[Senate Hearing 115-251]
[From the U.S. Government Publishing Office]
S. Hrg. 115-251
THE SEMIANNUAL TESTIMONY ON THE FEDERAL RESERVE'S SUPERVISION AND
REGULATION OF THE FINANCIAL SYSTEM
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE EFFORTS, ACTIVITIES, OBJECTIVES, AND PLANS OF THE FEDERAL
RESERVE BOARD WITH RESPECT TO THE CONDUCT, SUPERVISION, AND REGULATION
OF FINANCIAL FIRMS SUPERVISED BY THE FEDERAL RESERVE BOARD
__________
APRIL 19, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Elad Roisman, Chief Counsel
Joe Carapiet, Senior Counsel
Travis Hill, Senior Counsel
Elisha Tuku, Democratic Chief Counsel
Laura Swanson, Democratic Deputy Staff Director
Amanda Fischer, Democratic Professional Staff Member
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
James Guiliano, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, APRIL 19, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESS
Randal K. Quarles, Vice Chairman for Supervision, Board of
Governors of the Federal Reserve System........................ 4
Prepared statement........................................... 36
Responses to written questions of:
Senator Brown............................................ 41
Senator Sasse............................................ 52
Senator Rounds........................................... 54
Senator Warner........................................... 60
Senator Warren........................................... 65
Senator Heitkamp......................................... 67
Senator Schatz........................................... 68
Senator Cortez Masto..................................... 70
(iii)
THE SEMIANNUAL TESTIMONY ON THE FEDERAL RESERVE'S SUPERVISION AND
REGULATION OF THE FINANCIAL SYSTEM
----------
THURSDAY, APRIL 19, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:32 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. The Committee will come to order.
Today we will receive testimony from Federal Reserve Vice
Chairman of Supervision Randy Quarles regarding the efforts,
activities, objectives, and plans of the Federal Reserve Board
with respect to the conduct, supervision, and regulation of
financial firms supervised by the Federal Reserve Board.
Welcome, Chairman Quarles.
Vice Chairman Quarles has done an excellent job so far, and
I urge Congress to confirm him for his full term on the Board
as soon as possible.
Promoting economic growth remains a top priority for this
Congress, and reducing the rate and cost of excessive and
unnecessary regulation leads to more jobs and enables a better
functioning economy and more consumer choices.
As Vice Chairman for Supervision, Mr. Quarles plays a key
role in developing regulatory and supervisory policy for the
Federal Reserve System.
I have been encouraged by the statements by both Federal
Reserve Chairman Powell and Vice Chairman for Supervision
Quarles which they have made about the need to revisit some of
the Federal Reserve's existing regulations.
I was particularly encouraged by Vice Chairman for
Supervision Quarles' statements in January that the overarching
objectives of his agenda are efficiency, transparency, and
simplicity of regulation.
I agree with those objectives.
He highlighted the following initiatives as consistent with
these objectives: revising capital rules applicable to
community banks; extending the resolution planning cycle for
certain banks; enhancing the transparency of stress testing;
recalibrating the leverage capital ratio requirements;
streamlining the Volcker rule; tailoring liquidity requirements
to differentiate between large non- G-SIBs and G-SIBs;
revisiting the ``Advanced Approaches'' thresholds; and
reexamining the ``complex and occasionally opaque'' framework
for making determinations of ``control'' under the Bank Holding
Company Act.
Some of these initiatives are already underway, and I hope
the others will be commenced and completed in the near future.
I also hope that the Economic Growth, Regulatory Relief,
and Consumer Protection Act makes it to the President's desk
soon.
The primary purpose of that bill is to make targeted
changes to simplify and improve the regulatory regime for
community banks, credit unions, midsized banks and regional
banks to promote economic growth.
It affords the banking regulators, including the Federal
Reserve, more flexibility to tailor regulations, and it will
fall on your agency and others to interpret this bill.
I look forward to working with the regulators to ensure
their interpretations are consistent with Congress' intent.
I also welcome any additional color Vice Chairman Quarles
can provide on areas where the Fed and Congress may act to
further reduce regulatory burdens.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman. And, Vice Chairman
Quarles, nice to see you again. Thank you for joining us. Thank
you for the access and discussions we are able to have.
On this very day 10 years ago--April 19th, 2008--the
Columbus Dispatch, the newspaper of record in the largest city
in my State, reported that 28,000 Ohioans had lost their jobs
just in the previous month. As the economy collapsed during
those last months and months of the Bush administration, as the
economy collapsed because of Wall Street's recklessness, a vice
president at the Columbus Chamber of Commerce described Ohio's
economy as ``the worst of all possible worlds.''
For those 28,000 Ohioans, and the millions more around the
country that ultimately lost their jobs, 10 years ago probably
does not feel so far away. The heartbreak, the fear, and the
stress of losing a home to foreclosure, being forced to switch
schools, needing to postpone buying expensive prescription
drugs, all that casts a long, long shadow.
The Fed missed the crisis the last time. It had the power
to rein in predatory mortgage lending; it did not. It had the
power to stop banks from operating with too much borrowed
money; it did not. It had the power to hold bank executives
accountable; it did not. It failed, even as advocates in
communities--and I heard from them often in the part of
Cleveland I now live in--even as advocates in communities
spotted problems and pleaded for the Fed to act.
Because the Fed neglected its mission and the Bush
administration, of which you were a part, did not do its job,
Congress the next year had to pass Wall Street reform over the
opposition of so many on this Committee and so many members of
the Senate.
Now with legislation coming from this Congress and the
backsliding of this Administration, we are on the verge of
unraveling many of these reforms. In the words of one banking
analyst, ``when we fast forward 5 years, 10 years from now, the
dismantling of the financial infrastructure is going to be
greater than anyone could foresee at the time.''
When Washington dismantles protections, Wall Street always
cheers. Ultimately, Main Street pays the price. It did 10 years
ago. It will in the future.
The decisions being made now may lead us to the next crash.
When times are good, policymakers, lawmakers, and regulators--
if they are not vigilant--can get lulled into a sense that
``this time it is different.''
The horizon certainly looks clear right now--just as it did
during the Bush years right before the crisis, when Mr. Quarles
was in charge of overseeing bank policy at Treasury.
Just like back then, big banks are raking in record
profits. Just like back then, they are lining their pockets
with stock buybacks. Just like back then, the White House looks
like an executive retreat for Goldman Sachs and other Wall
Street executives.
The Fed slapped Wells Fargo with a penalty right as Chair
Yellen's term ended. Now that bank is about to get a big boost
from a Fed proposal released last week. Under the new plan,
Wells Fargo will be allowed to pay out $20 billion in capital
to executives and shareholders rather than use that money to
make loans or prevent bailouts. And, almost inconceivably, the
CEO of Wells Fargo got a 36-percent raise in 2017, even as he
presided over one consumer abuse after another. I cannot
imagine anybody in either party on this Committee that has sat
here and listened to the litany of abuses from Wells Fargo
would think that is justified to give a CEO of a bank like that
a 36-percent raise.
Collectively, the country's biggest banks stand to get a
$121 billion windfall from a plan that would let them operate
on more borrowed money, with less skin in the game. Really.
While Mr. Quarles talks about this proposal, and the Fed's
many other plans, as a simple ``recalibration'' or
``tailoring'' or ``re-evaluation''--his words--of the rules, we
know what it really means. We know from last week when we heard
from CFPB Acting Director Mulvaney what he is doing to consumer
protections. The end result? Fewer rules guarding hardworking
Americans from taxpayer bailouts and financial scammers; more
incentives for Wall Street greed.
Somehow ``tailoring'' only seems to go in one direction
these days. It happens to be the direction that Wall Street
wants.
History tells us what will happen next. The IMF, an
international financial agency, studied financial markets since
the 18th century. Periods of deregulation usually provoke a
crisis. Policymakers ``learn their lessons'' and re-regulate.
Eventually, the collective amnesia sets in--we know a lot about
collective amnesia in this Committee. The collective amnesia
sets in; they deregulate yet again. We know that cycle.
Unfortunately, the middle class pays for that cycle.
When big banks are flush with profits, as they are now,
policymakers should be preparing them for rough times ahead.
Instead, Washington is repeating a failed pattern of boom and
bust. When things go bad once again, executives will get golden
parachutes. Workers, retirees, and consumers will be left
holding the bag. Shameful. Just shameful. Makes me wonder why
we are here.
Chairman Crapo. Thank you.
Now, Chairman Quarles, we will turn to your testimony. As
you are aware, we ask that you try to keep your remarks to 5
minutes, but we want to hear everything you have to say, and
then we will open it to questions. You may proceed.
STATEMENT OF RANDAL K. QUARLES, VICE CHAIRMAN FOR SUPERVISION,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Quarles. Thank you. Thank you, Chairman Crapo, Ranking
Member Brown, Members of the Committee. I very much appreciate
the opportunity to testify today on the Federal Reserve's
regulation and supervision of financial institutions.
The Federal Reserve, along with the other U.S. banking
agencies, has made substantial progress in building stronger
regulatory and supervisory programs since the global financial
crisis, especially with respect to the largest and most
systemic firms. These improvements have helped to build a more
resilient financial system, one that is well positioned to
provide American consumers, businesses, and communities access
to the credit they need even under challenging economic
conditions.
At the same time, we are mindful that just as there is a
strong public interest in the safety and soundness of the
financial system, there is a strong public interest in the
efficiency of the financial system. Our financial sector is the
critical mechanism for directing the flow of savings and
investment in our economy in ways that support economic growth,
and economic growth, in turn, is the fundamental precondition
for the continuing improvement in the living standards of all
of our citizens that has been one of the outstanding
achievements of our country. As a result, our regulation of
that system should support and promote the system's efficiency
just as it promotes its safety. And, moreover, our achievement
of these objectives will be improved when we pursue them
through processes that are as transparent as possible and
through measures that are clear and simple rather than
needlessly complex.
So in my testimony today, I will review our regulatory and
supervisory agenda to improve the effectiveness of the
postcrisis framework through these principles of increased
efficiency, transparency, and simplicity.
I have also included an update on the condition of the
industry and the Federal Reserve's engagement with foreign
regulators in my written testimony.
Beginning with efficiency measures, the Board and the
Office of the Comptroller of the Currency last week issued a
proposal that would recalibrate the enhanced supplementary
leverage ratio, or eSLR, applicable to the G-SIBs. The proposal
would calibrate the eSLR so that it is less likely to act as a
primary constraint--because when it is a primary constraint it
can actually encourage excessive risk taking--while still
continuing to serve as a meaningful backstop.
Last year, the Board also adopted a rule that eliminated
the so-called qualitative objection of the Federal Reserve's
CCAR exercise for midsized firms--those that pose less systemic
risk. As a result, deficiencies in the capital planning
processes of those firms will be addressed in the normal course
of supervision. I think that approach should also be considered
for a broader range of firms. Last week, we called for comment
on that potential expansion.
On the subject of tailoring, I support congressional
efforts regarding tailoring, as offered here in the Senate and
in the House. In addition to this potential legislation, there
are further measures I believe we can take to match the content
of our regulation to the character and risk of the institutions
being regulated. For example, I believe it is time to take
concrete steps toward calibrating liquidity coverage ratio
requirements differently for non- G-SIBs than for G-SIBs. I
also think that we can improve the efficiency of our
requirements with regard to living wills.
The U.S. banking agencies have also taken a number of steps
to advance more efficient and effective supervisory programs.
For example, we recently increased the threshold for requiring
an appraisal on commercial real estate loans from $250,000 to
$500,000. That does not pose a threat to safety and soundness.
And the Fed has instituted various measures to clarify and
streamline its overall approach to the supervision of community
and regional banks, in particular. All of that is detailed in
my written testimony.
Transparency is central to the Fed's mission, in
supervision no less than in monetary policy. Late last year, in
the first material proposal following my confirmation, the
Board released for public comment an enhanced stress testing
transparency package. The proposal would provide greater
visibility into the supervisory models that often determine the
bank's binding capital constraints, and we are continuing to
think about how we can make the stress testing process more
transparent without undermining the strength and usefulness of
the supervisory stress test.
Looking ahead, we are also in the process of developing a
revised framework for determining ``control'' under the Bank
Holding Company Act. A more transparent framework of control
should, among other things, facilitate the raising of capital
by community banks where control issues are generally more
prevalent.
Simplicity of regulation promotes public understanding and
compliance by the industry with regulation. Just last week, we
issued a proposal that would effectively integrate the results
of the supervisory stress test into the Board's nonstress
capital requirements. For the largest bank holding companies,
the number of loss absorbency ratios would be reduced from 24
to 12, but the proposed changes would generally maintain or in
some cases modestly increase the minimum risk-based capital
required for the G-SIBs--although no bank would actually be
required to raise capital because their existing capital levels
are well above the minimums--and modestly decrease the amount
of risk-based capital required for most non- G-SIBs.
Our fellow regulators are also working with us to further
tailor implementation of the Volcker rule to reduce burden,
particularly for firms that do not have large trading
operations and do not engage in the sorts of activities that
may give rise to proprietary trading.
In conclusion, the reforms we have adopted since the
financial crisis do represent a substantial strengthening of
the Federal Reserve's regulatory framework and should help
ensure that the U.S. financial system remains able to fulfill
its vital role of supporting the economy. We will do everything
we can to fulfill the responsibility that has been entrusted to
us by the Congress and the American people, and I thank you
again for the opportunity to testify before you this morning. I
am looking forward to answering your questions.
Chairman Crapo. Thank you very much, Chairman Quarles. I
will start out.
First, last month, as you know, the Senate passed the
Economic Growth, Regulatory Relief, and Consumer Protection
Act. During the debate there was an intense attack on that bill
with a number of allegations. The one I want to refer to and
discuss with you is the one that by lifting the threshold, the
$250 billion threshold, we were going to leave a number of
major banks completely unregulated and susceptible to high
risk.
Do you believe that if enacted into law that bill will
provide significant regulatory relief to community banks and
midsized banks as well as some of our regional banks, while
still giving the Federal Reserve the authority it needs to
fully supervise and regulate those institutions?
Mr. Quarles. Yes, Mr. Chairman, both I and the Federal
Reserve as an institution are very supportive of efforts to
tailor regulation, particularly for community banks, as
exemplified in S. 2155. And I do think that the measures that
are in that bill would still leave the Federal Reserve with
full ability to protect the safety and soundness of the system.
Chairman Crapo. All right. Thank you. I want to switch now
to a question on firearms, which has become much, much more
topical these days. According to press reports, the New York
State Department of Financial Services is planning to send
letters that warn banks and insurers of the reputational risk
they incur by doing business with the National Rifle
Association and the gun industry. As a prudential regulator,
your job is to ensure the safety and soundness of banks. A
bank's reputation might be relevant to the bank's safety and
soundness, but reputational risk should not be used as an
excuse for a regulator to scrutinize any behavior it does not
like.
Do you believe that doing business with the NRA or with
firearms manufacturers or others in the firearms industry
threatens the safety and soundness of banks under the Fed's
supervision?
Mr. Quarles. Well, let me begin, Chairman, by acknowledging
the importance and significance of the tragedy in Florida and
other tragedies that have resulted in some of these concerns.
That said, I do not believe that lending to the NRA or to a
law-abiding gun firm in the gun industry raises safety and
soundness questions. I do not believe that the decision not to
lend raises safety and soundness questions, and as a
consequence, those issues are really outside of our remit as
regulators of the system at the Federal Reserve.
Chairman Crapo. All right. Thank you.
Mr. Quarles. If I could perhaps amplify.
Chairman Crapo. Yes.
Mr. Quarles. One of the principles that I have tried to
stress as a supervisor is that we should not substitute our
personal judgments as supervisors for the business judgments of
bank management and directors, and that is a principle that
applies across a broad range of issues, again, that I am trying
to stress throughout the supervisory system. And so I think
that would apply here as well.
Chairman Crapo. Well, thank you, and I appreciate the
approach you have taken in your career to regulation. You said
in your introductory statement something similar to the fact
that if we can eliminate complexity, if we can eliminate
opaqueness and get more transparency, there are benefits that
flow from that.
Could you just discuss what benefits flow from having a
regulatory system that is less complex, more transparent, and,
frankly, less excessive when we see excessive burdens being
applied to any industry, but in this case the financial
industry?
Mr. Quarles. Well, I think the benefits of transparency and
simplicity in regulation, actually they flow both ways, right?
So there is a significant benefit in reducing burden, not just
in the cost of complying with regulation, but there is an
improvement in compliance and achieving the objectives of
regulation, as well when the measures that are proposed are
understandable by the industry, they are then capable of
complying with them, that the public can see the consequences
better of regulation, understand more what the particular
provisions are.
So, I think that you have a significant reduction in cost
and an increase in the efficiency of the system at the same
time as you have, a greater ability to achieve the objectives
of regulation through transparent processes and simple
measures.
Chairman Crapo. And doesn't that all ultimately result in
more capital being available to individuals and small
businesses?
Mr. Quarles. It results in an increased ability of the
financial sector to support the real economy, the source of job
creation, real economic growth, growing living standards; and
it also supports the ability of the public to engage with
regulation if it is more understandable.
Chairman Crapo. Thank you.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
The FDIC joined the Fed and the OCC in 2014 to establish
the enhanced supplemental leverage ratio, as you know, in part
to ensure that not just the parent company has capital but that
families' savings in depository institutions are also
protected. But last week, FDIC dissented from the Fed's
proposed changes to the leverage ratio which would allow the
eight largest banks to drain away $120 billion in capital to
fund more stock buybacks and dividends and executive bonuses.
The leverage ratio proposal also received a no vote from one of
the three members of the Fed's Board.
To put that in perspective, Chair Yellen went her entire 4-
year term developing consensus without a single dissent from
any member of the Fed Board.
Are you concerned the agency tasked with protecting
families' deposits opposes your plan and that the Fed is moving
away from the consensus-based approach that characterized all
the Dodd-Frank rulemakings? Or are you just waiting until the
whole entire Trump deregulatory deregulation regulators get put
in place?
Mr. Quarles. We have had a full discussion on the eSLR
regulatory proposal, both among the members of the Board and
with the other regulatory agencies. I think the issue there is
that when the eSLR or any leverage-based capital measure
becomes the binding capital constraint on a firm's decision,
then that means that it is making its decisions not on a risk-
based basis. It has an incentive to take more risk than it
otherwise would if it is going to incur the same capital cost.
The FDIC put out a statement expressing its concern that at
this point in the cycle this was a modest release of capital.
It is quite a small amount given the overall level of capital
that would actually be released. It is about $400 million
actual change given the role of the eSLR and the overall
capital framework. And in the judgment of the majority of the
regulators, removing that perverse incentive was something that
was important to do quickly.
Senator Brown. Thank you. I would point out that Chair
Yellen had some very conservative regulators, regulators that
came out of your administration, with regulators that came
later, and she found a way to get consensus. I think your
proposals are radical enough that you have not.
A couple other questions. The Fed released a second plan
last week proposing changes to CCAR. The Fed's press release
said capital requirements would be maintained or would somewhat
increase for the eight largest U.S. banks. Analysts at Goldman
Sachs estimate that the biggest banks, however, would see a
windfall of $54 billion in dividends, buybacks, and bonuses.
Is Goldman's analysis wrong? Did the Fed conduct a
comprehensive analysis like Goldman did?
Mr. Quarles. We have done an analysis on the basis of our
2017 information as to what the capital consequences of the
measures that we proposed last week would be, and, as I have
indicated, while it varies modestly from firm to firm, for the
G-SIBs, capital is basically modestly increased, for the non-
G-SIBs modestly decreased. The overall level of capital in the
system remains effectively flat.
Senator Brown. I guess Goldman's analysis would not use, as
you did a couple of times, the word ``modestly'' there. My
concern about the Chairman's bank deregulation bill and all of
these Fed proposals, it is like a game of Jenga. You are
pulling out piece after piece, and soon enough the entire
foundation is going to collapse, and you probably will have
moved on from your job. Maybe the Chairman and I will have
moved on. But it is a concern that I hope this Fed addresses
more acutely than you have.
Last question. Last month, Chairman Powell provided a
carefully worded answer that obscured the fact that large
foreign banks may very well face weaker rules in the U.S. under
the Chairman's bank deregulation bill, even if not outright
exemption from Section 165. Since that testimony, your former
colleagues at your firm, Davis Polk, whose clients have
included Deutsche Bank and Barclays, seem to disagree. Davis
Polk lawyers about a month ago said they ``saw no reason to
expect that the Federal Reserve would deviate from their
approach in implementing Dodd-Frank when implementing the new
$250 billion threshold. It likely means that the toughest Dodd-
Frank rules and the requirement to establish an intermediate
holding company would not apply unless the foreign bank had
$250 billion in assets in the U.S. We attempted to amend. We
were unsuccessful.''
My question is: Will you commit, absolutely commit,
contrary to Secretary Mnuchin, that the Fed will not raise the
$50 billion intermediate holding company threshold above which
the toughest Dodd-Frank rules apply?
Mr. Quarles. Well, there is certainly nothing in S. 2155
that would require us to change our approach with respect to
the foreign banks, either on the level of establishment of an
IHC or on the application of enhanced standards to them. The
issue is that the threshold being raised from $50 to $250
billion that is contained in the Senate bill, does not have a
practical effect for any foreign bank operating in the United
States because you look at their global assets and the global
assets of all of them, there is not a bank that is sort of in
that range that would be affected by a move from 50 to 250.
So there is nothing in the bill that requires us to change
our approach. The overall IHC framework I think has been
working fairly well.
Senator Brown. So I guess--and I'm closing, Mr. Chairman. I
guess I can only see that you are leaving your options open to
deregulate these foreign banks that have assets above 50 and
under 250 assets in the U.S.
Mr. Quarles. That was not the purpose of my response.
Senator Brown. But is that the outcome? I mean, are you
leaving that option open to deregulate?
Mr. Quarles. No. As one member of a Board that I hope is
soon not just three people, but as one member of a Board of
Governors, I obviously cannot commit on what the final outcome
will be. But I can assure you we do not have a sort of secret
plan in my satchel here as to what we are going to do as soon
as the bill passes.
Chairman Crapo. Senator Corker.
Senator Corker. Thank you, Mr. Chairman. I appreciate you
calling this hearing. Vice Chair, thank you for being here and
being accessible, as the Ranking Member mentioned. I will say
chairing another committee and thinking about the bland opening
comments I make, Senator Brown, I admired the cadence and
rhetorical flair of your opening comment. I noticed the
repetition. It was really something. I am actually going to go
chastise my staff for me----
Senator Brown. I can help you come to some of your new
political positions, too, if you would like.
[Laughter.]
Senator Corker. All right. Thank you so much.
Mr. Vice Chair, you are not confirmed for the longer term,
and that has not happened just because it takes so much floor
time to make that happen. I have had some conversations with
you, and I can tell that there is a little tentativeness as you
talk with people like me and others because you have got to
depend on Republican votes to be confirmed.
I would say to the my Democratic counterparts that I think
the Vice Chair would actually push back more against
Republicans if he was actually confirmed. It is just something
to think about. I know I called him about something the other
day, and he knew Chairman Crapo was in a different place, and
he was tentative about talking to me about it. I would just say
that to have a guy who is sort of on the bubble really means
that even when he disagrees with Crapo or myself or someone
else, he is going to be tentative about that until he is
confirmed. It is just something to think about. So that is my
belief. It really is. And I think it is affecting his ability
to push back on some of the large institutions and others and
work with them and them rely on guidance. So that is just my
observation. He is shaking his head up and down, actually,
agreeing with me.
Mr. Quarles. You might say that, Senator. I could not
possibly comment.
[Laughter.]
Senator Corker. It is something for, I think, people on
both sides of the aisle to think about.
During this last bill passage, there was a Section 402--it
is actually the issue I was talking about. You know, Senators
here try to take care of their constituents back home
sometimes, and so we have these custodial banks that are
located in only a few States, and so we had some Senators write
a bill that did away with certain types of investments on the
denominator side of the equation, right? And so everybody
around here is enterprising, and so other Senators figured out,
hey, you know, there is a way for me to get some other
institutions in under the hood if I can just change the
language here just a little bit. And so that occurred during
the process.
Would we not be better off on technical decisions like that
relative to what should and should not be counted, wouldn't we
be much better off if people like you were making those
decisions? And doesn't the 402 section that we actually have in
the bill, doesn't it complicate your life as far as setting
ratios in an appropriate way? I would like for you to be really
honest with me.
Mr. Quarles. I appreciate the question and----
Senator Corker. And I probably will vote for your
confirmation regardless, OK?
Mr. Quarles. And I think I can be pretty candid. You know,
I do think that the issue of the fact that the current
calibration of the eSLR is a binding constraint, and
particularly for the custody banks, but it is not just an issue
for the custody banks. You know, it creates those perverse
incentives that I----
Senator Corker. You are saying what is in the bill.
Mr. Quarles. And so I think that a solution to it is
important. The solution that is in the bill, you know, is one
solution.
Senator Corker. Not the preferred solution.
Mr. Quarles. Well, it is a solution for a limited number of
institutions. The concern that I would have as a regulator in
pursuing that solution--and, you know, there are regulatory
arguments for that solution, but the concern I would have as a
regulator is that I do not know where one would turn off the
dial, where one would stop on this slippery slope. So if one
excludes a certain class of assets--in this case central bank
reserves--should one also include Treasury securities, et
cetera? As a regulator, the strong arguments that would be made
against me would sort of push me down that slope.
I do think that a legislature is in a better position to
resist the slipper slope for that solution. But I also think
that there is a broader response----
Senator Corker. You are saying the regulators are not good
at resisting pushback from----
Mr. Quarles. Well, I think it depends on the specific
issue, and on this specific issue you have got sort of a series
of arguments, you know, that at least from my perspective I was
worried would lead to a slippery slope. I do not think that
that applies, however, to the provision in S. 2155. I do think
that there is a broader solution that is required. That is why
last week we proposed to recalibrate the eSLR to address this
same issue. I think that that has broad applicability across a
range of firms.
If the provision in S. 2155 does become law, then we will
need to think as regulators about how we adjust the calibration
to ensure that we are not sort of double counting in some
places.
Senator Corker. So I know my time is up. I would just say
to the Chairman, I think 402 is a damaging section to this
bill. In some ways it helps lend credence to some of the
arguments that Ranking Member Brown was laying out on the front
end--just a little bit, not much. Just a little credence, not
much. And I would think that we would be better off in your
negotiations with Hensarling, we would be better off dropping
402 and letting the regulators do their job. And I think left
to their own accord, most of my Democratic colleagues would
agree with that. Many Republicans colleagues I know already
agree with that, and so I hope we will strike that entire
section with that.
