 165 and the OCC's Supervisory
Approach
A key principle underlying section 165 is that the rigor of
capital, liquidity, and risk management standards and the intensity of
supervisory oversight should increase with, and be reflective of, the
risk and complexity of a banking organization's structure and
activities. This principle also underlies the OCC's risk-based
supervisory approach and programs, and it is one that we fully support.
As noted earlier, we begin the application of this principle by
structuring our bank supervisory activities into three distinct
portfolios--community banks, midsize banks, and large banks--to reflect
the inherent differences in these banks' business models, risk
profiles, and complexity. In this respect, while asset size is
important and is generally the starting point in determining to which
portfolio an individual bank is assigned, it is not the sole
determinant. Thus, for example, while most banks in our midsize
portfolio fall into the $8 to $50 billion range, model, corporate
structure, and risk profile that are distinctly different from the
banks in our large bank portfolio, which typically have national or
global operations, complex corporate structures, extensive activities
and exposures in the wholesale funding and capital markets, or are part
of a larger, complex financial conglomerate. This flexible approach,
which considers both size and risk profiles, allows us to transition
and adjust the intensity of our supervision and our supervisory
expectations as a bank's profile changes.
Our midsize bank program is an example of how we tailor and
transition our supervisory expectations as a bank's size and complexity
increase. As noted above, the banks in this program range in size and,
at the low end, may overlap with some banks that are in our community
bank portfolio, and at the high end, overlap with banks that are in our
large bank portfolio. Banks in our midsize portfolio are generally
those that through growth and mergers have acquired a regional or
multistate footprint, yet do not present the same level of complexity
and interconnectedness as banks in our large bank program. A major
focus of midsize supervision is ensuring that as the scale of each
bank's operations and activities increases, so does its risk management
and control systems. Banks in this program have a dedicated examiner-
in-charge and a team of specialists for each core risk function that
provide ongoing monitoring and continuity in our supervision of each
bank. The individual examination program for each bank is tailored and
may, depending on the complexity and risks of the particular area, draw
examiners and blend examination procedures from both our community bank
and large bank programs.
As I noted earlier, section 165 requires the development of
prudential standards in various areas, including capital, liquidity,
risk management, and concentrations. The OCC has, areas that we expect
national banks and Federal savings associations to meet. This
combination is reflected, for example, in our approach to assessing
capital adequacy. Through regulation, we have established explicit,
minimum capital requirements that all banks must meet. There are
additional, explicit requirements related to market and operational
risks that generally apply only to the largest banks that have
significant trading activities and complex operations. Our capital
rules, however, also allow us to require additional capital based on
factors that are not explicitly covered by our quantitative capital
rules, including for example, exposures to interest rate risk and
credit concentrations. Our supervisory guidance on interest rate risk,
concentrations, and capital planning set forth factors that examiners
will consider when determining whether additional capital may be
needed. The ability to require an individual bank to maintain capital
levels above regulatory minimums is especially important when we
encounter banks, regardless of size, that may have significant
concentrations in certain loan products or market segments.
In the aftermath of the financial crisis, we, along with our U.S.
and international supervisory colleagues, have been revising the
standards for many of the areas specified in section 165 to strengthen
those that apply to the most complex banking organizations and to
better align them with risk in the system. With respect to leverage and
risk-based capital requirements, the OCC, along with the Federal
Reserve and the Federal Deposit Insurance Corporation (FDIC), has
implemented a number of enhancements that improve the quality and
quantity of capital and impose additional, more stringent leverage
ratio requirements for large, internationally active banks, with even
higher levels required for the largest, most systemically important
banks. \1\ With respect to liquidity, in 2010, the OCC and other
banking agencies issued an interagency policy statement on funding and
liquidity risk management. \2\ Consistent with our risk-based approach
to supervision, the policy applies to all banks, but specifies that the
processes and systems used by banks will vary, based on their size and
complexity. In 2013, we, the Federal Reserve, and the FDIC augmented
these qualitative expectations with explicit, quantitative liquidity
requirements for large, internationally active banks. \3\ These
requirements, known as the Liquidity Coverage Ratio (LCR), set minimums
for the level of high-qualityliquid-assets that a bank must maintain to
cover its projected net cash outflows over a 30-day period. \4\ The
Federal Reserve separately adopted a modified LCR requirement for bank
holding companies and savings and loan holding companies without
significant insurance or commercial operations that, in each case, have
$50 billion or more in total consolidated assets but are not
internationally active.
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\1\ See September 9, 2014, testimony of Comptroller of the
Currency Thomas J. Curry before the Committee on Banking, Housing, and
Urban Affairs available at: http://www.occ.gov/news-issuances/
congressionaltestimony/2014/pub-test-2014-122-written.pdf for a fuller
description of these enhancements.
\2\ See OCC Bulletin 2010-13 available at http://www.occ.gov/news-
issuances/bulletins/2010/bulletin-2010-13.html.
\3\ Generally, these are banks with $250 billion or more in total
consolidated assets or $10 billion or more in onbalance-sheet foreign
exposure and any consolidated bank or savings association subsidiary of
one of these companies that, at the bank level, has total consolidated
assets of $10 billion or more.
\4\ See OCC Bulletin 2014-51 available at http://www.occ.gov/news-
issuances/bulletins/2014/bulletin-2014-51.html.
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As I discussed in an appearance before this Committee in September,
\5\ the OCC also has taken action to apply heightened risk management
and corporate governance standards to large institutions. These
standards address: comprehensive and effective risk management; the
need for an engaged board of directors that exercises independent
judgment; the need for a robust audit function; the importance of
talent development, recruitment, and succession planning; and a
compensation structure that does not encourage inappropriate risk
taking. We issued the final standards as a new appendix to Part 30 of
our regulations. Part 30 codifies an enforcement process set out in the
Federal Deposit Insurance Act that authorizes the OCC to prescribe
operational and managerial standards and is a valuable part of our
regulatory toolbox. Under Part 30, if an insured bank fails to satisfy
a standard, the OCC may require it to submit a compliance plan
detailing how it will correct the deficiencies and how long it will
take. Rather than prescribing a ``one-size-fits-all'' remedy, this
approach allows us and the bank to implement actions that are
appropriate to the bank's unique circumstances. The approach, however,
does not diminish our ability to take more forceful action: we can
issue an enforceable order if the bank fails to submit an acceptable
compliance plan or fails in any material way to implement an OCC-
approved plan.
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\5\ See September 9, 2014, testimony noted above.
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We believe the expectations for a strong risk management culture,
effective lines of defense against excessive or imprudent risk taking,
and an engaged board of directors as set forth in our heightened
standards are essential for all large banks with significant operations
and size. We also recognize, however, that systems and processes that a
bank may need to implement, such as culture and risk controls, will
vary according to the size and complexity of the bank. Thus, our
expectations for how the largest banks implement these standards are
substantially more demanding than our expectations for banks with less
extensive operations. This difference in expectations is reflected in
the phased-in compliance dates we established such that the guidelines
were effective immediately for the largest banks but are being phased-
in for the other banks covered by our standards with lesser risk
profiles. While our heightened standards generally apply to all insured
national banks and Federal savings associations with consolidated
assets equal to or greater than $50 billion, our rule provides us with
the flexibility to determine that compliance with the standards is not
required if a bank's operations are no longer highly are consistent
with and complement the objectives of section 165, and they illustrate
how we are able through our supervisory processes to apply, tailor, and
adjust our standards to risks inherent in individual banks.
The only provision of section 165 for which the OCC has direct
rulemaking authority is section 165(i)(2) with respect to the annual
company-run stress testing requirements. As previously noted, this
provision mandates that all banks with consolidated assets of more than
$10 billion must conduct stress tests using at least three sets of
economic conditions. The OCC issued its final rule to implement section
165(i)(2) in October 2012. The rule, which is consistent with and
comparable to the stress test rules issued by the other Federal banking
agencies, establishes methods for conducting stress tests and requires
that the tests be based on at least three different economic scenarios
(baseline, adverse, and severely adverse). The rule also requires banks
to report test results in the manner specified by the OCC and publish a
summary of their results.
