[Senate Hearing 115-408]
[From the U.S. Government Publishing Office]
S. Hrg. 115-408
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
__________
NOVEMBER 15, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov/
______
U.S. GOVERNMENT PUBLISHING OFFICE
33-484 PDF WASHINGTON : 2019
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
Joe Carapiet, Chief Counsel
Brandon Beall, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Elisha Tuku, Democratic Chief Counsel
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, NOVEMBER 15, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 21
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
Prepared statement....................................... 22
WITNESS
Randal K. Quarles, Vice Chairman for Supervision, Board of
Governors of the Federal Reserve System........................ 4
Prepared statement........................................... 23
Responses to written questions of:
Senator Brown............................................ 70
Senator Toomey........................................... 74
Senator Cotton........................................... 76
Senator Rounds........................................... 77
Senator Tillis........................................... 82
Senator Warren........................................... 84
Senator Cortez Masto..................................... 89
(iii)
THE SEMIANNUAL TESTIMONY ON THE FEDERAL RESERVE'S SUPERVISION AND
REGULATION OF THE FINANCIAL SYSTEM
----------
THURSDAY, NOVEMBER 15, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:01 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. 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 for 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.
We last heard from Vice Chairman Quarles in October on the
Fed's progress implementing S. 2155, the Economic Growth,
Regulatory Relief, and Consumer Protection Act.
At that time the Fed had taken actions to implement some
provisions of S. 2155, including those related to the 18-month
exam cycle, high-volatility commercial real estate, and the
Small Bank Holding Company Policy Statement.
Since then, the Fed has taken new steps to implement key
provisions of the bill.
Recently, the Fed issued proposals revising the application
of enhanced prudential standards across four categories of
firms to reflect each category's varying risks. These proposals
are a step in the right direction, and I appreciate the Fed's
work to issue them quickly.
I understand the amount of staff work that went into
getting the proposals out, and thank you and your staff for
your work on these proposals.
The proposals would assign banking organizations to one of
four categories based on their size and other risk-based
indicators, including cross-jurisdictional activity; nonbank
assets; short-term wholesale funding; off-balance-sheet
exposures; and status as a U.S. global systemically important
bank, or a U.S. G-SIB.
The category to which an institution is assigned would
determine the enhanced prudential standards and capital and
liquidity requirements to which it would be subject.
I look forward to hearing how the application of certain
enhanced prudential standards would address the risks
associated with cross-jurisdictional activity, nonbank assets,
short-term wholesale funding, and off-balance-sheet exposures.
The proposal incorporates a number of very positive changes
to the current framework for regional banks, including relief
from advanced approaches capital requirements; a reduced
liquidity coverage ratio; changes to the frequency of
supervisory and company-run stress testing, and, in some cases,
the disclosure of the results.
Despite this positive step, the agencies have left a number
of items unaddressed, including the treatment of foreign
banking organizations; additional details on stress testing,
including the Fed's Comprehensive Capital Analysis and Review,
or CCAR; and resolution planning.
I encourage the regulators to revisit all regulation and
guidance thresholds that were consistent with the outdated
Section 165 threshold to an amount that reflects actual
systemic risk.
Regulators have two options: use a systemic risk factors-
based approach, or raise all thresholds to at least $250
billion in total assets to be consistent with S. 2155.
There are also other noteworthy provisions of the bill on
which the Fed, working with other regulators, has yet to act,
including implementation of the Community Bank Leverage Ratio
and the provision that exempted cash deposits placed at central
banks by custody banks from the supplemental leverage ratio.
The Fed should work promptly to issue proposals to address
these critical outstanding issues.
I was encouraged by Vice Chairman Quarles' speech last
week, particularly the emphasis on providing more transparency
around stress testing and capital planning processes.
Finally, last week all Republican Members of the Banking
Committee sent a letter to the FDIC on Operation Choke Point.
Operation Choke Point is an initiative in which Federal
agencies devised and relied upon a list of politically
disfavored merchant categories with the intent of ``choking
off'' these merchants' access to payment systems and banking
services.
Staff at the banking agencies use verbal recommendations to
encourage banks to stop doing business with disfavored but
legal businesses.
I plan to look into how policy is communicated from the
banking agencies to the regulated institutions more broadly.
I appreciate Vice Chairman Quarles joining us today to
discuss developments in the Fed's supervision and regulation
and look forward to hearing more about the Fed's pending work
to implement Senate bill 2155.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman, and thanks to Vice
Quarles for joining us. Good to see you again.
The Fed's responsibility and Vice Chairman Quarles' job is,
as we know, to ensure that the economy works for average
Americans--that if you work hard, you can get ahead; that Wall
Street does not again crash the financial system and squander
the pensions that families worked their whole lives to earn;
and that banks cannot cheat workers out of their hard-earned
savings; and that executives are held accountable when they
break the law.
We know the Fed failed in its mission 10 years ago. The Fed
had all the power it needed to prevent the crash. Its leaders
in Washington were too complacent and too cozy with Wall Street
to use their authority to rein in the largest banks and to
protect American taxpayers.
That is why immediately after the crash, we put in place
rules to strengthen taxpayer protections from big bank risk and
to protect consumers from predatory practices.
The rules worked. Our system got safer, and the rules have
not stopped banks from becoming more profitable than ever, as
we see. The Fed released a report on Friday showing that two
important measures of banks' profitability--return on equity
and average return on assets--hit a 10-year high in the second
quarter of 2018. They have reported a 30-percent growth in loan
volume since 2013, while experiencing a 10-year low in the
share of loans that are not performing.
But now, with legislation enacted earlier this year and the
actions of this Administration, we are witnessing--piece by
piece by piece--the dismantling of these protections for
American workers and an undermining of the dignity of work.
Since the last time Mr. Quarles testified before this
Committee, we have two new developments that underscore this
point.
First, the Fed's proposal to implement the bank giveaway
bill, S. 2155, goes far beyond what the authors of that
legislation claimed the bill would do. The Fed's proposed rule
loosens protections for banks with more than $250 billion in
assets--not small community banks, the way the bill was sold.
We are talking about the Nation's biggest financial
institutions. Combined, these firms hold $1.5 trillion in
assets.
The Fed's proposal also promises more goodies for the big
banks, with rollbacks for large foreign banks expected in the
next few months. This is despite the fact that the Fed's own
progress report said that foreign banks continue to violate
anti- money-laundering laws and skirt Dodd-Frank requirements.
No need today to go down that list of foreign banks. We all
know who they are. We have talked about them in this Committee.
Senator Cortez Masto has brought it up. I have brought it up. A
number have brought it up. Yet we are saying to these foreign
banks we sort of ignore the illegal things they do and continue
to deregulate them.
Vice Chair Quarles gave a speech last week announcing the
Fed's plans for the very largest domestic banks--a speech,
frankly, that could have easily been written by one of those
banks' lobbyists.
Mr. Quarles wants to weaken capital requirements for the
megabanks, eliminating any leverage capital standards in stress
tests. We got a preview of what this would look like in June
when the Fed gave passing grades to three banks that had
clearly failed their stress tests. Now Mr. Quarles wants to
make this year's giveaway permanent.
The speech outlined a series of other changes to the Fed's
stress tests that would render them essentially meaningless.
Mr. Quarles makes no secret of the fact he wants to ease up on
the assumptions that guide the tests, wants to eliminate
portions of the tests, and wants to share with the banks the
Fed's internal models against which they are graded--you know,
giving students the answers ahead of time.
These changes, taken alongside the weakening of the Volcker
Rule, other big bank leverage standards, and an abandonment of
nonbank financial oversight, these changes amount to gutting
the postcrisis protections we put in place that have worked
marvelously for about a decade to protect American taxpayers
future bailouts. Again, repeat, the banks are doing very, very,
very well with these rules and regulations in terms of
profitability and return, all of those things. So why do we
think weakening those rules makes sense?
It is not just I who says this. Stanley Fischer, the former
Vice Chair of the Fed, called these combined rollbacks ``mind
boggling'' and ``very dangerous.''
When regulators have not finished implementing Dodd-Frank,
when the economy has not even gone through a full economic
cycle, now is not the time to begin dismantling our postcrisis
protections. It is the same story: Wall Street recovers,
working families in Cleveland and Baltimore and Birmingham and
Las Vegas do not. When Washington policymakers suffer from
collective amnesia, as this Committee does, working families
and savers and taxpayers too often end up paying the price.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Brown.
Again, Vice Chairman Quarles, we appreciate you being with
us. You may now make your statement.
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 am grateful for the
opportunity to testify on the Federal Reserve's regulation and
supervision of the financial system.
My prepared remarks address two main topics: our efforts to
improve regulatory transparency and our progress in making the
postcrisis regulatory framework simpler and more efficient. I
am mindful that this semiannual testimony, like my position as
Vice Chairman for Supervision, is grounded in Congress' efforts
to strengthen and improve the Nation's regulatory framework
following the financial crisis, and this testimony reflects a
critical element of those efforts: the desire and the need for
greater transparency.
Transparency is part of the foundation of public
accountability, and it is a cornerstone of due process. It is
also key to a well-functioning regulatory system and an
essential aspect of safety and soundness as well as financial
stability. Transparency provides firms clarity on the letter
and spirit of their obligations. It provides supervisors with
exposure to a diversity of perspectives. And it provides
markets with insight into the condition of regulated firms,
which fosters market discipline. Transparency increases public
confidence in the role of the financial system to support
credit, investment, and economic growth.
The Federal Reserve has taken a number of steps since my
last testimony to further increase transparency and to provide
more information about our supervisory activities to both
regulated institutions and the public. We recently improved our
supervisory ratings system for the large financial
institutions, better aligning ratings with the supervisory
feedback that those firms receive. With our fellow banking
agencies, we clarified that supervisory guidance is a tool to
enhance the transparency of supervisory expectations and should
never be the basis of an enforcement action. And we expect
shortly to make final a set of measures to increase visibility
into the Board's supervisory stress testing program, including
more granular descriptions of our models, more information
about the design of our scenarios, and more detail about the
outcomes we project.
The report that accompanies my testimony today and that
Ranking Member Brown referred to is another tool to keep
Congress and the public informed about our work, the banking
system, and the role of both in supporting the broader economy.
As the report shows and as my written testimony discusses, the
banking sector remains in strong condition, in line with strong
U.S. economic performance, with lending growth, fewer
nonperforming loans, and strong overall profitability.
We are, however, very much aware of the dangers of
complacency, and our report lists several priority areas of
risk we will continue to monitor closely, including cyber and
IT risks at supervised firms of all sizes.
Improving regulatory efficiency is another core element of
our current efforts. Tailoring regulation and supervision to
risk has been a programmatic goal of the Federal Reserve for
more than two decades. The motivations are clear: supervisory
resources are not limitless; supervision is not costless,
either to the public or to supervised institutions. Activities
and firms that pose the greatest risk should receive the most
scrutiny, and where the risk is lower, the regulatory burden
should be lower as well.
This principle guided Congress and the agencies in
designing the postcrisis regulatory framework, and it has
guided our implementation of the Economic Growth, Regulatory
Relief, and Consumer Protection Act. On this front, as my
written testimony details, we have made substantial progress.
Our most significant step came 2 weeks ago when the Board
issued two proposals to better align prudential standards with
the risk profile of regulated institutions. These proposals
would significantly reduce regulatory compliance requirements
for firms in the lowest risk category, including most
institutions with between $100 billion and $250 billion in
assets. Firms with $250 billion or more in assets or firms
between $100 billion and $250 billion that meet a risk
threshold will face reduced liquidity requirements. The
proposals would largely maintain existing requirements for the
largest and most complex firms.
These new categories draw on our experience administering
enhanced prudential requirements and other postcrisis measures,
and they move toward a more risk-sensitive, nuanced framework,
where riskier activities and a larger systemic footprint
correspond to higher supervisory and regulatory requirements.
I have detailed several other efforts to improve regulatory
efficiency in my written testimony, including simplifying and
tailoring requirements under the Volcker Rule.
Our work to improve regulatory efficiency is not done, and
we expect to make additional progress in the months ahead on a
number of issues. In particular, we are working with our
counterparts at the OCC and FDIC on a community bank leverage
ratio proposal. I look forward to making progress on that and
other efforts and to participating in the Committee's oversight
of our work.
Thank you, and I look forward to answering your questions.
Chairman Crapo. Again, thank you, Mr. Quarles.
My first question is really just one on timing for what is
coming next. I do appreciate the work the staff has gone
through, truly. I know the amount of work it has taken for you
to move as expeditiously as you have. I am concerned, however,
that it is difficult to get a full picture of what the
supervisory and regulatory landscape will look like until other
proposals on foreign banks, resolution planning and capital
planning, and stress testing are out. And I encourage you to
keep the heat on to move quickly and would appreciate any
updates you might have on timing.
Mr. Quarles. Certainly, Mr. Chairman. So as I indicated,
our implementing proposal which we are working on jointly with
the OCC and the FDIC on the community bank leverage ratio
proposal we expect very soon. And, again, I hope that the speed
with which we put forward the main implementing proposal
indicates that very soon really will be very soon.
Shortly following after that, I think we will have
proposals for modernizing or bringing up to date the resolution
framework and foreign banking organizations, tailoring for
foreign banking organizations. I view the tailoring for foreign
banking organizations as a somewhat separate question from
implementation of S. 2155. We have been considering, and
obviously we need to consider, and will come up with a proposal
for that. But the domestic operations of foreign banking
organizations I do not think are one-for-one correspondent with
domestic firms of the same size because those intermediate
holding companies, they interact with branches that are subject
to a different regulatory regime here. They are parts of larger
organizations.