Thank you for the time.
Chairman Crapo. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Vice Chair Quarles, do you agree with the conclusion of the
Financial Crisis Inquiry Commission that in the years leading
up to the crisis compensation and bonus practices at big banks
too often rewarded short-term gains, big bets, and encouraged
senior executives to green-light irresponsible risk taking?
Mr. Quarles. Yes. I do not have sort of in my immediate
short-term memory all of the reasoning behind that, but I agree
with that statement. I do.
Senator Menendez. OK. In a speech last month, New York Fed
President Dudley said, `` . . . an effective regulatory regime
and comprehensive supervision are not sufficient. We also need
to focus on the incentives facing banks and their employees.
After all, misaligned incentives contributed greatly to the
financial crisis and continue to affect bank conduct and
behavior.''
Most recently we saw this very problem exposed at Wells
Fargo. The former CEO and the head of the Community Bank
Division were raking in bonuses while their employees were
churning out millions of unauthorized accounts.
Section 956 of Dodd-Frank requires bank regulators to
prohibit incentive-based compensation practices that reward
senior executives for irresponsible risk taking. Regulators
issued a proposal in May of 2016, but nearly 2 years later,
nothing has been finalized. In the meantime, Wall Street
bonuses jumped 17 percent in 2017 to an estimated $184,220,000,
the most since 2006.
When you were asked about this rulemaking in January, you
said, ``I do not have any updates on that for you. It is not
something that I have talked to the other regulators about
yet.''
So today I am asking you: How is it that you have had time
to revisit capital rules, revisit leverage rules, revisit the
Volcker rule, all of which were finalized after years of
deliberation, public comments, and input from other regulators,
and you have not had time to finish the incentive-based
compensation rulemaking for the first time?
Mr. Quarles. That is something that is on the agenda, but
it is not something that I have a timeframe for you on today.
Senator Menendez. Well, you revisited a whole host of
already existing rules, but a rule that is actually part of a
requirement of the law has not even been visited. And it is on
the agenda, you tell me, but you cannot give me a timeframe.
Well, I think that is pretty outrageous. Can you give me some
sense of a timeframe?
Mr. Quarles. Not a specific timeframe, but I can tell you
that I do think that that is an important issue, and it is
something that we will be discussing.
Senator Menendez. President Dudley thought a key way of
addressing a big bank culture of recidivism was through
changing compensation arrangements. In contrast, when you were
asked about bank culture, you said it is ``perhaps not
impossible but very difficult for a financial supervisor to
come up with useful, predictable interventions.''
Isn't changing compensation precisely how you can address
bank culture?
Mr. Quarles. Addressing the culture of an organization is
one of the most important things for an organization, but an
extremely complex matter that involves a variety of different
incentives. It is something that is most appropriate and ought
to be a very high priority for the management of an
institution. It is something that is a very high priority for
me at the Federal Reserve with our own culture.
Senator Menendez. It is a very high priority for the
Congress. They put it into law. And I do not see how you all
are seeking to follow the law.
Mr. Quarles. Well, we are working on implementing that. It
has not fallen behind the refrigerator and been forgotten
about.
Senator Menendez. Well, I can assure you it will not be
going behind the refrigerator because I am going to remind you
of it, and others about it as we go ahead.
Finally, I know there is significant interest by this
Administration in offering a proposal to make changes to the
Community Reinvestment Act. I am not opposed to modernization.
When 97 percent of banks receive satisfactory or outstanding
ratings, but yet African American and Latino families continue
to be disproportionately denied mortgage loans, even when
controlling for income loan amount and location, we have got a
real problem on our hands.
Now, I have, however, real concerns that new proposals will
lead to weakened enforcement by regulators and discounted
importance on physical bank branches. Do you expect the Federal
Reserve will join the OCC's forthcoming proposed rulemaking?
Mr. Quarles. We are working on that as a joint matter, so I
expect that that will be issued as a joint proposal.
Senator Menendez. If I may, Mr. Chairman, the Treasury
report issued earlier this month recommends that the Federal
Reserve adopt the OCC's new policy allowing banks with failing
CRA ratings to merge or expand so long as they can demonstrate
a potential benefit. Do you anticipate the Federal Reserve will
adopt this policy?
Mr. Quarles. We have not considered that policy as a Board,
so I do not want to prejudge the judgment of my fellow
Governors. But I think that it is important to note that what
the Treasury is saying there is that if a benefit in that
particular area, in the service of middle-income and lower-
income communities can be demonstrated from a particular
application, that the whole picture should be taken into
account, and that seems reasonable to me.
Senator Menendez. I have other questions, but I will submit
them for the record.
Thank you, Mr. Chairman.
Chairman Crapo. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. Good morning, Mr.
Chairman.
First, I want to join Senator Corker in his observation
that our Ranking Member has a silver tongue, and I mean that as
a compliment. A silver-tongued devil.
Number two, this is an observation. I am not looking for a
comment. We have not had a recession since 2008, so from one
point of view, our too-big-to-fail banks have not really been
tested. And I would strongly encourage, for what my opinion is
worth, that we tread very carefully before we lower capital and
liquidity ratios and start fooling with the leverage ratio
until we see how our banks do in a real full-blown recession.
But that is not what I really wanted to ask you questions
about.
Would Citigroup have survived the meltdown in 2008 had the
U.S. Congress not provided it capital?
Mr. Quarles. I do not know the answer to that question,
Senator, but, obviously, it was under extreme financial stress.
Senator Kennedy. How about the Bank of America?
Mr. Quarles. I would have to take the same position.
Senator Kennedy. OK. Did any person in senior management at
Citigroup go to jail as a result of the meltdown in 2008?
Mr. Quarles. I am not aware of anyone.
Senator Kennedy. OK. And I believe the American taxpayer
provided Citigroup somewhere in the neighborhood of $475
billion in capital and loan guarantees. Does that sound about
right?
Mr. Quarles. That sounds about right.
Senator Kennedy. Let us suppose that a senior member of
management at Citigroup had been investigated in 2008 and an
FBI agent showed up at his or her house and said, ``Hey, I want
to come in and look around, but I do not have a warrant,'' and
that Citigroup senior manager said, ``Well, look, man, you
know, I have got a Fourth Amendment right. You cannot come in
here without a warrant.'' Do you think other banks should not
do business with that senior manager at Citigroup because he
exercised his Fourth Amendment right?
Mr. Quarles. No, I do not.
Senator Kennedy. OK. Let us suppose that senior manager had
been subpoenaed to testify in court, and the senior manager
took the stand, was sworn in, and said, ``You know, I have got
a right under the Fifth Amendment of the United States
Constitution not to answer questions, and I do not mean to
upset anybody, but I think I am going to use that right.''
Would that have been legal?
Mr. Quarles. No.
Senator Kennedy. For him to take the Fifth Amendment?
Mr. Quarles. I am not speaking as a lawyer here, but I
cannot imagine that it would have been illegal.
Senator Kennedy. Well, trust me. It would have been. OK? Do
you think that other banks ought not to do business with that
senior manager at Citigroup because he exercised his right
under the Fifth Amendment to the United States Constitution?
Mr. Quarles. That would not be my personal decision, no.
Senator Kennedy. OK. Let us suppose that a customer wants
to exercise his First Amendment right to speak out against
abortion. Do you think banks ought not to do business with him?
Mr. Quarles. On that basis alone, that would not be my
personal view. As a supervisor, I am not sure it would be my
role to direct the bank on that question.
Senator Kennedy. OK.
Mr. Quarles. But that would not be my personal view.
Senator Kennedy. Let us suppose that a customer wants to
speak out in favor of a woman's right to choose. Do you think a
bank ought not to do business with him?
Mr. Quarles. I would have the same view. I would not think
that the bank should refuse to do business. As a supervisor,
given my stress that we should not be second judging
managements and directors on what business lines they choose to
go into, I am not sure it would be my role to second guess it,
but I personally would not do it.
Senator Kennedy. Would your answers be the same if the
subject were climate change as opposed to abortion?
Mr. Quarles. Completely.
Senator Kennedy. OK. Well, as you know, Citigroup and Bank
of America have decided to make gun policy for the American
people, supplanting the U.S. Congress. Citigroup in particular
says it will not do business with anybody that sells guns to
people who have not passed a background check. It will not do
business with anybody who sells guns to someone under 21, who
sells bump stocks, high-capacity magazines, all of which are
permissible under the United States Constitution. Would that
position violate State and local age discrimination laws?
Mr. Quarles. I do not know the answer to that.
Senator Kennedy. Well, if it did and a federally regulated
bank was in violation of State and local law, would you do
something about it?
Mr. Quarles. If a bank is violating local law, we have a
responsibility as a supervisor to----
Senator Kennedy. OK. Citigroup says that it will not do
business with anybody that sells guns to someone who does not
have a background check. Under the NICS data base system, you
can actually buy a gun without a data base if your name--if the
FBI does not give you an answer within 3 days, you get to buy
the gun, and then they keep checking, and later on if they find
out you are not entitled to the gun, they come get it. So if
Citigroup's position violates Federal law, would you have
something to say about that?
Mr. Quarles. If there were a violation of Federal law, yes,
that is part of our role as supervisors.
Senator Kennedy. All right. I have only got a couple more,
Mr. Chairman.
In Arizona, in Alaska, in Wyoming, you can carry a handgun
without a permit, concealed or unconcealed, under the United
States Constitution. Do you think Citigroup ought to stop doing
business in Arizona, Alaska, and Wyoming?
Mr. Quarles. Well, that is a pretty fraught question
because, as a supervisor, I think that their decision----
Senator Kennedy. All right. Let me interrupt you because I
am going to get cutoff.
Mr. Quarles. OK.
Senator Kennedy. But I do not mean to be rude.
Mr. Quarles. I understand. Of course I understand.
Senator Kennedy. I think you are doing a swell job. In
Kansas--in Vermont, you only need to be 16 years old to
purchase certain guns. Do you think all banks ought to pull out
of Vermont? What do you think Senator Sanders would say?
Mr. Quarles. I know what Senator Sanders would say, but
those are issues, I think, that, again, as supervisors, I am
trying to stress that we should not substitute our judgment as
to what geographies and business lines banks go into.
Senator Kennedy. I understand. Well, what I am trying to
stress is we do not need red banks and blue banks. We do not
need banks that will only do business with people who voted for
President Trump. We do not need banks who will only do business
for people who voted for Secretary Clinton. We need banks that
are safe and sound and honest and that appreciate it when the
American taxpayer puts up billions and billions of dollars of
their hard-earned money to keep these banks from going belly
up. That is what we need.
Thank you, Mr. Chairman.
Mr. Quarles. Thank you, Senator.
Chairman Crapo. Thank you. And I have let one Senator on
each side take a couple extra minutes. I would like all the
other Senators to know that it is balanced and you are back to
5 minutes.
[Laughter.]
Senator Kennedy. I just did it because Senator Brown did
it.
Chairman Crapo. OK, so it is balanced. But, please, honor
the time. Senator Schatz.
Senator Schatz. Thank you, Mr. Chairman. Vice Chairman,
thank you for your service. thank you for being here.
I want to ask you about the evidence of a regulatory
burden. In a recent speech, Chairman Jerome Powell stated, ``As
you look around the world, U.S. banks are competing very, very
successfully. They are very profitable. They are earning good
returns on capital. Their stock prices are doing well.''
So I am looking for the case for some kind of evidence
that--and I am open to this--some kind of evidence that
regulation is holding them back, and I am not really seeing
that case as made at this point. And the data back up his
comment. Bank of America announced a profit of $6.9 billion in
the first 3 months of this year, the biggest quarterly profit
in history. The facts show that banks are thriving. The FDIC
shows that banks had record-breaking profits in 2016, and 2017
would have broken that record again if it were not for one-time
charges from the new tax law. JPMorgan Chase and Company
analysts predict record increases in bank dividends of 38
percent in 2018 and 26 percent in 2019, and the Bank of
America, for example, is expected to increase dividends by 126
percent through 2019. Demand for credit, such as home loans,
car loans, credit cards, has surpassed pre-recession highs, and
lending is up. These are the most profitable financial
institutions in history.
And so the question is quite simple: What problem are we
trying to solve with deregulation?
Mr. Quarles. In the first instance, I would say at least as
I look at the regulatory reform effort, it is not an effort to
deregulate. It is an effort to ensure that we achieve our
regulatory objectives in an efficient way. So of the proposals
that we made last week, there is in the capital reduction under
the stress capital buffer proposal----
Senator Schatz. OK, I understand. I mean, I do not want to
quibble about how we characterize this thing. I want you to
answer the question. If these banks are experiencing record
profits, that is one sort of--I think we can agree upon that.
Can we?
Mr. Quarles. Yes, absolutely.
Senator Schatz. OK. And then we can also agree that sort of
generally the reason you might want to loosen up restrictions
or what you call ``tailor'' is to allow more capital to be
deployed to small businesses and individuals who may want loans
so they can grow the economy and pursue the American Dream, not
so that all of those additional profits can be plowed back into
dividends and stock buybacks.
So I ask you again: What problem is being solved by what I
call ``deregulation'' and what you may name differently, but
what problem are you solving?
Mr. Quarles. Well, if we want to get sort of at the very
specific level, there has been sort of a shortage, a
restriction of small business credit. We have found that at the
Federal Reserve. That is the type of credit that has
historically in this country been provided by community and
regional banks. There are a variety of reasons for that
restriction, but I do think that one of those reasons is
regulatory burden, and that we can improve the efficiency of
the regulatory system without in any way undermining its safety
and soundness and address that problem, among a number of
others.
Senator Schatz. Is there any evidence that when they become
more profitable, either as a result of the tax law or as a
result of a loosening of the constraints from Dodd-Frank, that
they actually make more capital available to small businesses?
Because what I see is record stock buybacks and dividends. And
so I get the argument you are making, but you are a data-driven
person, I assume, and this is a data-driven industry. So I want
to understand. Do you have any research that demonstrates that,
to the extent that we give tax relief to the most profitable
financial institutions in human history and we give regulatory
relief to these same institutions, is there any evidence that
this actually helps the people that you are describing?
Mr. Quarles. I certainly know that on the regulatory
front--and I am pretty sure, although I cannot think of
specific studies on the tax front, but I am pretty sure that in
general they exist--that there are economic studies that show
that in both of those areas, the benefits will be spread among
a number of constituencies, and that will include both----
Senator Schatz. But you are just repeating your claim. I am
asking you for evidence, and you just kind of go around and
around sort of repeating the rhetoric that supports this claim.
But I am asking for evidence, and you are saying there is
evidence. I am asking you what it is.
Mr. Quarles. I will be happy to forward that to you.
Senator Schatz. OK. I will be waiting.
Thank you.
Senator Brown [presiding]. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman. Welcome, Mr.
Quarles. Thank you for testifying here. Two things I wanted to
touch on.
First, it is my understanding that the Board of Governors
of the Fed consists of three members right now. There are only
three of the seven members. And I wonder if from your
perspective that poses any challenges to the day-to-day
operations and functioning of the Fed and how important it is
in your mind that we confirm individuals to these vacancies.
Mr. Quarles. It is very obviously welcome but also
important to confirm the people who have been nominated to open
seats on the Federal Reserve Board. We can do our work, but it
is clearly a strain on the organization. And the organization
functions better when we have a broader range of viewpoints,
more diverse backgrounds, you know, a full complement of
people.
Senator Toomey. Thank you, and I am hoping soon we will be
able to confirm you to the full term that I would suspect and
hope would follow the big overwhelming vote I think you got
previously.
Mr. Quarles. Thank you, Senator.
Senator Toomey. Let me move on to another one. As you know,
the Senate passed by a substantial bipartisan margin a banking
regulatory reform bill with mostly modest regulations,
regulatory reforms. One of the most important items in that
legislation, in my opinion, was raising the threshold for the
automatic SIFI designation from $50 billion to $250 billion, so
I think that is very constructive because the banks otherwise
captured by this are, in fact, not systemically important to
the country and they, therefore, do not deserve to be subject
to this added cost and regulatory burden.
However, I still think that even in the case of $250 or
$300 or $500 billion banks, this whole category, it would still
be more appropriate to have a regulatory framework that is
based primarily on the activities of the institution rather
than an arbitrary asset designation. As you know, there is
nothing meaningfully different from an asset threshold point of
view about a bank that is $251 billion versus one that is $249
billion.
So, number one, do you agree with that point, with the idea
that this regulatory framework ought to be more based on
activities certainly for these banks that are in the lower end
of this range? And then I have one other question for you.
Mr. Quarles. On the question of asset thresholds versus
activities if I had my druthers, probably you would set an
asset threshold below which there was an exemption, below which
you were perfectly confident that firms of that size were going
to be of a complexity and nature that they would not pose
systemic risk. And then above that, you would take a variety of
factors into account in determining the application of enhanced
standards. Ultimately, as you all know better than I, it is up
to the Congress to decide how that balance will be struck. But
once it is struck, I think that we as regulators ought to take
into account those full range of factors in determining how to
tailor regulation in the realm where regulation remains to be
applied.
Senator Toomey. So one specific area where it is my
understanding that you have the discretion to modify this is
the application of the LCR, and especially for large regional
banks that are not G-SIBs. Smaller banks, under $250 billion,
my understanding is there is--the sort of default setting is a
different regime, a modified LCR, and that you have the
authority to apply a modified version of the LCR for larger
banks if their activities warrant that. Are you making progress
on making changes to how the LCR would be applied to banks that
might be bigger than $250 billion?
Mr. Quarles. We are, Senator, and I agree with you that
that would be an appropriate differentiation. I have said that
publicly, and that is something that we are working on to
determine exactly how to appropriately tailor that regulation.
Senator Toomey. Do you have a timeframe in mind that you
could estimate for us when we would see something?
Mr. Quarles. Well, without wanting to toss this back, we
are waiting to see what the legislative framework settles down
to be, and when we see what that is, then we will know how to
respond on the tailoring front. I suppose certainly at least
right now, if that were to extend for a longer period, we might
move forward on a different schedule, but at least right now we
are waiting to see sort of what the legislative framework we
are given is.
Senator Toomey. I am sorry for going--I will wrap up, but I
would just urge you to--we do not know the timeframe by which
we are going to--I assume you are referring to the disposition
of the Senate-passed bill.
Mr. Quarles. Correct.
Senator Toomey. It is an open question as to how that is
going to proceed, and when is very much an open question. So I
would really urge you to move ahead as quickly as you
reasonably can.
Mr. Quarles. I appreciate that, Senator.
Senator Toomey. Thank you.
Senator Brown. Senator Cortez Masto.
Senator Cortez Masto. Thank you, and thank you, Vice Chair,
for being here.
Let me switch topics a little to cost-benefit analysis. I
understand that the Federal Reserve has a new Policy
Effectiveness and Assessment Unit. Is that correct?
Mr. Quarles. That is correct.
Senator Cortez Masto. And so how many people are working in
the unit and what is the core mission of the unit?
Mr. Quarles. It is a small group of economists. I will have
to get you the exact number so that I do not misstate, but the
core mission of the unit is to look at the body of postcrisis
regulation and to kind of do a deep dive into an analysis of
the effectiveness in areas of capital liquidity and
resolvability.
Senator Cortez Masto. And do they engage in a cost-benefit
analysis? I have heard this topic quite often.
Mr. Quarles. In the broadest sense of the term, yes. I
mean, they are looking at overall effectiveness, and obviously,
costs, broadly considered, are part of that.
Senator Cortez Masto. Do you think cost-benefit analysis is
a key function for what you are supposed to be doing?
Mr. Quarles. I think that it is a very important element of
what we are supposed to be doing.
Senator Cortez Masto. And I agree. I think sound data is
critically important in informing the policies and decisions
that you will be making. But one of the things I do have
concerns about--and I have seen this over and over again--that
such analysis actually fails to capture the human and economic
costs of massive financial system failure. Would you agree?
Mr. Quarles. I would agree with that, yeah.
Senator Cortez Masto. Thank you. Let me ask you this: Would
you agree that the Fed underestimated the human costs of a
potential financial crisis prior to 2008?
Mr. Quarles. Yes, I would, because we underestimated the
likelihood of it, yes.
Senator Cortez Masto. All right. And, thus, the concern
that we are hearing and that I have about rolling back some of
these regulations and giving the Fed the authority over safety
and soundness. I will tell you, in Nevada, from 2007 to 2014,
there was no Federal oversight predicting what was going to
happen and then there helping us address the issue. So that is
the concern I have with S. 2155 and the rollback of the
regulations over the largest banks. So I appreciate your
agreeing with me with those concerns.
Let me jump to another topic on fair lending. The Center
for Investigative Reporting recently published several articles
on modern-day redlining after its year-long investigation based
on 31 million records publicly available under the Home
Mortgage Disclosure Act to identify lending disparities. The
studies found numerous fair lending violations. African
Americans and Latinos are charged higher fees and interest on a
mortgage than white borrowers with similar credit histories.
African Americans, Asians, Latinos, and Native Americans are
denied mortgages at higher rates even with similar credit and
income. And single women pay higher interest rates for
mortgages even when they have higher credit scores and bigger
downpayments than single men.
Now, you have said that you oppose discrimination in
lending. The Federal Reserve has examination and supervisory
authority of banks with fewer than $10 billion in assets. How
does the Federal Reserve discover discrimination in lending?
Does it involve using the HMDA data?
Mr. Quarles. We do use HMDA data, but where there is
additional data that we believe is necessary, we have the
supervisory ability to get that. So the HMDA data at issue
here, it is principally a question of public disclosure. We
have the ability to get the data that we need to perform that
supervisory assessment irrespective of those particular HMDA
provisions, and we do.
Senator Cortez Masto. So let me ask you this: If S. 2155,
which excludes 85 percent of banks and credit unions from
reporting HMDA, becomes law, can you ensure that banks making
fewer than 500 mortgage loans a year are not engaged in
redlining or other types of discrimination?
Mr. Quarles. We would have the information that we need,
again, through our ability to require it to be provided to us
as a supervisory matter to take those actions, yes.
Senator Cortez Masto. And how can we in the public sphere
ensure that you are doing that? Because prior to 2007, we know
the Feds were not there, and so how do we, without having that
public information transparent, so you have independent
watchdogs looking and assessing to make sure that redlining is
not occurring, how do we ensure that you are doing your job if
we do not have that information?
Mr. Quarles. Transparency and accountability is important,
particularly for an institution such as the Federal Reserve.
Ultimately, however, the balance between public disclosure and
the cost on institutions is one that the Congress will have to
make. I can assure you, though, that however you ultimately
choose to strike that balance, we will have the ability as
supervisors to get the information that we need.
Senator Cortez Masto. But there is no independent
verification that you are actually doing it, correct?
Mr. Quarles. Well, as I understand the provision in 2155,
there is quite a bit still of public disclosure. But, the
balance that you strike is up to you to strike.
Senator Cortez Masto. Thank you. I know my time is up.
Thank you very much.
Senator Brown. Senator Cotton.
Senator Cotton. Thank you, Mr. Quarles, for your appearance
here today. I want to speak to you about FINRA Rule 4210.
Two years ago, I sent a letter to the SEC expressing
concern about this rule, which established margin requirements
on to-be-announced securities such as mortgage-backed bonds.
The key problem here is that Rule 4210 applies to broker-
dealers but not to banks. Thus, broker-dealers can use their
banking arm to evade the requirement, which can create an
unfair and uneven playing field.
Earlier this week, Federal Reserve staff confirmed with my
adviser that this is a potential inequity, and I would say that
there are Arkansas firms that will simply exit the market if
this uneven playing field comes to pass. Do you share my
concern about this matter?
Mr. Quarles. I would say that certainly as a general
principle, a level playing field is important, and that is
across a range of issues, whether it is banks and broker-
dealers, big banks and small banks, domestic banks and
international banks. So it is a pretty high priority for us as
regulators to try to ensure that our regulatory system creates
a level playing field.
On the specific issue of the FINRA rule you are citing, I
am only now becoming familiar with it but am very engaged in
understanding how it is affecting that level playing field.
Senator Cotton. OK. Rule 4210 is one of those final rules
not yet in effect which both the SEC and the Federal Reserve
have the ability to alter. Can I get your commitment to take a
review of it and to ensure that it does not create an unequal
playing field between smaller broker-dealers and larger bank-
affiliated firms?
Mr. Quarles. We will certainly review it through that lens,
yes.
Senator Cotton. Thank you. Let us look now to the
international system, specifically the Financial Stability
Board, or FSB. In January, I sent a letter, along with several
other members of this Committee, to President Trump raising my
concerns that went to many other members of the Administration,
including yourself. I am sure it is right at the top of your
mind.
Mr. Quarles. Actually, it is.
Senator Cotton. Just in case it is not, I will say that I
am worried that the FSB has morphed from an advisory
organization into a global regulatory body and using quasi-
enforcement tools. A couple months ago, Secretary Mnuchin
testified that FSB is, in fact, an advisory organization and
that its rules are voluntary, not binding. Do you agree that
the FSB rules are voluntary?
Mr. Quarles. Yes. Yes, I do.
Senator Cotton. In 2015, four Chinese banks sought an
exemption from an FSB rule related to how much capital they
hold. Can you imagine a scenario in which a United States firm
would ever have to seek an exemption from an advisory rule of
the FSB?
Mr. Quarles. No.
Senator Cotton. In 2013, the FSB determined that two large
American insurers were globally systemically important
insurers. Those two insurers, though, had not yet been
designated as systemically important financial institutions in
the United States. That creates an unusual circumstance in
which the FSB, which operates by consensus to include U.S.
Government officials, had determined that U.S. firms were
globally systemic, yet those same U.S. officials had not
determined that they were systemic in our Nation itself. I
suspect the Trump administration would have a slightly
different approach to this matter, but what can we do to ensure
that future Administrations do not take such strange steps in
which they are acting through the FSB to achieve results on
regulating U.S. firms that they have not yet taken under U.S.
law?
Mr. Quarles. The FSB designations are purely advisory. It
is up to national authorities in any particular country to
implement them, and we have our FSOC process through which that
would be done, and the FSB advisory stance does not really
affect the FSOC process.
I think the larger question, though, that you are raising
is an important one, which is I do think that we in our
engagement in these international fora, the FSB, the Basel
Committee, I think is very important because I think trying to
ensure a level playing field for our globally active
institutions is in their interest. It is in our national
interest. But we need to ensure that we are fully engaged with
all of the various stakeholders in our country as we go into
those national fora and represent, you know, a broad range of
views as opposed to a narrow range of views.