In drafting the rule to implement this provision of the Dodd-Frank
Act, the OCC, FDIC, and Federal Reserve worked to tailor the
requirements as appropriate for the smaller, less complex firms. Thus,
banks with consolidated assets of between $10 and $50 billion are only
required to conduct the stress test once per year (versus the two
submissions per year required for bank holding companies with
consolidated assets in excess of $50 billion). They also do not have to
develop their own stress testing scenarios, nor are they subject to a
supervisory stress test. The rule provided a delayed implementation
date for banks with between $10 and $50 billion in assets, thereby
giving them time to prepare for their first stress test submission. The
rule also extended the annual due date for submission of stress test
results three months beyond the submission date required for banks with
consolidated assets in excess of $50 billion, thereby providing the
smaller banks more time in which to conduct their stress tests and
report the results. Additionally, we developed a substantially
abbreviated data reporting template for these smaller banks, thereby
reducing the amount and granularity of data the institutions are
required to provide to the agencies. The abbreviated data reporting
templates have a further benefit of permitting these banks to publish
simpler, less detailed public disclosures relative to the requirements
for the $50 billion and over banks. The rule also delayed for a year
the initial public disclosure for banks with less than $50 billion in
assets. In addition, to reduce burden and avoid duplicative regulatory
requirements, the OCC's rule permits disclosure of the summary of the
stress test results by the parent bank holding company of a covered
institution if the parent holding company satisfactorily complies with
the disclosure requirements under the Federal Reserve's company-run
stress test rule.
As the OCC noted in its final rule, the annual stress tests
required by the Dodd-Frank Act are only one component of the broader
stress testing activities that the OCC expects of banks. The OCC's more
general and qualitative expectations are set forth in the 2012
interagency guidance on ``Stress Testing for Banking Organizations with
More Than $10 Billion in Total Consolidated Assets.'' \6\ That guidance
emphasizes that stress tests should be an integral part of a bank's
risk management and capital planning framework and tailored to a bank's
exposures, activities, and risks. It also sets out the broad principles
that we expect banks to adhere to when conducting their stress tests.
We have tailored separate guidance and tools for community banks to use
to assess the impact of various stress scenarios on concentrations
within their loan portfolios. \7\
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\6\ See OCC Bulletin 2012-14, available at: http://www.occ.gov/
news-issuances/bulletins/2012/bulletin-2012-14.html.
\7\ See OCC Bulletin 2012-33, available at: http://www.occ.gov/
news-issuances/bulletins/2012/bulletin-2012-33.html.
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Conclusion
The OCC is committed to a supervisory approach that appropriately
tailors supervisory expectations and requirements to the scale,
complexity, and risks of individual and groups of banks. We have
structured our supervisory programs in a manner that allows us to
adjust effectively and efficiently the intensity of our supervisory
oversight as a bank's risk profile changes. We have used our regulatory
tools and authorities to enhance and apply more rigorous capital,
liquidity, and risk management requirements to large banks whose size,
scope of operations, complexity, and interconnections with other
financial institutions pose more risk to financial stability. While the
OCC has taken most of these actions outside of Dodd-Frank section 165
authorities, we believe our actions and supervisory approach are
consistent with and complement the objectives of section 165. As the
primary supervisor of the Nation's largest banks, the OCC has a vital
interest in ensuring a robust regime of prudential standards for these
institutions and retaining the tools we have to effect such a regime.
______
PREPARED STATEMENT OF MARTIN J. GRUENBERG
Chairman, Federal Deposit Insurance Corporation
March 19, 2015
Chairman Shelby, Ranking Member Brown, and Members of the
Committee, I appreciate the opportunity to testify on the regulatory
regime for regional banks. My testimony will begin with a profile of
the large companies subject to the enhanced prudential standards
requirements of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act). I then will describe how regulators
have implemented the enhanced standards requirements. Finally, I will
review various considerations important to any discussion of proposals
to change these requirements.
Profile of Large Companies Subject to Section 165
Section 165 of the Dodd-Frank Act requires the Board of Governors
of the Federal Reserve System (Federal Reserve) to establish enhanced
prudential standards for certain groups of institutions. The Act
defines these institutions to include bank holding companies with total
consolidated assets equal to or greater than $50 billion and nonbank
financial companies that the Financial Stability Oversight Council
(Council) has designated for Federal Reserve supervision.
The companies that meet the $50 billion threshold for enhanced
prudential standards represent a significant portion of the U.S.
banking industry. As of December 31, 2014, 37 companies with combined
assets of $15.7 trillion reported total assets greater than $50
billion. They owned a total of 72 FDIC-insured subsidiary banks and
savings institutions, with combined assets of $11.3 trillion, or 73
percent of total FDIC-insured institution assets.
The 37 companies represent a diverse set of business models. The
four largest companies, holding combined assets of $8.2 trillion, are
universal banks that engage in commercial banking, investment banking,
and other financial services. Another 20 companies holding $3.3
trillion in assets are diversified commercial banks that essentially
take deposits and make loans. The remaining 13 companies, with a
combined total of $4.2 trillion in assets, do not engage predominantly
in traditional commercial banking activities. These companies include
two investment banks, four custodial banks, two credit-card banks, one
online bank, and four specialty institutions. The 37 institutions
include eight U.S.-owned institutions that are designated as global
systemically important banks by the Financial Stability Board. They
include the four universal banks, two investment banks, and two
custodial banks.
By way of contrast, the FDIC's Community Banking Study of December
2012 profiled institutions that provide traditional, relationship-based
banking services. The FDIC developed criteria for the Study to identify
community banks that included more than a strict asset size threshold.
These criteria included a ratio of loans-to-assets of at least 33
percent, a ratio of core deposits-to-assets of at least 50 percent, and
a maximum of 75 offices operating in no more than two large
metropolitan statistical areas and in no more than three States. Based
on criteria developed in the Study, 93 percent of all FDIC-insured
institutions with 13 percent of FDIC-insured institution assets
currently meet the criteria of a community bank. This represents 6,037
institutions, 5,676 of which have assets under $1 billion. The average
community bank holds $342 million in assets, has a total of six
offices, and operates in one State and one large metropolitan area.
The FDIC does not have a similar set of criteria to identify
regional banks. Regional banks may be thought of as institutions that
are much larger in asset size than a typical community bank and that
tend to focus on more traditional activities and lending products.
These institutions typically have expanded branch operations and
lending products that may serve several metropolitan areas and they may
do business across several States. Regional banks are less complex than
the very largest banks, which may have operations and revenue sources
beyond traditional lending products.
The 20 holding companies identified as diversified commercial
banks--the subset of the 37 institutions with total assets over $50
billion noted earlier--have a traditional banking business model that
involves taking deposits and making loans, and they derive the majority
of their income from their lending activities. Operationally, however,
the 20 diversified commercial banks are much more complex than
traditional community banks. They operate in a much larger geographic
region, and have a much larger footprint within their geographic
region.
Of the 20 holding companies:
Seven have total assets from $50 billion to $100 billion.
They have an average of nearly 700 offices, and operate in 12
States and 22 large metropolitan areas.
Nine have assets from $100 billion to $250 billion. They
have an average of nearly 1,200 offices, and operate in 12
States and 24 large metropolitan areas.
Four have total assets from $250 billion to $500 billion.
They have an average of nearly 1,800 offices, and operate in 18
States and 24 large metropolitan areas.
The operational complexity of these 20 diversified commercial bank
holding companies presents challenges that community banks do not.
Supervisory tools and regulations need to match the complexity of these
large $50 billion plus organizations. Any particular institution at the
lower to middle part of the grouping may be a dominant player within a
particular geographic or market segment and as such may require greater
regulatory attention. If there would be a failure, the resolution of
any one of these organizations may present challenges. In addition, the
failure of more than one of these institutions during a period of
severe financial stress could present challenges to financial
stability.
Implementation of Enhanced Prudential Standards
Section 165 provides the FDIC with explicit responsibilities in two
substantive areas related to prudential supervision: resolution plans
and stress testing. In both areas, the FDIC has tailored requirements
to fit the complexity of the affected institutions.
Resolution Planning
Resolution plans, or living wills, are an important tool for
protecting the economy and preventing future taxpayer bailouts.
Requiring these plans ensures that firms establish, in advance, how
they could be resolved in an orderly way under the Bankruptcy Code in
the event of material financial distress or failure. The plans also
provide important information to regulators, so they can better prepare
for failure to protect markets and taxpayers.
In 2011, the FDIC and the Federal Reserve jointly issued a final
rule implementing the resolution plan requirements of Section 165(d) of
the Dodd-Frank Act (the 165(d) rule) for bank holding companies. The
FDIC also issued a separate rule that requires all insured depository
institutions (IDIs) with greater than $50 billion in assets to submit
resolution plans to the FDIC for their orderly resolution through the
FDIC's traditional resolution powers under the Federal Deposit
Insurance Act (FDI Act). The 165(d) rule and the IDI resolution plan
rule are designed to work in tandem by covering the full range of
business lines, legal entities, and capital-structure combinations
within a large financial firm.