So I think there is tailoring that can be done. We need to
ensure that we have a level playing field, that firms that are
alike are treated alike. That is very important. But I do think
it is a separate implementation question than 2155
implementation.
Chairman Crapo. All right. Thank you very much.
Are you familiar with the letter or have you seen the
letter that the Republican Members of this Committee recently
sent to the FDIC on Operation Choke Point?
Mr. Quarles. I have seen that letter, yes.
Chairman Crapo. And are you familiar with Operation Choke
Point, what it is?
Mr. Quarles. I am familiar with what I have read about it,
yes.
Chairman Crapo. OK. As I indicated in my opening statement,
I am very concerned with the lack of accountability in the
supervisory process. What we are finding is that many of the
regulators who are verbally giving instructions to those
regulated that are not actually contained in their authority or
the law, and that, frankly, financial institutions,
particularly a lot of our smaller financial institutions, feel
an incredible pressure from things that are not coming even
from regulations or guidances, but just from verbal
communications.
This raises the question to me of whether those who are
conducting the supervision throughout our agencies, our
financial regulatory agencies, are engaging in regulatory
direction and activity that is not authorized by law or
regulation.
My question to you is: What are you doing to make sure that
staff at the Federal Reserve is accountable to you? And is
there anything Congress can do to make sure that you have the
tools necessary to make staff at the agency accountable to you?
Mr. Quarles. So I appreciate that concern, and I would
share that concern. Obviously, if there were instances where
examiners were communicating and requiring banks to take action
that was not required by regulation and that was not
transparent to those above them in the hierarchy, you know,
obviously that would be extremely concerning.
We have a pretty vigorous training program at the Fed. I
personally have undertaken as well to spend time in the various
reserve banks in dealing with the supervisors on the ground,
conferences of all the supervisory personnel, leadership
conferences. We are working hard--none of that is terribly
visible. All that is within the system. But we are working hard
to ensure that our expectations for supervisory practice as
well as our regulatory process is very clear to those who are
on the ground.
Chairman Crapo. Well, thank you. I appreciate that and I--
well, I appreciate your attention to that. As the letter that
some of the Members of this Committee recently sent to the
FDIC, we want to assure that all of our regulatory agencies in
the financial system follow their own regulations and the law
of the United States rather than, frankly, social managing
ideas that they have with regard to which businesses in America
should be allowed to do business. It is an extremely serious
concern, and I appreciate your attention to this.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Following your speech, one bank analyst told clients that
your proposed changes are ``a positive for the biggest banks by
providing capital and compliance relief. It reinforces our
deregulatory theme for the banking sector. It shows how
deregulation can proceed, even with Democrats retaking the
House of Representatives.''
Two questions. Do you think this analysis of the Fed's
actions is accurate? And, second, can you guarantee this
Committee that when the Fed is done, megabank capital standards
will not decrease relative to where they are today?
Mr. Quarles. As I have indicated each time I talk about
increasing transparency and improving the efficiency of that
system, including our stress testing proposals, our objective
is not to have any--certainly no material effect on the
resiliency of the system and not to have any material effect on
the loss-absorbing capacity of these largest firms. I think
that there are things that we can do that improve the
incentives, that reduce burden, that are more appropriate in a
democracy about the transparency that is required about
regulatory expectations without undermining the safety and
soundness of the system and without, again, in any way reducing
the loss-absorbing capacity of the system.
Senator Brown. But does that mean no diminishing of the
capital standards?
Mr. Quarles. Capital standards are a very important element
of that, but I think we also look broadly. So it is not just
capital standards. It is all the cushions that are built into
the capital structure.
Senator Brown. It includes capital standards?
Mr. Quarles. Capital standards are included in my
understanding of loss absorbency that we do not intend to
reduce.
Senator Brown. So was that analysis of your speech fair and
accurate?
Mr. Quarles. I think it did not--I mean, to the extent that
they believe that there would be material capital reductions
for the largest firms, I do not think they were--I think they
ignored the clear statement that I made, that our intention is
not to----
Senator Brown. This is a group of people that want those
standards diminished, and there is, I mean, almost an arrogance
to it: ``Well, we know the regulators will help us do that even
though those people in the House of Representatives will not.''
Mr. Quarles. So I believe that it is--I know from what it
is that we are proposing that it is possible to have, again, a
material improvement in the efficiency and reduction in the
cost of our regulatory system without undermining what is at
the core of it, which is improved resiliency and strong loss
absorbency for these firms.
Senator Brown. You outlined a lot of bold changes in your
speech. Are you speaking for the whole Fed Board in speeches
like that?
Mr. Quarles. In some cases the Fed Board has made decisions
resolving this. We have come out with proposals. In other
cases--and I have tried to be clear about this when that was
the case--I have said what it is that I would place before the
Board in short order.
Senator Brown. Thank you. Thanks for your honesty. This is
short of an admonition, but we have noticed already, even
though Chair Yellen--and every Chair is different. I get that.
Chair Yellen wanted unanimity when the Board made decisions,
and when one of the Board members, the only non- Trump Board
member, voted the other way, they went ahead. I hope that--I
said this is short of an admonition, but I hope that you keep
that in mind, that the best way to do this is consensus. And if
it means convincing a wayward or two Board member, one or two
Board members to come around, be patient and try to do that, or
look elsewhere.
Mr. Quarles. So we do look for consensus, and certainly
there is a process on the Board that I think each Board member
would say has taken every Board member's thoughts into account
and is open, and adjustments have been made even where at the
end of the day the Board cannot be unanimous. I do not think
that unanimity can be the sole measure of legitimacy or the
whole Dodd-Frank Act would be illegitimate. It was not passed
unanimously. But we do at the Board have a very robust process
to ensure that every Board member's voice is heard.
Senator Brown. I appreciate that, but a regulatory body is
very different from a politically elected--I mean, you, I
assume--I think I can assume your political party, but it does
not matter. You are on the Fed, and regardless of Ms. Brainard
or Mr. Quarles or anybody else on that Board, political party
should not really matter.
One more question. You said the Fed intended to give
megabanks a cheat sheet for the stress test in the coming
years, handing over details about the Fed's models, how the Fed
predicts hypothetical loan performance, even letting banks
comment on the Fed's scenarios that predict what economic
shocks may occur over the next year.
Given the lead-up to the 2008 crisis, why are you so
confident that banks will not optimize their assets to gain the
models? Isn't that exactly what banks did to game credit rating
agency models for mortgage-backed securities?
Mr. Quarles. So in our transparency proposal, we have tried
to strike a balance between more transparency, again, which I
think is appropriate for a number of reasons--again, not just
due process, but also to improve the quality of our models. The
more that people understand them, not just the industry but
academics, Congress, the public, the more input that we can
receive on how to improve them.
But as I have said a number of times, I do think that there
is a concern about the so-called mono model problem, and that
if we were completely transparent, that whatever idiosyncracies
there are in our model would become the locuses of risk
throughout the entire system, and we could end up making the
system more fragile rather than less. And so we are not being
completely transparent about our models even in these increased
transparency proposals that we have made for that reason.
Senator Brown. Well, and I will close, Mr. Chairman. I
appreciate the word ``transparency'' used at least six times in
that answer, and you and I when we had breakfast talked about
that, and I appreciate that view. But this is more like in some
ways giving banks the teacher's edition of the textbook with
the answers listed out in the back when you call giving them
that transparency. We all want transparency in your
deliberations, and I think the Fed has made progress under--
really under Bernanke and Yellen and now. But I just caution
you with the word ``transparency'' when it is giving
information to the people that you are stress testing.
Thank you, Mr. Chairman.
Chairman Crapo. Senator Corker.
Senator Corker. Thank you. We welcome you here, and while I
have enjoyed working with all of those who have held your
position, it is good to have someone who is actually confirmed
and in this role in the appropriate manner.
I know there are going to be comments based on my staff
input earlier today relative to some of the tailoring issues
and some concerns and people alluding to bank profits. But when
we have tried to do safety and soundness, put in place safety
and soundness regulations for institutions--and I think many of
us here strongly support higher capital levels to make sure
that they are safe and sound. But we really do not look at
trying to manage bank profits when we do that, do we?
Mr. Quarles. No.
Senator Corker. Talk to us a little bit about what you
think about when you go through those processes.
Mr. Quarles. So I think that we have two principal concerns
as regulators. We have a concern for the safety and soundness
of individual institutions, and we have a concern for the
safety and soundness of the system as a whole and for the
efficiency of the system as a whole because all of us as
citizens benefit from the efficiency of the financial sector.
That is what provides the support for economic growth, provides
credit for small businesses and businesses generally.
So really irrespective of bank profitability, our concern
is that that system should be operating as efficiently as
possible and that our regulation of that system, while
achieving the objective of safety and soundness, is doing so in
the most efficient way practicable, because when we do that, we
support economic growth that benefits us all.
Senator Corker. I notice the FDIC appropriately is moving
down the path of making sure they have a rulemaking in place
relative to private flood insurance, and I think many of us
here would like to see steps taken to ensure that institutions
are accepting private flood insurance. What is the status of
that right now at the Fed?
Mr. Quarles. So we share the view that private flood
insurance should be acceptable, and we are working to ensure
that that is understood throughout our supervisory system, so
as a supervisory matter that private flood insurance will be
acceptable.
Senator Corker. So we look forward to you moving ahead with
that, and hopefully that will happen very soon.
The GSEs have been something of debate here since 2008,
unsuccessfully. I know that the new Congress likely will take
up legislation. My sense is the Administration potentially will
try to lead on that issue by putting in place some things they
can do on their own accord and then coming back and talking
with Congress about things that are necessary to fully
implement reforms as it relates to Fannie and Freddie.
Currently they are in conservatorship, as you know.
I am just curious. Some people on this Committee may
disagree with the whole creation of FSOC. Some people I think
would have thought maybe the Fed's responsibility was that. But
we do have FSOC, and we do have some firms that are designated
as systemically important.
I am just interested in why the Fed and why FSOC has not
chosen to say that Fannie and Freddie themselves, with such a
huge concentration and such importance systemically to the
banking system itself, have not even during conservatorship
chosen to designate them as systemically important.
Mr. Quarles. Well, ultimately that is a question for the
FSOC as a whole as opposed to just the Federal Reserve.
Senator Corker. Would you all push for that, though? You
have a very strong voice in that.
Mr. Quarles. I think that the right--myself, I think that
the right answer for the GSEs is to have a comprehensive
solution, and FSOC designation in the context of that, I think
it needs to be thought of as what is a comprehensive solution
for these institutions. And so I would not want to do anything
piecemeal until it was clearer what the whole solution is going
to be. I know that the Treasury and the FHFA are both working
hard on that, and I think as we see how that evolves----
Senator Corker. So you look at designating someone with $3
trillion in assets as part of a reform solution, not something
that you deem to be important as it relates to systemic risk?
That is an odd response, just for what it is worth.
Mr. Quarles. Well, again, I think that everything that
involves----
Senator Corker. Just for what it is worth, you know, I
support you and I appreciate your being here. It feels like the
Fed is taking a political look at this and not wanting
themselves to be entangled in versus pushing for the fact that
these institutions, if they ever survive conservatorship,
certainly would need to have capital and all of those kinds of
things. And it feels like you all are kind of dodging a
political issue to keep yourselves from being maybe wounded by
taking a step that is appropriate. Is that kind of where the
Fed is today?
Mr. Quarles. I certainly would not characterize it that
way. I think it is that we are in early days of what ultimately
is a very complex problem and a difficult solution, and I think
we should not approach that solution piecemeal, but should look
at what is a comprehensive answer.
Senator Corker. So yes or no, are they systemically
important?
Mr. Quarles. Well, I think it is unarguable that those
institutions have systemic consequence. The question is: What
is the right response to that?
Senator Corker. So they are systemically important. Thank
you.
Chairman Crapo. Senator Jones.
Senator Jones. Thank you, Mr. Chairman. And thank you, Mr.
Quarles, for being here.
I would like to ask you a little bit about something that I
am hearing more and more about in Alabama, and that is the
current expected credit loss accounting standard, CECL, that
has come in. As someone who tries to run away anytime people
start talking numbers and accounting, I really appreciate what
FASB has been doing, so I am not making any judgment here. But
I am concerned in what I hear from our banks a little bit, the
concern about unintentional consequences that may impact the
ability of banks to make long-term loans, whether small
business loans or residential loans. And I think and my
recollection is that in recent comments at Brookings, you
stated that you believe that there was some agreement that CECL
was going to be procyclical, but that these issues could be
addressed as you phased in those rules.
Can you just expand on those comments a little bit and what
you are looking at to try to make sure that we do not have
those unintended consequences and making sure particularly
smaller banks are protected?
Mr. Quarles. Certainly. So I agree with you that there is a
lot that we still do not know about how CECL will really
operate in practice and what the effect will be on banks of any
size, but particularly smaller banks. And that is why we had
proposed that we will have a 3-year phase-in period, at least a
3-year phase-in period, so that we can understand before
phasing the CECL results into our capital calculations, exactly
what those effects are really in operation.
We have gotten a lot of different estimates ex ante as to
what the consequence will be of CECL. Will there be an
immediate increase in reserves on day one? Is the real issue
with CECL or the real consequence of CECL that there will be
procyclicality in the event of stress? And if there is
procyclicality in the event of stress, does that affect banks
that are covered by our stress tests? And how does CECL work
there? And it really is too early to say and I do not think we
have enough data to know exactly what those consequences are
going to be, the day one consequences versus the ongoing
consequences and the stress consequences.