Senator Cotton. Thank you. I agree with that. It is
important to stay engaged to ensure that we have fair and equal
playing fields overseas. It is also important to ensure that
U.S. sovereignty prevails in the regulation of our financial
institutions, to include large financial institutions which
have----
Mr. Quarles. I completely agree.
Senator Cotton. ----not just rich bankers at their top but
lots of clerks and secretaries and delivery personnel and
tellers and everything else spread around the country whose
jobs may depend on the United States getting a fair and level
playing field overseas as well as not having overseas advisory
institutions stretch their regulatory hands inside of our
borders.
Thank you, Mr. Quarles.
Mr. Quarles. Thank you, Senator.
Chairman Crapo [presiding]. Senator Jones.
Senator Jones. Thank you, Mr. Chairman, and thank you, Vice
Chairman Quarles, for your attendance here today. I really
appreciate your being here.
I want to go back just a moment to an area that Senator
Menendez discussed with you, and that is with the Community
Reinvestment Act. Frankly, from my State's perspective, that is
one of the most important things that the Fed will do, and I
think modernizing the CRA is going to be one of the most
important things that you may do in your term.
What gives me a little bit of concern right now is that
coming out of the OCC I see comments that as part of the
modernization effort, they would like to see a universal
measurement system, I think the comment was, for $100 million
banks in Iowa the same as JPMorgan. That gives me a little bit
of concern because of the obvious disparities in communities
around the country, and I would like to kind of get your views
on what you think. I am not tying you to specifics. I
understand that. But I would like to kind of get your views on
whether or not the CRA rules should appropriately reflect the
individual needs of specific communities across the country.
Mr. Quarles. I want to make sure that I do not sort of
front-run the joint process that is going on----
Senator Jones. Yes.
Mr. Quarles. ----in discussing exactly these issues among
the regulator, because we do want to come out with a joint
proposal, and we are still talking about how some of these
issues will be handled.
As a general matter, though, I think that the purpose of
CRA modernization, CRA reform, however one wants to describe
it, is precisely to--I think there is a lot of consensus and
desire on the part of community development organizations and
players themselves, not just the banks and the regulators, in
order to have that process really be broader, directed toward a
broader range of community development activities than has
happened in the past. And I think that under the principles of
transparency and simplicity, I think that we can improve the
regulation in a way that creates incentives to do that and
creates incentives for compliance--really more than
compliance--engagement by the banks that really does help
revitalize the moderate- and lower-income sections of
communities. And that is the lens through which the Fed is
participating in these discussions.
Senator Jones. All right. Thank you, sir. And going back to
Senator Cortez Masto's questions, I was a cosponsor and voted
for the bank regulatory bill, S. 2155, but the concerns that
she raised are still a concern of mine as well. Again, we have
a lot of minority communities, and I want to make sure that
those folks are not discriminated against. I want to make sure
that they are not redlined. Can you just simply--and I heard
your answer, and I appreciate that. But will discrimination in
housing and lending still be--will it be a priority with you
and the Fed?
Mr. Quarles. A very high priority for me personally and for
the Federal Reserve as an institution.
Senator Jones. All right. Thank you, sir.
You have also talked about--I know one of the other
priorities has been cybersecurity, and I think that that is a
very--that is something that also gives me a lot of pause in
today's world. And, particularly, I know there are a lot of
efforts going on right now to beef up cybersecurity within our
own system, but we are so globally connected now that I worry
about our connectivity with other global markets and other
banks.
Can you give me a sense of what you are doing in working
with international banking regulators to make sure that those
banks are as secure and as up-to-date in working with the
cybersecurity? Because if it happens somewhere else, it could
very well affect folks in Alabama.
Mr. Quarles. Yeah, that is obviously one of the most
significant, if not the most significant risk that faces the
financial sector currently, and you are right to highlight the
international aspect of it. In our discussions among central
banks and among bank regulatory agencies around the world, I
would say that that is probably the highest priority item that
we have, discussing ways to ensure that our systems are
resilient. Internally, domestically, we look at that, including
the international component, in sort of a broad range of
interagency activities. There is the FBIIC, which is focused on
tech infrastructure, the FSOC, you know, there are processes
within the FSOC to look at this issue, very high priority for
us.
All of that said, I would say that we still have to do
more. It is the issue that I am most concerned about and the
one that I think that we are probably--that we have most to do
on. I do not think that we have the best handle on it yet. We
are working very hard on it.
Senator Jones. All right, great. Thank you, Vice Chairman
Quarles.
Thank you, Mr. Chairman.
Mr. Quarles. Thank you, Senator.
Chairman Crapo. Senator Scott.
Senator Scott. Thank you, Mr. Chairman. Thank you, Vice
Chairman, for being here this morning.
As you may know, I spent about 20-plus years in the
insurance industry.
Mr. Quarles. I knew that.
Senator Scott. I am glad to hear that. And I am a big fan
of the State-based regulation system for insurance. We have an
old saying in South Carolina, like many things Georgia thinks
it started in Georgia, but it started in South Carolina: ``If
it ain't broke, don't fix it.''
Unfortunately, Congress did some fixing in the Dodd-Frank
Act as it relates to insurance. Many insurance savings and loan
holding companies are now supervised at the holding company
level by both the Federal Reserve and State insurance
regulations, creating redundant rules of the road that are not
proportional to the risk profile of these firms. That runs
counter to your preference for regulatory efficiency, and it
adds costs for policyholders. I will ask you just a couple
questions.
Do you support a more streamlined regulatory approach that
would uphold a State-based system of insurance regulation while
right-sizing the Fed's examination authority? And will you
ensure that the Federal Reserve does not apply bank-centric
supervisory tools or expectations to insurance savings and loan
holding companies?
Mr. Quarles. At that level of answer, the answer is
definitely yes. I have been concerned, as I have talked with
these insurance savings and loan holding companies, that it
does seem as if the burden that our regulation of the holding
company because of their owning what are sometimes relatively
small and certainly in the context of their organizations
relatively small savings and loans is out of whack. We are
imposing too much burden on them.
I do think that as long as they have a depository
institution subsidiary, I think that there are sort of bank
regulatory principles that we need to apply. We have not got
the balance right. We have not worked out how to do that in a
way that does not impose excessive burden on the institutions,
and it is a high priority for me to fix that.
Senator Scott. That is one of the reasons why I used the
word ``right-sizing.''
Mr. Quarles. Yes.
Senator Scott. Because the reality of it is that the
regulatory burden that is placed upon really the policyholders
through additional cost should be appropriate for the risk
profile that those firms actually have.
Mr. Quarles. Agreed.
Senator Scott. The Fed also regulates insurance through
FSOC. Secretary Mnuchin told me a revamp of the nonbank SIFI
designation process is underway. Can you give me an update on
that? And is it a rule or guidance that is coming?
Mr. Quarles. Well, again, not wanting to front-run a
process that has a number of agencies involved in it and that
we are in the middle of, the general direction of the process
is pretty clear, which is that we are looking at how to--and
certainly I support the approach of designating on an
activities basis as opposed to an entities basis and
determining what activities can create systemic risk and then
finding a way to apply appropriate regulation to those
activities. I think that while the practical issues that that
raises are difficult, they are solvable, and I think that
intellectually that is a superior way to think about the
process.
Senator Scott. Another way the Fed regulates insurance is
through the IAIS. The ICS that you are working on should
accommodate our State-based system of insurance regulation, not
the other way around. Will you make that clear to the IAIS? And
where are we in the ICS process?
Mr. Quarles. Yes, that has our support for an
internationally agreed capital regime that reflects our U.S.-
based approach. It is something that we have been pursuing in
the international fora and are continuing to do so. We are
pretty strong about that.
Senator Scott. So I am going to take that as a yes, you
will make clear to the IAIS----
Mr. Quarles. We will, yes.
Senator Scott. Thank you. Before I close, I want to mention
the Fed's recent enforcement actions against Wells Fargo. I am
all for regulatory relief. I think it is clear that we
overcorrected in the past and our economy suffered as a result.
What I am not for is fraud. What I am not for is theft. I hope
you and your colleagues do not hesitate to pursue similar
actions in the future when they are warranted.
Thank you.
Mr. Quarles. Thank you, Senator.
Senator Scott. Thank you, Mr. Chairman.
Chairman Crapo. Senator Warren.
Senator Warren. Thank you, Mr. Chairman.
So before the financial crisis, regulators treated
dangerous mortgage-backed securities the same way they treated
safe Treasury bonds when establishing capital requirements. The
regulators badly misjudged the risk of those mortgage-backed
securities. The result was that taxpayers were left holding the
bag when the big banks did not have enough capital to withstand
losses.
So after Dodd-Frank Act, too-big-to-fail banks were
required to have a certain amount of capital for each dollar in
assets, regardless of the riskiness of those assets. Last week,
the Fed proposed weakening this rule.
So, Governor Quarles, this new rule will allow each and
every too-big-to-fail bank to satisfy the non- risk-weighted
capital requirement while holding less capital than the
previous rule, right?
Mr. Quarles. That is correct.
Senator Warren. OK. So the Fed is rolling back capital
requirements for the biggest banks, and it is not just a
marginal rollback. The FDIC has estimated for this Committee
that under the proposed rule, JPMorgan, Citigroup, and Morgan
Stanley will be able to reduce their capital by more than 20
percent at their bank subsidiaries and still meet their
leverage capital requirements. Wells Fargo and Bank of America
can each reduce their capital by more than 15 percent.
The FDIC, which insures these banks and has to pay out if
the banks fail, refused to join in this new proposal. Chairman
Gruenberg said the leverage ratio requirements are ``among the
most important postcrisis reforms'' and the existing ``simple
approach has served well in addressing the excessive leverage
that helped depend the financial crisis.'' And Governor
Brainard voted no on the proposal, the first dissent since the
Fed started making its votes public.
So, Governor Quarles, why did you think it was all right to
roll back capital requirements given this unprecedented level
of opposition from both the FDIC and your fellow Governor at
the Fed?
Mr. Quarles. A number of reasons. One, our estimate of the
actual capital effect of the rule is much smaller.
Senator Warren. Do you think the FDIC does not know the
numbers?
Mr. Quarles. Our estimate is much smaller, and the
incentive that is created when a leverage ratio is actually the
binding ratio--I completely agree with you, Senator, that the
crisis has shown us that leverage capital measures are an
important element of capital regimes, and I have a much greater
appreciation of that than I did before the crisis, because our
risk assessments, there will always be idiosyncracies, mistakes
in even the most careful and granular risk assessment.
But if we set the leverage ratio so that it becomes the
binding ratio, which at the level we had set it, it was for a
number of institutions, and basically what we are saying to
them is you will bear the same capital cost if you take on a
very risky asset or if you take on a less risky asset.
Senator Warren. You know, but what troubles me about this
is--I believe the FDIC on their numbers. I have no reason not
to. They have been in this business for a very long time, and
they are the ones that pay out. But even more importantly,
under Chair Yellen the Fed moved carefully and with consensus
to strengthen capital requirements. In your first year, you
have already started rolling back these requirements, despite
significant opposition, and, you know, this is great for big
banks already making record profits. But it is the taxpayers
that end up on the hook for the risk.
So I want to ask you a related question to this. The
banking bill that just passed the Senate also eases capital
requirements for institutions ``predominantly engaged in
custody, safekeeping, and asset servicing activities.'' Now,
this provision clearly applies to the so-called custody banks
like Bank of New York Mellon. The question is whether JPMorgan
and Citi can also cut their capital under this provision. The
CBO says it is a 50-50 shot whether or not JPMorgan and Citi
would qualify. You are the guy who will get to make that
decision.
So if the bill that just passed the Senate is written into
law, will you interpret the custody bank provisions to include
JPMorgan and Citi?
Mr. Quarles. So although I am a lawyer, I am not appearing
here as a lawyer, so I do not want to perform--a surgeon should
not perform his own appendectomy, but my reading of that
provision would be that the word ``predominantly'' would not
include the activities of a firm such as Citi or JPMorgan.
Senator Warren. So are you saying for certain that the
language of the legislation cannot be interpreted to allow
JPMorgan and Citi to reduce their capital by an estimated $30
billion?
Mr. Quarles. That would not be my view.
Senator Warren. So it will not happen.
Mr. Quarles. Well, I am one person on a Board that I hope
soon has other members.
Senator Warren. OK, good. You know, I am worried about this
because I am worried about the cumulative effect of these
rollbacks. Taken separately, each of the rollbacks, the
rollbacks you have already done and the rollbacks under the
bill, I believe are dangerous. But when they are taken
together, they are downright reckless. The banking bill gives
even more discretion to you, Mr. Quarles, so that you can help
out giant banks and leave taxpayers holding the bag, and I just
think that is the wrong direction for us to go.
Thank you, Mr. Chair.
Chairman Crapo. Senator Tillis.
Senator Tillis. Thank you, Mr. Chairman. Mr. Quarles, thank
you for being here.
I believe it was Senator Corker that was talking about why
our colleagues on the other side of the aisle should be really
pounding the table for your confirmation to the 14-year term,
and I would really recommend an article that was published back
in October of last year titled, ``Does the new Fed Governor
serve at the pleasure of the President?'' It was by Peter
Conti-Brown, a Democrat who thinks that in this particular case
we should be removing all the hurdles and get you on the agenda
as quickly as possible and, like you said, get other members
appointed so that you all can be independent and get a lot of
work done that we need to get done.
I do not remember the time, but I know you recently--maybe
it back in January--spoke to the ABA.
Mr. Quarles. Yes.
Senator Tillis. And you talked about revisiting advanced
approaches thresholds for identifying internationally active
banks.
First off, is it still your position that we should revisit
the advanced approaches thresholds? Is it still a priority for
you? And could you discuss your broader position on the issue
and what lies ahead under your leadership?
Mr. Quarles. Absolutely. Yes, that is a priority, and it is
on the agenda. Because it is significantly related to
legislative movement on the thresholds, at least for the
moment, we have thought that the better part of valor has been
to hold off until we see what direction the Congress goes
there. But I think that wherever the legislative process
settles, there will be an ability for us to continue to move
the thresholds on the advanced approaches.
Senator Tillis. I think you also recently talked about the
Volcker rule and how it has been detrimental to capital markets
and it has created a great deal of uncertainty. There was a
House bill recently passed to streamline the Volcker rule. I
believe it passed by a very big margin, 300-104. We have been
working on the bill and trying to increase awareness in the
Senate to move it forward at some point. But can you talk to me
a little bit about the consequences of having five different
regulators enforcing the rule and how the bill would be
streamlined or how you could streamline it and maybe make that
a little bit less problematic?
Mr. Quarles. There is obviously a lot of coordination work
that is involved to have five regulators to agree, even when we
are all pulling in the same direction. I would----
Senator Tillis. What is the rational basis for five of them
being at the table, though? I mean, I want you to finish your
thought, but cover that as well.
Mr. Quarles. Well, each of them has sort of entity
supervisory authority over entities that are affected by the
Volcker rule. So there is a logic to the provision. There are
logistical consequences to the provision. I would say that the
cooperation that we have had since the beginning of the year on
working on revising the Volcker rule has been very productive.
The other regulators have worked together very closely with us
in developing proposals to simplify that regulation, and it is
actually moving fairly well, but it is moving fairly well for a
five-headed process.
Senator Tillis. I think you mentioned earlier you were--I
know you were questioned yesterday over on the House side, and
someone else mentioned already the insurance saving and loan
holding corporations. I will review that for the record, but my
staff told me you have already covered that question. I tend
not to revisit questions already asked.
So just on a final note in the minute left, you and I have
had several discussions about regulatory right-sizing on a
broader basis. Volcker is just one of them. But let us assume
we fast forward, you have got your 14-year term. I know that
there are certain limits about what you can talk about about
precisely what you do on regs or reg repeals. But can you give
me in broad strokes what your top two or three areas would be
to look for opportunities to right-size regs?
Mr. Quarles. I think that some of them--I think probably
all of these I have talked about--that we have not proposed
yet, you will see a proposal for, again, a much more
transparent and codified framework for determining control
under the Bank Holding Company Act, which really is not just an
issue of interest to the lawyers, but really can be important
for capital raising for community banks because of control
issues that frequently come up in those contexts.
Liquidity regulation for firms below the G-SIB level, kind
of continuing to gradate that regulatory regime is something
that I think that you will see.
I think that as we finalize some of the transparency
proposals that we have made, they will go farther than the
initial proposals, and then as well the Volcker rule that we
are working on.
Senator Tillis. Thank you.
Chairman Crapo. Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman. Welcome, Mr.
Quarles.
Mr. Quarles. Thank you.
Senator Van Hollen. So I know my colleague Senator Schatz
mentioned this issue, but I do want to emphasize that we all
woke up to a headline in the Wall Street Journal the other day
stating, ``The biggest U.S. banks made $2.5 billion from the
tax law in one quarter.'' It talked about the four biggest
banks. That certainly was not how the tax reform plan was
advertised here on Capitol Hill, and I think Americans are
waking up to the fact that since January 1st of this year, big
corporations have spent $250 billion on stock buybacks.
Apparently, they could not think of a good investment for the
money within their corporation or did not want to use it to
give the promised $4,000 pay increases to their employees, so
they passed it on to the shareholders. And it is worth noting
that 35 percent of their shareholders are foreigners--35
percent of the stock out there is owned by foreigners. So out
of the pockets of many middle-class American families into the
bank accounts of foreigners. As someone at the Fed, I hope you
will continue to monitor the impact of this tax bill in many
different ways.
I want to follow up with some of the questions that my
colleague Senator Cortez Masto raised. I know in the House
yesterday, or whenever you testified, you were asked about a
recent Center for Investigative Reporting findings that
redlining, discrimination in mortgage lending continues in a
very real way. They looked at 31 million mortgage records and
found evidence of discrimination in mortgage lending in 61
metropolitan areas. And this, as you know, is not a new story.
It goes back decades.
In the lead-up to the financial crisis, there was a very
big scandal in Baltimore City. The city of Baltimore sued Wells
Fargo. Wells Fargo settled. Very clear documentation that many
African Americans and people of color who had good credit
ratings were being charged higher interest rates than their
peers. And also predatory lending where people who had no
documentation about income were granted loans that people knew
that they would fail, they knew they could pass those loans up
and not have to be held responsible.
So this is an ongoing pattern, and we have a recent report
here, and I was listening to your testimony and your answers
with respect to Senator Catherine Cortez Masto, and here is
what I would ask: Can you take a look at the report from the
Center for Investigative Reporting--I do not know if you had a
chance to look at it since your House----
Mr. Quarles. To look at it, but certainly not to study it,
and I can obviously commit to do so.
Senator Van Hollen. Because I would like for you to take a
look at it, and your colleagues, because you mentioned in your
response that at the Fed you have lots of tools to get
information. I mean you mentioned the publicly available HMDA
information, but you went on to say you actually get a lot of
additional information, correct?
Mr. Quarles. That is correct.
Senator Van Hollen. So the obvious question here is: Where
is the breakdown in the system? If these reports are accurate--
and you have not looked at it, but it is a very well documented
study. I have taken a look. If these reports are accurate,
where is the system failing? Because we all, everyone on this
Committee is committed to making sure we do not have
discrimination in lending. But it is clearly still going on out
there in the real world.
So where is the breakdown? And I am going to ask you today,
since you do have a lot of data beyond HMDA, I do not think we
should have to wait for studies like that from the Center for
Investigative Reporting to catch what is happening. We need you
and the Fed and the OCC to be on the front lines.
So can you take a deep dive into this report and get back
to me and this Committee and let us know what your assessment
is and what is broken in the system?
Mr. Quarles. Absolutely. Very reasonable request. Of course
we can.
Senator Van Hollen. Because, you know, we keep hearing,
again, that folks have the tools, but the tools do not seem to
be working because we keep getting these reports. And it is
very disturbing to see the continuing wealth gap, right? We
have big income gaps----
Mr. Quarles. Yes.
Senator Van Hollen. ----we have big wealth gaps between the
African American community and communities of color and others.
And as you know, for most Americans that wealth is in their
home.
Mr. Quarles. Right.
Senator Van Hollen. So if you cannot get a loan to get a
home and build that wealth, that gap grows. So I just want your
commitment to work with us to get to the bottom of this. There
are these studies out there. We need your help.
Mr. Quarles. You have that commitment.
Senator Van Hollen. Thank you.
Chairman Crapo. Senator Perdue.
Senator Perdue. Thank you, Vice Chair, for being here
today. I just have two quick questions.
In your role as Vice Chair, you have a seat on the
Financial Stability Board, I believe, as well as the Basel
Committee on Banking Supervision. In those roles, give us your
opinion about how well capitalized U.S. banks are in your
opinion today.
Mr. Quarles. Relative to sort of peer banks around the
world, U.S. banks are extremely well capitalized.
Senator Perdue. Given that and given the accelerated
activity of our implementation of Basel III, particularly in
relative terms to what the rest of the signatories have been
doing, what are your thoughts about any further implementation
of the Basel III agreement relative to what other people--
shouldn't we see further implementation or acceleration of
implementation before we entertain further rules?
Mr. Quarles. Well, I think that, assuring that we have that
level playing field internationally is one of the reasons for
those----
Senator Perdue. Do we have that today?
Mr. Quarles. I would say that we are ahead of many other
jurisdictions.
Senator Perdue. Yes, sir.
Mr. Quarles. That is definitely something that we take into
account, assuring that we maintain a level playing field both
in encouraging others to come up to standard and as we think
about the role of our own regulations.
Senator Perdue. Under Senate bill 2155 that we just passed
in Committee and passed in the Senate, the banking regulatory
relief bill, if it becomes law, the Federal Reserve will have
the responsibility to determine which banks between $100 and
$250 billion in assets will be given relief for enhanced
supervision. Senator McCaskill and I actually have a bill,
Senate bill 1983, that would require the Federal Reserve to
actually use the Basel five-part test in designating G-SIBs.
Can you give us your opinion on that? And how do you feel about
the current activity level or the current asset size-based
approach versus the activity-based approach in determining risk
for banks of this size?
Mr. Quarles. I think that making those determinations is
something that we should take a range of factors into account
for. Size is one, but it is only one, and complexity and
interconnectedness and, you know, the character of bank
portfolios, I think all of that goes into an assessment of
systemic significance. And so I definitely think that that is
something that we ought to do.
Senator Perdue. You do support moving more to a multi-based
approach, multi-factor approach in terms of evaluating the risk
of those banks?
Mr. Quarles. Yes. I think we do that now. I certainly think
we should.
Senator Perdue. Good.
Mr. Quarles. Yes.
Senator Perdue. In your role, you evaluate emerging threats
and so forth. Can you give us a brief summary, particularly
with the size of the central banks in China, Japan, U.S., and
Europe, the largest balance sheets we have ever seen, and we
see the growth of debt really in emerging markets again within
the $200 trillion universe of global debt. Can you give us just
your thoughts today in your role here on emerging threats that
may threaten the global financial system? How should we be
thinking about that today?
Mr. Quarles. For the global financial system generally, I
would say that we view the risks to financial stability
essentially as moderate, which is to say about in the middle of
where we would expect them to be over a cycle.
Senator Perdue. Is that down from 10 years ago?
Mr. Quarles. Ten years before or after the crisis?
Senator Perdue. Before.
Mr. Quarles. That is probably about where it would have
been 10 years ago, where we would have thought that it would
have been 10 years ago. There are individual countries where we
think the risks are elevated. Some of the issues that you have
cited are issues that we certainly look at. But, in general,
the risks to financial stability, both our domestic financial
stability and global financial stability, we are in a reason
spot right now. I would not say that they are low, but they are
not excessively elevated either.
Senator Perdue. Thank you.
Thank you, Mr. Chair.
Chairman Crapo. Senator Heitkamp.
Senator Heitkamp. Thank you, Mr. Chairman. And thank you
for your patience. I think I might be the last one here
unless--oh, Jack. We have saved the best for last, and I guess
that is not me.
I want to just follow up on Senator Toomey's questions. He
talked about a lack of Federal nominees, and I would just like
to briefly comment on the lack of Federal Board of Governors'
confirmations. Do you know the number of Board nominees that
were denied a hearing under President Obama?
Mr. Quarles. I do not.
Senator Heitkamp. Yeah, well, that never gets talked about,
but the answer is two. So I think we have to be really careful
when we are pointing fingers about not having a full
contingent, because this is not something new. It is something
that needs to be addressed desperately here. But let us not
paint like this is a brand-new problem that we have here.
The other thing that I probably want to correct on the
record is Senator Toomey said, you know, below 250 there is no
SIFI designation under 2155. That is not true. Between 100 and
250, the Fed has complete authority if you see an institution
that presents systemic risk for whatever reason, and that is to
respond to the concern about Countrywide and the risk that they
presented. And this puts a burden on you, and I want to make
sure that the Fed understands that this is not--at least this
sponsor of 2155 did not in any way want to limit your ability
to identify those institutions under 250 who present systemic
risk. So I want to follow up on a couple quick questions on
2155.
As Vice Chair of Supervision, you will have a lot of
responsibility for implementing the changes in that bill,
should it be passed by the House and signed by the President,
which we very much hope. Some of the opponents of the bill have
claimed that the legislation will take us back to the state of
play before the financial crisis. Specifically, they have
argued that the bill could somehow open up widespread risk in
the mortgage market and result in the kind of foreclosure
crisis we saw in 2008.
Do you agree that one of the main drivers of the 2008
crisis was that firms were exporting mortgage credit risk and
failing to perform appropriate and basic underwriting duties?
Mr. Quarles. That was certainly an element, yes.
Senator Heitkamp. Does this legislation do anything to
change the strict mortgage lending requirements known as QM
rule for larger institutions?
Mr. Quarles. From my review of it, it does not.
Senator Heitkamp. Does it change any of the QM requirements
for community banks that do not keep that loan on portfolio?
Mr. Quarles. I do not see that it does, no.
Senator Heitkamp. Does the legislation do anything to
change the risk retention rules put in place after the crisis?
Mr. Quarles. I do not believe so.
Senator Heitkamp. So in your view, would 2155 preserve the
critical tools that were put in place after the crisis to
prevent another mortgage foreclosure crisis?
Mr. Quarles. I believe that it would, Senator.
Senator Heitkamp. OK. During your time at Treasury, you
worked quite a bit on housing reform, and obviously that is a
topic that we are very interested in here, kind of that next
turn the page after some of the credit union and small
community bank reform that we did in 2155. So I am going to ask
you some quick questions on mortgage reform.
Mr. Quarles. Sure.