Bank holding companies with $50 billion or more in total
consolidated assets and nonbank financial companies regulated by the
Federal Reserve are subject to the requirement to prepare resolution
plans. However, the FDIC and the Federal Reserve used our statutory
discretion to develop a joint resolution planning rule which recognizes
the differences among institutions and scales the regulatory
requirements and potential burdens to the size and complexity of the
institutions subject to that rule. The joint rule also allows the
agencies to modify the frequency and timing of required resolution
plans.
Our resolution plan regulations also are structured so that both
firms and regulators are focused on the areas of greatest risk.
Smaller, simpler, and less complex institutions have much smaller and
simpler resolution plans than more systemic institutions, with complex
structures, multiple business lines, and large numbers of legal
entities.
In implementing the requirement for resolution plans, the FDIC and
the Federal Reserve instituted a staggered schedule for plan
submissions to reflect differing risk profiles. The first group of
companies required to file plans on or before July 1, 2012, included
bank holding companies with $250 billion or more in nonbank assets.
This group comprised 11 institutions--seven U.S. bank holding companies
and four foreign banking organizations. These institutions generally
ranked among the largest institutions in the United States, although
some equally large institutions with smaller amounts of nonbank assets,
did not file in this group.
The second group was comprised of bank holding companies with $100
billion or more, but less than $250 billion, in total nonbank assets.
These firms submitted their initial resolution plans on or before July
1, 2013. The remaining companies, those subject to the rule with less
than $100 billion in total nonbank assets, submitted their initial
plans on or before December 31, 2013.
Grouping the firms by their holdings of nonbank assets provided the
agencies with an initial proxy for firm complexity. By delaying the
submission of plans for those with fewer nonbank assets, less complex
firms were given more time to prepare. The FDIC and the Federal Reserve
also were able to focus on those firms that are more likely to pose
serious adverse effects to the U.S. financial system should they need
to be resolved under the Bankruptcy Code. Based on their groupings and
measured by asset size as of December 2011, no U.S. bank holding
company (BHC) with less than $200 billion in total consolidated assets
was required to file with either the first or second group of filers.
For their initial submissions, bank holding companies with less
than $100 billion in total nonbank assets and 85 percent or more of
their assets in an insured depository institution also were generally
permitted to submit tailored resolution plans. Tailored resolution
plans simplify the task of creating a living will by aligning it with
the FDIC's IDI resolution plan requirement and focusing on the firm's
nonbank operations. Since the initial filings, the FDIC and Federal
Reserve have further recognized differences among institutions with
less than $100 billion in nonbank assets and nearly all U.S.
institutions in this category filed tailored plans.
Though smaller firms are less systemic, appropriately tailored
resolution plans or other enhanced prudential supervision requirements
for these firms provide important benefits. Any particular institution
at the lower to middle part of the grouping may be a dominant player
within a particular geographic or market segment, and its failure would
likely have a sizeable impact for those markets. The Deposit Insurance
Fund also would face a substantial loss from the failure of even one of
these firms. Finally, the size of these firms presents an obstacle in
arranging the sale to another firm as only other larger firms would be
likely acquirers. Therefore, the FDIC and Federal Reserve should
continue to receive and review resolution plans in order to ensure that
a rapid and orderly resolution of these companies through bankruptcy
could occur in a way that protects taxpayers and the economy.
Stress Testing
Section 165(i)(2) of the Dodd-Frank Act requires the Federal
banking agencies to issue regulations requiring financial companies
with more than $10 billion in total consolidated assets to conduct
annual stress tests. The statutory language governing stress testing is
more detailed and prescriptive than the language covering other
prudential standards, leaving the regulators with less discretion to
tailor the stress testing process. The Act requires IDIs and BHCs with
assets greater than $10 billion to conduct an annual company-run stress
test, while BHCs with assets greater than $50 billion must conduct
semiannual, company-run stress tests and also are subject to stress
tests conducted by the Federal Reserve. The company-run tests must
include three scenarios and the institutions must publish a summary of
the results.
In October 2012, the FDIC, OCC, and the Federal Reserve issued
substantially similar regulations to implement the company-run stress
test requirements. The FDIC's stress testing rules, like those of the
other agencies, are tailored to the size of the institutions consistent
with the expectations under section 165 for progressive application of
the requirements. Under the agencies' implementing regulations,
organizations in the $10 billion to $50 billion asset size range have
more time to conduct the tests and are subject to less extensive
informational requirements, as compared to larger institutions.
Currently, 107 IDIs are subject to the banking agencies' stress testing
rules, with the FDIC serving as primary Federal regulator for 28 of
these IDIs.
Stress testing requirements are an important risk-assessment
supervisory tool. The stress tests conducted under the Dodd-Frank Act
provide forward-looking information to supervisors to assist in their
overall assessments of a covered bank's capital adequacy and to aid in
identifying downside risks and the potential impact of adverse outcomes
on the covered bank. Further, these stress tests are expected to
support ongoing improvement in a covered bank's internal assessments of
capital adequacy and overall capital planning.
Other Regulatory Standards Affecting Regional Banks
Many of the standards required under section 165 address issues
that are within the longstanding regulatory and supervisory purview of
the Federal banking agencies. For example, with respect to banking
organizations, the agencies have preexisting authority to establish
regulatory capital requirements, liquidity standards, risk-management
standards, and concentration limits, to mandate disclosures and regular
reports, and to conduct stress tests or require banking organizations
to do so. These are important safety and soundness authorities that the
agencies have exercised by regulation and supervision in the normal
course and outside the context of section 165.
The FDIC's capital rules are issued pursuant to its general safety
and soundness authority and the FDI Act. In many cases, FDIC capital
regulations and those of other Federal banking agencies are consistent
with standards developed by the Basel Committee on Banking Supervision.
For example, recent comprehensive revisions to the agencies' capital
rules and the liquidity coverage ratio rule incorporated aspects of the
Basel III accord, which was developed separate and independent from,
and mostly before, the Dodd-Frank Act was finalized.
These capital and liquidity rules play an important role in
promoting the safety and soundness of the banking industry, including
regional and larger banks. The agencies' capital rules are entirely
consistent with the statutory goal in section 165 of progressively
strengthening standards for the largest institutions. As a baseline, a
set of generally applicable capital rules apply to all institutions. A
defined group \1\ of large or internationally active banking
organizations are subject to more extensive U.S. application of Basel
capital and liquidity standards. In addition, eight Global Systemically
Important Banks (G-SIBs) are subject to enhanced supplemental leverage
capital requirements.
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\1\ This group consists of banking organizations with total assets
of at least $250 billion or foreign exposures of at least $10 billion.
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Policy Considerations
Section 165 establishes the principle that regulatory standards
should be more stringent for the largest institutions. This idea is
rooted in the experience of the financial crisis, where the largest
financial institutions proved most vulnerable to sudden market-based
stress, with effects that included significant disruption of the real
economy. The thresholds in the enhanced prudential standards
legislative framework state Congress's expectation for the asset levels
at which enhanced regulatory standards should start to apply, while
providing for regulatory flexibility to set the details of how those
standards should progress in stringency.
In our judgment, the concept of enhanced regulatory standards for
the largest institutions is sound, and is consistent with our
longstanding approach to bank supervision. Certainly, degrees of size,
risk, and complexity exist among the banking organizations subject to
section 165, but all are large institutions. Some of the
specializations and more extensive operations of regional banks require
elevated risk controls, risk mitigations, corporate governance, and
internal expertise than what is expected from community banks. We
should be cautious about making changes to the statutory framework of
heightened prudential standards that would result in a lowering of
expectations for the risk management of large banks.
That being said, it is appropriate to take into account differences
in the size and complexity of banking organizations when formulating
regulatory standards. The Federal banking agencies have taken into
account such differences in a number of contexts separate and apart
from section 165. Examples include asset thresholds for the interagency
capital rules, trading book thresholds for the application of the
market risk rule, and proposed notional derivatives thresholds for
margin requirements. These examples and other size thresholds
illustrate that precedents exist apart from section 165 for the
application of different and heightened regulatory standards to larger
institutions, and that different size thresholds may be appropriate for
different types of requirements. Finally, many of the rules that apply
to more complex capital market activities do not apply, as a practical
matter, to the types of traditional lending activities that many
regional banks conduct.