So we are going to be looking at all of that on the basis
of the real operation of CECL when it is in effect by delaying
our implementation of including it in our capital----
Senator Jones. All right. And I assume you will be taking
the comments.
Mr. Quarles. Absolutely.
Senator Jones. I mean, that phase-in is going to give you
the opportunity to tweak, to go back and get comments from the
banks and how it is going to be----
Mr. Quarles. We will be looking for input from all sources
on that.
Senator Jones. All right. Perfect. Thank you for that.
And so the other thing is the Community Reinvestment Act. I
think that is going to be one of the most important items that
banking regulators take up this year. I have spoken to the OCC
about this. You know, if we get it right, it is going to be
really important to modernize the CRA. But if we get it wrong
and go in the wrong direction, I am concerned still--and I want
to make sure that this is being addressed--that we are not
having different regulators addressing the CRA in different
ways.
So can you give me an update about the Fed's role working
with the OCC about trying to modernize the Community
Reinvestment Act?
Mr. Quarles. Certainly. So we have worked with the OCC. The
OCC has put out an Advance Notice of Proposed Rulemaking, and
we had extensive discussions, all the banking agencies had
extensive discussions together before the OCC went out with
that ANPR. We will all be looking at the information that comes
in as a consequence of that process. We are having a very
athletic outreach process at the Federal Reserve on questions
about the CRA. I think we have got 20 different seminars and
events that are set up throughout the system, throughout our
various reserve banks, looking for input on that. And I expect
that, moving forward, our expectation is that we will have a
joint NPR, Notice of Proposed Rulemaking, at the end of this
outreach process that will reflect all the information that we
receive.
Senator Jones. Great. Thank you.
Finally, just a couple of comments. Number one, I know that
the Fed is part of a working group dealing with anti- money-
laundering issues that I know this Committee is likely to take
up this year. I have been hearing that law enforcement may not
be as included on that. I know you have got some. But as a
former U.S. Attorney, I would just encourage that working group
to bring in the FBI or other Treasury criminal officials,
because there is nothing like boots on the ground to really do
that, and I would just encourage you to include some boots-on-
the-ground law enforcement as part of that working group.
And the final thing I just want to say is I want to tell
you that I appreciate very much you and your fellow Fed Board
Governors for maintaining your independence during a time of
recent criticism. I think the independence of the Federal
Reserve is truly a core bedrock of our economy and our
democracy here on both monetary and regulatory policy. It is
critical that you maintain that independence, so thank you for
that. And I want to tell you that for as many of us here that
we can, we will do what we can to preserve that independence
for you. So thank you.
Mr. Quarles. Thank you, Senator.
Chairman Crapo. Senator Rounds.
Senator Rounds. Thank you, Mr. Chairman.
Vice Chair Quarles, first of all, thanks for being here.
Before I get into the questions that I have got for you, I
would like to make one real quick comment. I would like to echo
the remarks made yesterday by my colleague from the House
Financial Services Committee, Congressman Ted Budd, regarding
the insurance regulation. I agree with Congressman Budd that
the Fed and other American regulators should stand up for
State-based insurance regulation and fight overreach from the
international regulators like the IAIS, and hopefully you folks
will stand strong on that.
Let me also just jump into where my questions would begin.
As we conclude the 115th Congress, Americans have a lot of
things to be thankful for. The postcrisis economic expansion
has continued for a near record 97 months. Tax reform and the
Trump administration's deregulatory efforts have pushed GDP
growth to 4 percent. Unemployment remains at a low of 3.7
percent. These are all positive developments. Yet I remain very
concerned about a number of troubling economic signals from
back home in South Dakota with our strong reliance on an ag
economy--not just South Dakota, but North Dakota, Minnesota,
Nebraska, Iowa, the Upper Midwest.
More specifically, our country's ongoing trade disputes are
causing significant economic problems for my State's ag
economy. As an example, the retaliatory tariffs from China on
American soybeans have caused soybean sales to China to plummet
by 94 percent compared to last year's harvest.
Now, while the Federal Government's financial assistance
has helped to offset some of these losses, the subsidy for each
bushel of soybeans in some cases covers less than half of the
actual loss that farmers are facing, and it is the producers
that are really taking the brunt. They are on the tip of the
spear in this trade dispute.
The impact, I cannot overemphasize how critical this trade
impact is to the economic well-being of farmers in the Upper
Midwest. In South Dakota, the farm economy is down for 5 years
in a row. We are down 50 percent in net farm income, and this
is not helping at this point. And while we see some relief
coming, there is going to be a time--just as an example,
soybeans down by 94 percent sales to China, some people say,
``Big deal.'' China buys 60 percent--of all those that are
exported, 60 percent of it goes to China. It is close to 30
percent of the entire soybean market. And so this is a real
impact to farmers in the Upper Midwest.
Some of these folks, after 5 years of low commodity prices,
will be coming in to ask for operating loans. The banks in the
Upper Midwest, those who have survived year in and year out,
have over the past understood at the local level that every
year is not going to be a profitable year for an ag operator.
And most of those smaller banks that do that expect that some
years they are going to have to look at something and say,
``You may not have performed well last year or commodity prices
are down, but we understand long term this is going to be a
profitable program for our bank, and if you do not survive, we
do not survive either.''
I am hopeful and what I am asking for is some reassurance
from the Federal Reserve that the Fed and the FDIC, the
regulators and the folks who are going to come in and actually
audit the banks will have an understanding that this short-term
trouble we are in right now is not going to cost these banks to
be identifying these ag operators as nonperforming loans if
they come back in looking for assistance to get by this tough
time period in which they are on that tip of the spear in this
trade dispute.
Could you comment on that, please?
Mr. Quarles. Certainly. I think one of the strengths of our
supervisory system is that we have people on the ground with
experience both with individual institutions and different
categories of institutions and a history of understanding how
different markets work, and all of that should be brought to
bear as they make their individual supervisory decisions.
Senator Rounds. I am going to go one step farther because I
think this is really important. In the previous Administration,
there were times in which at the upper echelons there was an
attempt to get more money out into the economy, and yet at the
lower echelons, where the actual audits were being done, there
was a disconnect in that it was very difficult to get the money
into the ag economy because in some cases specific sections of
the ag economy were identified as nonperforming sectors, and
even loans that had been repaid on time were still being
identified as nonperforming assets.
I just want to hear once again a reassurance that there is
some sort of a message out there that says that the ag economy
is going through a tough time; we understand that there can be
exceptions made, and that we are not going to be punishing the
banks for trying to get these folks through a tough time. And
that has got to come from the top down so that the folks on the
front line who are doing the audits, making the reviews of the
banks, have some understanding about what the banks are trying
to do to make sure these producers survive and actually
continue to help make those banks a profit in the future.
Mr. Quarles. So I can absolutely commit to you that I take
the supervision part of this job as important as the regulatory
part of this job. For what it is worth, as I think you know, I
come from an agricultural background myself and understand the
issues that you are talking about, very much so, and will be
engaging with the supervisors to ensure that they take
reasonable decisions.
Senator Rounds. Thank you.
Thank you, Mr. Chairman.
Senator Brown [presiding]. Senator Warren.
Senator Warren. Thank you, Mr. Chairman. It is good to see
you again, Governor Quarles.
I want to follow up on a letter I sent yesterday to the Fed
and to several other Federal regulators. In it I raised
concerns about the rapid growth of leveraged corporate lending,
that is, lending to companies that already have a lot of debt.
There was a record $1.1 trillion in leveraged loans in the
U.S. last year, nearly double what it was just a few years ago.
In the last few weeks, former Fed officials have raised serious
concerns about the growth of leveraged lending. Former Fed
Governor Dan Tarullo called for more oversight and transparency
because of the risks these loans pose to the economy, and
former Fed Chair Yellen said she is ``worried about the
systemic risks associated with these loans.''
So do you agree with former Fed Chair Yellen and Governor
Tarullo that this is a concern?
Mr. Quarles. Well, I agree that the framework that they are
talking about it in, the systemic risk is what it is that we
ought to be looking at and ensuring that we understand how
systemic risk is evolving as opposed to simply the volume of
leveraged lending. I think that is the right way to look at it.
Senator Warren. OK. I understand you think it is the right
way to look at it. Are you concerned about it, the amount? That
is the question.
Mr. Quarles. Yeah, again, I think the question is what are
the structures that these loans are being held in. The amount
itself is not what is critical. What is critical is, you know,
are they being held in vulnerable structures? Do we understand
how the system is evolving? And that is something that we are
looking at very closely.
Senator Warren. All I can say, even your fellow Trump
appointee, OCC head Joe Otting, said recently that ``there is
probably a bit more leverage in this market than we as a
country should be comfortable with.''
So I tell you what, let me move on. In 2013, under the
Obama administration, the Fed, the OCC, and the FDIC were
worried about leveraged lending, so they issued joint guidance,
and that guidance provided risk management and underwriting
expectations for the leveraged commercial loans, and then they
enforced it. The next year a dozen banks received notices that
they were not following the guidance, and the Fed issued a
supervisory finding that directed Credit Suisse to abide by the
guidelines.
But things have shifted in the Trump administration.
Earlier this year, Comptroller Otting said he did not care if
the banks under his supervision violated the guidelines if it
did not affect their overall safety and soundness. Is that your
position as well?
Mr. Quarles. Well, our position with respect to leveraged
lending supervision is that we are actually quite athletically
looking at that. That is something----
Senator Warren. OK, so that is not your position. You are
enforcing the guidelines.
Mr. Quarles. Well, guidance is guidance. Guidance is
intended to provide transparency, but it is not something that
can be enforceable. It is not a rule. So what we are enforcing
are----
Senator Warren. I am sorry. The Fed directed Credit Suisse
to abide by the guidelines back in 2014, so you cannot say
there is nothing you can do. The Fed has done it.
Mr. Quarles. To enforce guidance is inappropriate. That is
not something that can be done.
Senator Warren. Well, it directed them to follow the
guidance. I mean, I do not want to split hairs with you. I am
just asking a question. Are you still holding them to the
guidance or not?
Mr. Quarles. We are holding them to standards of safety and
soundness, and I think that is an important distinction,
Senator. We are not in any way abrogating or not looking at
leveraged lending. That is an important part of our
supervision.
Senator Warren. Are you monitoring compliance with the 2013
guidelines?
Mr. Quarles. We are monitoring compliance with safety and
soundness.
Senator Warren. Is that a no on the 2013 guideline?
Mr. Quarles. The guidance is intended to provide
transparency as to what it is that we will look at.
Senator Warren. Are you monitoring compliance with that?
Mr. Quarles. We should not monitor compliance with
guidance. We should monitor compliance----
Senator Warren. I take that as a no, then.
Mr. Quarles. ----with safety and soundness.
Senator Warren. I will take that as a no. There have been
reports of banks offering loans that plainly violate the 2013
guidelines, so it is clear to me that at least the market does
not think you are monitoring these. What concerns me, Governor
Quarles, is this market looks a lot like the subprime mortgage
market looked pre-2008. The loans are badly underwritten with
minimal protections. Like subprime mortgages, these loans are
being packaged up and sold to investors as collateralized loan
obligations, or CLOs, which spread the risk throughout the
system and take the lender off the hook for originating a bad
loan. And these loans have adjustable rates, which means that
if interest rates continue to go up, companies will owe more
money just at the moment when the overall economy may be
slowing down.
Now, the Fed dropped the ball before the 2008 crisis by
ignoring the risks in the subprime mortgage market. What are
you doing differently this time in coordination with other
Federal regulators so that you are limiting the risk that
leveraged loans cause serious harm to the financial system?
Mr. Quarles. So we are--as I said, it is an important theme
of our supervision and monitoring--this cycle is monitoring the
underwriting standard for leveraged loans. We will be looking
at that carefully in this supervisory cycle. We are also
monitoring carefully how the CLO ecosystem is evolving to make
sure that we understand where risks are evolving there.
Senator Warren. OK. I am not sure that I see much
distinction between what you are doing now and the Fed was
doing pre-2008, and I think that is deeply worrisome. I have
sent a letter, asked more questions in that letter. I hope I
will be able to get a response soon to that. I am very
concerned that the Fed dropped the ball before and may be
dropping it one more time on this.
Thank you.
Chairman Crapo [presiding]. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. Good morning, Mr.
Vice Chairman.
Can you tell me what exposure, if any, the American banking
system has to any instability in Italy, including but not
limited to its banking system?
Mr. Quarles. So the exposure of our banking system to
Italian banks is--the direct exposure is relatively modest. We
do not think that there is a particular issue there. Obviously
it is a single financial sector. There are parts of the
European financial sector that are exposed to Italy, and we
continue to monitor whether developments there could have
feedback effects into the United States. We are not--we do not
view cause for particular concern there at the moment.
Senator Kennedy. OK. What is a short form call report?
Mr. Quarles. The intention of the short form call report is
to be a form that has less burden on the institutions that fill
it out, requires less cost and time, but still provides us all
the information that we need to ensure that institutions that
are less risky are safe and sound appropriate to the riskiness.
Senator Kennedy. And I believe that Congress and, for lack
of a better expression, our Dodd-Frank reform bill directed you
to come up with a short form call report for banks $5 billion
or less that would be less onerous. Is that right?
Mr. Quarles. That is correct.
Senator Kennedy. Why haven't you done that?