Senator Heitkamp. With respect to Fannie and Freddie, do
you think it is likely that one or both could fail again? That
is probably not a quick question.
Mr. Quarles. Exactly. I guess that would be a very
difficult question to answer. I would have to dig deeper to----
Senator Heitkamp. But is there a possibility that they
could fail again?
Mr. Quarles. I would think that there is a possibility.
Senator Heitkamp. Do you think it is likely that one or
both could take a substantial draw from their line of credit
from Treasury in the near future?
Mr. Quarles. Well, I know that when I was at the Treasury,
we proposed strict controls on that, and the Treasury does have
the ability to limit that. So a lot of that would depend on the
Treasury.
Senator Heitkamp. But you are saying--you cannot give a
sense of likelihood, but there is a possibility, correct?
Mr. Quarles. I think there is the legal possibility.
Senator Heitkamp. So if Congress fails to take action, what
long-term risk do you see in our financial system if our GSEs
remain in conservatorship?
Mr. Quarles. Well, you know, I think certainty is a benefit
to the economy in general, and so for me, the principal benefit
is to create certainty around what our system of housing
finance is going to be going forward and to have that be sort
of as private sector driven as possible.
Senator Heitkamp. Do you believe that a Government backstop
is essential to retaining the 30-year fixed-rate mortgage?
Mr. Quarles. I would want to analyze that question more
deeply before giving you a yes or no answer. My belief today is
probably not, but I would really want to get back to you with a
more considered----
Senator Heitkamp. We would have to have a long conversation
about that because I think that there are a number of people
certainly in smaller and midsized institutions who believe that
it would be very difficult to take a 30-year interest rate risk
without some kind of assurance that they could offload that
risk.
Mr. Quarles. Fair enough.
Senator Heitkamp. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman. And
welcome, Chairman Quarles.
Last time when Chairman Powell was here, we talked about
the impact of technology on employment, which is increasingly
both problematic and beneficial, so let us talk about the
problems first. There is a real concern, I think, about
people--and not just economic analysts, but people who are Main
Street--who fear that their job will be automated away. That I
think contributes to kind of the real concern that is out there
despite fairly good economic news. And that raises the issue
of, well, how do we respond to multiple ways? First, you know,
technology is coming, we know that. Can education and training
and more resources in that regard allow us to make the
transition so that people can still work, they will not be sort
of left behind?
Mr. Quarles. I think that those are important factors. We
need to put a lot of resources into education and training in a
society that is innovating like ours, particularly innovating
through technology.
Senator Reed. I appreciate that. One of the battles we have
perennially is putting resources into education. One could
always be more efficient or aspire to be more efficient, but I
think given this technological challenge, this automation
challenge, the emphasis on training actually beginning in pre-K
and STEM, et cetera, requires a huge investment. And this year
we have done OK, but in the future we are going to look at some
very difficult choices.
The other issue this raises would be in terms of the full
employment mandate, Mr. Vice Chairman, of the Fed, which is as
technology displaces workers, do you factor that in as sort of
the new norm, that, you know, our full employment is not X
because those jobs do not exist anymore, and that creates kind
of a dynamic where there are literally millions of Americans
who have a job and we are at full employment?
Mr. Quarles. We obviously look closely at the relationship
between the unemployment rate and the labor participation rate
and how that is passing through to inflation, and there have
been changes in that relationship over the course of the last
10, 15, 20 years that we do not understand well, that we are
doing a lot of research in. Technology clearly has to be an
element. I do not think it is the only element. How big of a
driver it is, you know, I could not tell you. We really are
still trying to figure out exactly why those relationships are
changing relative to what they have been in the past.
Senator Reed. And I think you would concur, this is a very
important analysis because----
Mr. Quarles. Incredibly important.
Senator Reed. This phenomenon, you know, it is not
something that 10 years from now we will deal with it. It seems
with every week we are seeing more and more amazing
applications of technology that just basically takes jobs away
or changes them so dramatically.
Mr. Quarles. Certainly changes the nature of the economy.
Now, you know, our experience up to now in this country,
globally, with technological advance, has been that jobs are
created as jobs are removed. You know, and so I think the
historical evidence would give us reason to think that we will
see some of that effect here. But this is a pretty dramatic--
some of the advances that we are seeing are pretty dramatic and
could have significant effects. We are looking at that.
Senator Reed. Just a final point. It is my understanding
that in 26 States, the number one occupation is driving a
vehicle of some kind, and every day we hear more and more--some
good, but some bad, but mostly good--about autonomous vehicles
and sophisticated AI systems in which driving will be something
like blacksmithing, and that will have a huge impact. And it is
years away. It is not decades away.
Just a final topic, and I only have a few remaining
seconds, and the Chairman and the Vice Chair have been very
kind. There is an Advanced Notice of Proposed Rulemaking from
the Fed, OCC, and FDIC on cyber, and this is another issue
which cannot wait. So can you give us an update on where we
are? I think we have got to get the rule out.
One of the components of the rule is that at least raising
the question whether board members of publicly held companies--
at least one member has to have some type of cybertraining or
some arrangement in the company to include cybersensitivity.
Can you comment?
Mr. Quarles. I completely agree with you. Cyber is not only
an important risk, it is probably the most important risk that
is faced by the financial sector. I think that as regulators we
need to step up the pace with which we are taking measures to
help support the resiliency of the system.
The ANPR that we put out is an example. The idea of having
a board member with cyberexpertise, when I have been on boards
that have had a board member with that kind of expertise, that
has been extremely useful. That has not just been a nice thing
to have. It has been extremely useful.
But I also think that even beyond some of the issues that
are in the ANPR, we really need to step up our work not just as
regulatory agencies but across the Government in really
thinking how we can support the resiliency of the financial
sector to cyberrisk in ways that we are not yet. And I think
that that needs to be a priority for us beyond even some of
these regulatory measures, and that requires not just the
banking agencies, but work, you know, across the various
agencies of the Government because it is a serious issue for
all of us.
Senator Reed. Thank you, Mr. Vice Chairman.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Reed. And thank you,
Governor Quarles, for being here today and the service you give
us at the Federal Reserve Board.
For Senators who wish to submit questions for the record,
those questions are due on Thursday, April 26th, and I
encourage you, Vice Chairman Quarles, if you receive questions,
to please respond very promptly.
Mr. Quarles. I will do so.
Chairman Crapo. And with that, this hearing is adjourned.
Mr. Quarles. Thank you very much.
Chairman Crapo. Thank you.
[Whereupon, at 11:25 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF RANDAL K. QUARLES
Vice Chairman for Supervision, Board of Governors of the Federal
Reserve System
April 19, 2018
Chairman Crapo, Ranking Member Brown, and other Members of the
Committee, I appreciate the opportunity to testify on the Federal
Reserve's regulation and supervision of financial institutions.
The Federal Reserve, along with the other U.S. banking agencies,
has made substantial progress in building stronger regulatory and
supervisory programs since the global financial crisis, especially with
respect to the largest and most systemically important firms. These
improvements have helped to build a more resilient financial system,
one that is well positioned to provide American consumers, businesses,
and communities access to the credit they need even under challenging
economic conditions. At the same time, we are mindful that--just as
there is a strong public interest in the safety and soundness of the
financial system--there is a strong public interest in the efficiency
of the financial system. Our financial sector is the critical mechanism
for directing the flow of savings and investment in our economy in ways
that support economic growth, and economic growth, in turn, is the
fundamental precondition for the continuing improvement in the living
standards of all our citizens that has been one of the outstanding
achievements of our country. As a result, our regulation of that system
should support and promote the system's efficiency just as it supports
its safety.
In fact, I believe that the supervisory objectives of safety,
soundness, and efficiency are not incompatible, but rather are mutually
reinforcing. Our job as regulators is to pursue each of these
objectives. Moreover, our achievement of these objectives will be
improved when we pursue them through processes that are as transparent
as possible and through measures that are clear and simple, rather than
needlessly complex. In doing this, we at the Federal Reserve intend to
maintain the core elements of the postcrisis framework that have been
put in place to protect the financial system's strength and resiliency,
while also seeking ways to enhance its effectiveness.
In my testimony today I will: (1) review the current condition of
the Nation's banking institutions; (2) review our regulatory and
supervisory agenda in light of the efficiency, transparency, and
simplicity principles that enhance effectiveness; and (3) touch upon
our engagement with foreign regulators.
Current Condition of Regulated Firms
Before I discuss our regulatory and supervisory agenda in more
detail, let me provide an update regarding the current condition of the
Nation's banking institutions.
Overall, the U.S. commercial banking system has strengthened
considerably over the past decade. The largest U.S. banking
organizations--those the failure of which would pose the greatest risk
to the financial system and that are subject to the Federal Reserve's
stress testing framework--have increased the dollar amount of their
loss-absorbing common equity capital by more than $700 billion since
2009, more than doubling their common equity capital ratios from
approximately 5 percent to more than 12 percent. In addition, the eight
U.S. global systemically important banking organizations, or G-SIBs,
have developed significantly more stable funding positions as their
reliance on short-term debt--including repurchase agreement, or repo,
financing--has decreased by more than half since 2007 and now is equal
to less than 15 percent of their total assets. The G-SIBs now also hold
approximately $2.4 trillion in high-quality liquid assets, representing
an increase of more than 60 percent since 2011.
The financial condition of community banks also has strengthened
significantly since the financial crisis. Aggregate reporting data from
the more than 5,000 community-based holding companies subject to
Federal Reserve oversight show marked improvements in profitability
that have contributed to a strong overall capital position. Community
banks reported net income of $20.6 billion during 2017, up 4 percent
from 2016. They also experienced particularly strong loan activity, as
their most recent year-over-year loan growth of 7.7 percent materially
exceeded that of the banking industry as a whole.
In the aggregate, banks realized profits of approximately $152
billion during 2017. While total net income fell in 2017 compared with
2016, this was largely a result of nonrecurring items. Total loans held
by U.S. commercial banks grew roughly 5 percent during 2017 and
currently exceeds the previous peak from 2008.
While the overall position of the banking system is strong, the
Federal Reserve continues to monitor ongoing risks that pose potential
threats to banking firms of all sizes. It is often said that bad loans
are made during good times. Therefore, more than 8 years into the
recovery, we continue to emphasize the need for banking organizations
to maintain underwriting discipline and strong risk-management
practices. We are particularly focused on banking organizations that
have or are developing concentrations in loan segments vulnerable to
adverse economic developments. Banks generally would also be vulnerable
to an unexpected and swift change in the shape of the yield curve.
In addition, banks continue to innovate and keep pace with
financial technology, or FinTech, developments. These innovations can
present promising opportunities, and I believe our role as regulators
is to allow that innovation to develop in a responsible way. These
innovations can expand access to credit, including to underserved
consumers and small businesses, which in turn can benefit the real
economy. We must also acknowledge that these opportunities likely are
not without risk. Our supervision regarding FinTech is therefore
focused on ensuring that banks understand and manage these risks and
that consumers remain protected.
We are also very focused on the increased risk to all financial
institutions of cyberattacks and are working with key public- and
private-sector entities to strengthen the cyberresiliency of the
financial sector. \1\ Cyberrisk continues to grow, driven by
unprecedented technological innovation, the interconnectivity of the
financial services sector, and inadequate or incomplete defenses. We
also observe, and incorporate into our own supervisory approach, the
reality that many of the most serious cybervulnerabilities are rooted
in the basic challenges of managing large IT infrastructures. We
continue to collaborate with other governmental agencies, and Federal
Reserve supervisors are closely following each of these areas of
concern.
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\1\ See Randal K. Quarles, ``Brief Thoughts on the Financial
Regulatory System and Cybersecurity'', speech at the Financial Services
Roundtable 2018 Spring Conference, Washington, February 26, 2018,
www.federalreserve.gov/newsevents/speech/quarles20180226b.htm.
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Regulatory and Supervisory Agenda
The U.S. banking agencies' build-out of the regulatory and
supervisory framework since the financial crisis has resulted in a
substantially more resilient financial system, particularly at the
largest firms. Stronger regulatory capital rules and the development of
the Federal Reserve's stress testing regime have resulted in higher
levels and quality of capital, new liquidity regulations and a
heightened supervisory focus on liquidity have resulted in stronger
liquidity positions, and resolution rules and living wills have
contributed to improvements in the resolvability of systemically
important firms.
That said, this body of regulation is broad in scope and
complicated in detail. It is inevitable that there will be ways to
improve the framework, especially with the benefit of experience and
hindsight, and--given the public interest in the financial system's
efficiency--it is important that we pursue this task as assiduously as
we can. I will turn now to highlighting some of the ways we have sought
to improve the effectiveness of the postcrisis framework through
increased efficiency, transparency, and simplicity.
Efficiency
Efficiency of supervision and regulation means that if we have a
choice between two methods that are equally effective in achieving a
supervisory goal, we should strive to choose the one that is less
burdensome. That can take many forms, including focusing the most
stringent of supervisory standards and practices on the riskiest firms,
as well as refining the calibration of specific requirements to make
them more aligned with their original intent. I will briefly discuss a
few recent measures that the Federal Reserve has taken designed to
increase efficiency and thus improve the effectiveness of our
regulation and supervision, such as the enhanced supplementary leverage
ratio calibration proposal, the removal of midsized banking firms from
the qualitative objection of our annual supervisory stress tests, and
specific examination and supervisory process adjustments. I will also
provide a few thoughts on where I believe additional improvements in
efficiency can be made.
The Board and the Office of the Comptroller of the Currency last
week issued a proposal that would recalibrate the enhanced
supplementary leverage ratio, or eSLR, applicable to G-SIBs and most of
their insured depository institution subsidiaries. \2\ The proposal
would help ensure that leverage capital requirements generally serve as
a backstop to risk-based capital requirements. When the leverage ratio
acts as a primary constraint, it can actually encourage excessive risk-
taking behavior because it does not distinguish between the capital
cost of safer and that of riskier assets. The eSLR's current
calibration has made it the primary capital constraint for some of the
largest firms, which is inconsistent with its original purpose and
provides an incentive for inappropriately risky behavior. The proposal
would calibrate the eSLR so that it is less likely to act as a primary
constraint while still continuing to serve as a meaningful backstop.
The proposal also would enhance efficiency by making each firm's
leverage surcharge a function of its individual systemic footprint.
Last year, the Board also adopted a rule that reduced the burden
associated with the qualitative aspects of the Federal Reserve's
Comprehensive Capital Analysis and Review, or CCAR, for midsized firms
that pose less systemic risk. Under that rule, the Board will no longer
object to the capital plans of firms with total consolidated assets
between $50 billion and $250 billion because of deficiencies in their
capital planning process; rather, any deficiencies in their capital
planning processes will be addressed in the normal course of
supervision. \3\ Recently, we have solicited comment on whether that
approach should be applied to a broader range of firms. I believe that
our supervisory goal of ensuring a robust capital planning process at
most firms can be achieved using our normal supervisory program
combined with targeted horizontal assessments without compromising the
safety and soundness of the financial system.
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\2\ Board of Governors of the Federal Reserve System, ``Rule
Proposed To Tailor `Enhanced Supplementary Leverage Ratio'
Requirements'', news release, April 11, 2018, www.federalreserve.gov/
newsevents/pressreleases/bcreg20180411a.htm.
\3\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Announces Finalized Stress Testing Rules Removing
Noncomplex Firms From Qualitative Aspect of CCAR Effective for 2017'',
news release, January 30, 2017, www.federalreserve.gov/newsevents/
pressreleases/bcreg20170130a.htm.
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I also believe that there are additional tailoring opportunities
with respect to large firms that are not G-SIBs to ensure that
applicable regulation matches their risk. In this regard, I support
congressional efforts regarding tailoring, as offered in both the House
and Senate, which have proposed prudent modifications. In addition to
this potential legislation, I believe there are further measures we can
take to match the content of our regulation to the character and risk
of the institutions being regulated. Liquidity regulation, for example,
does not have a G-SIB versus non- G-SIB gradation. In particular, the
full liquidity coverage ratio requirement of enhanced prudential
standards apply to large, non- G-SIB banks in the same way that they
apply to G-SIBs. I believe it is time to take concrete steps toward
calibrating liquidity requirements differently for non- G-SIBs than for
G-SIBs.
I believe that we can also improve the efficiency of our regulation
with respect to our requirements regarding living wills. In light of
the substantial progress made by firms over the past few years with
their resolution planning processes, I believe that we should adopt a
permanent extension of submission cycles from annually to once every 2
years, and that we can again reduce burden for firms with less
significant systemic footprints by reducing specific information
requirements.
The U.S. banking agencies have also taken a number of steps to
advance more efficient and effective supervisory programs. For example,
in response to feedback from banks in the context of the review
required by the Economic Growth and Regulatory Paperwork Reduction Act
of 1996, the agencies recently increased the threshold for requiring an
appraisal on commercial real estate loans from $250,000 to $500,000,
determining that the increased threshold will not pose a threat to the
safety and soundness of supervised financial institutions. \4\
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\4\ Board of Governors of the Federal Reserve System, ``Federal
Banking Agencies Issue Final Rule to Exempt Commercial Real Estate
Transactions of $500,000 or Less From Appraisal Requirements'', news
release, April 2, 2017, www.federalreserve.gov/newsevents/
pressreleases/bcreg20180402a.htm.
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Over the past several years, the Federal Reserve has also
instituted various measures to clarify and streamline its overall
approach to the supervision of community and regional banks in
particular. For example, the Federal Reserve implemented a program it
calls Bank Exams Tailored to Risk, or the BETR program. BETR uses
financial metrics to differentiate the level of risk between banks
before exams and ensure that examiners tailor examination procedures to
minimize the regulatory burden for firms that engage in low-risk
activities, while subjecting higher-risk activities to more testing and
review. The Federal Reserve has also shifted a significant amount of
its examination activity offsite to address concerns from community
banks about burden.
We have also implemented less complex and burdensome examination
approaches in the supervision of regional banking organizations with
assets between $10 and $50 billion. For example, we have streamlined
procedures to reduce the burden associated with assessing compliance
with Dodd-Frank Wall Street Reform and Consumer Protection Act company-
run stress testing requirements and decreased reporting burden by
refining our tools for assessing liquidity positions at these banking
organizations and eliminating the quarterly FR Y2052(b) liquidity
report.
Finally, the Board has begun a broad review to identify ways to
increase the efficiency of the applications process, which we expect to
reduce processing times for certain types of applications.
Transparency
Transparency is central to the Federal Reserve's mission, in
supervision no less than in monetary policy. In addition to
transparency being a core requirement for accountability to the public,
there are valuable, practical benefits to transparency around
rulemaking: even good ideas can improve as a result of exposure to a
variety of perspectives.
A prime example of the Board's efforts to increase transparency was
its release for public comment of an enhanced stress testing
transparency package late last year. \5\ The Board issued the package
in response to feedback from firms that there should be greater
visibility into the supervisory models that often determine their
binding capital constraints, as well as questions from analysts,
investors, academics, and others who want to better understand details
of how the Federal Reserve's supervisory stress tests work in practice.
We are continuing to think about how we can make the stress testing
process more transparent without lowering the strength of the test
itself or undermining the usefulness of the supervisory stress test. I
personally believe that our stress testing disclosures can go further,
and that we should consider additional measures, such as putting our
stress scenarios out for comment. My colleagues and I on the Board will
be paying particularly close attention to comments on how we might
improve the current proposal.
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\5\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Requests Comment on Package of Proposals That Would
Increase the Transparency of Its Stress Testing Program'', news
release, December 7, 2017, www.federalreserve.gov/newsevents/
pressreleases/bcreg20171207a.htm.
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Looking ahead, we are also in the process of developing a revised
framework for determining ``control'' under the Bank Holding Company
Act. This framework would be more transparent, simpler to understand,
easier to apply, and would liberalize some existing limitations. A
clearer set of standardized rules should facilitate the raising of
capital by banks, particularly community banks where control issues are
generally more prevalent, and noncontrolling investments by banking
organizations in nonbanking companies.
Simplicity
The third principle that should guide an assessment of our current
framework, simplicity, is about promoting public understanding and
compliance by the industry with regulation. Confusion and compliance
burden that results from overly complex regulation does not advance the
goal of a safe financial system. The Federal Reserve has worked to
simplify the vast and often complex postcrisis regulatory framework in
several different ways. The most recent example was the issuance of the
proposed stress capital buffer rulemaking just last week. \6\ The
proposal would effectively integrate the results of the supervisory
stress test into the Board's nonstress capital requirements. Doing so
would result in a much simpler capital framework overall while
maintaining its risk-sensitivity. For example, for the largest bank
holding companies, the number of required loss absorbency ratios would
be reduced from 24 to 14. While the proposal would result in burden
reduction for both firms and supervisors, the proposed changes would
generally maintain or increase the minimum risk-based capital required
for G-SIBs (although no firm would be required to raise capital, since
all firms currently maintain capital above these minimum levels) and
generally modestly decrease the amount of risk-based capital required
for most non- G-SIBs. Note, however, that a firm's stressed capital
requirement is expected to vary in size throughout the economic cycle.
---------------------------------------------------------------------------
\6\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Seeks Comment on Proposal To Simplify Its Capital Rules
for Large Banks While Preserving Strong Capital Levels That Would
Maintain Their Ability To Lend Under Stressful Conditions'', news
release, April 10, 2018, www.federalreserve.gov/newsevents/
pressreleases/bcreg20180410a.htm.
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Let me turn to the Volcker rule. Many within and outside of the
industry have said that this is an example of a complex regulation that
is not working well. While the fundamental premise of the rule is
simple, the implementing regulation is exceedingly complex. Our fellow
regulators are working actively with the Federal Reserve in seeking
ways to further tailor implementation of the Volcker rule and to reduce
burden, particularly for firms that do not have large trading
operations and do not engage in the sorts of activities that may give
rise to proprietary trading.
Also with regard to large financial institutions, last year we
issued for comment a proposal that would simplify the Board's ratings
system by reducing the number of ratings. The proposed ratings system
would be better aligned with the Board's postcrisis supervisory program
for large financial institutions, which will allow us to target our
supervisory messaging to those areas of greatest concern. \7\
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\7\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Invites Public Comment on Two Proposals; Corporate
Governance and Rating System for Large Financial Institutions'', news
release, August 3, 2017, www.federalreserve.gov/newsevents/
pressreleases/bcreg20170803a.htm.
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Our simplification efforts have, of course, also extended to our
supervision and regulation of smaller community banks. For example, in
its continuing efforts to reduce data reporting and other burdens for
small financial institutions, the U.S. banking agencies implemented a
new streamlined Call Report form for small financial institutions in
2017. \8\ Applicable to financial institutions with less than $1
billion in total assets, the streamlined reporting form removed
approximately 40 percent of the nearly 2,400 data items previously
included. The agencies have also proposed further streamlining of this
Call Report. The cumulative effect would implement burden-reducing
revisions to approximately 51 percent of the data items previously
reported by small banks.
---------------------------------------------------------------------------
\8\ Federal Financial Institutions Examination Council (FFIEC),
``FFIEC Finalizes June 2017 Proposed Revisions To Streamline the Call
Report'', news release, January 3, 2018, www.ffiec.gov/press/
pr010318.htm.
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International Engagement
Finally, I would like to briefly touch upon the Federal Reserve's
engagement with our foreign counterparts. As the supervisor of both
U.S. banks operating overseas and foreign banks operating in the United
States, we continue to maintain effective working relationships with
our foreign supervisory counterparts, including through our
participation in the Financial Stability Board (FSB) and the Basel
Committee on Banking Supervision (BCBS). Our engagement with foreign
bank regulators aids in promoting global financial stability and a more
level playing field for our supervised firms. Let me note that I
believe transparency in these process is important, and I support the
BCBS's efforts to increase the transparency of its international
standard setting. With respect to more specific initiatives of each of
these bodies, I also expect to implement the BCBS's recently completed
package of reforms, which conclude its postcrisis capital standard
reforms. I also want draw the Committee's attention to the FSB's recent
statement, which I fully support, that now is the appropriate time to
pivot focus from new policy development toward evaluating policies that
have been implemented to ensure the reforms are efficient and effective
and to address any unintended consequences.
Conclusion
The reforms we have adopted since the financial crisis represent a
substantial strengthening of the Federal Reserve's regulatory framework
and should help ensure that the U.S. financial system remains able to
fulfill its vital role of supporting the economy. As I have outlined,
the Board has already taken steps to increase the effectiveness of the
framework currently in place by improving its efficiency, transparency,
and simplicity. There are other areas where I believe that we can
increase the framework's effectiveness, and we will look to do so where
we are confident that we still have all appropriate tools needed to
maintain the gains in safety and soundness made over the past several
years.
At the same time, it is critical that we continue to monitor for
emerging risks affecting the financial system. This calls for better
analysis and more agility by supervisors in identifying emerging risks,
as well as vigilance against complacency. We will do everything we can
to fulfill the responsibility that has been entrusted to us by the
Congress and the American people.
Thank you again for the opportunity to testify before you this
morning, and I look forward to answering your questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM RANDAL K. QUARLES
Q.1. Would removing the Supplemental Leverage Ratio (SLR) from
the Comprehensive Capital Analysis and Review (CCAR), as
proposed in the Board of Governors of the Federal Reserve
System's (Fed) Stress Capital Buffer (SCB) proposal, \1\ shift
the binding constraint on capital distributions from leverage
capital to risk-based capital for any of the domestic Global
Systemically Important Banks (G-SIBs)?
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\1\ https://www.federalreserve.gov/newsevents/pressreleases/files/
bcreg20180410a2.pdf
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If so, which ones?
A.1. As a general matter, leverage capital requirements should
serve as a backstop to risk-based capital requirements in order
to reduce incentives for firms to increase their exposure to
riskier assets. The Federal Reserve Board's (Board) stress
capital buffer (SCB) proposal would currently extend the
proposed stress buffer concept to the tier I leverage ratio,
but not to the supplementary leverage ratio (SLR). The Board is
seeking public comment on the advantages and disadvantages of
both of these specific aspects of the proposal (i.e., the
elimination of the post stress SLR but retention of the tier 1
leverage ratio; see questions 1 and 3 in the preamble of the
proposed rulemaking). \2\
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\2\ See 83 FR 18160, 18166-7 (April 25, 2018).
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The Board included an impact analysis as part of the
proposal. Due to the confidential nature of certain data (e.g.,
firms' future capital distribution plans) that were used to
develop the impact analysis, the proposal only describes the
aggregate impact. The impact of the proposal on individual
firms would vary based on each firm's individual risk profile
and planned distributions, as well as across time based on the
severely adverse stress scenario used in the supervisory stress
test.