Conclusion
Section 165 provides for significant flexibility in implementation
of its requirements. The agencies have made appropriate use of this
flexibility thus far, and where issues have been raised by industry, we
believe that we have been responsive. The FDIC remains open to further
discussion on how best to tailor various enhanced prudential standards
and other regulations and supervisory actions to best address risk
profiles presented by large institutions, including regional banks.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM DANIEL K. TARULLO
Q.1. Governor Tarullo, we talked about the Federal Reserve's
tiering of enhanced prudential standards, however, there seemed
to be some disagreement about how the tiering works.
Please explain: Each enhanced prudential standard that
applies to bank holding companies with $50 billion in total
assets.
A.1. In February 2014, the Federal Reserve adopted a final rule
implementing enhanced prudential standards under section 165 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) for bank holding companies and foreign banking
organizations, each with $50 billion or more in total
consolidated assets (Regulation YY). For bank holding companies
with total consolidated assets of $50 billion or more,
Regulation YY incorporated as enhanced prudential standards the
previously issued capital planning and stress-testing
requirements, and imposed enhanced liquidity requirements,
enhanced risk-management requirements, and a debt-to-equity
limit for those companies that the Financial Stability
Oversight Council (Council) has determined pose a grave threat
to the financial stability of the United States.
For a foreign banking organization with total consolidated
assets of $50 billion or more, Regulation YY implemented
enhanced risk-based and leverage capital requirements,
liquidity requirements, risk-management requirements, stress
testing requirements, and the debt-to-equity limit for those
companies that the Council has determined pose a grave threat
to the financial stability of the United States. In addition,
it required foreign banking organizations with U.S. non-branch
assets, as defined in Regulation YY, of $50 billion or more to
form a U.S. intermediate holding company and imposed enhanced
risk-based and leverage capital requirements, liquidity
requirements, risk-management requirements, and capital-
planning and stress-testing requirements on the U.S.
intermediate holding company.
In addition to the enhanced prudential standards in
Regulation YY, the Board has strengthened capital requirements
applicable to all banking organizations through comprehensive
revisions to its capital framework (revised capital framework).
Further, the Resolution Plans rule (Regulation QQ), adopted in
October 2011, requires bank holding companies with assets of
$50 billion or more and nonbank financial firms designated by
the Council for supervision by the Board to annually submit
resolution plans to the Board and the Federal Deposit Insurance
Corporation (FDIC).
Finally, as part of the liquidity coverage ratio (LCR) rule
(Regulation WW), adopted in September 2014 as an enhanced
prudential standard, the Board will apply a less stringent
modified LCR requirement to bank holding companies and certain
savings and loan holding companies that have $50 billion or
more in total assets, but less than $250 billion in total
consolidated assets or $10 billion in on-balance-sheet foreign
exposure. As described in (b) below, the Federal Reserve also
will apply the more stringent LCR requirement to all banking
organizations with $250 billion or more in total consolidated
assets. In addition, the banking organizations subject to the
less stringent modified LCR requirements are required to report
their LCR monthly rather than daily as required of those
banking organizations with $250 billion or more in total
consolidated assets.
Q.2. Each enhanced prudential standard that applies to bank
holding companies with $250 billion in assets or $10 billion in
foreign exposures; and
A.2. Regulation WW also will apply to all banking organizations
with $250 billion or more in total consolidated assets or $10
billion or more in on-balance sheet foreign exposure (advanced
approaches banking organizations) and to these banking
organizations' subsidiary depository institutions that have
assets of $10 billion or more.
Advanced approaches banking organizations are subject to
heightened risk-based and leverage capital requirements under
the Federal Reserve's revised capital framework. For instance,
these firms must reflect changes in accumulated other
comprehensive income in regulatory capital, and hold an
additional buffer of capital if the Federal banking agencies
determine that the economy is experiencing excessive credit
growth, as well as meet a minimum supplementary leverage ratio
requirement of 3 percent.
Q.3. Any other enhanced prudential standards that may apply,
including the thresholds upon which that applicability is
based.
A.3. The Board has adopted risk-based and leverage capital
surcharges applicable to the largest, most systemically
important U.S. bank holding companies globally systemically
important financial banking organizations (G-SIBs). Effective
January 1, 2016 (subject to transition arrangements), a bank
holding company that is designated as a G-SIB is subject to a
risk-based capital surcharge (G-SIB surcharge) above its
minimum regulatory capital requirements. The amount of the G-
SIB surcharge is calibrated to each firm's overall systemic
risk. In addition, effective January 1, 2018, a G-SIB must
maintain a leverage buffer greater than 2 percentage points
above the minimum supplementary leverage ratio requirement of 3
percent, for a total of more than 5 percent (enhanced
supplementary leverage ratio ). \1\ Failure to maintain capital
above the G-SIB surcharge or supplementary leverage ratio will
result in restrictions on capital distributions and certain
discretionary bonus payments.
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\1\ IDI subsidiaries of covered bank holding companies must
maintain at least a 6 percent supplementary leverage ratio to be
considered ``well capitalized'' under the banking agencies' prompt
corrective action framework.
Q.4. Governor Tarullo, we talked about stress tests.
In a submission for the record, one regional bank stated
that the leverage a risk-based capital requirement under
section 165(b) of the Dodd-Frank Act ``is primarily manifested
through higher risk-based capital standards and through the
annual Comprehensive Capital Analysis and Review (CCAR).'' We
have heard from other regional banks that the Federal Reserve
is using CCAR to satisfy 165(b)'s enhanced risk-based capital
and leverage standards.
What is the legal authority for CCAR and which enhanced
prudential standard does CCAR satisfy?
A.4. In the Comprehensive Capital Analysis and Review (CCAR),
the Federal Reserve evaluates whether a bank holding company
has effective capital planning processes and sufficient capital
to absorb losses during stressful conditions, while meeting
obligations to creditors and counterparties and continuing to
serve as credit intermediaries. The Federal Reserve derives its
authority for CCAR from the Bank Holding Company Act (BHC Act)
and the International Lending Supervision Act. Specifically,
section 5 of the BHC Act (12 U.S.C. 1844) authorizes the Board
to issue regulations and orders, and to collect and require
reports from bank holding companies. \2\ Further, the Federal
Reserve's rulemaking authority to set regulatory capital
requirements and standards for bank holding companies is found
in sections 908 and 910 of the International Lending
Supervision Act, as amended (12 U.S.C. 3907 and 3909).
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\2\ Section 616(a) of the Dodd-Frank Act amended section 5(b) of
the BHC Act (12 U.S.C. 1844(b)) to specifically authorize the Board to
issue regulations and orders relating to capital requirements for bank
holding companies.
---------------------------------------------------------------------------
In addition, the Dodd-Frank Act expressly directed the
Federal Reserve to impose enhanced prudential standards on
large bank holding companies to prevent or mitigate risks to
the financial stability of the United States. These standards
must include enhanced risk-based and leverage capital
requirements, among other requirements. The capital plan rule,
which governs CCAR, serves as enhanced risk-based and leverage
capital standards for large bank holding companies. \3\ In
addition, the Dodd-Frank Act mandates that the Federal Reserve
conduct annual stress tests on large bank holding companies to
determine whether large bank holding companies have the capital
needed to absorb losses in baseline, adverse, and severely
adverse economic conditions. These stress tests are integrated
into the ongoing assessments of a bank holding company's
required capital and are an important component of the annual
assessment of capital plans. \4\
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\3\ See 12 CFR 225.8.
\4\ See 12 CFR part 252, subpart E.
Q.5. How is the Federal Reserve satisfying the 165(b) enhanced
---------------------------------------------------------------------------
risk-based capital and leverage standards?
A.5. The Federal Reserve has strengthened the capital
requirements applied to all banking organizations it supervises
and, in keeping with the mandate established by section 165 for
progressively more stringent prudential standards to be applied
to banks of greater systemic importance, the Federal Reserve
has also established several tiers of enhanced requirements.
\5\ In July 2013, the Federal Reserve issued a final rule to
comprehensively revise the capital regulations applicable to
banking organizations (revised capital framework). \6\ The
revised capital framework strengthens the definition of
regulatory capital, generally increases the minimum risk-based
capital requirements, modifies the methodologies for
calculating risk-weighted assets, and imposes a minimum
generally applicable leverage ratio requirement of 4 percent
for all banking organizations.