Mr. Quarles. I know that we are in the process of
implementing that. I think that----
Senator Kennedy. You promulgated a rule. It is going to
save the average bank a grand total of 1.18 hours a quarter.
The stuff that you are cutting out is the stuff that most small
banks always put zero on. You are not doing anything. I mean, I
would like you to get in another lick and let us try to be
serious about it.
Refresh my memory what banks $5 billion or less did wrong
in 2008.
Mr. Quarles. Well, overconcentration in commercial real
estate, but we do not believe that they are----
Senator Kennedy. But did they cause--they did not cause the
meltdown.
Mr. Quarles. We do not believe that they are likely to have
systemic----
Senator Kennedy. Right, but we punished the hell out of
them in Dodd-Frank. OK?
Mr. Quarles. Yeah, I do believe that it was--that the
regulatory burden on the smaller banks was too much.
Senator Kennedy. I wish you would take another look at your
promulgated rule. I think it is all hat and no cattle.
Mr. Quarles. I appreciate that, and I will go back and look
at it.
Senator Kennedy. OK. Tell me, Mr. Vice Chairman--and I
really do appreciate the job that you are doing. Tell me what a
community bank leverage ratio is.
Mr. Quarles. So that is a proposal that we are working on
with the other regulators to develop standards that a community
bank that has a certain leverage ratio and other standards
would be subject to simplified, much simplified regulation.
Senator Kennedy. OK. Would it be fair to say that it would
mean that a community bank which has a lot of capital, a lot of
cushion, particularly with respect to or in comparison with the
larger systemically important banks, would get less
supervision?
Mr. Quarles. Well, I----
Senator Kennedy. Well, not less supervision.
Mr. Quarles. Exactly.
Senator Kennedy. Less paperwork.
Mr. Quarles. Less paperwork, absolutely. Absolutely.
Senator Kennedy. OK. Have you promulgated a rule?
Mr. Quarles. We have not promulgated a rule yet, but that
is one that I expect very soon, and very soon in real time, not
Fed time.
Senator Kennedy. OK. Well, let us suppose that a community
bank had 6 percent capital. Would you consider that to be well
capitalized?
Mr. Quarles. Depending on the type of capital, that could
be well capitalized.
Senator Kennedy. OK, with reasonable liquidity.
Mr. Quarles. Yeah, I think the community bank leverage
ratio instruction is somewhere between 8 and 10. We are to look
between 8 and 10 percent.
Senator Kennedy. Right, 8, 10, 12. I am just saying there
are a lot of small institutions out there that are very well
capitalized, and if they belly up, the world is not going to
spin off its axis. It may for its shareholders, but that is the
way capitalism works.
Mr. Quarles. Sure.
Senator Kennedy. So we really ought to be trying to do
everything we can to get a little Government off their back so
you can concentrate your efforts on banks whose demise could
threaten our banking system. Would that be fair?
Mr. Quarles. I agree.
Senator Kennedy. OK. I hope you will do that in developing
the ratio, and I hope you will take a good second look at that
rule that I mentioned. Thank you, Mr. Vice Chairman.
Mr. Quarles. Thank you, Senator.
Senator Kennedy. Have a Happy Thanksgiving.
Mr. Quarles. Thank you.
Chairman Crapo. Senator Menendez.
Senator Menendez. Thank you.
Last week it was reported that more than 500 families,
including 22 in New Jersey, wrongly lost their homes to
foreclosure because of an error in Wells Fargo underwriting
software which caused the bank to incorrectly deny mortgage
modifications to homeowners. That is unacceptable, and there is
no amount of remediation or apology that makes up for losing
your home.
Now, I know, Mr. Vice Chair, that you have recused yourself
from matters specific to Wells Fargo, but I do think this
raises a more serious overarching question about the oversight
of the Nation's biggest banks. I am seriously concerned that we
are re-creating a world where homeowners are at the mercy of
the banks and there will not be a cop on the beat when things
go bad.
So what assurances can you give us that the Federal Reserve
is specifically monitoring for these types of issues and in a
larger sense ensuring that homeowners are not subject to the
same abuses they were during the crisis?
Mr. Quarles. So we have a large and active Division of
Consumer and Community Affairs where we have regulatory
authority that remains after the Dodd-Frank Act--and our
authority was restricted to some extent as you know, but where
we have regulatory authority, we have a very active enforcement
program in ensuring that we are both examining and, where we
see deficiencies, enforcing against consumer problems.
Senator Menendez. And so in this case, that would have been
lost in that process? Or would something like this be lost in
that process?
Mr. Quarles. So I would not think so. I mean, that is the
sort of thing that we would look at. I would have to--we can
get back to you with more specifics. The Fed can get back to
you with more specifics about Wells Fargo since I am recused,
but as a general systemic matter, we certainly--we do not
underemphasize----
Senator Menendez. My point is if you, in fact--I appreciate
your answer. If you, in fact, are saying that you are looking
at systemic issues that might affect homeowners in a way that
this particular instance did, then it did not work as it
relates to Wells Fargo. So we have to understand what is it
that did not work. I would love to hear from the Fed the
specific about Wells Fargo. But I would like to also hear what
did not work at the end of the day that did not catch this.
The Federal Reserve recently proposed loosening liquidity
rules for banks as large as $700 billion in assets. During the
crisis these same banks received almost $60 billion in taxpayer
bailouts. Liquidity standards are critical to ensuring banks
have enough cash on hand to meet the demand should there be a
stress in the market. The Fed's proposal, however, would slash
those requirements and would result in a $77 billion decrease
in liquid assets for banks with assets of $100 to $700 billion.
Fed Governor Brainard voted against the proposal saying she
saw no changes in the financial environment that would require
the Federal Reserve to substantially weaken such rules.
Moreover, she said, this proposal comes at the ``expense of an
economically meaningful increase in the probability of stress
at affected institutions,'' which, in other words, I translate
into it is pretty risky.
How can you justify these changes which put taxpayers at
risk of future bailouts?
Mr. Quarles. So I do not think that they have put taxpayers
at risk of future bailouts. The effect of our proposed
liquidity changes would be a reduction in the overall amount of
liquidity in the system of between 2 and 2.5 percent. We have
since the crisis added $3 trillion of liquidity. That is
multiples of liquidity than existed before the crisis. And
these changes to tailor the burden of complying with
regulation, according to the riskiness of firms, you know, I
think are quite appropriate. The firms in that category are
generally funded with much less wholesale funding. They are
much less subject to liquidity risk. And yet the overall
consequence of this change is only 2 to 2.5 percent available
liquidity in the system.
Senator Menendez. Let me talk to that 2.5 percent that you
cite. My reading of that decline is that it is based on a
larger consideration of all liquid assets in the system for
banks with more than $100 billion in assets. What we are
talking about is the decline in liquid assets for banks between
$100 and $700 billion. So surely that ratio is much higher if
you consider the liquid assets of the institutions who are
receiving relief.
It is estimated that it is a decline of 30 percent for the
banks over $250 billion in assets and 15 percent for those with
assets between $100 and $250 billion. So it is not 2.5 percent.
Mr. Quarles. Well, I think the appropriate denominator is
the system. If you take a subset, you will always get a higher
percentage if you take just a subset. But if you look at the
system as a whole, we are not affecting in any material way the
liquidity resources of the system.
We also are under a statutory instruction to tailor our
regulation for all firms, and I think this is a way to do that
to implement the statute without having an important systemic--
--
Senator Menendez. I do not think that statutory instruction
is one that drives you to ultimately create the potential for
greater risk as part of that instruction.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Governor Quarles, that concludes the questioning. We
appreciate again you taking the time to be here with us today.
For Senators wishing to submit questions for the record,
those questions are due on Monday, November 26th, and, Vice
Chairman Quarles, we ask that you respond promptly to those
questions. And, once again, thank you for being here.
Mr. Quarles. Thank you.
Chairman Crapo. This Committee is adjourned.
[Whereupon, at 11:04 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today we will receive testimony from Federal Reserve Vice Chairman
for 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.
We last heard from Vice Chairman Quarles in October on the Fed's
progress implementing S. 2155, the Economic Growth, Regulatory Relief
and Consumer Protection Act.
At that time, the Fed had taken actions to implement some
provisions of S. 2155, including those related to the 18-month exam
cycle, high-volatility commercial real estate and the Small Bank
Holding Company Policy Statement.
Since then, the Fed has taken new steps to implement key provisions
of the bill.
Recently, the Fed issued proposals revising the application of
enhanced prudential standards across four categories of firms to
reflect each category's varying risks.
These proposals are a step in the right direction, and I appreciate
the Fed's work to issue them quickly.
I understand the amount of staff work that went into getting the
proposals out, and thank you and your staff for your work on these
proposals.
The proposals would assign banking organizations to one of four
categories based on their size and other risk-based indicators,
including: cross-jurisdictional activity; nonbank assets; short-term
wholesale funding; off-balance-sheet exposures; and status as a U.S.
global systemically important bank, or U.S. G-SIB.
The category to which an institution is assigned would determine
the enhanced prudential standards and capital and liquidity
requirements to which it would be subject.
I look forward to hearing how the application of certain enhanced
prudential standards would address the risks associated with cross-
jurisdictional activity, nonbank assets, short-term wholesale funding
and off-balance-sheet exposures.
The proposal incorporates a number of very positive changes to the
current framework for regional banks, including: relief from advanced
approaches capital requirements; a reduced liquidity coverage ratio;
and changes to the frequency of supervisory and company-run stress
testing and, some cases, the disclosure of the results.
Despite this positive step, the agencies have left a number of
items unaddressed, including: the treatment of foreign banking
organizations; additional details on stress testing, including the
Fed's Comprehensive Capital Analysis and Review, or CCAR; and
resolution planning.
I encourage the regulators to revisit all regulation and guidance
thresholds that were consistent with the outdated Section 165 threshold
to an amount that reflects actual systemic risk.
Regulators have two options: use a systemic risk factors-based
approach, or raise all thresholds to at least $250 billion in total
assets to be consistent with S. 2155.
There are also other noteworthy provisions of the bill on which the
Fed, working with other regulators, has yet to act, including
implementation of the Community Bank Leverage Ratio and the provision
that exempted cash deposits placed at central banks by custody banks
from the supplemental leverage ratio.
The Fed should work promptly to issue proposals to address these
critical outstanding issues.
I was encouraged by Vice Chairman Quarles' speech last week,
particularly the emphasis on providing more transparency around stress
testing and capital planning processes.
Finally, last week, all Republican Members of the Banking Committee
sent the FDIC a letter on Operation Choke Point.
Operation Choke Point is an initiative in which Federal agencies
devised and relied upon a list of politically disfavored merchant
categories with the intent of ``choking-off'' these merchants' access
to payment systems and banking services.
Staff at the banking agencies use verbal recommendations to
encourage banks to stop doing business with disfavored, but legal
businesses.
I plan to look into how policy is communicated from the banking
agencies to regulated institutions more broadly.
I appreciate Vice Chairman Quarles' joining us today to discuss
developments in the Fed's supervision and regulation and look forward
to hearing more about the Fed's pending work to implement S. 2155.
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you, Mr. Chairman and thank you Vice Chairman Quarles for
appearing before the Committee today.
The Federal Reserve's responsibility, and Vice Chairman Quarles'
job, is to ensure that the economy works for average Americans--that if
you work hard, you can get ahead.
That Wall Street doesn't again crash the financial system and
squander the pensions that families worked their whole lives to earn.
That banks can't cheat workers out of their hard-earned savings.
And that executives are held accountable when they break the law.
We know the Fed failed in its mission 10 years ago. The Fed had all
the power it needed to prevent the crash, and its leaders in Washington
were too complacent, and too cozy with Wall Street, to use their
authority to rein in the largest banks and protect American taxpayers.
That's why immediately after the crash, we put in place rules to
strengthen taxpayer protections from big bank risk, and to protect
consumers from predatory practices.
The rules worked--our system got safer, and the rules haven't
stopped banks from becoming more profitable than ever. The Fed released
a report on Friday showing that two important measures of banks'
profitability--return on equity and average return on assets--hit a 10-
year high in the second quarter of 2018.
Banks have also reported a 30 percent growth in loan volume since
2013, while experiencing a 10-year low in the share of loans that
aren't performing.
But now, with legislation enacted earlier this year, and the
actions of this Administration, we are witnessing--piece by piece--the
dismantling of these protections for American workers.
Since the last time Mr. Quarles testified before this Committee, we
have two new developments that underscore this point.
First, the Federal Reserve's proposal to implement the bank
giveaway bill, S. 2155, goes far beyond what the authors of that
legislation claimed the bill would do. The Fed's proposed rule loosens
protections for banks with more than $250 billion in assets--not small
community banks--we're talking about the Nation's biggest financial
institutions. Combined, these firms hold $1.5 trillion in assets.
The Fed's proposal also promises more goodies for the big banks,
with rollbacks for large foreign banks expected in the next few months.
This is despite the fact that the Fed's own progress report said that
foreign banks continue to violate anti- money laundering laws and skirt
Dodd-Frank requirements.
Second, Vice Chairman Quarles gave a speech last week outlining the
Fed's plans for the very largest domestic banks--a speech that could
have easily been written by one of their lobbyists.
Mr. Quarles wants to weaken capital requirements for the megabanks,
eliminating any leverage capital standards in stress tests. We got a
preview of what this would look like in June, when the Fed gave passing
grades to three banks that had clearly failed their stress tests. Now,
Mr. Quarles wants to make this year's giveaway permanent.