Q.2. How would common equity tier 1 (CET1) capital and total
distributable capital change for each of the domestic G-SIBs
under the Fed's proposed SCB rule? Please provide firm by firm
numbers.
A.2. As noted in the response to Question 1 above, due to the
confidential nature of the supervisory data included in the
projected impact of the proposal on individual firms, the Board
is not in a position to provide firm-specific estimates.
The proposal would generally maintain or in some cases
increase common equity tier 1 (CET1) capital requirements for
global systemically important banks (G-SIBs). The estimated
increase for G-SIBs would occur because the capital
conservation buffer requirement under the proposal--which, for
a G-SIB, includes both the SCB requirement and the G-SIB
surcharge--would be greater than the capital required under the
current supervisory poststress capital assessment.
Based on data from Comprehensive Analysis and Reviews
(CCAR) in 2015, 2016, and 2017, CET1 capital requirements for
G-SIBs are projected to increase by approximately $10 billion
to $50 billion in aggregate. Had the proposal been in effect
during recent CCAR exercises, analysis of those CCAR results
and the current level of capital at the G-SIBs indicates that
no such firm would have needed to raise additional capital in
order to avoid the proposal's limitations on capital
distributions.
Q.3. Please review the attached analysis from Goldman Sachs
equity research. Does the Fed agree that the SCB proposal would
lead to an excess capital increase of $54 billion across the
large banks the research report considered?
A.3. For firms with over $50 billion in assets that are not G-
SIBs, the Board estimates that the proposal would generally
result in a reduction in the required level of capital to avoid
capital distribution limitations relative to what is required
today. This estimated reduction is attributable to the
proposal's modified assumptions regarding balance sheet growth
and capital distributions. While these assumptions would more
appropriately reflect the expected performance of bank
portfolios under stress, they would be somewhat less stringent
than the assumptions currently used in the supervisory stress
test. As noted above, for G-SIBs, the proposal would generally
maintain or in some cases increase CET1 capital requirements.
The impact of the proposal would vary through the economic
and credit cycle based on the risk profile and planned capital
distributions of individual firms, as well as on the specific
severely adverse stress scenario used in the supervisory stress
test. Based on data from CCAR 2015, 2016, and 2017, the impact
of the proposal would range from an aggregate reduction in CET1
capital requirements of about $35 billion (based on 2017 data)
to an aggregate increase in CET1 capital requirements of about
$40 billion (based on 2015 data). More specifically, G-SIBs
would have experienced an increase in CET1 capital requirements
ranging from $10 billion to $50 billion, while non- G-SIBs
would have experienced a decrease in CET1 capital requirements
ranging from $10 billion to $45 billion. Had the proposal been
in effect during recent CCAR exercises, analysis of those CCAR
results indicates that participating firms would not have
needed to raise additional capital in order to avoid
limitations on capital distributions.
The analysis from Goldman Sachs seems to make additional
assumptions about how banks might respond to the SCB proposal.
Our estimates describe the changes in the actual level of
capital that would be required under the proposal.
Q.4. If the goal of the Fed's SCB proposal is to integrate CCAR
with ongoing capital requirements, please provide the Fed's
rationale for excluding the SLR as a binding constraint in the
SCB proposal.
A.4. Leverage capital measures work best when they serve as a
backstop to risk-based capital measures in the context of a
comprehensive capital regime. When leverage measures are
binding constraints, they serve as an incentive for regulated
institutions to increase the risk in their portfolios (because
the capital cost for each additional asset will be the same
whether the asset is risky or safe--institutions will thus have
an incentive to add high risk/high return assets because the
capital cost of those assets is the same as that of lower
return but safer assets). We should try to ensure that the
capital regime does not only result in the retention of a
robust amount of capital, but also that the structure of the
regime does not create unintended incentives for firms to take
on risk.
The SCB proposal currently proposes to introduce a stress
leverage buffer requirement on top of the 4 percent minimum
tier 1 leverage ratio requirement but not extend the stress
buffer requirement to the SLR. As noted in the response to
question 1 above, the Board is seeking comment on the
advantages and disadvantages of these specific aspects of the
proposal.
Q.5. Why did the Fed choose not to include the enhanced SLR
(eSLR) in the SCB proposal?
A.5. The enhanced supplementary leverage ratio (eSLR) standards
apply in the Board's regulatory capital rule to G-SIBs and
their insured depository institution (IDI) subsidiaries. Under
the current CCAR program, the Board evaluates the ability of
each of the largest bank holding companies to maintain capital
above minimum regulatory capital requirements under expected
and stressful conditions, assuming that a firm makes all
planned capital actions that are in its capital plan. As it is
a buffer concept, the eSLR standards are not, and have never
been, included in the Federal Reserve's stress testing
framework.
With regard to the Board's SCB proposal not extending the
stress buffer concept to the supplementary leverage ratio,
please see the response to Question 4 above.
Q.6. The Fed's eSLR proposal would reduce the amount of tier 1
capital required across the lead insured depository institution
(IDI) subsidiaries of the G-SIBs by approximately $121 billion.
\3\
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\3\ https://www.gpo.gov/fdsys/pkg/FR-2018-04-19/pdf/2018-08066.pdf
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How would that $121 billion be deployed by bank holding
companies if this proposal were enacted?
A.6. The Board estimates that, taking into account the capital
constraints imposed by the supervisory stress tests and the
Board's regulatory capital rules, the proposed changes to the
eSLR standards would reduce the amount of tier 1 capital
required across the U.S. G-SIBs on a consolidated basis by
approximately $400 million. Thus, nearly all of the $121
billion would be required to remain within the consolidated
banking organization, as the G-SIBs would not be able to
distribute the capital released at the IDI level. Each
individual G-SIB would be able to determine how to reallocate
capital, based on its business model or needs within the
organization. For example, each G-SIB could continue to hold
the capital at the IDI, deploy that capital to nonbank
subsidiaries, or hold that capital at the holding company level
to use as needed.
Q.7. The proposed rulemaking for the Fed's eSLR proposal asks
commenters for their views on excluding central bank deposits
from the denominator of the SLR, but unlike section 402 of S.
2155, does not narrow the question strictly to custody banks.
Is the Fed considering excluding central bank deposits from
the denominator of the SLR for all banks (custody and
noncustody)?
A.7. The Board and the Office of the Comptroller of the
Currency's (OCC) eSLR proposal is based on the current
definitions of tier 1 capital and total leverage exposure,
which include central bank deposits in the denominator of the
SLR. However, the Board and the OCC thought it appropriate
generally to seek commenters' views on alternatives to the
proposal, including the exclusion of central bank deposits from
the denominator. The Board will consider all comments received
in connection with the proposal.
Q.8. Please provide firm-by-firm analysis for each domestic G-
SIB on the combined impact on total distributable capital
related to both the SCB and eSLR proposals.
A.8. As noted in the response to question I above, due to the
confidential nature of the supervisory data included in the
projected impact of the proposals on individual firms, the
Board has made only aggregate impact data publicly available.
The estimated impacts of the SCB proposal and of the eSLR
proposal across G-SIBs are described above in the response to
Question 2 and Question 6, respectively.
While the discussion in each of the SCB proposal and the
eSLR proposal reflects the estimated impact of those individual
proposals relative to current requirements, in developing the
proposals; the combined impact was also considered. Factoring
the relatively immaterial estimated reduction in required tier
1 capital across G-SIBs under the eSLR proposal ($400 million,
as noted above in response to Question 6) into the estimated
impact of the SCB proposal across G-SIBs does not meaningfully
affect the estimates.
Q.9. During your testimony before the House Financial Services
Committee, you indicated a desire to change the G-SIB surcharge
methodology, perhaps based on the result of a bank holding
company's living will submission.
Can you elaborate on this idea? \4\
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\4\ Response to a question from Congressman Hollingsworth. House
Financial Services Committee Hearing. ``Semi-Annual Testimony on the
Federal Reserve's Supervision and Regulation of the Financial System''.
April 17, 2017.
A.9. The G-SIB surcharge was calibrated so that each G-SIB
would hold enough capital to lower its probability of failure
so that the expected impact of its failure would be
approximately equal to that of a non- G-SIB. The Board monitors
the impact of its regulations after implementation to assess
whether the regulations continue to function as intended. As I
have noted more broadly, such a review should have as a goal
not only maintaining safety and soundness and financial
stability, but also efficiency, transparency, and simplicity.
In the preamble to the G-SIB surcharge final rule, the Board
indicated that it would be appropriate to reevaluate
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periodically the fixed coefficients used in the rule.
Q.10. Has the Fed considered the potential interaction between
this idea, the proposed rule changing the eSLR, and the Fed's
intention to make living will submissions required every other
year, rather than annually? \5\
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\5\ https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20171219a.htm
A.10. The Board's capital rules have been designed to
significantly reduce the likelihood and severity of future
financial crises by reducing both the probability of failure of
a large banking organization and the consequences of such a
failure were it to occur. Capital rules and other prudential
requirements for large banking organizations should be set at a
level that protects financial stability and maximizes long-
term, through-the-cycle, credit availability and economic
growth. At the same time, the Board recognizes that prudential
requirements should be tailored to the size, risk, and
complexity of the firms subject to those requirements. In this
regard, the Board is considering additional potential
modifications to its rules, including both the capital rule and
the living will rule, to simplify the rules and reduce
unnecessary regulatory burden without compromising safety and
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soundness.
Q.11. Earlier this year in Tokyo, you gave a speech describing
the strength of the U.S. economy, noting growing optimism,
solid bank earnings, the tax bill, and the strong labor market.
\6\
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\6\ https://www.federalreserve.gov/newsevents/speech/files/
quarles20180222a.pdf
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If the economy is strong, isn't now the time to impose a
Countercyclical Capital Buffer that banks can draw on when the
economy eventually gets tough?
A.11. The countercyclical capital buffer (CCyB) is an important
element of the system of capital regulation that applies to
U.S. bank holding companies with more than $250 billion in
total assets or more than $10 billion in foreign assets, as
well as intermediate holding companies of foreign banking
organizations with more than $50 billion in total assets.
In 2016, the Federal Reserve issued a policy statement on
the CCyB, in which we spelled out a comprehensive framework for
setting its level. The framework incorporates the Board's
judgment of not only asset valuations and risk appetite, but
also the level of three other key financial vulnerabilities--
financial leverage, nonfinancial leverage, and maturity and
liquidity transformation--and how all five of those
vulnerabilities interact. In this assessment, the Board
considers a wide array of economic and financial indicators, as
well as a number of statistical models developed by staff.
Several of those models are cited in the policy statement. As
indicated in the policy statement, the CCyB is intended to
address elevated risks from activity that is not well-supported
by underlying economic fundamentals. As such, the Board expects
the CCyB to be nonzero if overall vulnerabilities were judged
to have risen to a level that was ``meaningfully above
normal.''
Within that framework, the runup in asset prices that we
have seen in recent years is certainly a key consideration, but
we view that run up in the context of the levels of other
vulnerabilities, importantly including leverage and maturity
transformation in the financial system. Bank capital ratios and
liquidity buffers are now substantially higher than they were a
decade ago. The stress tests ensure that the largest banks can
continue to support economic activity even in the face of a
severe recession--importantly, one characterized by extreme
declines in asset prices. Outside the banking system, leverage
of other financial firms does not appear to have risen to
elevated levels, and the risks associated with maturity
transformation by money-market mutual funds is much reduced
from the levels seen a decade ago. Thus, we believe that
overall vulnerabilities in the financial system remain moderate
and near their normal range.
Q.12. Do you agree that procyclical regulation has contributed
to past downturns in the economy?
If so, why not make bank regulations more stringent during
a time when risk appetites in the banking sector are growing?
\7\
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\7\ https://www.wsj.com/articles/financial-deregulation-throws-
fuel-on-already-hot-economy1524654001#comments_sector
A.12. Procyclical regulation certainly may have contributed to
boom and bust cycles in the past. For instance, as house prices
rose from 2000 to 2006, the maximum loan amount of residential
mortgages that could be guaranteed by the Government-sponsored
mortgage enterprises, Fannie Mae and Freddie Mac, increased
from $252,700 to $417,000. In addition, research by Federal
Reserve economists has shown that there is a procyclical
pattern in the assignment of CAMELS ratings to banks by the
Federal banking agencies. Our reforms to bank supervision after
the financial crisis, such as the establishment of the Large
Institution Supervisory Coordinating Committee and the
collection of granular data on loan and securities portfolios,
are designed to better identify and push back against such
tendencies in the future.
Further, to guard against the tendency for lenders to
become less cautious during good economic times, the Federal
Reserve and the other Federal banking agencies have implemented
robust structural capital and liquidity regulation regimes. In
addition to requiring higher ratios of capital to total assets
and to risk-weighted assets, U.S. capital rules have narrowed
the types of instruments that qualified as tier 1 capital, in
order to increase loss absorbency. Likewise, capital rules
place caps on volatile assets, like mortgage servicing rights
and deferred tax assets, above which their amounts must be
deducted from capital. Further, the postcrisis capital rules
increased the risk weights on certain assets, such as high-
volatility commercial real estate, which can be highly
procyclical.
Another feature of the U.S. implementation of the new
capital and liquidity regimes is that the changes were phased
in gradually over several years starting in 2013 in order to
give banks time to adjust to the more-stringent regulations
without unduly influencing credit availability while the
expansion was still relatively weak. Thus, the minimum
requirements have indeed been increasing each year, though most
U.S. banks have been compliant with the fully phased-in
requirements for some time. Most of the requirements will be
fully phased in by January 1, 2019, providing a much stronger
structural backstop than previously against any excesses that
emerge in this and future financial cycles.
Finally, the annual stress tests (that is, CCAR) are based
on macroeconomic scenarios that, in line with the Board's
policy statement on scenario design, become more adverse as
macroeconomic conditions improve. The increased severity of
scenarios in the stress tests during buoyant times is designed
to limit the procyclicality of regulation.
Q.13. Does the Fed have any plans to change the total
consolidated asset threshold above which CCAR applies to bank
holding companies?
A.13. We are considering a number of potential changes to our
regulatory framework in light of the passage of S. 2155,
including raising the asset threshold for CCAR.
Q.14. Will this at all change if S. 2155 is enacted?
A.14. As noted, we are considering potential changes to our
regulatory framework in light of the passage of S. 2155.
Q.15. How often does the Fed plan to require Dodd-Frank Act
supervisory stress tests for banks with total consolidated
assets between $100 billion and $250 billion if the change from
``annual'' to ``periodic'' is enacted pursuant to S. 2155?
A.15. Supervisory stress tests are one of our most valuable
tools to ensure that large banking firms have sufficient
capital to continue to lend and operate, even in a severely
adverse macroeconomic scenario. Continuing to conduct the
supervisory stress tests for institutions with more than $100
billion in assets will provide the Federal Reserve with
valuable insight into the state of the American economy.
The dynamic nature of banks and the risks they face could
render the results of stress tests stale within a short
timeframe. Accordingly, we believe there are safety and
soundness and financial stability benefits in conducting
capital stress tests regularly. We plan to consider the
appropriate timing of stress tests for banks with total
consolidated assets between $100 billion and $250 billion as we
consider other potential changes to our regulatory framework
for the largest and most complex banks.
Q.16. How often does the Fed plan to require company-run stress
tests for banks with total consolidated assets of more than
$250 billion if the change from ``semi-annual'' to ``periodic'
is enacted pursuant to S. 2155?
A.16. Company-run stress tests have served as a useful
complement to supervisory stress tests. They are another tool
to assess whether banks sufficient capital to continue
operations throughout times of economic and financial stress.
In our experience, there are safety and soundness and financial
stability benefits in conducting capital stress tests
regularly.
As with supervisory stress tests, the dynamic nature of
banks and the risks they face could render the results of
stress tests stale within a short timeframe. Accordingly, as we
implement S. 2155, we will consider the appropriate timing of
company run stress tests for banks with more than $250 billion
in consolidated assets. We would take into account the tradeoff
between firms having less recent information about their risks
and their resilience to economic stress, and the reduced burden
of less frequent stress tests.
Q.17. In testimony before the House Financial Services
Committee, you proposed subjecting CCAR stress scenarios to
notice and comment, but noted that a formal process under the
Administrative Procedures Act (APA) may be unworkable. How does
the Fed contemplate putting CCAR scenarios out for comment
without following a formal APA process? \8\
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\8\ Response to a question from Congressman Barr. House Financial
Services Committee Hearing. ``Semi-Annual Testimony on the Federal
Reserve's Supervision and Regulation of the Financial System''. April
17, 2017.
A.17. The Board regularly considers feedback on its stress
testing process and scenario design, including through the
public notice and comment process, and we're currently
reviewing comments on proposed amendments to the policy
statement on scenario design.
In addition, the Board publishes a summary of its stress
testing methodologies each year. The methodology has included
information about the supervisory scenarios, analytical
framework, and information about the models employed in the
stress test. The Board has sought comment on a policy statement
on the overall approach to stress testing as well as a
description of our model risk management and governance
framework. The Federal Reserve is considering how best to
publish the CCAR scenarios for public comment in a manner that
is consistent with the rulemaking procedures in the
Administrative Procedure Act and the timelines set forth in the
Federal Reserve's capital plan and stress testing rules.
Q.18. What problem would putting CCAR scenarios out for comment
solve?
A.18. The Federal Reserve remains committed to finding ways to
continue to enhance transparency in a manner that appropriately
balances the benefits and risks of releasing more information
about supervisory models and scenarios used in CCAR.
Putting the CCAR scenarios out for comment would provide an
opportunity for the Federal Reserve to learn about unintended
consequences of the scenarios and ways of improving the overall
stress testing process.
Q.19. In a speech, you said that the Fed should ``revisit'' the
so-called advanced approaches threshold, which identifies
certain large banks whose failure could inflict especially
significant damage on the U.S. economy. \9\ In the Senate
Banking Committee hearing, you told the Committee that you
would hold off on revising the advanced approaches threshold
until Congress moves. \10\
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\9\ https://www.federalreserve.gov/newsevents/speech/
quarles20180119a.htm
\10\ Response to a question from Senator Tillis. Senate Banking,
Housing, and Urban Affairs Committee Hearing. ``Semi-Annual Testimony
on the Federal Reserve's Supervision and Regulation of the Financial
System''. April 19, 2017.
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How could enactment of S. 2155 affect the Fed's decision to
revise the advanced approaches threshold?
Is the Fed considering raising the advanced approaches
asset threshold to a level that is higher than $250 billion?
What changes to the foreign exposure threshold is the Fed
considering?
A.19. The advanced approaches threshold was established on an
interagency basis with the Federal Deposit Insurance
Corporation (FDIC) and OCC, and is relevant for multiple
elements of the Board's regulatory framework, including capital
requirements, the liquidity coverage ratio rule, and related
reporting requirements. The Board believes that capital and
other prudential requirements for large banking organizations
should be set at a level that protects financial stability and
maximizes long-term, through-the-cycle credit availability and
economic growth. At the same time, the Board recognizes that
prudential requirements should be tailored to the size, risk,
and complexity of the firms subject to those requirements and
is considering ways to adjust its regulations that will
simplify rules and reduce unnecessary regulatory burden without
compromising safety and soundness. We currently are considering
ways to better align the advanced approaches threshold with
these objectives, which could include changing both the total
asset and foreign exposure thresholds, and would take S. 2155
into account. Any proposed changes to the threshold would be
issued for public notice and comment after consultation with
the FDIC and OCC.
Q.20. Is it your opinion that the domestic asset threshold
above which foreign banking organizations (FBOs) must establish
an Intermediate Holding Company (IHC) should increase from $50
billion?
If so, what is the appropriate threshold?
A.20. The Board monitors the impact of its regulations after
implementation to assess whether the regulations continue to
function as intended. In implementing enhanced prudential
standards for foreign banking organizations (FBOs) with a large
U.S. presence, the Board sought to ensure that FBOs hold
capital and liquidity in the United States--and have a risk
management infrastructure--commensurate with the risks in their
U.S. operations. As a result of the intermediate holding
company requirement with the current threshold, these firms
have become less fragmented, hold capital and liquidity buffers
in the United States that align with their U.S. footprint, and
operate on more equal regulatory footing with their domestic
counterparts and we should ensure that these results continue.
Q.21. The Fed in 2016 proposed a rule to limit some of banks'
activities in commodities markets, with the rationale being
that banks' owning, trading, and moving commodities might post
a safety and soundness risk to individual banks or to the
banking system. \11\
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\11\ https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20160923a.htm
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Does the Fed plan to finalize the 2016 commodities
proposal?
If not, why not?
If so, when?
A.21. The Board began its review of the physical commodities
activities of financial holding companies after a substantial
increase in these activities among financial holding companies
during the financial crisis. In January 2014, the Board invited
public comment on a range of issues related to these activities
through an Advance Notice of Proposed Rulemaking. In response,
the Board received a large number of comments from a variety of
perspectives. The Board considered those comments in developing
the proposed rulemaking that was issued in September 2016.
After providing an extended comment period (150 days) to allow
commenters time to understand and address the important and
complex issues raised by the proposal, the Board again received
a large number of comments from a variety of perspectives,
including Members of Congress, academics, users and producers
of physical commodities, and banking organizations. The Board
continues to consider the proposal in light of the many
comments received (and to monitor the physical commodities
activities of financial holding companies).
Q.22. S&P Global warned earlier this month that leveraged
lending standards were deteriorating, and that underwriting
standards in this $1 trillion market continue to get weaker and
weaker. \12\ Previously, guidance was in place to protect
banking organizations from leveraged lending risks, but while
at the OCC, Acting Comptroller Noreika rescinded it. You have
also said that this guidance, because it was declared a rule by
the GAO, is ``not something that should be cited in supervisory
action or taken into account by examiner.'' \13\
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\12\ https://www.ft.com/content/680953c0-3e2a-11e8-b9f9-
de94fa33a81e
\13\ https://www.americanbanker.com/news/feds-quarles-to-seek-
more-tailoring-of-large-bank-rules
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How do you plan to protect banks from systemic risk
stemming from leveraged lending if you're telling supervisors
to ignore this guidance?
Does the Fed have plans to replace the leveraged lending
guidance with a proposed rule?
A.22. The Board has broad authority to supervise and regulate
banking organizations to promote their safety and soundness. As
part of that authority, Federal Reserve supervisors and
examiners assess credit and other risks to the safe and sound
operations of firms, including risks that may be posed by
leveraged lending, and to direct the films to address such
risks as appropriate. As part of assessing credit and other
risks, Federal Reserve examiners routinely evaluated the
underwriting of leveraged loans prior to the issuance of the
most recent leveraged lending guidance, and they continue to do
so. The guidance was issued to provide clarity regarding safety
and soundness issues that may be present in making such loans.
The guidance was not issued as a regulation that would be
enforceable, and therefore the guidance itself should not be
used as the basis for an enforcement or supervisory action.
Rather, banking organizations should use it to better
understand and manage the risks they are taking, and
supervisors should assess a bank's standing under comprehensive
principles of safety and soundness rather than pursuant to
informal guidance.
Thus, ensuring the guidance is being used in the manner
always intended is not telling examiners to ``ignore'' the
guidance nor is it changing the safety and soundness standard
that has always governed the evaluation of a bank's loan
portfolio. To the contrary, we continue to expect that
examiners will evaluate leveraged loans to determine whether
they are posing undesirable amounts of risk in a bank's
portfolio.
The Board, FDIC, and OCC are discussing whether it would be
appropriate to again solicit public comment on the guidance
with a view to improving the clarity and reducing any
unnecessary burden.
Q.23. Publicly you asserted that you believe the Volcker Rule
has damaged financial markets. \14\
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\14\ https://www.marketwatch.com/story/volcker-rule-is-harmful-to-
capital-markets-feds-top-regulator-says-2018-04-17
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What evidence can you point to that indicates the Volcker
Rule has had a causal impact on liquidity?
Is there a range of optimal liquidity?
A.23. Federal Reserve staff and a variety of other researchers
have performed substantial analyses of the recent state of
financial markets and liquidity in particular. While overall
results of these studies are mixed, there are findings
suggesting that the Volcker Rule has had an impact on
liquidity. For example, one recent study finds evidence that
cost of trading distressed corporate bonds (i.e., bonds
recently downgraded to below investment-grade ratings) is
higher since implementation of the Volcker Rule. \15\
Furthermore, the paper finds that broker dealers subject to the
Volcker Rule appear less willing to hold inventories of
corporate bonds relative to other broker dealers. Taken
together, these results indicate that the Volcker Rule has had
an adverse impact on the liquidity of distressed corporate
bonds. Other studies indicating a causal relationship between
the Volcker Rule and reduced liquidity in some markets or for
some instruments include Dick-Nielsen and Rossi (2016); Choi
and Huh (2016); Bessembinder, Jacobsen, Maxwell, and
Venkataraman (2016); and Adrian, Boyarchenko, and Shachar
(2016). \16\
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\15\ Bao, Jack, and O'Hara, Maureen, and Zhou, Xing (Alex), ``The
Volcker Rule and Market-Making in Times of Stress'' (December 8, 2016).
Journal of Financial Economics (JFE), Forthcoming; Fourth Annual
Conference on Financial Market Regulation. Available at SSRN: https://
ssrn.corn/abstract=2836714 or http://dx.doi.org/10.2139/ssrn.2836714.
\16\ Dick-Nielsen, J., and M. Rossi (2016), ``The Cost of
Immediacy for Corporate Bonds'', Copenhagen Business School Working
Paper; Choi, J., and Y. Huh (2016), ``Customer Liquidity Provision:
Implications for Corporate Bond Transaction Costs'', Bessembinder, H.,
S. Jacobsen, W. Maxwell, and K. Venkataraman (2016), ``Capital
Commitment and Illiquidity in Corporate Bonds'', Working Paper,
Southern Methodist University; Adrian, T., N. Boyarchenko, and O.
Shachar (2016), ``Dealer Balance Sheets and Bond Liquidity Provision'',
Federal Reserve Bank of New York Staff Report, 803.
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The Federal Reserve and the four other Volcker regulatory
agencies (OCC, FDIC, the Securities and Exchange Commission and
the Commodity Futures Trading Commission) recently issued a
proposal that would simplify and streamline the rule to further
tailor and reduce burden for firms. For example, the proposal
would simplify compliance for a banking entity engaged in
market-making, by establishing a presumption that trading
activity within appropriately set risk limits is permissible
market making. By reducing the current compliance burden
associated with the rule and improving the availability of key
exemptions like market-making, the simplified proposal, if
finalized, should promote increased market liquidity.