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\5\ See 12 CFR part 252. Regulation YY imposes risk-based capital
and leverage requirements on U.S. intermediate holding companies of
foreign banking organizations. These requirements are generally the
same as those described above for bank holding companies.
\6\ See 78 FR 62018 (October 11, 2013).
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The Federal Reserve's capital plan rule serves as an
enhanced risk-based capital and leverage standard by helping to
ensure that bank holding companies with assets above the
threshold established by Congress in section 165 hold
sufficient capital to meet obligations to creditors and other
counterparties and serve as financial intermediaries during
periods of stress.
The revised capital framework imposes additional
requirements on large, complex organizations that are
internationally active and subject to the banking agencies'
advanced approaches risk-based capital rules. For instance,
these firms must reflect changes in accumulated other
comprehensive income in regulatory capital, hold an additional
buffer of capital if the Federal banking agencies determine
that the economy is experiencing excessive credit growth, and
meet a minimum supplementary leverage ratio requirement of 3
percent. \7\ This supplementary leverage ratio is developed to
help reduce risk to U.S. financial stability and improve the
resilience of the U.S. banking system by limiting the amount of
leverage that a banking organization may incur.
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\7\ A U.S. banking organization is subject to the advanced
approaches rule if it has consolidated assets of at least $250 billion,
if it has total consolidated on-balance sheet foreign exposures of at
least $10 billion, if it elects to apply the advanced approaches rule,
or it is a subsidiary of a depository institution, bank holding
company, or savings and loan holding company that uses the advanced
approaches to calculate risk-weighted assets. See 78 FR 62018, 62204
(October 11, 2013); 78 FR 55340, 55523 (September 10, 2013); 79 FR
57725 (September 26, 2014).
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Finally, the Federal Reserve has adopted both a risk-based
and leverage capital surcharge applicable to the largest, most
systemically important U.S. bank holding companies (G-SIBs). A
bank holding company that is designated as a G-SIB will be
subject to enhanced supplementary leverage ratio standards
through application of a ``leverage buffer'' of 2 percent (in
addition to the minimum supplementary leverage ratio of 3
percent). \8\ In addition, the G-SIB will be subject to a risk-
based capital surcharge that is calibrated to each firm's
overall systemic risk. \9\ These enhanced risk-based and
leverage capital standards are designed to help reduce the
probability of failure of systemically important banking
organizations, thereby mitigating the risks to the financial
stability of the United States posed by these organizations.
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\8\ See 79 FR 24528 (May 1, 2014). In addition, all insured
depository institution subsidiaries of such bank holding companies
would be subject to an enhanced supplementary leverage ratio of 6
percent in order to be considered well-capitalized under the prompt
corrective action framework.
\9\ See ``Regulatory Capital Rules: Implementation of Risk-based
Capital Surcharges for Global Systemically Important Bank Holding
Companies'', available at: www.federalreserve.gov/newsevents/press/
bcreg/bcreg20150720a1.pdf.
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Q.6. During the Committee hearing on March 24th, Deron Smithy,
the Treasurer for Regions Bank, said:
[A]t the $50 billion level, we are subject to enhanced
standards, which, again, as I mentioned, includes
stress tests, which frankly we think are a good idea. I
will fully stipulate that pre-crisis the banking
industry was in greater need of enhanced risk
management practices and stronger internal modeling,
stronger capital planning activities. I think the
stress test that emanated from the original SCAP and
have evolved into CCAR are a good thing. As a matter of
fact, we built our whole entire capital planning
process and strategic planning process around the
stress testing framework . . . Where it becomes more
challenging or restrictive is, as part of the CCAR
process, there is a stress test that the Fed conducts
on banks, and there is an outcome from that stress test
in terms of losses. And at the end of the day, our
capital levels that we must manage to, despite what we
calculate internally, the binding constraint becomes
what the Fed calculates for us. And so one of the
challenges--there are certain asset classes and
products where the Fed sees risk just inherently higher
than do the banks.
Do you continue to believe that stress testing is not
appropriate for regional banks?
A.6. Rigorous stress testing helps to compensate for the
somewhat backward-looking nature of conventional capital
requirements by assessing on a forward-looking basis the losses
that would be suffered by a bank under stipulated adverse
economic scenarios. In doing so, capital can be built and
maintained at levels high enough for banks to withstand such
losses and still remain viable financial intermediaries. The
importance of this aim is reflected in Congress' mandate, via
the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act), to require annual supervisory stress tests
for bank holding companies (BHCs) with $50 billion or more in
assets and to require company-run stress tests for institutions
with $10 billion or more in assets. These stress tests allow
supervisors to assess whether firms have enough capital to
weather a severe economic downturn and contribute to the
Federal Reserve's ability to make assessments of the resilience
of the U.S. banking system under stress scenarios.
As I stated in my testimony, it has been somewhat difficult
to customize the supervisory stress tests that are required by
the Dodd-Frank Act. While some elements of the test, such as
the market shock and single counterparty default scenarios, are
applied only to larger firms, the basic requirements for the
aggregation and reporting of data conforming to our supervisory
model and for firms to run our scenarios through their own
models entail substantial expenditures of out-of-pocket and
human resources. This can be a considerable challenge for a $60
billion or $70 billion bank. On the other side of the ledger,
while we do derive some supervisory benefits from the inclusion
of these banks toward the lower end of the range in the
supervisory stress tests, those benefits are relatively modest,
and we believe we could probably realize them through other
supervisory means. This is why I have suggested that it may be
appropriate to raise the threshold to $100 billion.
Dodd-Frank Act stress testing is a complementary exercise
to the Comprehensive Capital Analysis and Review (CCAR), an
annual exercise by the Federal Reserve to assess whether bank
holding companies with $50 billion or more in assets have
rigorous, forward-looking capital planning processes and
sufficient capital to continue to operate through times of
extreme economic and financial stress. Because we generally
believe that smaller institutions would not impose sizable
negative externalities on the U.S. financial system in the
event of their stress or failure and that the regulatory costs
to these institutions of complying with CCAR far outweigh any
supervisory benefit that might result, we do not subject them
to CCAR. We believe, however, that all banking organizations,
regardless of size, should have the capacity to analyze the
potential impact of adverse outcomes on their financial
condition.
Q.7. We discussed the importance of the Fed's separate stress
testing evaluations. How do you respond to Mr. Smithy's
comments?
A.7. As noted above, with the CCAR, the Federal Reserve
evaluates whether BHCs with total consolidated assets greater
than $50 billion have sufficient capital to continue operations
throughout times of economic and financial market stress. To do
so, the Federal Reserve uses its own independent, validated
models, with detailed data provided by the banks, to project
post-stress capital ratios that are applied consistently across
all subject firms. By using the same set of scenarios, models,
and assumptions, the supervisory stress test ensures the
comparability of results across various firms. The results of
supervisory stress tests and a BHC's own stress tests may
differ for a number of reasons, including modeling techniques,
key assumptions, and accounting treatments. For example, the
Federal Reserve uses an expected loss framework for estimating
loan losses, which pulls losses forward, while firms may
produce accounting-based loss estimates, which tend to be more
spread out over time. These differences can result in
divergence in projected loan losses for the same portfolio.
Qualitative assessments in CCAR do not consider differences
in quantitative outcomes between supervisory stress tests and
the banks' own stress tests, but rather focus on the banks'
capital planning processes, including banks' internal stress
testing practices. We want to encourage firms to think
innovatively about risk management and that can mean adopting
different modeling approaches. We believe that looking at
capital adequacy from multiple perspectives and under multiple
models is useful for understanding vulnerabilities under a
range of scenarios.
Q.8. Should Members of the Committee be concerned by the March
23 Wall Street Journal report that there is a $400 million
discrepancy between the loss estimates of the Federal Reserve
and Zions Bank related to Zions' CDO portfolio? If not, why
not?
A.8. As noted in response to Question 2, there are numerous
reasons why a bank's own estimate of losses may vary from the
estimate generated in our supervisory stress tests. An
assessment of the reasons for significant variations is part of
our qualitative assessment of a firm's capital planning
process. In any case, investors and the public know that the
Federal Reserve's estimates are based on models and assumptions
applied consistently to all CCAR banks.
Q.9. Governor Tarullo, you have said--both in speeches and your
testimony--that it may be appropriate to lift the $50 billion
threshold for enhanced prudential standards generally, and
particularly for stress tests. In addition to section 165, a
number of other provisions of Dodd-Frank use a $50 billion
threshold.