The speech outlined a series of other changes to the Fed's stress
tests that would render them essentially meaningless. Mr. Quarles makes
no secret of the fact that he wants to ease up on the assumptions that
guide the tests, wants to eliminate portions of the tests, and wants to
share with the banks the Fed's internal models against which they are
graded--that's like giving students the answers ahead of time.
These changes, taken alongside the weakening of the Volcker Rule,
other big bank leverage standards, and an abandonment of nonbank
financial oversight, amount to gutting the postcrisis protections we
put in place to protect American taxpayers future bailouts.
It's not just me saying this. Stanley Fischer--the former Vice
Chairman of the Fed--called these combined rollbacks quote, ``mind
boggling'' and quote ``very dangerous.''
When regulators haven't finished implementing Dodd-Frank, and the
economy hasn't even gone through a full economic cycle, now is not the
time to begin dismantling our postcrisis protections. It's always the
same story--Wall Street recovers, working families don't. And when
Washington policymakers suffer from collective amnesia, working
families, savers, and taxpayers end up paying the price.
______
PREPARED STATEMENT OF RANDAL K. QUARLES
Vice Chairman for Supervision, Board of Governors of the Federal
Reserve System
November 15, 2018
Chairman Crapo, Ranking Member Brown, other Members of the
Committee, thank you for the opportunity to testify on the Federal
Reserve's regulation and supervision of the financial system. My
testimony today covers two main topics: our efforts to improve
regulatory transparency, including the report accompanying my
submission to the Committee, and our progress in making the postcrisis
regulatory framework simpler and more efficient.
The Role of Transparency in Regulation and Supervision
I am mindful that this semiannual testimony--like my position as
Vice Chairman for Supervision--is grounded in Congress's efforts to
strengthen and improve the Nation's regulatory framework following the
financial crisis. This testimony reflects a critical element of those
efforts: the desire, and the need, for greater transparency.
Transparency is part of the foundation of public accountability and
a cornerstone of due process. It is also key to a well-functioning
regulatory system and an essential aspect of safety and soundness, as
well as financial stability. Transparency provides financial firms
clarity on the letter and spirit of their obligations; it provides
supervisors with the benefit of exposure to a diversity of
perspectives; and it provides markets with insight into the condition
of regulated firms, fostering market discipline. Transparency increases
public confidence in the role of the financial system to support
credit, investment, and economic growth.
The Federal Reserve has taken a number of steps since my last
testimony to further increase transparency, and to provide more
information about our supervisory activities to both regulated
institutions and the public.
For example, the Board recently improved its supervisory ratings
system for large financial institutions. \1\ Ratings are an essential
vehicle for supervisory feedback--a clear, concise way to convey
whether a firm meets expectations, with tangible, predictable
consequences for those that fall short. Our ratings system for large
institutions had remained unchanged since 2004, even as our supervision
of those institutions evolved significantly after the crisis. The new
rating system will better align ratings for these firms with the
supervisory feedback they receive, and will focus firms on the capital,
liquidity, and governance issues most likely to affect safety and
soundness.
---------------------------------------------------------------------------
\1\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Finalizes New Supervisory Rating System for Large
Financial Institutions'', news release, November 2, 2018, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20181102a.htm.
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The banking agencies also recently clarified that supervisory
guidance is a tool to enhance the transparency of supervisory
expectations, and should never be the basis of an enforcement action.
\2\ Guidance--a valuable tool for examiners to help evaluate firms and
explain supervisory findings--should always be based on concerns for
safety and soundness or compliance at a particular firm. However,
guidance is not legally enforceable, and Federal Reserve examiners will
not treat it that way.
---------------------------------------------------------------------------
\2\ Board of Governors of the Federal Reserve System, Bureau of
Consumer Financial Protection, Federal Deposit Insurance Corporation,
National Credit Union Administration, and Office of the Comptroller of
the Currency, ``Agencies Issue Statement Reaffirming the Role of
Supervisory Guidance'', news release, September 11, 2018, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20180911a.htm.
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Finally, we expect shortly to make final a set of measures to
increase visibility into the Board's supervisory stress testing
program. The enhanced disclosures will include more granular
descriptions of our models; more information about the design of our
scenarios; and more detail about the outcomes we project, including a
range of loss rates for loans held by firms subject to the
Comprehensive Capital Analysis and Review. The disclosures will provide
a more complete picture of the stress testing process, and facilitate
thoughtful comments from academics and other members of the public,
while mitigating the risk of convergence on a single model. As a
result, we believe the disclosures will improve our work, making the
tests more reliable, visible, and credible. We will continue our
efforts toward greater transparency in stress testing over the next
several years, including by disclosing descriptions of additional
material models and modeled loss rate disclosures for loan and nonloan
portfolios.
Semiannual Review of the Safety and Soundness of the U.S. Banking
System
The report that accompanies my testimony today is another tool to
keep Congress, and the public, informed about our work, the banking
system, and the role of both in supporting the broader economy. \3\ The
report focuses on the Federal Reserve's prudential supervisory
activities. \4\ As the report shows, the banking sector remains in
strong condition, in line with strong U.S. economic performance, with
lending growth, fewer nonperforming loans, and strong overall
profitability.
---------------------------------------------------------------------------
\3\ Board of Governors of the Federal Reserve System,
``Supervision and Regulation Report'', November 9, 2018,
www.federalreserve.gov/publications/supervision-and-regulation-
report.htm.
\4\ The Federal Reserve is also responsible for timely and
effective supervision of consumer protection and community reinvestment
laws and regulations. More information about the Federal Reserve's
consumer-focused supervisory program can be found in the Federal
Reserve's Annual Report to Congress. See section 5, ``Consumer and
Community Affairs'', at https://www.federalreserve.gov/publications/
annual-report.htm. The Federal Reserve also publishes the Consumer
Compliance Supervision Bulletin, which shares information about
examiners' supervisory observations and other noteworthy developments
related to consumer protections. See https://www.federalreserve.gov/
publications/consumer-compliance-supervision-bulletin.htm.
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Large institutions are well capitalized and liquid, and their
capital planning and liquidity-risk-management processes are improving.
Ninety-nine percent of regional and community banks are currently well
capitalized, and supervisory recommendations made to smaller firms
during the financial crisis have largely been closed. We are, however,
very much aware of the dangers of complacency, and our report lists
several priority areas of risk we will continue to monitor closely in
the coming year, including cyber and information technology risks at
supervised firms of all sizes.
Improvements in Regulatory Efficiency
Improving regulatory efficiency is another core element of our
current regulatory efforts. Tailoring regulation and supervision to
risk has been a programmatic goal of Federal Reserve policy for more
than two decades. The motivations are clear: supervisory resources are
not limitless, and supervision is not costless, either to the public or
to supervised institutions. Activities and firms that pose the greatest
risk should receive the most scrutiny, and where the risk is lower, the
regulatory burden should be lower as well.
This principle guided Congress and the Federal banking agencies in
designing the postcrisis regulatory framework, which imposed greater
restrictions on larger, more systemically important firms and less
intrusive requirements on smaller ones. It has also guided our
implementation of the Economic Growth, Regulatory Relief, and Consumer
Protection Act (EGRRCPA, or the Act). \5\ On this front, we have made
substantial progress:
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\5\ EGRRCPA, Pub. L. No. 115-174, 132 Stat. 1296 (2018).
expanding eligibility of community banking firms for the
Small Bank Holding Company Policy Statement, and for longer,
18-month examination cycles; \6\
---------------------------------------------------------------------------
\6\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Issues Interim Final Rule Expanding the Applicability of
the Board's Small Bank Holding Company Policy Statement'', news
release, August 28, 2018, https://www.federalreserve.gov/newsevents/
pressreleases/bcreg20180828a.htm.
giving bank holding companies below $100 billion in assets
immediate relief from supervisory assessments, stress testing
requirements, and some additional Dodd-Frank Act prudential
measures; \7\ and
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\7\ Board of Governors of the Federal Reserve System, ``Statement
Regarding the Impact of the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA)'', July 6, 2018, https://
www.federalreserve.gov/newsevents/pressreleases/files/
bcreg20180706b1.pdf.
implementing changes to liquidity regulation of municipal
securities and capital regulation of high-volatility commercial
real estate exposures. \8\
---------------------------------------------------------------------------
\8\ Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, and Office of the Comptroller of the
Currency, ``Agencies Propose Rule Regarding the Treatment of High
Volatility Commercial Real Estate'', news release, September 18, 2018,
https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20180918a.htm.
The Board, Federal Deposit Insurance Corporation (FDIC), and Office
of the Comptroller of the Currency (OCC) have also continued the work
to significantly reduce the reporting burden on community banking
organizations, altering reporting frequencies, items, and thresholds,
while preserving the data necessary for effective oversight. \9\ The
agencies recently issued a proposal to reduce further reporting
requirements for small depository institutions in the first and third
quarters of the year. Under the proposal, around 37 percent of data
items would not be required in those quarters.
---------------------------------------------------------------------------
\9\ Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, and Office of the Comptroller of the
Currency, ``Agencies Issue Proposal To Streamline Regulatory Reporting
for Qualifying Small Institutions'', news release, November 7, 2018,
https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20181107a.htm.
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Our most significant step to implement the Act came 2 weeks ago,
when the Board issued two proposals to better align prudential
standards with the risk profile of regulated institutions. \10\ These
proposals implement changes that Congress enacted this spring in the
EGRRCPA. One of the proposals addresses the Board's enhanced prudential
standards for large banking firms, and the other is an interagency
proposal amending the regulatory capital and liquidity regulations that
apply to large banking organizations. Both proposals separate large
banking firms into four categories, using size as a relevant but not
sufficient factor for increased regulatory requirements. Among the
other factors that will now enter into this assessment are nonbank
assets, short-term wholesale funding, and off-balance-sheet exposure.
The changes would significantly reduce regulatory compliance
requirements for firms in the lowest risk category, including most
institutions with between $100 billion and $250 billion in assets.
Firms with $250 billion or more in assets, or firms with assets between
$100 billion and $250 billion that meet a risk threshold, will face
reduced liquidity requirements. The proposals would largely maintain
existing requirements for the largest and most complex firms.
---------------------------------------------------------------------------
\10\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Invites Public Comment on Framework That Would More
Closely Match Regulations for Large Banking Organizations With Their
Risk Profiles'', news release, October 31, 2018, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20181031a.htm.
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These new categories represent a step forward in regulatory
efficiency. They draw on our experience administering enhanced
prudential requirements and other postcrisis measures. They recognize
that other indicators of risk beyond size are appropriate to consider
when determining if more stringent standards should apply to certain
firms. They move toward a more risk-sensitive, nuanced framework, where
riskier activities and a larger systemic footprint correspond to higher
supervisory and regulatory requirements.
Apart from the requirements of the Act, we also recently proposed a
new approach to calculating credit risk, known as the standardized
approach to counterparty credit risk, or SA-CCR. The new approach would
better account for the risks associated with derivatives exposures,
including market practices that reduce risk, such as netting and
initial margin. \11\ We issued a proposal simplifying and tailoring
requirements under the Volcker rule, to ensure that the most stringent
requirements apply to the firms with the most trading activity, and
that compliance is as simple and objective as possible. We also issued
a rule limiting the exposure of large firms to a single counterparty,
addressing a key source of contagion during the financial crisis. We
have received thoughtful input from the public that will help inform
our implementation of all of these measures.
---------------------------------------------------------------------------
\11\ Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, and Office of the Comptroller of the
Currency, ``Agencies Propose Rule To Update Calculation of Derivative
Contract Exposure Amounts Under Regulatory Capital Rules'', news
release, October 30, 2018, https://www.federalreserve.gov/newsevents/
pressreleases/bcreg20181030a.htm.
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Finally, we have continued to engage with supervisors and central
banks overseas. The ultimate goal of having an efficient and
transparent regulatory system is to help the American economy--to
enable banking organizations to offer safe, stable financial services
to households and businesses around the country. But American
businesses compete in a global marketplace, and as the financial crisis
showed, when regulatory standards fall in other countries, Americans
can pay the price. Engaging overseas, through forums like the Financial
Stability Board and the Basel Committee on Banking Supervision, helps
level the playing field--and it helps ensure that all countries, not
just the United States, do their part to maintain and protect the
global economy.
Our work to improve regulatory efficiency is not done, and we
expect to make additional progress in the months ahead on a number of
issues. In particular, we are working with our counterparts at the OCC
and FDIC on a community bank leverage ratio proposal. We expect that
this proposal would meaningfully reduce the compliance burden for
community banking organizations, while preserving overall levels of
capital at small banks and our ability to take prompt action when
problems arise.
I look forward to continuing our efforts to make our regulatory
framework simpler, more transparent, and more efficient--and I look
forward to participating in the Committee's oversight of those efforts.
As Chairman Powell said at his swearing-in: ``As a public institution,
we must be transparent about our actions so that the public, through
its elected representatives, can hold us accountable.'' \12\ We will
continue to do so to the best of our ability.
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\12\ Jerome H. Powell, ``Remarks at the Ceremonial Swearing-in''
(speech at the Federal Reserve Board, Washington, DC, February 13,
2018), https://www.federalreserve.gov/newsevents/speech/
powell20180213a.htm.
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Thank you, and I look forward to answering your questions.