Q.24. Without disclosure of any data regarding the metrics or
banks' positions in covered funds, the public, Congress, and
the markets can do little to confirm that covered banking
entities are complying with the Volcker Rule.
Can the Federal Reserve and the other four regulators
charged with enforcement of the Volcker Rule provide for
greater transparency on the implementation and enforcement of
the Volcker Rule's prohibitions on proprietary trading by
banking institutions?
A.24. The Federal Reserve, along with the four other Volcker
agencies, released rules implementing the statutory
requirements of the Volcker rule in December 2013. These
implementing rules included a number of provisions designed to
ensure compliance by firms, including specific provisions
related to the need for a compliance program, and the
requirement that certain firms report metrics information. The
agencies recently proposed significant revisions to the
regulations implementing the Volcker Rule, including
simplifying the compliance program standards applicable to most
banking entities, and refining the requirements for firms with
large trading operations to report trade-related metrics to the
agencies.
The quantitative trading metrics are an important component
of the agencies' supervisory work to monitor compliance with
the Volcker Rule. The metrics are intended to aid the staffs of
the Agencies in designing and conducting their examinations of
firms' compliance programs and activities subject to the final
rules. The metrics do not, on their own, indicate a violation
of the Volcker Rule. The staffs of the agencies use these
metrics as a tool to help identify instances that may warrant
further investigation to determine whether a violation of the
Volcker Rule has occurred or whether the activity is within a
permitted exemption, such as market making or hedging.
The final rule does not include a provision for public
disclosure of metrics data. Nonetheless, we appreciate the
value of transparency and public accountability, while striking
an appropriate balance between public disclosure and protecting
confidential information. Toward that end, the Federal Reserve
and the four other Volcker regulatory agencies proposed a
simplified and streamlined version of the rule that would
further tailor and reduce burden for firms. The proposal
requested comment regarding the required compliance program and
metrics, in addition to a general request for comment regarding
whether certain types of quantitative metrics information
should be made publicly available. We look forward to
considering all comments received on the proposal.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM RANDAL K. QUARLES
Q.1. I'd like to discuss how the Federal Reserve can encourage
innovation in the financial system. On October 18, 2017, now-
Federal Reserve Chairman Powell gave a speech entitled
``Financial Innovation: A World in Transition'', where he
articulated the promise and the peril of new financial
technologies:
[T]he challenge is to embrace technology as a means of
improving convenience and speed in the delivery of
financial services, while also assuring the security
and privacy necessary to sustain the public's trust . .
. Rapidly changing technology is providing a historic
opportunity to transform our daily lives, including the
way we pay. FinTech firms and banks are embracing this
change, as they strive to address consumer demands for
more timely and convenient payments. A range of
innovative products that seamlessly integrate with
other services is now available at our fingertips. It
is essential, however, that this innovation not come at
the cost of a safe and secure payment system that
retains the confidence of its end users.
To this end, what is the Federal Reserve exploring or doing
to encourage innovation in the financial system in a
responsible but effective manner? This is particularly
important given new innovations in from FinTech companies in
digital currency, the payments systems, artificial
intelligence, and more. For example, could the Federal Reserve
increase the use of no action letters or--as the SEC has done--
authorize limited pilot tests, to gather data on new
technologies or regulatory innovations? Do any of these changes
need statutory authorization?
A.1. The Federal Reserve's general approach to innovation is
that first and foremost, we have a responsibility to ensure
that the institutions subject to our supervision operate in a
safe and sound manner, and that they comply with applicable
statutes and regulations. Within that framework, we have a
strong interest in encouraging socially beneficial innovations
to flourish, while ensuring the risks that they may present are
appropriately managed. We do not want to unnecessarily restrict
innovations that can benefit consumers and small businesses
through expanded access to financial services or greater
efficiency, convenience, and reduced transaction costs.
The Federal Reserve System (System) has generally not
relied on authorizing pilot projects for private entities or
no-action letters, in part due to the necessarily shared nature
of many of our regulatory authorities and mandates, although I
think this is something we should give greater consideration to
in the future. However, within our legal authorities, the
System has sought to encourage responsible innovation in the
financial sector on a number of fronts.
For example, with respect to payment innovation, in 2015 we
issued a call to action for ``Strategies for Improving the U.S.
Payment System''. In the following 2\1/2\ years, hundreds of
organizations and individuals came together in the Federal
Reserve's Faster and Secure Payments Task Forces, to
collaborate on strategies for bringing about a payment system
that features fast, secure, and efficient cross-border
payments. System staff also focus on specific topic areas in
the payment space to help facilitate innovation, such as mobile
payments or distributed ledger technology. In so doing, System
groups routinely engage innovators from the private sector and,
in limited cases, have joined public-private consortia to
deepen the potential for learning.
From an international perspective, the System engages
international organizations that have collaborated on FinTech
issues, such as: the Financial Stability Board (and its
Financial Innovation Network); the Bank for International
Settlements (and related work through its Committee on Payments
and Market Infrastructures, Markets Committee, Committee on the
Global Financial System, and Basel Committee on Banking
Supervision's Task Force on Financial Technology); the
International Organization of Securities Commissions; and the
Financial Action Task Force.
From a domestic bank supervision perspective, the System
has also convened an Interagency FinTech Discussion Forum to
facilitate information sharing between Federal banking
regulators on FinTech consumer protection issues and
supervisory outcomes. System staff have used the Federal
Reserve's publications, such as our ``Consumer Compliance
Outlook'' bulletin, to offer financial institutions and FinTech
firms general guideposts for evaluating risks when considering
the adoption of new technologies.
Most recently, the System has organized two Systemwide
teams of experts tasked with monitoring FinTech and related
emerging technology trends as they relate to our supervisory
and payment system mandates, respectively. The new teams
include representation from all of the Federal Reserve Banks
and has leadership from Federal Reserve Board staff. These
teams routinely meet with banks, large and small nonbank
innovators who may partner with supervised institutions, and
domestic and foreign regulators to gather data on new
technologies and regulatory innovation.
These two new Systemwide teams share the goal of ensuring
that FinTech-related information is disseminated across the
System and informs relevant supervisory, policy, and outreach
strategies.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
FROM RANDAL K. QUARLES
Q.1. In South Dakota, many farmers, ranchers, and manufacturers
use the regulated derivatives markets to manage their risk of
price variations. It is important that they are able to access
these derivative markets in a cost effective manner. Many of
the service providers for these farmers, ranchers, and
manufacturers are banks.
When an end user accesses the cleared markets through a
bank, it must provide margin, in the form of highly liquid
assets, such as cash, that is kept in the name of the client
for use in the event the client cannot meet its payment
obligations.
Margin collected from the end user for the purpose of
clearing their derivatives is thus exposure reducing for the
banks, yet the leverage ratio still does not recognize it as
such.
Do you plan to recognize initial margin as offsetting under
the leverage ratio?
A.1. We understand that this offset is proposed for European
banks.
Q.2. Won't a lack of offset potentially put U.S. banks at a
disadvantage for the client clearing businesses?
A.2. Clearing improves safety for end users and has been
recognized by policymakers as such.
Q.3. Wouldn't recognizing client margin under the leverage
ratio incentive clearing?
A.3. Leverage capital requirements, such as the supplementary
leverage ratio, require banking organizations to hold a minimum
amount of capital against all on-balance sheet assets and
certain off-balance sheet exposures. Many banks hold cash
customer margin on their own balance sheet. Leverage capital
requirements by design cap the debt-to-equity ratio at a bank
without regard to the risk of individual exposures, and this
practice of banks placing initial margin on their own balance
sheets results in a capital charge against those assets.
Nevertheless, the purpose of, and protections around, the
funds used as initial margin does indicate that we should look
closely at adjusting the treatment of initial margin under the
leverage ratio. In my view, this is less because those assets
are not risky--the whole point of the leverage ratio is that it
applies regardless of risk--but rather because in a number of
important ways those assets are not really the bank's assets at
all, notwithstanding being placed on the balance sheet.
Finally, the Federal Reserve Board (Board) believes that it is
important for leverage capital requirements generally to act as
a backstop to risk-based capital requirements. To help ensure
that this relationship is maintained, the Board recently issued
a proposal to recalibrate its enhanced leverage capital
requirements for the largest and most complex banking
organizations. This should reduce the capital cost of client
clearing, and thus the disincentives to these businesses, while
we continue to address the issues identified above.
The exact way in which to adjust the leverage ratio to
reflect this status is complex, however, and is one of a number
of issues that our current capital regime raises for business
involving centrally cleared products. To address potential
unintended consequences of the leverage ratio on client
clearing, in December 2017, the Basel Committee on Banking
Supervision, of which the Board is a member, announced that it
would monitor the impact of the leverage ratio's treatment of
client cleared derivative transactions and review the impact of
the leverage ratio on banks' provision of clearing services and
its effect on central counterparty clearing. The review
involves surveying client clearing market participants to
understand the impact of the leverage ratio on incentives to
centrally clear over-the-counter derivatives.
Q.4. As I wrote to you in my letter dated October 25, 2017, it
is widely accepted that the Current Exposure Method (CEM) is
risk insensitive and does not appropriately measure the
economic exposure of a listed option contract.
Not surprisingly, the Treasury Report on Capital Markets
recommended both a longer term move to the Standardized
Approach for Counterparty Credit Risk (SA-CCR), as well as a
``near-term'' solution. At a hearing held by the House
Financial Services Committee on April 17, 2018, you indicated
that the Federal Reserve was working on the longer term
solution of a rulemaking to replace CEM with SA-CCR.
Although I believe the Federal Reserve should be working on
a near-term solution in addition to a rulemaking, can you
provide a date by which the rulemaking will be proposed and
when the move to SA-CCR will be effective?
A.4. The Board is working expeditiously to implement the
standardized approach for measuring counterparty credit risk
(SA-CCR) in the United States. Our aim is to issue a SA-CCR
proposal for public comment, jointly with the Federal Deposit
Insurance Corporation and the Office of the Comptroller of the
Currency as soon as feasible. SA-CCR has many benefits. SA-CCR,
as compared to the current exposure method, would allow for
increased recognition of netting and margin and results in a
more risk-sensitive exposure amount for listed option
contracts. We continue to believe that the best way to address
these issues is through a proposal to incorporate SA-CCR into
the Board's regulatory capital rule. The rulemaking process
would allow a wide variety of market participants to consider
the potential impact of SA-CCR and would open the way for its
potential benefits to apply to a wide range of derivative
products.
Q.5. During your confirmation hearing last July I asked you
whether you would support reexamining bank capital standards,
particularly the Supplementary Leverage Ratio or SLR, so that
we can simplify and properly calibrate these capital
regulations.
Reading the proposals the Federal Reserve made on these
issues recently, I want to thank you for taking those concerns
to heart.
The changes the Fed made, particularly the clear message it
sent that the leverage capital standards should not become a
binding capital constraint, will help right-size capital
regulations and allow banks to make loans and service their
customers. As you continue to examine capital regulations, I
want to raise two issues of concern.
First: The proposed capital framework introduces a new
``stress leverage buffer'' for the tier 1 leverage ratio. Like
the SLR, the tier 1 leverage ratio is not tied to the relative
risk of a firm's assets. If the stress leverage buffer becomes
a binding constraint, then it could create incentives for banks
to take on riskier assets and penalize banks with safe balance
sheets.
Second: Currently, stress testing is not subject to public
notice-and-comment rulemaking and changes year-to-year, making
capital planning unpredictable for firms and the market.
I think we would agree that predictable capital standards
and tailoring capital regulations to risk increases the
stability of the financial system.
To that end, will you commit to reviewing the role of
leverage in stress testing and to examine how stress testing
transparency could make capital regulations more predictable?
A.5. The proposed Stress Capital Buffer would not include one
poststress leverage measure (the poststress supplemental
leverage ratio) but, as you note, would include another (the
poststress tier 1 leverage ratio). This feature of the proposal
raises a number of questions, and we are eager for public input
on them. We are currently seeking comments on the proposal, and
will carefully consider any comments we receive, including
those on the stress leverage buffer.
With respect to the publication of the supervisory stress
test models, stress tests are designed to ensure that banks are
holding sufficient capital to not only survive a severe
recession but also continue to lend to creditworthy borrowers
during the stressful period. There is a degree of uncertainty
in forward-looking capital planning. Both the financial system
and the public benefit when firms' capital allocation decisions
account for the possibility of severe but plausible
macroeconomic outcomes.
The Federal Reserve is committed to further increasing the
transparency of the stress testing process to improve the
public's understanding of the supervisory stress test.
Q.6. Custodial banks, which provide safekeeping and related
services to pension funds, mutual funds, endowments, and other
institutional investors, have engaged in substantial dialogue
with the Federal Reserve in recent years to develop a new
standardized capital methodology for agency securities lending
services provided to clients. These discussions have led to the
inclusion of technical changes to these capital rules in the
finalization of the Basel Committee's postcrisis capital
reforms agreed to by the Federal Reserve in December 2017.
When does the Federal Reserve plan to adopt these technical
changes to the capital rules for securities financing
transactions?
Is there an opportunity for the Federal Reserve to propose
rules to implement these technical changes, and perhaps others,
separately and ahead of its longer range plan to solicit public
input on the broader and more substantive capital changes later
this year through the Advanced Notice of Proposed Rulemaking
process?
A.6. As you noted, changes to the capital treatment for
securities financing transactions are included in the Basel
Committee on Banking Supervision's document ``Basel III:
Finalizing Post-Crisis Reforms'' that was issued in December
2017. This document contains a large number of capital changes
that the Basel Committee has stated should be implemented by
2022. The Federal Reserve is aware of the importance of the
changes for securities financing transactions for custodian
banks, as well as for banking organizations that are active in
repo and securities lending markets. The revised treatment of
securities financing transactions in the December 2017 document
is a significant part of the revised framework that would
affect many institutions and their customers.
The Federal Reserve is reviewing the changes with the other
banking agencies to determine the extent to which
implementation in the United States would be appropriate. Any
regulatory changes would occur through the notice and comment
process under the Administrative Procedure Act. As part of this
process, the Federal Reserve will consider how best to
implement any revisions to the United States regulatory capital
framework, including in the order in which changes are made and
whether certain changes are most appropriate as a package with
other changes or separately.
Q.7. South Dakota has long been a leader in the financial
services industry. Given this time of innovation in our banking
system, with many new types of lenders and ``FinTech'' reducing
barriers to entry by expanding financial services products,
emerging companies may need capital investments from entities
that could be impacted by the Volcker rule if those entities
were owned by or partnered with a bank.
Based on comments you made during your testimony before the
House Financial Services Committee on April 17, I understand
that you agree on the need to limit the potential unintended
consequences of the Volcker Rule such that it doesn't limit
private capital's ability help to expand financial services
offerings to consumers.
As you work to refine and update the scope of the Volcker
rule through your notice of proposed rulemaking and other
regulatory efforts, will please you keep new technologies in
mind and keep my colleagues and I on the Senate Banking
Committee updated about your efforts?
A.7. With FinTech, as with any other emerging financial product
or service, the Federal Reserve is closely watching
developments and considering its implications for our
supervisory approach. The Federal Reserve has established a
multidisciplinary working group that is engaged in a 360-degree
analysis of FinTech innovation. We are also engaging with
various FinTech firms to learn more about the industry, its
business models, its technologies, and the opportunities that
it presents. Through these efforts, we continuously assess the
impact of technological development on the Federal Reserve's
responsibilities, including our role as a regulator.
The Federal Reserve and the four other Volcker regulatory
agencies recently issued a Notice of Proposed Rulemaking that
would simplify and streamline the rule to further tailor and
reduce burdens for firms. Throughout that rulemaking process,
we will certainly consider developments in FinTech as well as
all other financial products and services.
Q.8. I appreciate you putting increased attention at the
Federal Reserve on the heightened risk we are facing from
potential cyberattacks. I am encouraged to hear that you are
working with the private-sector to help provide solutions that
will protect our financial sector as a whole. We must be
diligent in protecting our financial institutions and the
customers they serve, and I believe that the best solutions we
can arrive at can be achieved through collaboration.
Can you discuss any steps the Fed has taken to strengthen
the cyberinfrastructure of the financial sector?
A.8. The Federal Reserve is responsible for supervising a
subset of the financial firms that operate the critical
infrastructure. Our supervisory program is primarily designed
to ensure these firms operate in a safe and sound manner.
However, as a member of the Financial and Banking Information
Infrastructure Committee (FBIIC), the Federal Reserve also
evaluates the resiliency of these firms to cyber and other
operational risks that could negatively impact the resiliency
of the financial services sector. The Federal Reserve engages
in interagency activities with other FBIIC members to improve
the cyberresiliency of the financial services sector. The FBIIC
holds periodic cyberincident response simulations, commonly
referred to as exercises, with the FBIIC members, law
enforcement, and industry in order to identify areas of concern
and develop the appropriate means to address them. The
exercises have led to the creation of a number of private-
sector run and public-sector supplied initiatives to enhance
the sector's cyberresiliency, including the development of
incident management and information sharing protocols that
encompass a large percentage of private sector entities.
Additionally, through participation in these exercises, the
Federal Reserve has improved its ability to respond, in
coordination with other financial regulators, to potential
operational disruption in the financial sector's critical
infrastructure.
The Federal Reserve works with other financial regulators,
through the Federal Financial Institutions Examination Council
(FFIEC) and other interagency bodies, to strengthen the
resilience of the financial sector and reduce the potential
impact of a significant cyberincident. The Federal banking
agencies have issued supervisory guidance to help the
institutions under our supervision to become more resilient to
cyberthreats. In addition, the member agencies of the FFIEC
regularly update the FFIEC Information Technology Examination
Handbook, which includes appropriate practices on cyberrisk
management and operational resiliency that can be tailored to
an individual institution's risk profile.
Due to the high degree of interconnection between the U.S.
financial system and global financial system, the Federal
Reserve has been an active participant and leader in
international forums addressing the cyberresiliency of the
global financial sector. Most recently, the Federal Reserve
played a leadership role in the Committee on Payments and
Market Infrastructures (CPMI) development of a strategy for
reducing the risk of wholesale payments fraud related to
endpoint security. The CPMI strategy report, ``Reducing the
Risk of Wholesale Payments Fraud Related to Endpoint
Security'', outlines seven elements that are designed to work
holistically to address all areas relevant to preventing,
detecting, responding to, and communicating about, fraud. The
Federal Reserve made significant contributions to the
``Stocktake of Publicly Released Cybersecurity Regulations,
Guidance and Supervisory Practices'' published by Financial
Stability Board (FSB) and is leading the FSB's efforts to
develop a common cyberlexicon. The Federal Reserve also has a
leadership role in the efforts underway at the Basel Committee
on Banking Supervision to improve the cyberresiliency at
internationally active banks.
At the G7, the Federal Reserve engaged in an initiative to
identify a core set of cyberresilience measures expected across
the global financial sector, which led to the publication of
the G7 ``Fundamental Elements of Cybersecurity for the
Financial Sector''. The publication identifies key elements as
the building blocks upon which an entity can design and
implement its cybersecurity strategy and operating framework.
The Federal Reserve also played a leadership role in the
development of cyberresilience guidance for financial market
infrastructures (FMIs) by CPMI and the International
Organization of Securities Commissions (IOSCO). The CPMI-IOSCO
``Guidance on Cyber Resilience for FMIs'' outlines an
expectation that FMIs must be prepared for the eventuality of
successful attacks and make preparations to respond and recover
critical services safely and promptly.
With regard to the payments infrastructure, the Federal
Reserve is continuing its efforts to identify and provide
information related to fraud risks and advance the safety,
security, and resiliency of the payment system. The Federal
Reserve, in partnership with Boston Consulting Group, is
conducting a study designed to inform industry security-
improvement efforts. The study analyzes payment fraud and
payment system security vulnerabilities. In addition, the
Reserve Banks, as operators of critical financial services such
as Fed wire, continue to advance initiatives aimed at enhancing
the resiliency of the payments system. For example, the Reserve
Banks have implemented risk-mitigating processes, controls, and
technology highly aligned with the aforementioned CPMI strategy
to reduce payments fraud emanating from weak security at the
endpoint (see https://www.newyorkfed.org/newsevents/speeches/
2018/dzi180418).
Q.9. Are there any areas where Congress can be helpful on this
front?
A.9. The Federal Reserve appreciates the heightened focus on
this issue by Congress and recognizes our strong, mutual
interest in the cyberresilience of the financial sector. The
sector's resilience and cyberincident preparedness is evolving
rapidly as more firms join information sharing organizations
and participate in the sector exercise program, allowing them
to develop and test incident protocols and improve their
processes and practices. Through the continued work programs of
interagency groups like the FFIEC and FBIIC, as well as our
partnership with the private sector through the Financial
Services Sector Coordinating Council and the Financial Sector
Information and Analysis Center, the Federal Reserve continues
to advocate for and drive initiatives that strengthen the
financial sector's critical infrastructure. Since the financial
sector has critical dependencies with the energy and
telecommunication sectors, it would be helpful for Congress to
support legislative and other effort to strengthen the
resiliency of these sectors. It would also be helpful for
Congress to support collaborative efforts between these
critical sectors and the intelligence community that are
intended to coordinate our resiliency to cyberthreats posed by
foreign and domestic perpetrators. We would be pleased to
discuss with you further details of the collaboration that is
currently underway and these suggestions.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM RANDAL K. QUARLES
Q.1. Countercyclical Capital Buffer. The IMF Global Financial
Stability Report said that short-term financial stability risks
have been increasing, including vulnerabilities within banks,
funding risks, concerns about a trade war, and the risks of a
too-sharp monetary policy tightening. At the same time, we're
seeing robust global growth and strong corporate earnings, and
credit continues to be widely available. One of the lessons of
the crisis is just how procyclical credit provision can be. As
important as stress testing and risk-based capital requirements
are, they can underestimate weaknesses in underwriting and
other cyclical behaviors that are revealed during bad economic
times.
Given where we are in the economic cycle, and the
significant run up in asset prices that we've seen in recent
years, under what circumstances would you support an increase
in the countercyclical capital buffer from zero?
A.1. The countercyclical capital buffer (CCyB) is an important
element of the system of capital regulation that applies to
U.S. bank holding companies with more than $250 billion in
total assets or more than $10 billion in foreign assets, as
well as intermediate holding companies of foreign banking
organizations with more than $50 billion in total assets.
In 2016, the Federal Reserve issued a policy statement on
the CCyB, in which we spelled out a comprehensive framework for
setting its level. The framework incorporates the Federal
Reserve Board's (Board) judgment of not only asset valuations
and risk appetite, but also the level of three other key
financial vulnerabilities--financial leverage, nonfinancial
leverage, and maturity and liquidity transformation--and how
all five of those vulnerabilities interact. In this assessment,
the Board considers a wide array of economic and financial
indicators, as well as a number of statistical models developed
by staff. Several of those models are cited in the policy
statement. As indicated in the policy statement, the CCyB is
intended to address elevated risks from activity that is not
well-supported by underlying economic fundamentals. As such,
the Board expects the CCyB to be nonzero if overall
vulnerabilities were judged to have risen to a level that was
``meaningfully above normal.''
Within that framework, the runup in asset prices that we
have seen in recent years is certainly a key consideration, but
we view that runup in the context of the levels of other
vulnerabilities, importantly including leverage and maturity
transformation in the financial system. Bank capital ratios and
liquidity buffers are now substantially higher than they were a
decade ago. The stress tests ensure that the largest banks can
continue to support economic activity even in the face of a
severe recession--importantly, one characterized by extreme
declines in asset prices. Outside the banking system, leverage
of other financial firms does not appear to have risen to
elevated levels, and the risks associated with maturity
transformation by money-market mutual funds is much reduced
from the levels seen a decade ago. Thus, we believe that
overall vulnerabilities in the financial system remain moderate
and near their normal range.
Q.2. The key criteria for whether to raise the countercyclical
capital buffer is an assessment that financial risks are in the
upper third of their historical distribution.
What is your assessment of current financial risks versus
their historical distribution?
A.2. As emphasized in our policy statement, a nonzero
countercyclical capital buffer is appropriate when risks are
judged to be meaningfully above normal. As you noted in your
previous question, asset valuations across a number of
important markets are elevated, and if that were the only
criterion for activation of the CCyB, it would be appropriate
to consider increasing the CCyB now. However, we also believe
that the financial system is quite resilient, with the
institutions at the core of the system well-capitalized, run
risk well below earlier levels, and central clearing of
derivatives limiting the amount of contagion from the distress
of an institution. Therefore, our comprehensive assessment is
that overall vulnerabilities are moderate, or about at the
midpoint of their historical range, and therefore do not meet
the criteria of being ``meaningfully above normal'' set in the
policy statement. However, we are carefully assessing
developments. If asset valuation pressures were to continue to
build, especially if they were accompanied by increased
leverage or increased maturity and liquidity transformation,
activation of the CCyB could promote additional resilience
among the largest U.S. banks.
Q.3. Recent eSLR and Capital Rule Proposals. The Board recently
proposed rules on the calibration of the eSLR and the
introduction of a stress capital buffer. Each proposal includes
an analysis of the expected changes in required tier 1 capital
if the proposal were to be adopted as proposed. The eSLR
proposal assesses the effect of the proposal if it were
adopted, assuming no changes to the CCAR process; and the
stress capital buffer proposal assess the effect of the
proposal if it were adopted, assuming no changes to the current
eSLR. Neither proposed rule, however, analyzes the cumulative
effect on required tier 1 capital at the holding company level
were both proposals adopted as proposed.
Before proposing the two rules, did the Board analyzed the
effect on tier 1 capital if both proposals were adopted as
proposed?
What would the cumulative effect on required tier 1 capital
at the holding company level be for G-SIBs if both proposals
were adopted as proposed?
A.3. While the discussion in each of the stress capital buffer
proposal and the enhanced supplementary leverage ratio (eSLR)
proposal reflects the estimated impact of those individual
proposals relative to current requirements, the Board also
considered the potential combined impact in developing the
proposals. Factoring the relatively immaterial estimated
reduction in required tier 1 capital across global systemically
important banks (G-SIBs) under the eSLR proposal (approximately
$400 million) into the estimated impact of the stress capital
buffer proposal across G-SIBs does not meaningfully affect the
estimates.