Would you also support lifting the $50 billion thresholds
for the following provisions:
a. Section 163
b. Section 164
c. Section 166
d. Section 210
e. Section 726
f. Section 763
g. Section 765
A.9. In the Dodd-Frank Act, Congress used the $50 billion
threshold for the mandatory application of a number of
regulatory requirements, including those cited above.
Establishing such statutory thresholds is a useful means of not
merely giving banking agencies the authority to engage in a
particular form of prudential regulation, but requiring that
they do so. In that way, Congress was in effect guarding
against memories of the problems the provisions were meant to
protect fading and the consequent possibility of supervisory
relaxation, which might allow for a recurrence of similar
banking problems in the future.
The requirements for mandatory application of the
provisions in sections 163, 164, 166, and 210 seem to me
similar to those in section 165. Thus I would be inclined to
raise the threshold in these sections, with the important
caveat--as with section 165--that Congress should be clear it
is not restricting the authority of the Federal Reserve to use
its discretion to apply additional requirements to any bank, as
needed for prudential reasons.
The thresholds in Title VII have a somewhat different
purpose and effect, more relevant to the activities of market
regulators, to whose judgment I would defer on the issue of
raising these thresholds.
Q.10. At our Committee hearing on March 24th, one of the
majority witnesses, Oliver Ireland from Morrison & Foerster,
testified: ``I find the statutory language a little bit
confusing myself, but one of the listed criteria or
requirements in subsection (b) which is not accepted is
resolution plans. And so it appears that they cannot lift the
resolution plans if they are adhering to that statutory
language.'' As I read the text of the Dodd-Frank Act, the
Federal Reserve has the authority to lift the $50 billion
threshold for resolution plans because they are contained in
section 165(d).
Does the Federal Reserve interpret the statute as providing
the Federal Reserve the authority to lift the threshold for
resolution plans, pursuant to a recommendation by the Financial
Stability Oversight Council (FSOC)?
A.10. Section 165(a)(2)(B) of the Dodd-Frank Act grants
authority to raise the asset threshold for resolution plans,
though only pursuant to a recommendation from the Financial
Stability Oversight Council. While Mr. Ireland is correct that
the statutory language is potentially a little confusing, the
Federal Reserve believes that the adjustments authorized in
subsection (a)(2)(B) to the enhanced prudential standards
established in subsections (c) through (g) also apply to those
same enhanced prudential standards generally referenced in
subsection (b) (i.e., contingent capital, resolution plans,
concentration limits, enhanced public disclosures, and short
term debt limits).
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM DANIEL K. TARULLO
Q.1. Mr. Tarullo in your written statement you suggested
raising the asset threshold to $10 billion for regulating small
banks under the Volcker rule and the incentive compensation
requirements of Sec. 956 of the Dodd-Frank Act.
What criteria led you to determine that $10 billion in
assets is an appropriate line where the benefits of compliance
are not exceeded by the costs of the regulations?
A.1. Section 619 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act), which added a new
section 13 to the Bank Holding Company Act of 1956 (BHC Act),
also known as the Volcker Rule, generally prohibits any banking
entity from engaging in proprietary trading, and from acquiring
or retaining an ownership interest in, sponsoring, or having
certain relationships with a covered fund, subject to certain
exemptions. Under the terms of the statute, section 13 applies
to any banking entity regardless of its size. As a result,
section 13 and the final rules apply to community banks of all
sizes.
Section 956 of the Dodd-Frank Act requires the Federal
Reserve, the Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation, the Securities and
Exchange Commission, the National Credit Union Administration
Board, and the Federal Housing Finance Agency (the Agencies) to
jointly issue regulations or guidelines that would prohibit any
types of incentive-based payment arrangement, or any feature of
any such arrangement, that regulators determine encourage
inappropriate risks by providing excessive compensation or that
could lead to material financial loss to a covered financial
institution. Under the terms of the statute, covered financial
institutions with assets of less than $1 billion are exempt;
larger institutions, including those with assets between $1
billion and $10 billion, would be covered.
The Federal Reserve makes substantial efforts to tailor its
supervisory practices in accordance with the size, business
models, risks, and other salient considerations of the
institutions supervised. Requirements are the least stringent
for smaller, local institutions and increase with factors
including the size, complexity, and geographic reach of firms.
In general, we shape our supervisory practices by considering
the increase in safety and soundness that we are likely to
achieve through a specific practice or requirement, in light of
the regulatory costs for the banking organization at issue and
the impact that the stress or failure of that organization
would likely have on credit intermediation, the deposit
insurance fund, and financial stability.
In a number of instances in the Dodd-Frank Act where
Congress showed an intent to distinguish between smaller and
larger, more complex institutions, a $10 billion threshold was
used. For example, formal stress testing was required only for
banks with total assets of $10 billion or more. In addition,
the Dodd-Frank Act required the Federal Reserve to issue
regulations requiring that publicly traded bank holding
companies with more than $10 billion establish risk committees.
Furthermore, banks with less than $10 billion in total assets
were exempted from a number of the debit interchange
restrictions.
With respect to the Volcker Rule, the Agencies charged with
implementing that statutory provision endeavored to minimize
the compliance burden on banking entities. As part of the
implementing rules, the Agencies reduced the compliance program
and reporting requirements applicable to banking entities with
$10 billion or less in total consolidated assets. This was
based in part on information that indicated that banking
entities of this size generally have little or no involvement
in prohibited proprietary trading or investment activities in
covered funds. \1\ Exempting community banks from section 13
would provide relief for thousands of community banks that face
ongoing compliance costs incurred simply to confirm that their
activities and investments are indeed exempt from the statute.
At the same time, an exemption at this level likely would not
increase risk to the financial system. The vast majority of the
activity and investment that section 13 of the BHC Act is
intended to address takes place at the largest and most complex
financial firms whose failure would have a significant effect
on the stability of the U.S. financial system. Moreover, were
an exemption granted, the Federal banking agencies could
continue to use their existing prudential authority in the
event that these small institutions engage in imprudent
investment activities that raise safety and soundness concerns.
---------------------------------------------------------------------------
\1\ See ``The Volcker Rule: Community Bank Applicability'' (Dec.
10, 2013), available at: http://www.federalreserve.gov/newsevents/
press/bcreg/bcreg20131210a4.pdf.
---------------------------------------------------------------------------
Similarly, with respect to incentive compensation, the $10
billion threshold would reflect the fact that the types of
incentive compensation concerns intended to be addressed by
section 956 apply almost exclusively to larger financial
institutions. Community banking organizations are less likely
to be significant users of incentive compensation arrangements
and any incentive compensation issues at these organizations
would be less likely to have adverse effects on the broader
financial system. While the Agencies expect to tailor
application of section 956 to make clear the limited extent to
which it should effect small institutions, it may be
appropriate for Congress to consider exempting community
banking organizations with less than $10 billion in total
consolidated assets completely from the requirements of the
rule.
Q.2. Mr. Tarullo, in your written statement you concluded
``while enhanced prudential standards are important to ensure
that larger banks can continue to provide credit even in
periods of stress, some of those same enhancements could
actually inhibit credit extension by rending the reasonable
business models of middle-sized and smaller banks
unprofitable.''
In light of this statement, do you believe these
regulations on smaller community banks has led to the sharp
consolidation in their number? Are these regulations in any way
responsible for the slow-moving economic recovery the United
States is experiencing since the financial crisis of 2008?
A.2. Relevant data suggests that the economic reverberations of
the financial crisis and recession were a major cause of the
consolidation that has taken place in recent years. Figure 1
displays the percent decline in the number of community banks
from the prior year. \2\ The annual rate of community bank
consolidation was generally trending lower before the financial
crisis, but then began to increase during and after the crisis.
---------------------------------------------------------------------------
\2\ The decline includes both failed banks and acquired banks.
---------------------------------------------------------------------------
However, even if the main drivers of consolidation have
been the challenges of an adverse economic environment, we
surely do not want to add to those challenges through the
application of regulations that are unnecessary to protect the
safety and soundness of small banks, and in many cases, were
developed in response to the quite different activities and
risks at the larger banks.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM DANIEL K. TARULLO
Q.1. Regulators clearly already have some flexibility on how
they apply the same regulatory principles to different kinds of
institutions. For example, the Liquidity Coverage Ratio (LCR)
rule allows for ``modified'' applications to firms that are not
complex enough to warrant full treatment. But even in the LCR,
where regulators knew they had this flexibility, a line was
drawn at $250 billion that seemed to take sheer size into
account more than the actual business activities firms were
engaged in. In fact, banking regulators appear to have a
sensible methodology in place to determine which firms are
``globally systemically important banks.''