SUPERVISION AND REGULATION REPORT--NOVEMBER 2018
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM RANDAL K. QUARLES
Q.1. The Fed's regulation report released on November 9, 2018,
said that foreign banking organizations (FBOs) still face
challenges in complying with Dodd-Frank Act enhanced prudential
standards (EPS). And yet your testimony noted that FBOs can
expect a rule to ``tailor'' EPS in the coming year.
Why would the Fed alter taxpayer protections with regard to
FBOs when the Fed's own report says that banks aren't fully
complying with existing requirements?
A.1. The Board of Governors of the Federal Reserve System
(Board) has taken, and will continue to take, a risk-based
approach to supervision, focusing its resources on those
institutions (both domestic and foreign) that pose the greatest
risk to safety and soundness and financial stability. On
October 31, 2018, the Board approved two notices of proposed
rulemaking that would establish a revised framework for
applying enhanced prudential standards to large U.S. banking
organizations based on their risk profiles. The proposals would
establish four categories of standards that reflect the
different risks of firms in each group and would largely keep
existing requirements in place for the riskiest and largest
firms. The proposals build on the Board's existing tailoring of
its rules and experience implementing those rules, and account
for statutory changes enacted by the Economic Growth,
Regulatory Relief, and Consumer Protection Act.
The changes proposed on October 31, 2018, do not apply to
foreign banking organizations. As a part of the Board's current
effort to develop a tailoring proposal for foreign banks, we
are considering the appropriate way to assign foreign U.S.
operations to the category of prudential standards described in
the tailoring proposal for domestic firms, in light of the
structures through which these firms conduct business in the
Unites States.
I expect that this proposal and the two proposed
rulemakings from October 31, 2018, by applying enhanced
prudential standards based on risk profile, will enable the
Board to continue to apply its risk-based approach to
supervision in a more effective and efficient manner.
Q.2. In April, the Fed proposed weakening the enhanced
supplemental leverage ratio (eSLR) by $121 billion for the
insured depository institutions of the eight largest banks and
proposed weakening the version of the leverage ratio used in
stress tests. In a recent speech, you went further, saying that
the leverage ratio should be eliminated altogether in stress
tests. More than half of global systemically important banks
(G-SIBs) have had their stock buybacks and dividends limited in
recent years because the leverage ratio was the binding
constraint on capital distributions.
How do you justify letting large banks send capital to
shareholders and executives when it could otherwise be
protecting taxpayers from bailouts?
A.2. Postcrisis regulatory reforms, including the supplementary
leverage ratio, were designed to improve the safety and
soundness and reduce the probability of failure of banking
organizations, as well as to reduce the consequences to the
financial system if such a failure were to occur. For large
banking organizations in particular, the objective of the
Federal Reserve Board (Board) has been to establish capital and
other prudential requirements at a level that not only promotes
resiliency at the banking organization and protects financial
stability, but also maximizes long term, through-the-cycle
credit availability and economic growth. In reviewing the
postcrisis reforms both individually and collectively, the
Board has sought ways to streamline and tailor the regulatory
framework, while ensuring that such firms have adequate capital
to continue to act as financial intermediaries during times of
stress.
Consistent with these efforts, the Board proposed to
recalibrate the enhanced supplementary leverage ratio (eSLR) to
align leverage capital requirements with risk-based capital
requirements for the G-SIBs. In particular, leverage capital
requirements should generally act as a backstop to the risk-
based requirements. If a leverage ratio is calibrated at a
level that makes it generally a binding constraint, it can
create incentives for firms to reduce participation in or
increase costs for low-risk, low-return businesses. Over the
past few years, however, concerns were raised that in certain
cases the eSLR has become a binding constraint rather than a
backstop to the risk-based standards. With respect to the April
2018 proposal, a decrease in capital requirements at a
subsidiary depository institution does not necessarily result
in its holding company being able to distribute those funds to
shareholders. This happens because the capital rule and other
regulatory restrictions at the holding company level, such as
the Board's annual stress tests, limit the amount of capital
that a holding company can distribute to shareholders. The
analysis that accompanied the April 2018 proposal showed that
the banking organizations that would be subject to the
proposal--global systemically important banking organizations
(U.S. G-SIBs)--would be able to release only up to $400 million
of tier 1 capital (or approximately 0.04 percent of the amount
of tier 1 capital held by these firms) to their shareholders.
With respect to the stress testing program, explicitly
assigning a leverage buffer requirement to a firm on the basis
of risk-sensitive poststress estimates, as the stress testing
framework is intended to do, may be inconsistent with the goals
of the leverage ratio.
Q.3. In a recent comment letter, the Federal Reserve Bank of
Minneapolis noted that the ``proposed tailoring of the eSLR and
alterations to the existing stress testing that the Board is
considering will weaken taxpayer protection from bailouts.
Recent evidence--some of which economists from the Board of
Governors itself has produced--finds that equity funding
requirements for the largest banks are too low, not too high.
Even measures of the credit cycle and financial stability risk
indicate that it is likely prudent for banks to continue to
build capital.''
Please provide your perspective on this statement.
A.3. Maintaining the safety and soundness of the largest U.S.
banks is critical to maintaining the stability of the U.S.
financial system and the broader economy. Accordingly,
postcrisis, the Board along with the other U.S. banking
agencies substantially strengthened regulatory capital
requirements for large banks. 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. In general, I believe overall
loss-absorbing capacity for our largest banking organizations
is at about the right level.
More recently, the Board has proposed various regulatory
refinements to pursue its long-standing goal of applying
prudential standards based on a bank's risk profile and size.
This tailoring of regulations enables the Board to supervise
banking organizations in an effective and efficient manner
while maintaining their safety and soundness.
Q.4. In a recent speech, you noted that the Fed is going to
repropose a rule on its stress testing regime in light of
comment letters it received. Then your speech goes on to list a
whole host of changes the Fed may make--each of which is more
favorable to the banks.
If the Fed reproposing the Stress Capital Buffer (SCB)
proposal as you've outlined, would G-SIBs be required to hold
more or less capital relative to the original SCB proposal?
Can you point us to an example of a proposed change, as
noted in your speech, which would require G-SIBs to hold
additional capital?
A.4. The Board's notice of public rulemaking entitled
Amendments to the Regulatory Capital, Capital Plan, and Stress
Test Rules \1\ issued in April 2018 would integrate the Board's
regulatory capital rules, the Board's Comprehensive Capital
Analysis and Review (CCAR), and stress test rules. Under the
proposal, the Board's supervisory stress test would be used to
establish the size of a firm's stress capital buffer
requirement. As noted in the proposal, the stress capital
buffer requirement would generally maintain or in some cases
increase common equity tier 1 capital requirements for global
systemically important banking organizations (G-SIBs). That
said, the impact of the proposal on firms would vary through
the economic and credit cycle based on the risk profiles and
planned capital distributions of individual firms, as well as
the specific severely adverse stress scenario used in the
supervisory stress test. The same potential impact on
individual firms also would exist under the changes that I have
outlined previously in greater detail. \2\
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\1\ https://www.govinfo.gov/content/pkg/FR-2018-04-25/pdf/2018-
08006.pdf
\2\ See, ``A New Chapter in Stress Testing'', at https://
www.federalreserve.gov/newsevents/speech/guarles20181109a.htm.
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Board staff are currently reviewing all comments on the
proposal and will carefully consider whether any changes to the
proposal are appropriate.
Q.5. Does the Fed plan to incorporate the G-SIB surcharge into
the Comprehensive Capital Analysis and Review (CCAR) for 2019?
A.5. In 2019, as in past CCAR cycles, the Board intends to
evaluate each firm's ability to maintain capital ratios above
the poststress minimum requirements. The global systemically
important bank holding company surcharge is not a minimum
requirement, and thus, would not be considered as part of the
CCAR's quantitative assessment.
We are continuing to evaluate ways to simplify the Board's
capital framework by more closely integrating the regulatory
capital rules and stress testing. The Board's proposal, issued
in April 2018 as noted in the response to 4(a), would introduce
the concept of stress buffer requirements into the regulatory
capital rules. This proposal would integrate the results of the
Board's supervisory stress test into the regulatory capital
rules, which already incorporates the G-SIB surcharge.
The goal of the proposal is to provide a more integrated
and cohesive framework that reduces redundancies and
inconsistencies across the capital rules and stress testing
rules. The proposal includes other modifications as well, such
as changes to the assumptions used in our stress test.
Q.6. Will you commit to making your meeting schedule
transparent so that the Congress and the public can see who
you're talking to before the Fed announces any proposed rules
changing bank capital, leverage, liquidity, or other standards?
A.6. In my work as a Federal Reserve Board (Board) Governor, as
well as the Vice Chair for Supervision and Regulation, I
regularly meet with a wide range of representatives from the
industry, peer domestic and foreign regulators, academics,
public interest groups, and others. These meetings inform me
and, in turn, the Board on a broad array of critical issues.
Consistent with the practice of other Board members, I have
always provided my calendar to the public upon request and will
be happy to provide a copy to your staff.
Q.7. You have proposed eliminating the qualitative objection
currently included in CCAR. Previously, banks such as Deutsche
Bank, Santander, Citigroup, HSBC, RBS, Ally, and BB&T have
received objections to their capital distribution plans based
on qualitative factors.
What is your justification for eliminating the qualitative
objection under CCAR?
A.7. Capital planning is a core aspect of financial and risk
management that helps ensure the financial strength and
resilience of a firm. Strong, forward-looking capital planning
processes ensure that large firms have sufficient capital to
absorb losses and continue to lend to creditworthy businesses
and consumers, including during times of stress.
In 2017, the Federal Reserve eliminated the qualitative
objection as part of the Comprehensive Capital Analysis and
Review (CCAR) for large and noncomplex firms, which are
generally firms with less than $250 billion in assets, in part
because of improvements in risk management at these firms. I
believe that the removal of the qualitative objection for these
firms has not diminished the effectiveness of supervision.
Similarly, larger firms have also generally improved their
risk management in the years since the inception of CCAR.
Removing the public objection tool and continuing to evaluate
firms' stress testing practices through normal supervision for
all firms would align the outcome of the CCAR qualitative
assessment with other supervisory programs. Firms would remain
subject to the same supervisory expectations, and examiners
would continue to conduct rigorous horizontal and firm specific
assessments of a firm's capital positions and capital planning,
tailored to the risk profile of the firm. While much of the
examination work would center on a firm's capital plan
submissions, examination work would continue on a year-round
basis, taking into account the firm's management of other
financial risks. The evaluation of the firm's capital position
and capital planning would culminate in a rating of the firm's
capital position and planning. Firms with deficient practices
would receive supervisory findings through the examination
process, and would be at risk of a ratings downgrade or
enforcement action if those deficiencies were sufficiently
material or not addressed in a timely manner.
Q.8. When you were asked about the Community Reinvestment Act
at a recent House of Representatives hearing, you said that the
law had become too ``formulaic'' and that it was therefore less
effective.
If that's the case, would you oppose the aspect of the
OCC's proposal--which would make the CRA even more formulaic by
grading banks' performance according to one simple ratio?
A.8. I was referring to the fact that, over the years,
practices have developed among both banks and their supervisors
that result in much Community Reinvestment Act (CRA) compliance
being satisfied with a single type of activity. The drafters of
the CRA contemplated, and the language of the statute itself
supports, a much broader potential for involvement in community
development and a much wider range of qualifying investments
than currently tends to result from CRA compliance. We are
reviewing information the Office of the Comptroller of the
Currency has received in response to its advance notice of
proposed rulemaking on the CRA, as well as information gathered
through the Federal Reserve's listening sessions at many of the
Federal Reserve Banks around the country, to determine whether
there are steps we might take as regulators to come closer to
both the letter and intent of the statute. That review is
ongoing, and our evaluation of any particular proposal or
element of a proposal, including any potential measurement
standards, will depend on a full analysis of the available
information upon completion of that review.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM RANDAL K. QUARLES
Q.1. Section 402 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act instructed bank regulators to issue a
rule exempting custody banks' cash deposits placed at central
banks from the Supplemental Leverage Ratio calculation.
When do you expect to implement Section 402?
A.1. As you indicate, the recent Economic Growth, Regulatory
Relief, and Consumer Protection Act (EGRRCPA) legislation
requires the Federal banking agencies to amend the
supplementary leverage ratio as applied to custodial banks. The
Federal banking agencies are actively working to issue a notice
of proposed rulemaking and expect to issue it for public
comment in the near future.
The April 2018 proposal to recalibrate the enhanced
supplementary leverage ratio standards assumed that the
components of the supplementary leverage ratio used the capital
rule's existing definitions of tier 1 capital (the numerator of
the ratio) and total leverage exposure (the denominator);
however, the definition of total leverage exposure will change
for certain banking organizations, through the implementation
of section 402. As the Federal Reserve Board (Board) and the
Office of the Comptroller of the Currency noted in the April
2018 proposal, significant changes to either component of the
supplementary leverage ratio would likely necessitate
reconsideration of the proposed recalibration, as the proposal
was not intended to materially change the aggregate amount of
capital in the banking system. Accordingly, staff is evaluating
the April 2018 proposal in light of the statutory change, in
addition to comments received on the proposal.
Q.2. Holding almost $5 trillion in U.S. banking and nonbanking
assets, foreign banking organizations (FBOs) play an important
role in the U.S. financial system and overall economy. FBOs
operating within the U.S. and U.S. firms operating abroad
should compete on a level playing field. For that reason, I was
encouraged to learn that you intend to review and possibly
update regulations applicable to FBOs early in 2019.
Previously, you have highlighted Total Loss-Absorbing Capital
(TLAC) requirements for the intermediate holding companies
(IHCs) of FBOs as worthy of review.