Q.4. Community Reinvestment Act. You stated before the House
Financial Services Committee that the Community Reinvestment
Act (CRA) is ``a little formulaic and ossified'' and you
advocated for giving banks greater flexibility in helping their
communities. The Treasury Department recently issued a formal
memorandum to bank regulators suggesting changes to the CRA and
its implementation. I agree that the CRA needs to be
modernized--I think there's widespread agreement that that's
the case since the regulations have not been meaningfully
updated since 1995. But I am concerned that some of the
recommendations in the Treasury memo, depending on their
implementation, could weaken one of the stronger tools we have
to ensure access to credit for the underserved and investment
in communities that have been left behind while others prosper.
One change that seems overdue, and is recommended in the
Treasury report, is the need to recognize that, in this digital
age, physical branches do not accurately reflect a bank's
business footprint.
Do you support reflecting this shift to the age of online
banking by updating existing assessment areas?
A.4. The Federal Reserve is deeply committed to the Community
Reinvestment Act's (CRA) goal of encouraging banks to meet
their affirmative obligation to serve their entire community,
and in particular, the credit needs of low- and moderate-income
communities. When banks are inclusive in their lending, it
helps low- and moderate-income communities to thrive by
providing opportunities for community members to buy and
improve their homes and to start and expand small businesses.
I agree that it is time to review changes to the definition
of ``assessment area,'' which is the area in which a bank's CRA
performance is evaluated. The banking environment has changed
since CRA was enacted and the current CRA regulations were
adopted. Banks may now serve consumers in areas far from their
physical branches. Therefore, it is sensible for the agencies
to consider expanding the assessment area definition to reflect
the local communities that banks serve through delivery systems
other than branches. Additional thought and analysis on this
matter will be needed to determine how best to define such
assessment areas and how to evaluate performance in those
areas.
Q.5. One Treasury recommendation that concerns me is
deemphasizing a bank's branch network in its CRA assessment.
While technology has certainly helped expand access to credit
through alternative delivery systems, studies continue to show
that physical branches still provide a significant boost to
access to credit to their surrounding community.
Will you support keeping a bank's footprint as a critical
factor in a bank's service test in its CRA assessment?
A.5. Yes, we are confident that there are ways to expand the
area where we evaluate a bank's CRA performance without losing
the regulation's consideration of the role banks play in
meeting local credit needs and providing services through their
branch networks. Treasury's recommendation that the Federal
banking agencies revisit the regulations to allow CRA
consideration for a bank's activities in its assessment area,
as currently delineated around branches and deposit-taking
automated teller machines, as well as in low- and moderate-
income areas outside that branch footprint, is a reasonable
place to start our interagency discussions. Further, CRA
provides an incentive to bankers and community stakeholders to
work together to identify needs, create investment
opportunities, and improve local communities, particularly low-
and moderate-income or underserved rural areas.
Q.6. Anti-Money Laundering (AML). One criticism I've heard
about anti-money laundering enforcement is that the banking
regulators view AML-compliance as a check-the-box exercise that
encourages banks to defensively file SARs that may not truly
reflect suspicious activity instead of spending resources to
catch bad guys.
Do you believe there is a check-the-box mentality among
bank examiners regarding AML compliance? If so, do you believe
it is a problem, and if so what do you plan to do to address
it?
A.6. Under current law and regulations implementing the Bank
Secrecy Act (BSA), insured depository institutions and other
banking organizations must maintain a system for identifying
and reporting to the Government transactions involving known or
suspected illegal activities that generally exceed certain
dollar thresholds (known as a ``Suspicious Activity Report'' or
``SAR''). The Federal Reserve and the other Federal banking
agencies review an institution's compliance with this and other
anti-money laundering (AML) requirements through the
examination process.
The interagency examination manual that was developed
jointly among the Federal Reserve and the other members of the
Federal Financial Institutions Examination Council (FFIEC) in
consultation with Treasury's Financial Crimes Enforcement
Network (FinCEN) describes the regulatory expectations for
banking industry compliance with the suspicious activity
reporting requirements and explains how examinations will be
performed. The examination manual recognizes that the decision
to file a SAR under the reporting requirement is an inherently
subjective judgment. The manual directs examiners to focus on
whether the institution has an effective SAR decision-making
process, not individual SAR decisions. The Federal Reserve,
along with the other Federal banking agencies, provides ongoing
training opportunities to its examiners regarding BSA topics
and various aspects of the BSA examination process.
The Federal Reserve recognizes that existing regulatory
requirements governing the filing of SARs have prompted
criticism due to the concern that they encourage institutions
to report transactions that are unlikely to identify unlawful
conduct, so-called defensive SARs. Recently, the Federal
Reserve and the other Federal banking agencies completed a
review consistent with the statutory mandate under the Economic
Growth and Regulatory Paperwork Reduction Act. As part of this
review, several commenters suggested regulatory changes to the
SAR and other reporting requirements, which were referred to
FinCEN. FinCEN is the delegated administrator of the BSA, and
any changes to the SAR or other reporting requirements would
require a change in FinCEN's regulations.
Q.7. Some have suggested that having FinCEN retake
responsibility for some AML compliance reviews is a good way to
realign the compliance incentives--the agency trying to catch
the bad guys would be the same agency that's inspecting a
bank's AML program.
What do you think about that approach?
A.7. The Federal Reserve and the other Federal banking agencies
are required by statute to review the BSA/AML compliance
program of the banks we supervise at each examination. \1\
Thus, unless this requirement is changed by Congress, banking
agencies must continue to examine for BSA compliance at banking
institutions.
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\1\ See Anti-Drug Abuse Act of 1986, H.R. 5484, 99th Cong. 1359
(1986).
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There are important benefits that arise from these
statutorily mandated reviews by the banking agencies. A review
of an institution's compliance with the BSA is integrally
related to our assessment of an institution's safety and
soundness. The Federal Reserve expects the institutions we
supervise to identify, measure, monitor, and control the risks
of an institution's activities. The inability to properly
manage legal and compliance risk, for example, can compromise a
bank's safety-and-soundness by reducing the confidence of its
customers and counterparties and result in loss of capital,
lower earnings, and weakened financial condition.
Currently, the Federal Reserve and the other Federal
banking agencies routinely coordinate with FinCEN on a range of
BSA matters. The FFIEC BSA/AML Working Group, which includes
representatives of the banking agencies and FinCEN, meets
regularly to share information among its members about various
BSA/AML initiatives. This forum can encourage the sharing of
information developed by FinCEN related to specific types of
money laundering typologies and other relevant data that would
help prioritize the ongoing examination efforts by the banking
agencies.
Q.8. It seems another way we can build a more effective
compliance regime is to facilitate more information sharing
among banks and between the Government and banks.
What role do you think the Federal Reserve should have in
facilitating this increased information flow?
A.8. Effective implementation of the BSA requires coordination
among the different Government agencies and regulated
institutions. The Federal Reserve takes seriously its
obligation to coordinate with FinCEN and the Federal banking
agencies to ensure that banking organizations operate in a safe
and sound manner and in compliance with the law. In particular,
we participate in the Bank Secrecy Act Advisory Group, a
public-private partnership established by Congress for the
purpose of soliciting advice on the administration of the BSA,
which facilitates sharing of information on regulatory policies
and initiatives, industry developments, and emerging money-
laundering threats.
As you know, the Federal banking agencies do not have the
authority to conduct criminal investigations or to prosecute
criminal cases. Rather, the Federal banking agencies ensure
that suspected criminal activity is referred to the appropriate
criminal authorities for prosecution and the BSA rules are
intended to achieve this purpose. Accordingly, the Federal
Reserve relies on the Department of Justice and other law
enforcement agencies to communicate whether the reporting
obligations of banks are furthering law enforcement's
objectives. Indeed, communication from law enforcement to
regulators and the banking industry is vitally important.
Finally, in terms of information sharing between financial
institutions, the primary means of communication related to BSA
is governed by Section 314(b) of the USA PATRIOT Act, which
encourages financial institutions and associations of financial
institutions located in the United States to share information
in order to identify and report activities that may involve
terrorist activity or money laundering. FinCEN is the agency
with the responsibility and authority to facilitate information
sharing under the regulation. As part of the ongoing
initiatives with FinCEN and the other Federal banking agencies
described above, the Federal Reserve has encouraged FinCEN to
further consider ways to facilitate financial institutions'
ability to share information.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM RANDAL K. QUARLES
Q.1. During our exchange, you referenced an analysis that the
Fed conducted about how much the less capital each G-SIB would
be required to hold under the new Enhanced Supplementary
Leverage Ratio rule recently proposed by the Fed. You noted
that the Fed's calculations differed from the FDIC's analysis,
which I cited.
Could you please provide the Fed's analysis that you
referenced and an explanation of the divergence between the Fed
and the FDIC?
A.1. The Federal Reserve Board (Board) estimated that, taking
into account the capital constraints imposed by the supervisory
stress tests and the Board's regulatory capital rules, the
proposed changes to the enhanced supplementary leverage ratio
(eSLR) standards would reduce the amount of tier 1 capital
required across the U.S. global systemically important bank
holding companies (G-SIBs) by approximately $400 million. That
figure is approximately 0.04 percent of the amount of tier 1
capital held by the G-SIBs as of the third quarter of 2017. The
Federal Deposit Insurance Corporation's analysis of April 11,
2018, cites the Board's and the Office of the Comptroller of
the Currency's estimate that the proposal would reduce the
amount of tier 1 capital required across the lead bank
subsidiaries of the G-SIBs by approximately $121 billion. The
$121 billion figure represents the potential reduction in tier
1 capital required across the lead insured depository
institution subsidiaries of the G-SIBs; however, these firms
are wholly owned by their parent holding companies. On a
consolidated basis, G-SIBs would continue to be subject to
risk-based capital requirements, supervisory stress testing
constraints, and other limitations applicable at the holding
company level that would restrict the amount of capital that
such firms may distribute to investors. Thus, due to these
limitations at the holding company level, the G-SIBs would be
required to retain nearly all of the $121 billion amount and
would not be able to distribute it to third parties.
Q.2. During the hearing, you told me that in your view, Section
402 of S. 2155, which recently passed the Senate and allows
banks ``predominantly engaged in custody, safekeeping, and
asset servicing activities'' to have less capital, could not be
interpreted to include JPMorgan Chase and Citigroup.
Would that analysis hold if those banks created
intermediate holding companies to house their custody services?
A.2. Because an intermediate holding company would be
disregarded in financial consolidation, the creation of an
intermediate holding company to house custody services would
not affect the analysis of whether the consolidated
organization was ``predominantly engaged in custody,
safekeeping, and asset servicing activities.''
Q.3. Will the Fed alter the Enhanced Supplementary Leverage
Ratio proposal if S. 2155 passes?
In what way?
A.3. The proposal is based on the current regulatory
definitions of tier 1 capital (the numerator of the ratio) and
total leverage exposure (the denominator of the ratio), which
include central bank deposits in the denominator. As noted in
the preamble to the proposed rule, significant changes to
either of the components of the supplementary leverage ratio
would likely necessitate reconsideration of the proposal so
that the eSLR standards continue to require an appropriate
level of capital. We are considering potential ways that the
regulation could be adjusted to account for the changes to the
eSLR due to the enactment of S. 2155 into law.
Q.4. Why is a reduction in capital requirements necessary at
this point in the business cycle?
A.4. The proposal would not represent a material reduction in
the amount of capital held by firms subject to the eSLR. Taking
into account the capital constraints imposed by the Board's
supervisory stress testing requirements, as well as the Board's
regulatory capital rules, we estimate that the proposal would
reduce the amount of tier 1 capital required across the G-SIBs
by approximately $400 million. That figure is approximately
0.04 percent of the amount of tier 1 capital held by the G-SIBs
as of the third quarter of 2017.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HEITKAMP
FROM RANDAL K. QUARLES
Q.1. In response to my question about whether a Government
backstop is essential to retaining the 30-year fixed-rate
mortgage, you responded, ``probably not'' but added that you
would need more time to analyze the question.
Can you elaborate on your views regarding the connection
between a Government guarantee and the availability of the 30-
year fixed-rate mortgage in all credit cycles?
Do you believe that Government guarantees promote or
detract from housing market stability?
During the 2000s, as private-label securitization grew to
dominate the U.S. housing finance system, we saw very clearly
the tendency of nonguaranteed mortgage financing to shun the
30-year fixed-rate mortgage. Indeed, during the period from
2001-2008, private-label securitization displayed a remarkable
bias toward adjustable-rate products. Do you believe that
nonguaranteed financing and its tendency towards adjustable
rates would provide affordable access to credit for American
families? In a housing downturn, do you believe that
nonguaranteed mortgage financing could provide consumers with
similar access to affordable, long-term housing credit?
A.1. The 30-year fixed-rate mortgage is a very popular product
in this country and for decades has been associated with a
credit guarantee. Without a guarantee, it is still likely to be
available throughout the credit cycle. However, the cost and
availability of the product could vary significantly.
The jumbo-conforming spread, which measures the price
difference between private mortgage financing and Government-
guaranteed mortgage financing, has varied greatly over time and
has tended to increase sharply during times of financial
stress. For instance, the jumbo-conforming spread averaged
about 10 basis points prior to the financial crisis (2005
through mid-2007), 30-40 basis points during the early stages
of the crisis (mid-2007 through mid-2008), and over 75 basis
points during the depths of the crisis (mid-2008 through mid-
2009). The jumbo-conforming spread has since declined to about
10-15 basis points during the 2016-2017 time period.
A 30-year horizon for a financial asset is a long horizon,
particularly an asset with credit risk. Households with such
mortgages are likely to encounter periods of financial turmoil
over this horizon, sometimes with little equity in their home.
In addition, the 30-year fixed-rate mortgage is usually
prepayable and thus a household can refinance and withdraw any
home equity it has accumulated from the house. As a result of
these two factors, managing the credit risk for this mortgage
product can be difficult for certain mortgage investors.
Secondary market traders of financial assets usually manage
interest-rate risk and avoid assets with credit risks. Thus,
the 30-year fixed-rate mortgage can be difficult to trade
without a substantial financial premium for traders if it has
credit risk. A Government guarantee for the credit risk allows
the 30-year fixed-rate mortgage to be more easily used in
secondary market trading.
Ultimately, the question of the Government's role in
housing finance is an issue for Congress. If Congress does
choose to provide a guarantee for mortgages, I would urge that
the guarantee be explicit and transparent, done in a manner
that protects taxpayers, and apply to securities not
institutions.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHATZ
FROM RANDAL K. QUARLES
Q.1. During the March meeting of the Federal Open Market
Committee, the Fed discussed the expected impacts of the recent
tax cuts: according to the minutes, ``participants generally
regarded the magnitude and timing of the economic effects of
the fiscal policy changes as uncertain, partly because there
have been few historical examples of expansionary fiscal policy
being implemented when the economy was operating at a high
level of resource utilization.''
There are few historical examples of expansionary fiscal
policy being implemented when the economy is so strong because
it is bad economics. Mainstream economists agree that it is
harmful for an economy to enact fiscal stimulus when the
economy is operating at or near maximum capacity because it
creates strong inflationary pressure.
Do you agree?
Is it good economy policy to enact massive fiscal stimulus
when the economy is operating at a high level of resource
utilization?
A.1. As noted in the March Minutes, because there have been few
historical examples of expansionary fiscal policy being
implemented when the economy was operating at a high level of
resource utilization, the magnitude and timing of the economic
effects of recent changes in fiscal policy are uncertain. While
the Congress and the President are solely responsible for
determining the timing and contours of fiscal policy changes, I
will note that Federal fiscal policy is not currently on a
sustainable trajectory. Over the coming decades, a large and
growing Federal Government debt, relative to the size of the
economy, would have negative effects on the economy. In
particular, a rising Federal debt burden would reduce national
saving, all else equal, and put upward pressure on longer-term
rates.
Q.2. Bank holding companies under the Fed's supervision have
been fined more than $174 billion since the financial crisis
for deceptive practices, anti-money laundering violations, and
glaring consumer abuses. The egregious practices at Wells Fargo
led the Fed to cap the bank's growth and resulted in hundreds
of millions in fines, with more to come.
What these fines demonstrate is that our largest financial
institutions are either intentionally and repeatedly breaking
the law, or they are too large to be properly managed.
Which do you think it is?
A.2. Since 2008, the Federal Reserve has assessed civil money
penalties totaling approximately $5.7 billion against 35
institutions of varying asset sizes. Most commonly, these fines
were focused on an institution's unsafe or unsound practices
that resulted from breakdowns in the institution's oversight,
controls, and risk management related to particular regulatory
frameworks, for example the Bank Secrecy Act, U.S. sanctions
requirements, the application of antitrust law to individual
financial markets, such as foreign exchange trading, and
servicing and foreclosing on residential mortgage loans.
The enforcement actions taken by the Federal Reserve
invariably supplemented the monetary penalty by also requiring
the institutions to develop and implement acceptable plans,
policies, and programs to remedy the managerial, operational,
or compliance deficiencies that were the basis for the actions.
Before the remedial requirements of such an enforcement action
can be terminated, the Federal Reserve must be assured that the
institution has implemented a sustainable, long-term solution
to the problem that led to the enforcement action. To that end,
the relevant Federal Reserve Bank reviews the plans and
programs and the progress reports developed in response to the
enforcement action, and provides feedback to senior management.
The Federal Reserve also conducts a broader annual supervisory
assessment of the institution that includes a review of the
institution's compliance with any outstanding enforcement
action to ensure the institution addresses the underlying
issues.
Q.3. Why should we think about lightening prudential
requirements on institutions that have such serious legal
compliance problems?
A.3. The institutions subject to enforcement actions described
above were required as part of the actions to fully correct
these defective programs. The improvements in regulatory
effectiveness, efficiency, and transparency currently being
considered by the Federal Reserve should not in any way detract
from the obligation of all regulated institutions to maintain
comprehensive and effective compliance programs.
Q.4. Does the fact that banks have paid record fines at a time
when they have made record profits mean that banks have just
baked the cost of fines into their business plan?
Are these fines accomplishing anything?
A.4. It is the experience of the Federal Reserve that,
enforcement actions that impose substantial penalties also tend
to serve a deterrent purpose. In addition, effective
accountability for institutional misconduct can also be
achieved by taking appropriate enforcement actions against
culpable individuals who are responsible for the misconduct.
Pursuing such actions against culpable insiders, where supplied
by the record, is an important priority for the Federal
Reserve. In addition, in cases of pervasive and persistent
institutional misconduct, such as the Board's recent
enforcement action against Wells Fargo & Company, the Federal
Reserve did not impose a fine but restricted the institution's
asset growth until the firm accomplishes effective remediation.
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RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM RANDAL K. QUARLES
Q.1. Following up on my questions to you, I am very concerned
that cost-benefit analysis fails to capture the human and
economic cost of massive financial system failure. For example,
in 2009, when I was Attorney General, Nevada had 165,983 people
unemployed. That year, in a State of 3 million people, we had
28,223 personal bankruptcies, 366,606 mortgage delinquencies
and 421,445 credit card delinquencies. In addition, 121,000
Nevada children's lives and educations were disrupted by the
foreclosure crisis. We had more than 219,000 foreclosures
between 2007 and 2016.
Do you believe that cost-benefit analysis
disproportionately benefits industry, since the costs of
compliance are easier to calculate, while the benefits of a
sound financial system are more difficult to measure?
You noted that the Federal Reserve underestimated the human
costs of a potential financial crisis prior to 2008? Please
describe some of the ways that Fed underestimated the costs of
the Crisis and how you would have assessed them knowing what
you know now?
How will the Federal Reserve's new ``policy effectiveness
and assessment'' unit consider the benefits of avoiding a
future financial crises? How many people work in the unit? Who
are they and what is their background and expertise?
If they were employed at the Federal Reserve prior to the
Financial Crisis, what was their role?
If they published anything on the stability or risks in the
financial sector between 2004-2008, please provide those
documents.
A.1. Cost-benefit analysis is intended to provide an objective
assessment of the net costs and benefits to society from a
pending regulation. This takes into account the myriad impacts
of a regulation, including those on consumers, businesses and
financial intermediaries. The fact that some of these impacts,
such as the cost of compliance, are easier to quantify does not
imply that the cost-benefit analysis will favor any particular
group.
As I noted in my testimony, the Federal Reserve
underestimated the likelihood of a crisis prior to the
financial crisis. Indeed, it is in response to these
shortcomings that the Federal Reserve has worked with other
agencies to significantly raise prudential standards, such as
capital and liquidity of financial institutions, thus lowering
the probability of another crisis.
The Policy Effectiveness and Assessment section will follow
established methods and consider the benefit of avoiding a
financial crisis by considering the impact of increased safety
and soundness on the reduced probability of a crisis, and the
economic losses given a crisis.
Currently, the section has a manager in place (an economist
by training) and the team consists of a small number of Ph.D.
economists and support staff. As with all Federal Reserve
economists, their professional profile and publications are
available on our public website at https://
www.federalreserve.gov/econres/theeconomists.htm. In addition,
we recently hired additional Ph.D. economists, and these
individuals will be joining the team in the coming months.
Q.2. Under S. 2155, the Federal Reserve would have the
discretion to apply financial stability rules to banks with
between $100 billion and $250 billion in assets. Such
discretion especially requiring tailored rules to each
institutions--opens up banking regulators to lawsuits. For
example, SIFMA sued the CFTC over the definition of ``as
appropriate'' when it came to setting position limits.
Are you concerned that giving the Federal Reserve
discretionary authority to implement financial stability rules
for banks--rather than relying on a bright line threshold from
Congress--will open the Fed to lawsuits by banks that are
selected for additional oversight?
A.2. The Federal Reserve Board (Board) has developed experience
in tailoring its prudential regulations and supervisory
programs based on factors such as the size, systemic footprint,
and the risk profile of individual institutions.
The Board remains committed to transparency in its
rulemaking process and believes it is important to provide the
public with an adequate justification for its rules. The public
would have the opportunity to comment on any proposed rule,
which would provide the Federal Reserve with important
information, focus, and feedback, including whether the
proposal is appropriately tailored to its intended purpose.
Q.3. Former Deputy Treasury Secretary--and Fed Governor--Sarah
Bloom Raskin called this ``reach down'' authority afforded to
the Fed, ``legislative fool's gold.'' She knows the Fed will
wait until it's too late to regulate banks in the $100 to $250
billion band.
What do you think of her comments?
A.3. In the absence of Enhanced Prudential Standards for
institutions under $250 billion, the Federal Reserve maintains
broad supervisory and regulatory tools to ensure firms continue
to adhere to prudential safety and soundness standards. These
tools include a rigorous supervisory program with standards for
internal stress testing of capital and liquidity as well as
risk management frameworks. A firm with $100 billion to $250
billion in assets is still expected to ensure that the
consolidated organization and its core business lines can
survive under a broad range of internal and external stresses
and that it maintains sufficient capital and liquidity, as well
as operational resilience, through effective corporate
governance and risk management. Moreover, under the Economic
Growth, Regulatory Relief, and Consumer Protection Act, the
Federal Reserve has discretion to determine which enhanced
standards to apply to an institution between $100 billion and
$250 billion. I expect that the Board will seek public comment
on the application of those standards to this group of
institutions.
Q.4. As of 2016, the financial sector accounted for 20 percent
of the GDP and 25 percent of corporate profits. Do you believe
that the financial sector's outsized grasp on profits has a
chokehold on the overall economy?
A.4. Our responsibilities with regard to the financial sector
are to ensure that the financial entities we supervise operate
in a safe and sound manner, and to promote financial stability.
We take these responsibilities very seriously. Currently, we
see financial conditions as generally supportive of continued
economic expansion, consistent with the attainment of maximum
employment and price stability.
Q.5. As your team addresses and analyzes the cost-benefit
analysis of any proposed rule, how will they calculate the cost
of having a financial sector with outsized and increasing
power, influence, and wealth?
A.5. As part of the rulemaking process, the Board considers the
economic impact, including costs and benefits, of its proposed
and final rules. As part of this evaluation, staff will take
into account the benefits accruing from improvements in the
safety and soundness of Board-regulated institutions and U.S.
financial stability, the costs imposed on the regulated
entities, as well as potential effects on the overall economy.
In addition, the Board provides an analysis of the costs to
small depository organizations of its rulemaking consistent
with the Regulatory Flexibility Act \1\ and computes the
anticipated cost of paperwork consistent with the Paperwork
Reduction Act. \2\ In adopting the final rule, the Board seeks
to adopt a regulatory option that faithfully reflects the
statutory provisions and the intent of Congress, while
minimizing regulatory burden.
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\1\ 5 U.S.C. 601.
\2\ 12 U.S.C. 3506.
Q.6. I represent Nevada, which is within the San Francisco
Federal Reserve District. We are one of the most diverse
districts in the Nation--with many Latino and Asian Pacific
American families. We value that diversity because it leads to
innovation, economic growth, and stronger connections with
other nations in our globally connected world.
A recent report by Fed Up, ``Working People Still Need a
Voice at the Fed: 2018 Diversity Analysis of Federal Reserve
Bank Directors'', found that there is inadequate diversity at
the Federal Reserve. It specifically cited the San Francisco
Federal Reserve as one of system's least diverse regional
banks. The report states, ``Despite covering some of the most
demographically diverse counties in the United States, 100
percent of the San Francisco Fed's Board of Directors come from
the banking and financial sector. The directors are 78 percent
white and 78 percent male.''
As the Vice Chair of Supervision, what steps have you taken
to promote diversity with the Fed's supervisory, regulatory and
enforcement staff?
A.6. The Board's action to approve the Diversity and Inclusion
Strategic Plan 2016-2019 reflects the Board's strategic
initiative on diversity, inclusion, and equality. The
implementation of the plan involves the active involvement of
leaders throughout the Board. In support of the Board's
strategic objectives and commitment to attract, hire, develop,
promote and retain a highly diverse workforce, each division is
required to establish a diversity and inclusion scorecard. The
purpose of the scorecard provides a process that helps us
organize and develop a systematic effort in support of the
diversity and inclusion strategic plan. I am firmly committed
to addressing the division of Supervision and Regulation's and
related divisions' challenges and achievement of their goals.
Q.7. What steps can the Fed take to promote diversity within
the financial system, especially with respect to the firms the
Fed regulates?
A.7. As directed by section 342 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act), the Board
continues to request from the entities we regulate a submission
of information that supports the diversity policies and
practices of their institutions. The assessment of submissions
provides an opportunity to strengthen and promote transparency
of organizational diversity and inclusion within the entities'
U.S. operations and provides opportunities to discuss leading
practices and challenges in addressing diversity in the
financial services industry. In an effort to increase the
submission of diversity information, the Board is collaborating
with the other financial regulatory agencies to develop
symposiums, webinars, and other support initiatives to provide
a variety of forums to address what is needed to advance
diversity in the financial and banking industry.