Testimony by the Federal Reserve for this hearing
acknowledged that banking regulators begin with the same
``unitary approach'' to supervising regional banks, regardless
of their size. Why then, is this principle not followed when
promulgating regulations?
A.1. In September 2014, the Federal Reserve adopted a final LCR
rule which provides for different liquidity requirements based
on the size and complexity of a banking organization. Under the
LCR rule, large banking organizations--those with total
consolidated assets of $250 billion or more or total
consolidated on-balance sheet foreign exposure of $10 billion
or more, and their bank and thrift subsidiaries with total
consolidated assets of $10 billion or more--are subject to the
most stringent quantitative liquidity requirement and to daily
calculation requirements. The Federal Reserve's modified LCR
rule applies less stringent requirements to certain depository
institution holding companies with total consolidated assets of
at least $50 billion but less than $250 billion. The LCR is
designed to promote the short-term resilience of the liquidity
risk profile of large banking organizations and to improve the
banking sector's ability to absorb shocks during periods of
significant stress. The LCR does not apply to community banking
organizations.
The Federal Reserve recognizes that, when setting an asset
threshold in a regulation, relatively similar banking
organizations on different sides of that threshold will be
affected differently. Nonetheless, the Federal Reserve believes
that the LCR rule's asset thresholds appropriately address the
liquidity risks that covered banking organizations could pose
to the funding markets and the overall economy taking into
account factors such as their size, complexity, risk profile,
and interconnectedness. In implementing internationally agreed
upon regulatory standards in the United States, the Federal
banking agencies have historically applied a consistent
threshold for determining whether a U.S. banking organization
should be subject to such standards based upon similar factors.
The thresholds in the LCR rule are consistent with this
approach. The Federal Reserve's modified LCR's $50 billion
asset threshold is consistent with the enhanced prudential
standards required under section 165 of the Dodd-Frank Wall
Street and Consumer Protection Act.
The LCR rule takes into account individual characteristics
of a covered company in several ways. For example, the rule
calibrates the net cash outflow requirement for an individual
covered company based on the company's balance sheet, off-
balance sheet commitments, business activities, and funding
profile. Sources of funding that are considered less likely to
be affected at a time of a liquidity stress are assigned
significantly lower outflow rates. Conversely, the types of
funding that are historically vulnerable to liquidity stress
events are assigned higher outflow rates. The Federal Reserve
expects that covered companies with less complex balance sheets
and less risky funding profiles will have lower net cash
outflows and will therefore require a lower amount of high
quality liquid assets to meet the rule's minimum standard.
Furthermore, systemic risks that could impair the safety of
banking organizations are also reflected in the rule, including
provisions to address wrong-way risk, shocks to asset prices,
and other industry-wide risks. Banking organizations that have
greater interconnectedness to financial counterparties and have
liquidity risks related to risky capital market instruments may
have larger net cash outflows. Conversely, banking
organizations that choose to rely on a more traditional funding
profile may limit or avoid such outflows under the rule.
In promulgating the LCR rule, the Federal Reserve
recognized that some financial institutions could face
operational difficulties implementing the rule in the near
term. To address these difficulties, the LCR rule provides
relief to non-G-SIB financial institutions by differentiating
among the transition periods for the LCR daily calculation
requirement. Accordingly, the Federal Reserve provided an
extended implementation schedule for calculation of the LCR on
a daily basis. The Federal Reserve anticipates finalizing
liquidity reporting requirements for companies subject to the
LCR rule in the near future. Banking organizations subject to
the Federal Reserve's modified LCR requirements will calculate
the LCR on a monthly basis.
Q.2. Wouldn't it be better to apply ``modified'' treatment of
the LCR, or other rules, to banks of similar operational
activities or risk profiles, even if their sizes differ
substantially?
A.2. The Federal Reserve sought to calibrate the LCR
requirement so that a banking organization holds an amount of
highly liquid assets commensurate with both the organization's
liquidity risk profile and the wider impact of the organization
facing a liquidity shortfall at a time of significant stress.
For example, the LCR rule considers not only the resilience of
the organization's short-term funding but also the
interconnectedness of the organization with the financial
sector and its ability to continue lending to retail and
corporate counterparties. The Federal Reserve fully expects
firms with less complex, more resilient near-term funding
profiles to have a lower requirement under the rule. Liquidity
risk can also be a function of the scale of an organization's
funding profile. Banking organizations with historically more
stable funding sources, such as certain types of deposits, may
still face significantly greater funding needs in a period of
severe liquidity stress based on the overall volume and
regional distribution of their funding sources. Larger banking
institutions are typically more significant contributors to the
provision of credit in a regional economy. The Federal Reserve
believes that the ability of an institution to continue to be
able to provide credit in a period of significant stress should
be a consideration in a banking organization's wider liquidity
risk management practices.
Q.3. Would you be open to setting a break-point for regulatory
treatment where there seems to be a natural delineation in
terms of the systemic risk arising from those firms? As an
example, would you be open to reserving full treatment under
the LCR for firms that have been designated as globally
systemically important banks (G-SIBs)?
A.3. The Federal Reserve issued the LCR rule consistent with
its responsibility to promulgate, on a tailored basis, enhanced
prudential standards for large, complex banking organizations.
The LCR ensures that important aspects of the liquidity risk
profile of large banking organizations are addressed in a
prudent, consistent, and sophisticated manner. While the rule
incorporates aspects of financial interconnectedness, the
Federal Reserve believes that such prudent practices are
important for the continued safety and soundness of large
banking institutions individually, beyond the wider impact of
their failure on the financial system as a whole. The G-SIB
designation takes into account size, interconnectedness,
substitutability, complexity, and crossjurisdictional
activities and is applied only to the largest, most complex
institutions. The Federal Reserve's regulations, including
risk-based prudential regulations such as the LCR rule,
recognize the need to apply higher standards to a wider set of
large and internationally active banking organizations.
Q.4. In July of 2013, the Treasury Borrowing Advisory Committee
reported that new regulations stemming from Basel III and Dodd-
Frank will likely result in constrained liquidity in the
market. Even well-intentioned rules like the Supplementary
Leverage Ratio (SLR) may constrain liquidity in markets as deep
and understood as those for U.S. Treasury securities.
What work have you done to take into account the views of
the TBAC and other market participants?
A.4. The Federal Reserve has a strong interest in market
liquidity across a range of key financial markets, as
conditions are relevant to the conduct of monetary policy and
financial stability. Federal Reserve staff monitor a variety of
markets on an ongoing basis to keep abreast of current
liquidity conditions and emerging trends. Board members meet
regularly with market participants, including the Treasury
Borrowing Advisory Committee (TBAC), who provide their views on
market liquidity conditions and trends.
We have been listening to the concerns expressed about
reduced bond market liquidity, and we are monitoring a wide
range of indicators of liquidity. Federal Reserve System staff
worked with staff at the Department of the Treasury, the
Securities and Exchange Commission, and the Commodities Futures
Trading Commission to produce the report ``The U.S. Treasury
Market on October 15, 2014'' that analyzed reductions in market
depth in the Treasury securities and futures markets during a
12-minute event window that day. The report also highlights
important changes in market structure in recent years,
including the increased role of high-speed electronic trading
and the reduced share of traditional bank-dealer activity in
the interdealer market. We are committed to further studying
liquidity in the Treasury markets, including monitoring of
trading and risk management practices of market participants,
assessing available data, and strengthening monitoring efforts.
Overall, many price-based and volume-based measures do not
indicate a notable deterioration in liquidity, although average
trade sizes have fallen.
There are a number of reasons for why liquidity in markets
may be changing. Currently there are fewer active trading
participants and an increase in ``buy and hold'' investors.
Broker-dealers may now be willing to buy and sell bonds at the
request of their clients because of new regulatory
requirements, as the question suggests, but also importantly
because of changes to risk management practices that they have
made on their own. Technological changes also may be affecting
the provision of liquidity. Increased reporting requirements
have reduced trading costs, but also perhaps trading sizes. In
Treasury markets, greater high-speed electronic trading may be
leading to fundamental changes in trading practices. Federal
Reserve staff, along with other regulatory agencies, are
studying the potential role of these various factors. An
important consideration in any analysis is that some of the
possible changes may be transitory, reflecting an adjustment to
new regulations and technology, and a low interest rate
environment. As a result, fully understanding the effects of
these various factors on market liquidity may take time so that
a sufficient amount of data and experience can be brought to
bear on the question.