Will TLAC requirements be a part of your 2019 efforts?
If so, what are your plans to tailor and streamline
internal TLAC and long-term debt requirements?
A.2. In October 2018, the Board issued notices of proposed
rulemaking (NPR) to tailor certain prudential standards for
domestic banks. The Board plans to develop a separate proposal,
for public comment, relating to foreign banking organizations
(FBOs) and their U.S. operations. The October 2018 NPRs did not
modify the Total Loss-Absorbing Capital (TLAC) requirements for
U.S. firms; the specific content of a forthcoming FBO tailoring
NPR remains under consideration.
Q.3. Finally, are you considering adjusting the January 1,
2019, compliance date currently in effect?
A.3. In the remarks I gave on May 16, 2018, I noted that the
Board should consider whether the internal TLAC calibration for
intermediate holding companies (IHCs) could be adjusted to
reflect the practice of other regulators without adversely
affecting resolvability and U.S. financial stability. This
matter remains under consideration and the Board continues to
monitor relevant developments in other jurisdictions. The
Board's rule establishing TLAC, long-term debt, and clean
holding company requirements for U.S. IHCs of foreign global
systemically important banks became effective as of January 1,
2019. Any change to the internal TLAC requirements for IHCs, or
any other aspect of the rule, would need to be adopted through
the normal public rulemaking process.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON
FROM RANDAL K. QUARLES
Q.1. FINRA Rule 4210--Two years ago, I sent a letter to the SEC
expressing concern about FINRA Rule 4210, which established
margin requirements on To-Be-Announced (TBA) securities such as
mortgage-back 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 this requirement, creating
an uneven playing field. Earlier this year, Federal Reserve
staff confirmed this ``inequity'' in a call with my staff.
Last April, we spoke about this rule in a hearing with this
Committee. You promised to review that rule to ensure it did
not create an unequal playing field between small and medium
broker-dealers and large, bank-affiliated broker-dealers. I'm
sure we agree that restricting market competition isn't good
for anyone except the privileged few banks that would gain
business. The day after that hearing, FINRA delayed rule 4210
until March of 2019.
What steps can the Fed take to ensure that rule 4210 does
not create an unequal playing field between small and medium-
sized broker dealers and bank-affiliated broker dealers? Please
list them.
Do you agree that as implemented, rule 4210 creates an
unequal playing field for the aforementioned financial
institutions?
A.1. As you noted above in your question, the Financial
Industry Regulatory Authority's (FINRA) Rule 4210 To-Be-
Announced (TBA) amendments are not scheduled to be implemented
until spring 2019 at the earliest. In addition, recent action
by FINRA suggests it is working towards reducing the rule's
burden. For example, in September 2018, FINRA's Board approved
revisions to its Rule 4210 TBA requirements that would
eliminate the 2 percent maintenance margin requirement
contained in the rule. FINRA's Board also approved revisions
that would allow member firms to take a capital charge in lieu
of collecting margin for mark to market losses, subject to
specified limitations and conditions. \1\ These changes would
substantially reduce possible inequities between FINRA firms
and bank dealers. FINRA has not yet sought comment on these
revisions, and the Federal Reserve is monitoring FINRA's
efforts. If the final result creates an unequal playing field,
we will work with fellow bank regulatory agencies to address
disparities between FINRA firms and bank dealers in this area,
taking into account the differences between them.
---------------------------------------------------------------------------
\1\ See https://www.finra.org/industry/update-finra-board-
governors-meeting-092618.
Q.2. Mortgage Servicing Assets--As you know, many lenders
prefer to keep the relationship with the customer via servicing
the mortgage, even if the bank sells the mortgage itself. There
has been a bipartisan view in Congress that the original rule
on MSAs, which came out as part of the Basel process, was
misguided and, indeed, punitive as applied to small and midsize
banks. Many of us were encouraged when the regulators put out a
proposal to change the existing rule. But that proposal came
out over a year ago and still nothing has been done to finalize
it. The current situation is driving mortgage servicing out of
regulated entities and into unregulated ones, which I assume is
not your objective.
When can we expect a final rule on mortgage servicing
assets to be issued?
A.2. As part of the 2017 Economic Growth and Regulatory
Paperwork Reduction Act report, the Board of Governors of the
Federal Reserve System (Board), the Office of the Comptroller
of the Currency (OCC), the Federal Deposit Insurance
Corporation (FDIC) (collectively, the agencies), and the
National Credit Union Administration highlighted their intent
to meaningfully reduce regulatory burden, especially on
community banking organizations, while at the same time
maintaining safety and soundness and the quality and quantity
of regulatory capital in the banking system. Consistent with
that objective, the agencies issued a proposal in 2017 to
simplify certain aspects of the regulatory capital rules for
nonadvanced approaches banking organizations, including a
simplified treatment for mortgage servicing assets (MSAs)
(simplifications proposal).
The agencies are working jointly to implement Economic
Growth, Regulatory Relief, and Consumer Protection Act
(EGRRCPA), \2\ which addresses and supersedes aspects of the
simplifications proposal. For example, the agencies recently
issued a proposed rule to conform the regulatory capital
treatment of certain acquisition, development, or construction
loans to that under EGRRCPA. \3\ The agencies are actively
considering the comments received on the simplifications
proposal in the context of the changes made by the EGRRCPA.
---------------------------------------------------------------------------
\2\ See, e.g., Interagency Statement Regarding the Impact of the
Economic Growth, Regulatory Relief, and Consumer Protection Act (July
6, 2018), available at https://www.fdic.gov/news/news/press/2018/
pr18044a.pdf.
\3\ 83 Fed. Reg. 48,990 (Sept. 28, 2018).
---------------------------------------------------------------------------
In addition, on November 21, 2017, the agencies finalized a
rule to extend the current transition provisions in the capital
rules for certain capital deductions that would be affected by
the simplifications proposal. \4\ Thus, while the agencies
continue to evaluate comments on the simplifications proposal,
for most banking organizations, MSAs not deducted under the
capital rules will continue to be subject to a 100 percent risk
weight rather than the fully phased-in 250 percent risk weight.
---------------------------------------------------------------------------
\4\ 82 Fed. Reg. 55,309 (Nov. 21, 2017). The final rule extended
the transition provisions for banking organizations that are not
subject to the capital rule's advanced approaches. Banking
organizations subject to the capital rule's advanced approaches remain
subject to the stricter requirements beginning on January 1, 2018.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
FROM RANDAL K. QUARLES
Q.1. In South Dakota, many farmers use derivatives to manage
the risk of price disruptions due to any number of factors in
the marketplace. Given the challenges that farmers are facing
on several fronts, it's important that South Dakotans are able
to access tools like derivatives in a way that's as cost-
effective as possible.
When our farmers do choose to access derivatives markets
they're required to provide margin against their derivative
contracts. Banks hold that margin in the event the farmer can't
meet their obligations, thereby reducing the risk of default
for the bank and for the marketplace.
Unfortunately the Fed's methodology for the leverage ratio
doesn't recognize this reduced risk. As a result, an additional
cost is imposed on farmers across the country when they hedge
against price fluctuations.
When will the Fed act on this issue and provide relief on
client margin? Farmers are in need of relief wherever they can
get it.
I'm proud to be the Senate sponsor of S. 3577, the
Financial Stability Oversight Council Improvement Act of 2018.
As we continue to look at ways to make our financial system
safer and more resilient, it's important that FSOC also
regulates nonbanks based on the risk profile of a specific
business or industry, not for the sake of regulation, and not
based only on size.
Last year the Treasury Department released a report
recommending how FSOC can further improve the SIFI designation
process for nonbank institutions. Similar to my interest in
tailoring regulations, Treasury suggested that an activities-
based approach would be appropriate. I'm also pleased to hear
reports that FSOC may be taking action on this front by the end
of 2018.
Can you elaborate on FSOC's forthcoming proposals?
If you could, I'd like you to share some of the advantages
to the activities-based approach that FSOC is considering.
How will it help the Fed's work?
And how will it help the economy more broadly?
A.1. In October 2018, the Federal Reserve Board (Board), along
with the Federal Deposit Insurance Corporation (FDIC) and
Office of the Comptroller of the Currency (OCC) (collectively,
the Agencies), issued a proposal that would revise the capital
rule to require banking organizations to use a more risk-
sensitive methodology known as the standardized approach for
counterparty credit risk (SA-CCR) for reflecting derivative
contracts in the supplementary leverage ratio. The Agencies
believe that SA-CCR, which recognizes the shorter default risk
horizon applicable to margined derivative contracts, provides a
more appropriate measure of derivative contracts for leverage
capital purposes than does the current approach. Analysis
conducted by the Agencies indicates that, compared to the
current methodology, the implementation of SA-CCR would
increase covered banking organizations' supplementary leverage
ratios.
As noted in the proposal, the Agencies are sensitive to
impediments to banking organizations' willingness and ability
to provide client-clearing services. The Agencies also are
mindful of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) mandate to mitigate systemic
risk and promote financial stability by, in part, developing
uniform standards for the conduct of systemically important
payment, clearing, and settlement activities of financial
institutions. In view of these important, postcrisis reform
objectives, the Agencies are inviting comment on the
consequences of not recognizing collateral provided by a
clearing member client banking organization in connection with
a cleared transaction. The Agencies will carefully consider the
comments received on the proposal.
With respect to your second question on the Financial
Stability Oversight Council (FSOC), the Council has been
considering revisions to the interpretive guidance on the
designation of nonbanks that include taking an activities-based
approach (see, for example, the minutes of the June 15, 2018,
FSOC meeting). \1\ Of course, any revisions to the FSOC's
current guidance on the designation of nonbank financial
institutions will have to be approved by the FSOC.
---------------------------------------------------------------------------
\1\ See https://www.treasury.gov/initiatives/fsoc/council-
meetings/Documents/June152018
_minutes.pdf.
---------------------------------------------------------------------------
In principle, an activities-based approach toward the
designation of individual nonbank financial institutions would
shift the focus toward reviewing potential risks to U.S.
financial stability from a financial system perspective by
examining financial activities and products throughout various
industries. This approach offers some potential advantages,
including the consideration of how certain activities
undertaken by nonbanks could threaten financial stability and
how best these threats could be addressed. In addition, such an
approach could complement the FSOC's effort to monitor broader
vulnerabilities in the U.S. financial system.
In terms of helping the Federal Reserve's work, should a
firm be designated and thus subject to supervision by the
Federal Reserve, a clear statement from the FSOC of the
particular activities of concern could help focus supervisory
efforts to limit systemic risk. Further, the activities-based
approach proposed in the November 2017 Treasury Department
report \2\ could complement the Federal Reserve's monitoring of
financial stability risks. The Board provided an overview of
the framework it uses to monitor financial stability in the
November 2018 Financial Stability Report. \3\ This framework
focuses on monitoring vulnerabilities in the financial system,
such as elevated valuation pressures, excessive leverage within
the financial sector, excessive borrowing by businesses and
households, and funding risks.
---------------------------------------------------------------------------
\2\ See https://www.treasury.gov/press-center/press-releases/
documents/pm-fsoc-designations-memo-11-17.pdf.
\3\ See https://www.federalreserve.gov/publications/files/
financial-stability-report-201811.pdf.
---------------------------------------------------------------------------
Monitoring of financial vulnerabilities and activities that
could pose a threat to U.S. financial stability could help
regulators design policies to reduce the likelihood of
financial market disruptions or of credit crunches.
Q.2. Thank you for the ongoing dialogue on the ``standardized
approach for measuring counterparty credit risk'' rule in
derivatives markets. I appreciate regulators enacting risk-
based rules in any sector of the economy.
I understand that the Fed's goal was to follow the Basel
Committee's approach when it was designing the SA-CCR rule. I
also understand that the SA-CCR methodology as designed by the
Basel Committee recognized that margin posted by derivative
users reduces the risk of default. That being said, based on my
review of the Fed's SA-CCR rule, I noticed that the Fed omitted
the margin exposure provisions of the Basel SA-CCR rule.
One of the purposes of implementing the Basel Committee's
SA-CCR rule was to make American companies more competitive
with our European counterparts, all of whom have implemented
the Basel-driven version of SA-CCR.
Why did the Fed choose not to include margin exposure in
the U.S. SA-CCR rule?
Will this lack of recognition on margin perpetuate the
disparities between the U.S. and Europe and put our financial
institutions at a disadvantage?
A.2. The proposal is generally consistent with the Basel
Committee's standards on the recognition of margin in the risk-
based and leverage capital frameworks. In particular, the
proposal to require use of SA-CCR in calculating the
supplementary leverage ratio is generally consistent with the
Basel Committee's standard on leverage capital requirements,
which currently limits collateral recognition. The Agencies are
sensitive to impediments to firms' willingness and ability to
provide client-clearing services, and recognize the wide
support for the migration of derivative contracts to central
clearing frameworks. In particular, in October 2018, the Basel
Committee issued a consultative document seeking views on
whether to recognize collateral in their leverage capital
requirement. \4\ Accordingly, the Agencies are inviting comment
on the consequences of not recognizing collateral provided by a
clearing member client banking organization in connection with
a cleared transaction. The Agencies will carefully consider
each comment on the proposal.
---------------------------------------------------------------------------
\4\ See Consultative Document, ``Leverage Ratio Treatment of
Client Cleared Derivatives'', Basel Committee on Banking Supervision,
October 2018, available at https://www.bis.org/bcbs/publ/d451.pdf.