Q.8. How closely do you work with the Fed's Office of Diversity
and Inclusion? Please give a couple of examples.
A.8. In my role as Governor and Vice Chairman of Supervision, I
am available to the Director of the Office of Minority and
Women Inclusion (OMWI) to meet and discuss cultivating
diversity and inclusion in all aspects of employment. The OMWI
Director is involved in the appointment process of official
staff to ensure that the Board's leadership nomination criteria
and process are inclusive. Additionally, a meeting schedule has
been established for the OMWI Director and Deputy Director of
Supervision Policy to discuss a range of issues within the OMWI
purview.
Q.9. How will you work to end the outsized representation and
influence of the banking and business sectors among the
Regional Bank Boards of Directors?
Have you identified directors with nonprofit, academic, and
labor backgrounds that could also serve?
A.9. I, and my colleagues on the Board, are committed to
increasing diversity throughout the Federal Reserve System
(System). The Board focuses particular attention on increasing
gender, racial, and sector diversity among Reserve Bank and
Branch directors because we believe that the System's boards
function most effectively when they are constituted in a manner
that encourages a variety of perspectives and viewpoints.
Monetary policymaking also benefits from having directors who
effectively represent the communities they serve because we
rely on directors to provide meaningful grassroots economic
intelligence.
In vetting candidates for Class C and Board-appointed
Branch director vacancies, the Board considers factors such as
professional experience, leadership skills, and community
engagement. The Board also evaluates a candidate's ability to
contribute meaningful insights into economic conditions of
significance to the District and the Nation as a whole. As part
of this process, the Board focuses considerable attention on
whether a candidate is likely to provide the perspective of
historically under-represented groups, such as consumer,
community, and labor organizations, minorities, and women.
Although there is room for improvement, the System has made
significant progress in recent years in recruiting highly
qualified, diverse candidates for Reserve Bank and Branch
director positions. For example, in 2018, approximately 56
percent of all System directors are diverse in terms of gender
and/or race, which represents a 16 percentage point increase in
the share of directors since 2014.
As previously mentioned, in addition to gender and racial
diversity, the Board also seeks candidates from a wide range of
sectors and industries to serve as Reserve Bank and Branch
directors. We currently have consumer/community and labor
leaders serving on boards throughout the System, and we gain
invaluable insight from directors who are affiliated with other
types of organizations, including major health care providers,
universities and colleges, and regional chambers of commerce,
among others.
Q.10. If the Consumer Financial Protection Bureau continues to
drop lawsuits against predatory online loan companies, like
Golden Valley Lending or drop investigations against companies
like World Acceptance Corporation, one of the biggest payday
lenders, does the Federal Reserve have the enforcement
authorities and resources that would allow its staff pick up
the slack and protect people from unfair, deceptive and abusive
lending practices?
A.10. As prescribed by the Dodd-Frank Act, the Federal Reserve
has supervisory and enforcement authority for compliance with
section 5 of the Federal Trade Commission Act (FTC Act), which
prohibits unfair or deceptive acts or practices (UDAP), for all
State member banks, regardless of asset size. The Federal
Reserve is committed to ensuring that the institutions we have
authority to supervise comply fully with the prohibition on
unfair or deceptive acts or practices as outlined in the FTC
Act.
Under the Dodd-Frank Act, Congress granted supervision and
enforcement authority to the Consumer Financial Protection
Bureau (CFPB) for all other banks, thrifts, and credit unions
with assets over $10 billion, and their affiliates, as well as
nonbank mortgage originators and servicers, payday lenders, and
private student lenders. As such, the Federal Reserve cannot
supervise or enforce consumer protection laws and regulations
with respect to institutions that are not within our statutory
authority.
Q.11. Mick Mulvaney, the OMB Director and the CFPB Acting
Director appointed--illegally--by President Trump, has received
more than $60,000 in campaign contributions from payday
lenders. You recused yourself from any case involving Wells
Fargo because of your ``wife's family's historical
connection.''
Do you think Acting Director Mulvaney should recuse himself
from any decision on litigation or enforcement for any firm
that has provided him significant campaign contributions?
A.11. It is not our practice to comment on a non- Federal
Reserve official's decision to participate in or recuse himself
or herself from a particular matter that does not involve the
Federal Reserve. I have no comment on recusal decisions made by
other Government officials.
Q.12. If the Consumer Financial Protection Bureau's political
appointees refuses to police the consumer markets, will you let
us know if predatory and deceptive practices are going
unaddressed and increasing risks in the financial system?
A.12. The Federal Reserve takes seriously our responsibility to
supervise and enforce laws that guard consumers against UDAP in
the banks for which we have statutory authority. As granted by
the Dodd-Frank Act, the Federal Reserve supervises for
compliance with the section 5 of the FTC Act, which sets forth
consumer protections for UDAP, in State member banks,
regardless of asset size. For these banks, we conduct UDAP
reviews regularly within the supervisory cycle. Further,
examiners may conduct a UDAP review outside of the usual
supervisory cycle, if warranted by findings of a risk
assessment. When Federal Reserve examiners find evidence of
potential discrimination or potential UDAP violations, they
work closely with the Board's Division of Consumer and
Community Affairs (DCCA) for additional legal and statistical
expertise and ensure that fair lending and UDAP laws are
enforced consistently and rigorously throughout the System.
When violations are identified, the Federal Reserve
frequently uses informal supervisory tools (such as memoranda
of understanding between banks' boards of directors and the
Federal Reserve Banks, or board resolutions) to ensure that
violations are corrected. In these instances, the supervisory
information is confidential and cannot be shared with parties
outside of the institution and supervisory agencies.
Just as the Federal Reserve cannot share confidential
supervisory information with respect to the banks that we
supervise, neither can we share confidential supervisory
findings of other supervisory agencies.
However, the Federal Reserve has addressed unfair and
deceptive practices through public enforcement actions that
have collectively benefited hundreds of thousands of consumers
and provided millions of dollars in restitution. In 2014 and
2015, we brought two enforcement actions requiring restitution
for students who were not given full information about the
potential fees and limitations associated with opening deposit
accounts for their financial aid refunds.
In 2017, the Board brought two public enforcement actions
for UDAP violations. In October, the Board issued a consent
order against a bank for deceptive practices related to balance
transfer credit cards issued to consumers through third
parties. The order required the bank to pay approximately $5
million in restitution to nearly 21,000 consumers and to take
other corrective actions. In November, the Board issued another
consent order against a bank for deceptive residential mortgage
origination practices when it had given borrowers the option to
pay an additional amount to purchase discount points to lower
their mortgage interest rate, but that did not actually provide
the reduced rate to many of those borrowers. The enforcement
action required the bank to pay approximately $2.8 million into
an account to provide restitution to these borrowers. These are
a few examples. The Board reports its general overview of UDAP
and enforcement actions in our Annual Report to Congress.
Q.13. Has the Federal Reserve leadership--either directly or
through the Financial Stability Oversight Council--weighed in
on the impact from the Trump appointed leadership at the CFPB's
decision to weaken fair lending enforcement, suspend the civil
penalties fund and stop investigating into firms such as the
hack of 147 million people's information held by Equifax?
A.13. As you know, Title X of the Dodd-Frank Act transferred
rulemaking authority for a number of consumer financial
protection laws from seven Federal agencies to the CFPB. With
regard to rules for which the CFPB is responsible for
promulgating, such as those implementing the Fair Credit
Reporting Act, the Board's role in the process is on a
consultative basis. We do coordinate in institution
examinations as appropriate. The Federal Reserve does not have
any oversight of the CFPB's enforcement priorities, nor
decisions regarding its organizational or structural design.
These matters are solely the purview of CFPB's leadership.
Q.14. The Treasury Department, as you know, has released
several extensive reports that include dozens and dozens of
recommendations to revise the rules governing banks.
Do you think there should be penalties for banks that fail
to comply with the Community Reinvestment Act?
What should they be?
A.14. The Community Reinvestment Act (CRA) requires the
regulators to encourage banks to help meet the credit need of
their local communities. We do so by conducting CRA
examinations, publishing CRA ratings and performance
evaluations on our public website, and considering a bank's CRA
performance when evaluating applications for mergers,
acquisitions, and opening branches.
The applications process serves as a means of enforcing
CRA. CRA requires that the appropriate Federal supervisory
agency consider a depository institution's record of helping to
meet the credit needs of its local communities and to take that
record and public comments into account in evaluating
applications for deposit-taking facilities, such as for
mergers, acquisitions, and branches. An institution's most
recent CRA record is a particularly important consideration in
the applications process because it represents a detailed on-
site evaluation of the institution's performance under the CRA.
The public nature of the ratings and the agencies'
consideration of CRA performance in the application process
creates an incentive for financial institutions to work with
its community to help meet its needs.
Q.15. Which, if any, recommendations from the Treasury
Department related to CRA do you disagree with?
A.15. The Board's staff is continuing to analyze the
recommendations made by the Department of Treasury. I share
Treasury's goal of improving the current supervisory and
regulatory framework for CRA based on feedback from industry
and community stakeholders. I agree that many of the issues and
potential solutions they raised are worthy of consideration.
The Board is open to considering ways to make the CRA more
effective and believes there are ways to expand the area where
we evaluate a bank's CRA performance without losing the
regulation's focus on the unique role banks play in meeting
local credit needs.
For example, I agree that it is time to review changes to
the definition of ``assessment area,'' which is the area in
which a bank's CRA performance is evaluated. The banking
environment has changed since CRA was enacted and the current
CRA regulation was adopted. Banks may now serve consumers in
areas far from their physical branches. Therefore, it is
sensible for the agencies to consider expanding the assessment
area definition to reflect the communities that banks serve,
while retaining the core focus on place.
Q.16. Fed Chair Powell recently said that the Fed's
requirements for the largest banks are ``very high and they're
going to remain very high.'' \3\ He continued, ``As you look
around the world, U.S. banks are competing very, very
successfully. They're very profitable. They're earning good
returns on capital. Their stock prices are doing well. So I'm
looking for the case, for some kind of evidence that--and I'm
open to this--some kind of evidence that regulation is holding
them back, and I'm not really seeing that case as made at this
point.'' \4\
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\3\ https://www.federalreserve.gov/newsevents/speech/
powell20180406a.htm
\4\ Politico Pro, ``Powell Doesn't See Need To Loosen Rules on
Biggest Banks'', April 6, 2018.
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Why did the Fed issue a proposal last week that would
revise the enhanced Supplementary Leverage Ratio (eSLR), which
according to the FDIC, would reduce bank capital by more than
$120 billion at the Nation's largest banks?
With banks making big profits, why would the Fed propose to
reduce capital in a significant way that diminishes protections
for taxpayers and the economy?
If we are seeing regulations being weakened while the
banking sector is very strong economically, what do you expect
to see regarding banking regulations during an actual downturn
or recession?
A.16. The proposed recalibration of the enhanced supplementary
leverage ratio (eSLR) standards is an example of the Board's
efforts to ensure that the postcrisis financial regulations are
working as intended. Core aspects of postcrisis financial
regulation have resulted in critical gains to the financial
system, including higher and better quality capital, a robust
stress testing regime, new liquidity regulation, and
improvements in the resolvability of large firms. The financial
system is stronger and more resilient as a result, helping
banks to lend through the business cycle. With the revised
regulatory framework in place, the Board is assessing the
effect of those efforts. In undertaking this review and
assessment, the Board is mindful of the need for the
regulations not only to be effective for maintaining safety and
soundness and financial stability, but also to be efficient,
transparent, and simple.
The purpose of the eSLR proposal is to recalibrate our
capital standards for banking organizations such that the ratio
generally serves as a backstop to risk-based capital
requirements and not as a binding constraint. Over the past few
years, concerns have arisen that, in certain cases, the SLR has
become a generally binding constraint rather than a backstop to
the risk-based requirements. If a leverage ratio is calibrated
at a level that makes it generally binding, it can create
incentives for banking organizations to reduce their
participation in business activities with lower risks and
returns, such as repo financing, central clearing services for
market participants, and taking custody deposits, even when
there is client demand for those generally low-risk services
and to actually increase the risk in its portfolio since it
bears the same capital cost for a risky asset as for a safe and
sound one.
I do not believe that the proposal would materially change
the amount of capital held by U.S. global systemically
important bank holding companies (G-SIBs). The $121 billion
figure noted in the proposal represents the potential reduction
in tier 1 capital required across the lead insured depository
institution subsidiaries of the G-SIBs; however, these firms
all are wholly owned by their parent holding companies. On a
consolidated basis, G-SIBs would continue to be subject to
risk-based capital requirements, supervisory stress testing
constraints, and other limitations applicable at the holding
company level that would restrict the amount of capital that
such firms may distribute to investors. Due to these
limitations at the holding company level, the G-SIBs would be
required to retain the vast majority of the $121 billion amount
and would not be able to distribute it to third parties. The
Board estimates that the proposal would reduce the amount of
tier 1 capital required across the G-SIBs by approximately $400
million. That figure is approximately 0.04 percent of the
amount of tier 1 capital held by the G-SIBs as of the third
quarter of 2017.
Q.17. Mr. Quarles, you have repeatedly said that since it has
been a decade since the 2008 financial crisis, it is time to
review and revisit all of the postcrisis financial rules to
seek improvements.
Will these modifications to postcrisis reforms be one-sided
with a focus on deregulating the rules protecting people from
dangerous behaviors from the financial sector?
A.17. Core elements of the postcrisis financial regulatory
reforms have made our financial system stronger and more
resilient: higher and better-quality capital, an innovative
stress testing regime, new liquidity requirements, and
improvements in the resolvability of large firms. The reforms
to regulation and supervision that have been put in place since
the financial crisis have contributed to a financial system
that better supports lending to borrowers and protects
consumers.
That said, it is the responsibility of financial regulators
to review and revisit postcrisis regulations to ensure not only
that they are effective, but also to see if the same outcomes
can be achieved, where appropriate, in ways that are more
efficient, transparent, and simple. More specifically,
regulators should continue to tailor rules to the different
risks of different firms and ensure that our supervisory
program is as efficient as possible, including work to reduce
unnecessary burden on community and regional banks, while
simultaneously holding our largest, most complex firms to
heightened regulatory standards. As we consider possible
changes to the postcrisis structure of regulation and
supervision, we will remain focused on promoting the strength
and resilience of the financial system.
Q.18. Chair Powell has said not a single big bank rule requires
strengthening.
Do you agree?
A.18. At this point, regulators have completed the bulk of the
work of implementing postcrisis regulatory reforms, with an
important exception being the U.S. implementation of the
recently concluded international agreement on bank capital
standards. Due in significant part to gains from core
postcrisis reforms around capital, stress testing, liquidity,
and resolution, we undoubtedly have a stronger and more
resilient financial system.
I believe that now is the time to step back and assess
whether postcrisis regulations are working as intended and
determine ways to improve them, not only to ensure that we are
satisfied with their effectiveness, but also to explore
opportunities as appropriate to improve the efficiency,
transparency, and simplicity of these regulations, while
maintaining the resiliency of the current system.
Q.19. Do you believe the Fed failed, as many of us do, at
implementing and enforcing our consumer financial protections
laws prior to the creation of the Consumer Financial Protection
Bureau?
A.19. The financial crisis revealed the need to address
fundamental problems across the financial system in both the
private and public sectors, including failures of risk
management in many financial firms, deficiencies in Government
regulation of financial institutions and markets. In response,
Congress enacted the Dodd-Frank Act to address the weaknesses
that had emerged in various areas of the mortgage market,
including underwriting standards, capitalization, and
securitization, as well as consumer protection. As you know,
prior to the passage of the Dodd-Frank Act in 2010, the Board
had responsibility for writing regulations to implement many
consumer protection laws. The Dodd-Frank Act transferred most
of these responsibilities to the CFPB, and considerably
expanded its consumer protection statutory authorities for
supervision and enforcement, and granted the CFPB broad
authorities to promulgate consumer protections regulations
covering banks and nonbanking entities.
Although the Board no longer has rulewriting authority for
most consumer protection regulation, we remain committed to
strong consumer protection to promote a fair and transparent
financial marketplace, as we have for more than 40 years,
through the Board's Division of Consumer and Community Affairs
(DCCA), which is solely dedicated to consumer compliance
supervision, community development, and consumer-focused
research, analysis, and outreach. Through this division, we
oversee the Federal Reserve System's supervision and
examination policies and programs for the banks under our
supervisory authority to ensure consumer financial protection
and promote community reinvestment.
The Dodd-Frank Act established the CFPB as a dedicated
agency not only to consumer financial rulemaking, but also
supervision for banks, thrifts, and credit unions with assets
over $10 billion, as well as their affiliates, and for nonbank
mortgage originators and servicers, payday lenders, and private
student lenders of all sizes.
Despite responsibilities for supervision that were
transferred to the CFPB, the Federal Reserve continues to be
dedicated to consumer protection and community reinvestment in
carrying out our supervisory and enforcement responsibilities
for the financial institutions and for the laws and regulations
under our authority. We supervise all State member banks for
compliance with the Fair Housing Act and Equal Credit
Opportunity Act, as well as for other consumer protection rules
for State member banks of $10 billion or less. Federal Reserve
staff coordinate with the prudential regulators and the CFPB as
part of the supervisory coordination requirements under the
Dodd-Frank Act to ensure that consumer compliance risk is
appropriately incorporated into the consolidated risk-
management program of the approximately 135 bank and financial
holding companies with assets over $10 billion.
The Federal Reserve is committed to ensuring that the
financial institutions under our jurisdiction fully comply with
all applicable Federal consumer protection laws and
regulations. For example, in the last few years, the Federal
Reserve has addressed unfair and deceptive practices through
public enforcement actions that have collectively benefited
hundreds of thousands of consumers and provided millions of
dollars in restitution. In addition, our examiners evaluate
fair lending risk at every consumer compliance exam. Pursuant
to the Equal Credit Opportunity Act, if we determine that a
bank has engaged in a pattern or practice of discrimination, we
refer the matter to the Department of Justice (DOJ). Federal
Reserve referrals have resulted in DOJ public actions in
critical areas, such as redlining and mortgage-pricing
discrimination.
At the Board, DCCA staff provide oversight for the Reserve
Bank consumer compliance supervision and examination of
approximately 800 State member banks and bank holding companies
(BHCs) through its policy development, examiner training, and
supervision oversight programs, including for banks'
performance under the CRA; conducting oversight of and
providing guidance to Reserve Bank staff on consumer compliance
in BHC matters; assessment of compliance with and enforcement
of a wide range of consumer protection laws and regulations
including those related to fair lending, UDAP, and flood
insurance; analysis of bank and BHC applications in regard to
consumer protection, convenience and needs, and the CRA; and
processing of consumer complaints. DCCA also monitors trends in
consumer products to inform the risk-based supervisory planning
process. Quantitative risk metrics and screening systems use
data to assess market activity, consumer complaints, and
supervisory findings to assist with the determination of risk
levels at firms.
Q.20. The Administration has proposed in a November report
stripping FSOC of its power to designate nonbank SIFIs--like
AIG--for heightened supervision by the Fed. The report said
this authority was too ``blunt'' of an instrument.
Has the Fed acted as a blunt instrument in its supervision
of nonbank SIFIs?
A.20. As consolidated supervisor of nonbank financial companies
designated by the Financial Stability Oversight Council (FSOC),
the Board's primary objectives encompass ensuring
enterprisewide safety and soundness and mitigating threats to
financial stability. The Board continues to strive for a
tailored approach that reflects, among other things, the size,
complexity, and business model of the supervised firm. When
supervising firms significantly engaged in insurance
activities, the Board conducts its consolidated supervision in
coordination with State and foreign insurance regulators,
collaborating through mechanisms including discussions of
supervisory plans and examination findings, as well as
supervisory colleges. We additionally have hosted multiple
crisis management groups that included a variety of
participants including State insurance departments, the Federal
Insurance Office, and the Federal Deposit Insurance
Corporation.
Q.21. Or has the Financial Stability Oversight Council, or
FSOC, helped to eliminate regulatory gaps in our financial
regulatory system?
A.21. Prior to the creation of the FSOC, the U.S. financial
regulatory framework focused narrowly on individual
institutions and markets and no single regulator had the
responsibility for monitoring and assessing overall risks to
financial stability, which could involve different types of
financial films operating across multiple markets. The FSOC
established a venue to facilitate the sharing of regulatory
information and coordination to help minimize potential gaps
and weaknesses.
Notably, the FSOC must publish a financial stability report
each year, signed by the voting members. Past reports have
highlighted vulnerabilities such as prime money market mutual
funds that benefit investors who withdraw their funds first--
with the potential for destabilizing runs of the kind that
stressed the financial system in September 2008. Subsequent
reports have noted that the Securities and Exchange
Commission's (SEC) regulatory reforms, which took effect in
late 2016, were instituted to mitigate the risk of runs on
money funds, and led to significant structural changes in the
industry, with assets flowing to funds that held only assets
guaranteed by the Government.
Q.22. S&P Global warned earlier this month that leveraged
lending standards were deteriorating, and that underwriting
standards in this $1 trillion market continue to get weaker and
weaker. One PIMCO analyst said, ``I'm not sure the market can
tolerate much worse.'' \5\ There used to be guidance in place
to protect against these risks, but while at the OCC, Acting
Comptroller Noreika withdrew its guidance on leveraged lending.
And you have said that this guidance, because it was declared a
rule by the GAO, is ``not something that should be cited in
supervisory action or taken into account by examiner.'' \6\
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\5\ https://www.ft.com/content/680953c0-3e2a-11e8-b9f9-
de94fa33a81e
\6\ https ://www.americanbanker.com/news/feds-quarles-to-seek-
more-tailoring-of-large-bank-rules
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So judging by your comment, the Republicans' assault on
banking guidance has already had a chilling effect on the Fed's
ability to constrain emerging risks, is that right?
How do you plan to protect the market from systemic risk if
you're telling supervisors to ignore this guidance? What does
the Fed plan to replace this guidance with?
A.22. The Board has broad authority to supervise and regulate
banking organizations to promote their safety and soundness. As
part of that authority, Federal Reserve supervisors and
examiners assess credit and other risks to the safe and sound
operations of firms, including risks that may be posed by
leveraged lending, and to direct the firms to address such
risks as appropriate. As part of assessing credit and other
risks, Federal Reserve examiners routinely evaluated the
underwriting of leveraged loans prior to the issuance of the
most recent leveraged lending guidance. The guidance was issued
to provide clarity regarding safety and soundness issues that
may be present in making such loans. The guidance was not
issued as a regulation that would be enforceable. Rather,
banking organizations should use it to better understand and
manage the risks they are taking.
The Board, Federal Deposit Insurance Corporation (FDIC),
and OCC are discussing whether it would be appropriate to again
solicit public comment on the guidance with a view to improving
the clarity and reducing any unnecessary burden.
Q.23. The Fed in 2016 proposed a rule to limit some of banks'
activities in commodities markets, with the rationale being
that banks' owning, trading, and moving commodities might post
a safety and soundness risk to the banking system or allow
banks to wield outsized power in certain markets.
How does the Fed have time to revisit so many rules that
aren't even fully phased in yet--the Volcker Rule, the leverage
ratio, risk-based capital rules--when you haven't even
completed work from the recent past that was based on years and
years of study?
Since the election we have heard nothing about this rule
being finalized or about any progress on the rule. Has this
rule been abandoned, and if so, why?
A.23. The Board began its review of the physical commodities
activities of financial holding companies after a substantial
increase in these activities among financial holding companies
during the financial crisis. In January 2014, the Board invited
public comment on a range of issues related to these activities
through an Advance Notice of Proposed Rulemaking. In response,
the Board received a large number of comments from a variety of
perspectives. The Board considered those comments in developing
the proposed rulemaking that was issued in September 2016.
After providing an extended comment period (150 days) to allow
commenters time to understand and address the important and
complex issues raised by the proposal, the Board again received
a large number of comments from a variety of perspectives,
including Members of Congress, academics, users and producers
of physical commodities, and banking organizations. The Board
continues to consider the proposal in light of the many
comments received and to monitor the physical commodities
activities of financial holding companies.
Q.24. A recent NY State Comptroller report reported that Wall
Street bonuses showed a dramatic 17 percent increase from last
year. Bonuses have increased by 34 percent over the last 2
years, and the average bonus for Wall Street traders is now at
the second highest level ever recorded--behind only 2006, the
year before the financial crisis began.
We also know, from the Financial Crisis Inquiry Commission
and other sources, that out-of-control bonus practices were a
major driver of the 2008 financial crisis. Top executives at
Bear Stearns and Lehman took out almost $2.5 billion in bonuses
in the years before those two companies failed, and never had
to repay a dime. After the crisis, multiple surveys showed that
more than 80 percent of financial market participants agreed
that irresponsible bonus practices were a major contributor to
the short-term risk taking that brought down the financial
system.
Section 956 of the Dodd-Frank Act instructed bank
regulators to reform bonuses at financial institutions, by
eliminating ``take the money and run'' bonus practices that
encouraged irresponsible risk-taking. Prior to your
confirmation, regulators were close to completing rules that
would have placed new limits on big bank bonuses. Yet to all
appearances the Federal Reserve and other regulators appear to
have abandoned that effort completely, even as bonuses
skyrocket back to precrisis levels.
When will the Federal Reserve implement Section 956 of
Dodd-Frank and reform bonuses? Why has this rule been delayed
so long?
A.24. In June 2016, the Board, OCC, FDIC, the SEC, National
Credit Union Administration, and Federal Housing Finance Agency
(the Agencies), jointly published and requested comment on a
proposed rule under section 956 of the Dodd-Frank Act. This
joint effort proposed several requirements to address incentive
compensation arrangements. The Agencies received over 100
comments on the 2016 proposed rule and are considering the
comments. I do not have a projected date for completion of this
rulemaking.
The Federal Reserve, along with the other Federal banking
agencies, issued Guidance on Sound Incentive Compensation
Policies in June 2010 to address incentive compensation
programs at financial institutions. This guidance is intended
to assist regulated firms in developing appropriate incentive
compensation programs that do not encourage inappropriate or
excessive risk taking.
The Federal Reserve continues to evaluate incentive
compensation practices as a part of ongoing supervision. This
supervision has focused on: the design of incentive
compensation arrangements; deferral and risk adjustment
practices (including forfeiture and clawback mechanisms);
governance; and the involvement of the firm's controls and
control function groups in various aspects of incentive
compensation arrangements.
Supervision focuses on ensuring robust risk management and
governance around incentive compensation practices rather than
prescribing amounts and types of pay and compensation.
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