Q.5. What has been done specifically to address concerns
regarding market liquidity in anticipation or as a result of
new regulations?
A.5. As noted above, Federal Reserve staff have been working
with other agencies to monitor liquidity conditions across a
range of key financial markets and are talking to market
participants. As post-crisis reforms go into effect and begin
to have perceptible impacts on financial markets, Federal
Reserve staff will continue these monitoring efforts, including
exploring the effects of financial reforms on market liquidity
and financial stability.
Q.6. Given the views and commentary of the TBAC and other
market participants, which rules have you considered
revisiting?
A.6. Given that many of the post-crisis reforms in question
have either recently been implemented or are still in the
process of being implemented, the Federal Reserve is not
actively considering any specific changes at this time.
Changing rules shortly after their implementation can create
confusion and uncertainty in markets that may outweigh any
benefits that the changes might produce. As market participants
adjust to the reforms, the Federal Reserve will consider
whether changes are necessary to improve the regulatory
framework's ability to achieve the goal of enhancing financial
stability without unduly constraining market liquidity.
Q.7. As the Federal Reserve contemplates an increase in
interest rates, wouldn't it be prudent systemic risk management
to foster liquidity rather than hampering it?
A.7. The Federal Reserve has a strong interest in fostering a
level of robust market functioning while maintaining financial
stability. Some degree of liquidity risk will always be present
in securities markets. A key consideration for financial
stability is whether the bearers of liquidity risk are
sufficiently resilient to provide liquidity in most situations.
The Federal Reserve is committed to designing and implementing
policies consistent with the objectives of fostering efficient
markets and financial stability.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM THOMAS J. CURRY
Q.1. Regulators clearly already have some flexibility on how
they apply the same regulatory principles to different kinds of
institutions. For example, the Liquidity Coverage Ratio (LCR)
rule allows for ``modified'' applications to firms that are not
complex enough to warrant full treatment. But even in the LCR,
where regulators knew they had this flexibility, a line was
drawn at $250 billion that seemed to take sheer size into
account more than the actual business activities firms were
engaged in. In fact, banking regulators appear to have a
sensible methodology in place to determine which firms are
``globally systemically important banks.''
Testimony by the Federal Reserve for this hearing
acknowledged that banking regulators begin with the same
``unitary approach'' to supervising regional banks, regardless
of their size. Why then, is this principle not followed when
promulgating regulations?
Wouldn't it be better to apply ``modified'' treatment of
the LCR, or other rules, to banks of similar operational
activities or risk profiles, even if their sizes differ
substantially?
Would you be open to setting a break-point for regulatory
treatment where there seems to be a natural delineation in
terms of the systemic risk arising from those firms? As an
example, would you be open to reserving full treatment under
the LCR for firms that have been designated as globally
systemically important banks (G-SIBs)?
A.1. The OCC believes that the final LCR rule is calibrated
appropriately so that it applies in a tailored fashion to the
financial institutions with the most significant liquidity risk
profiles. In September 2014, the agencies adopted a tailored
LCR regime that increases in stringency based on the asset size
of a financial institution. Under the LCR rule, large financial
institutions--those with total consolidated assets of $250
billion or more or total consolidated on-balance sheet foreign
exposure of $10 billion or more, and their bank and savings
association subsidiaries with total consolidated assets of $10
billion or more--are subject to the most stringent liquidity
buffer and daily reporting requirements. The Federal Reserve
Board separately adopted a less stringent, modified LCR
requirement for bank holding companies and savings and loan
holding companies without significant insurance or commercial
operations that, in each case, have $50 billion or more in
total consolidated assets but are not internationally active.
Those holding companies are permitted to hold a lower amount of
a liquidity buffer and report the LCR monthly, rather than
daily.
As the preamble to the final rule explains, the agencies
believe that the LCR rules' asset thresholds appropriately
address the liquidity risks that covered financial institutions
could pose to the funding markets and the overall economy
taking into account their size, complexity, risk profile, and
interconnectedness. The LCR rule's $250 billion total
consolidated asset and $10 billion foreign exposure thresholds
also are consistent with the thresholds that trigger the more
stringent capital requirements for larger financial
institutions under the agencies' capital rules. The tailored
LCR asset thresholds appropriately address the liquidity risks
that financial institutions could pose to the funding markets
and the overall economy.
In promulgating the final LCR rule, the agencies recognized
that some financial institutions, including regional financial
institutions, could face operational difficulties implementing
the rule in the near term. To address these difficulties, the
LCR final rule provides relief to non-G-SIB financial
institutions by differentiating among the transition periods
for the LCR daily calculation requirement. Accordingly,
regional financial institutions subject to the LCR rule were
granted a delay by the agencies and do not have to calculate
the LCR on a daily basis until July 1, 2016.
Q.2. In July of 2013, the Treasury Borrowing Advisory Committee
reported that new regulations stemming from Basel III and Dodd-
Frank will likely result in constrained liquidity inthe market.
Even well-intentioned rules like the Supplementary Leverage
Ratio (SLR) may constrain liquidity in markets as deep and
understood as those for U.S. Treasury securities.
What work have you done to take into account the views of
the TBAC and other market participants?
What has been done specifically to address concerns
regarding market liquidity in anticipation or as a result of
new regulations?
Given the views and commentary of the TBAC and other market
participants, which rules have you considered revisiting?
As the Federal Reserve contemplates an increase in interest
rates, wouldn't it be prudent systemic risk management to
foster liquidity rather than hampering it?
A.2. The OCC generally receives comments on proposed
regulations from a variety of market participants, including
U.S. and foreign firms and trade associations representing
them, public officials (including members of the U.S. Congress
and State and local government officials), public interest
groups, private individuals, and other interested parties. The
OCC carefully reviews all comments we receive to identify areas
where changes would be appropriate, and we often modify or
adjust a proposed rule in response to commenters' concerns. For
example, in the LCR final rule, based on the banking agencies'
consideration of requests by several commenters to the proposed
rule, the agencies expanded the pool of publicly traded common
equity shares that may be included as high quality liquid
assets (HQLA).
Many post-crisis regulations were developed to provide
increased stability to the banking system and strengthen
banking system risk management throughout the economic cycle,
taking into account interest rates and other economic factors.
The final LCR rule, in particular, requires banks to hold
sufficient HQLA to cover outflows over a 30-day stress period,
which reduces systemic risk by ensuring adequate liquidity at
banking organizations. A bank's stock of HQLA provides a means
of meeting obligations during times of stress and is
independent of the current interest rate environment. It helps
to strengthen a bank's ability to meet its obligations during
both rising and falling interest rate scenarios. Furthermore,
the final LCR rule requirement will enable a bank to continue
to meet its liquidity needs during times of stress, thereby
helping to reduce the depth and duration of the systemic
stress.
The OCC prepared an assessment of the economic impact of
the liquidity rule and considered potential effects related to
market liquidity and economic growth. Such effects are
difficult to quantify before a regulation takes effect, but our
assessment describes them qualitatively. The OCC's ongoing
supervision of national banks and Federal savings associations
facilitates our ability to monitor market liquidity, and will
enable us to evaluate the effects on market liquidity of the
LCR rule and other rules over time.
The OCC, along with the Federal Deposit Insurance
Corporation and the Federal Reserve Board, are currently
engaged in a review of their regulations, as required by the
Economic Growth and Regulatory Paperwork Reduction Act of 1996
(EGRPRA). Specifically, the EGRPRA requires that, at least once
every 10 years, the agencies seek public comment on rules that
are outdated or otherwise unnecessary. The agencies
specifically request public comment on ways to reduce
unnecessary burden associated with their regulations. The
agencies will solicit comment on all of our regulations issued
in final form up to the date that we publish our last EGRPRA
notice for public comment, including the LCR, SLR, and other
Basel and Dodd-Frank regulations.
Additional Material Supplied for the Record
SYSTEMIC IMPORTANCE INDICATORS FOR 33 U.S. BANK HOLDING COMPANIES: AN
OVERVIEW OF RECENT DATA, SUBMITTED BY CHAIRMAN SHELBY
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
BCBS SYSTEMIC IMPORTANCE INDICATORS, SUBMITTED BY CHAIRMAN SHELBY
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]