Q.3. As you know, Section 402 of S. 2155 exempted the cash
deposits of custody banks held at central banks from the
supplemental leverage ratio.
Can you give us an update on when section 402 will be
implemented?
And can you shed a bit more light into how this section of
the law will interact with changes to the supplemental leverage
ratio that the Fed announced back in April?
Balancing these two priorities is important given that
regulatory changes announced in April could potentially blunt
the impact of S. 2155.
A.3. As you indicate, the recently enacted Economic Growth,
Regulatory Relief, and Consumer Protection Act (EGRRCPA)
requires the Federal banking agencies to amend the
supplementary leverage ratio as applied to custodial banks. The
Federal banking agencies are actively working to issue a notice
of proposed rulemaking and expect to issue it for public
comment in the near future.
The April 2018 proposal to recalibrate the enhanced
supplementary leverage ratio standards assumed that the
components of the supplementary leverage ratio used the capital
rule's existing definitions of tier 1 capital (the numerator of
the ratio) and total leverage exposure (the denominator);
however, the definition of total leverage exposure will change
for certain banking organizations through the implementation of
section 402. As the Board and OCC noted in the April 2018
proposal, significant changes to either component of the
supplementary leverage ratio would likely necessitate
reconsideration of the proposed recalibration, as the proposal
was not intended to materially change the aggregate amount of
capital in the banking system. Accordingly, staff is evaluating
the April 2018 proposal in light of the statutory change, in
addition to comments received on the proposal. The Board also
plans to implement the requirements of section 402 in the near-
term.
Q.4. I've reviewed remarks you gave at the Brookings
Institution on November 9th and appreciate efforts you're
undertaking to implement S. 2155 by tailoring capital and
liquidity for banks based on risk. As the Senate lead on S.
366, the TAILOR Act, I appreciate any and all steps our banking
regulators take to tailor regulations to the risk profile and
business model of a given institution as opposed to regulating
based on arbitrary asset thresholds.
During your remarks at Brookings you stated that S. 2155
did not provide relief for large banks and that after the Fed
finalizes its tailoring proposal it will turn its focus to
other parts of our regulatory system.
Can you shed a bit more light into what you meant by that?
What issues will you be considering in your efforts to
bring greater efficiency to our regulatory system?
A.4. The proposals approved by the Board for public comment on
October 31, 2018, are designed to efficiently tailor prudential
standards to the risks of large U.S. banking organizations
while ensuring that firms maintain sufficient resources and
risk management practices to be resilient under a range of
economic conditions. \5\ The proposals build on the Board's
existing tailoring of its rules and experience implementing
those rules, and account for changes made by the EGRRCPA to the
enhanced prudential standards requirements under section 165 of
the Dodd-Frank Act.
---------------------------------------------------------------------------
\5\ See https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20181031a.htm.
---------------------------------------------------------------------------
In the proposals, the Board stated its plans to propose at
a later date similar amendments that would tailor capital
planning and resolution planning requirements for large U.S.
banking organizations. The Board also stated its plans to issue
a separate proposal relating to foreign banking organizations
that would implement section 401 of the EGRRCPA for these
firms, take into account the structures through which these
firms conduct business in the United States and reflect the
principles of national treatment and equality of competitive
opportunity.
In addition, the Board in general aims to reduce
unnecessary costs associated with and streamline regulatory
requirements based on its experience implementing the rules and
consistent with the statutory provisions that motivated the
rules.
Q.5. The June 2017 Treasury Report on banks and credit unions
recommended, ``The application of U.S. enhanced prudential
standards to foreign banking organizations (FBOs) should be
based on their U.S. risk profile, using the same revised
threshold as is used for the application of the enhanced
prudential standards to U.S. bank holding companies, rather
than on global consolidated assets.''
How will the Federal Reserve tailor its regulations
according to this recommendation and the longstanding principle
of national treatment?
A.5. The Board is in receipt of the June 2017 Department of
Treasury report and has carefully reviewed its contents
including its recommendations. As noted above, the Board is
considering the appropriate way to assign the U.S. operations
of foreign banking organizations to the categories of
prudential standards described in the Board's October 31, 2018,
proposal to tailor prudential standards for domestic firms, in
light of the special structures through which these firms
conduct business in the United States.
Q.6. Given that foreign regulators may retaliate against
American institutions for overly aggressive actions taken by
U.S. regulators, what steps will the Federal Reserve take to
focus its tailoring on the risk profile of intermediate holding
companies and not the branch networks of international banks,
which are subject to regulation by their home countries?
A.6. In developing a proposal for foreign banking
organizations, the Board will consider the special structures
through which these firms conduct business in the United
States. The Board's current enhanced prudential standards were
designed to increase the resiliency of the U.S. operations of
foreign banking organizations, including the U.S. branches and
agencies of these firms. In developing the proposal, the Board
will continue to consider the principles of national treatment
and equality of competitive opportunity along with the extent
to which a foreign banking organization is subject, on a
consolidated basis, to home country standards that are
comparable to those applied to financial companies in the
United States.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TILLIS
FROM RANDAL K. QUARLES
Q.1. After Nasdaq became an exchange in 2006, it is my
understanding that the Federal Reserve has not undertaken any
effort to update its rules to provide a pathway to margin
eligibility for companies traded over-the-counter (OTC). Margin
eligibility of OTC-traded stocks can be an important part of
the growth of small and emerging companies, as it helps to
improve the market quality of those securities, impact an
investor's willingness to purchase those securities, and as a
result have a direct impact on capital formation. In addition,
U.S. investors in the American depositary receipts (ADR) for
Roche ($10bn yearly net income) and other large, international
OTC traded firms are also negatively impacted by the Federal
Reserve's inaction on this issue.
Will the Federal Reserve take action to revive the margin
list for certain OTC securities? If not, please explain why.
A.1. Responding to your question above and as previously posed
regarding the List of Over-the-Counter Margin Stocks (OTC List)
that is no longer published by the Federal Reserve Board
(Board), staff have continued to monitor OTC market
developments in the years since the publication of the OTC List
ceased. Any expansion of the types of securities that are
margin eligible would require careful consideration by the
Board of the benefits of such an approach weighed against
potential increased burden on banks and other lenders.
Please know that I appreciate your concerns as noted in
your questions, and we are looking into potential approaches
that may be considered while ensuring any changes would not
pose additional regulatory burdens. By way of background, I am
including a brief summary of the history of the Board's OTC
List.
In 1968, Congress amended section 7 of the Securities
Exchange Act of 1934 (SEA) to allow the Board to regulate the
amount of credit that may be extended on securities not
registered on a national securities exchange, or those
securities known as ``over-the-counter'' or ``OTC'' securities.
The following year, the Board adopted criteria to identify OTC
stocks that have ``the degree of national investor interest,
the depth and breadth of market, the availability of
information respecting the security and its issuer, and the
character and permanence of the issuer'' to warrant treatment
similar to equity securities registered on a national
securities exchange. The Board's first periodically published
OTC List became effective on July 8, 1969.
In 1975, Congress further amended the SEA to direct the
Securities and Exchange Commission (SEC) to facilitate the
development of a ``national market system'' (NMS) for
securities to accomplish several goals, including price
transparency. The SEC's criteria for NMS securities came to
cover both exchange-traded stocks (which were always
marginable) and a subset of stocks traded on Nasdaq, the
largest and most technologically advanced over-the-counter
market at that time. The majority of the securities traded on
Nasdaq's NMS tier were covered by the Board's OTC margin stock
criteria and appeared on the Board's OTC List. The Board's
analysis, however, indicated that the liquidity and other
characteristics of NMS securities generally compared favorably
with those of exchange-traded securities. Accordingly, the
Board amended its margin regulations in 1984 to give immediate
margin status to OTC securities that qualified as NMS
securities without regard to whether the stock appeared on the
Board's OTC List. This action established a precedent for
relying on NMS status under SEC rules as a substitute for
identifying margin-eligible OTC securities through the
application of Board established criteria.
The Board ceased publication of its OTC List in 1998, and
provided margin status to all securities listed on the Nasdaq
Stock Market, after Nasdaq raised the listing standards for
non-NMS securities trading on its market, making them
comparable to those traded on national securities exchanges.
Indeed, Nasdaq subsequently became a national securities
exchange.
Q.2. In previous reports on the state of supervision and
regulation, you have stated, ``the Federal Reserve relies to
the fullest extent possible'' on State insurance departments in
the supervision of Insurance Savings & Loan Holding Companies
(ISLHC) and that you have worked closely with State officials
and the National Association of Insurance Commissioners (NAIC)
to maximize supervisory efficiencies and avoid duplication. I
continue to hear from my constituents and insurance companies
in my State that ``tailoring'' is not occurring. It is
difficult to point to a single specific action the Federal
Reserve has taken to tailor for these companies, and they
continue to exit the business of banking, with several exits in
the last year.
Is the Federal Reserve concerned about this trend?
What specific further actions will the Federal Reserve take
to make sure that ISLHCs are not being driven from the business
of banking by inefficient and overly burdensome regulation?
A.2. In supervising insurance savings and loan holding
companies (ISLHCs), the Federal Reserve has aimed to develop
policies that are insurance-centric and appropriate for the
insurance business and regulatory environment. For instance,
the Board's advance notice of proposed rulemaking on insurance
capital requirements set out two frameworks for capital
standards that are each unlike the Board's capital rules for
bank holding companies. \1\ The Federal Reserve recognizes that
ISLHCs have multiple functional regulators and that State
insurance regulators are the primary functional supervisors of
the insurance companies. In supervising the consolidated
insurance organization, the Federal Reserve remains committed
to working cooperatively with State insurance regulators to
reduce the potential for duplication and undue burden of
supervisory activities. The Federal Reserve also tailors its
supervisory activities and guidance to account for the unique
characteristics, organizational and regulatory structures
associated with ISLHCs. Examples of tailoring for these
companies include the Board's exemption of ISLHCs from Federal
Reserve consolidated capital, stress testing and liquidity
rules which are generally applicable to banking organizations.
---------------------------------------------------------------------------
\1\ Capital Requirements for Supervised Institutions Significantly
Engaged in Insurance Activities, 81 Fed. Reg. 38,631 (June 14, 2016),
https://www.federalregister.gov/documents/2016/06/14/2016-14004/
capital-reguirements-for-supervised-institutions-significantly-engaged-
in-insurance-activities.
---------------------------------------------------------------------------
Federal Reserve examination teams rely on State insurance
regulators to the fullest extent possible for the assessment of
insurance risks and activities. For example, supervisory
evaluations and findings from State insurance regulators are
incorporated into the Federal Reserve's consolidated
supervision assessments. Federal Reserve examiners defer to
State insurance regulators for the evaluation of insurance
activities pertaining to insurance underwriting, reinsurance,
reserving, market conduct, and compliance with State insurance
laws.
The Federal Reserve also coordinates with State insurance
regulators through information sharing agreements and
supervisory colleges. Additionally, Federal Reserve examination
staff meet with each ISLHC's primary State insurance regulators
to share supervisory information (e.g., inspection reports,
supervisory plans), coordinate supervisory activities, and
identify opportunities to leverage each agency's work to
complement supervisory efforts and avoid duplication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM RANDAL K. QUARLES
Q.1. You recently made a speech about the Federal Reserve's
``Stress Capital Buffer'' proposal, which makes significant
changes to the annual supervisory Comprehensive Capital
Analysis and Review (CCAR) administered by the Fed. You
indicated that the Fed would make a second proposal in response
to some industry comments.
According your remarks, the Fed is considering allowing a
firm to develop a capital distribution plan after its stress
tests because ``firms have told us that they would be able to
engage in more thoughtful capital planning if they had
knowledge of that year's stress test results before finalizing
their distribution plans for the upcoming year.''
What evidence has the Fed received that firms will actually
be more thoughtful rather than simply plan to distribute the
maximum amount permitted by the stress tests, thereby
outsourcing their capital decisions to the Fed?
A.1. Currently, and under the Stress Capital Buffer proposal, a
firm must decide whether to increase or decrease its planned
dividends and share repurchases for the upcoming year without
knowledge of a key constraint: the results of the stress test.
While this practice is intended to encourage firms to think
rigorously about their capital uses and needs in developing
their capital plans, it also introduces significant uncertainty
into a firm's capital planning process.
Adjusting the operation of the rule such that firms know
their stress capital buffer before they decide on their planned
distributions for the coming year would remove this
uncertainty. This change would not change the expectation that
firms continue to engage in meaningful capital planning and use
their internal capital planning processes to set their planned
capital distributions. The Federal Reserve would continue to
use the supervisory process to evaluate the strength of each
firm's capital planning process, including identifying its
material risks and determining the capital necessary to
withstand those risks during stressful conditions.
Q.2. You indicated in your speech that ``reducing volatility''
of stress test demands would be the goal of a future proposal.
The purpose of a stress test is to determine how a firm will
fare under an unanticipated shock.
How is a goal of reducing or minimizing changes in stress
test results to avoid ``management challenge'' to banks
compatible with this purpose?
A.2. The supervisory stress test allows the Federal Reserve to
assess the resilience of banking organizations under various
economic stress scenarios. It is essential to the continued
success of the stress test as a supervisory tool that we
preserve the dynamism of the stress test, and we seek to
balance this objective with other supervisory objectives in
evaluating future proposals.
One of these supervisory objectives is to mitigate
excessive volatility in stress test results. It is typical for
supervisory stress test results for a given firm to change
year-over-year, as the scenarios and firms' portfolio
characteristics change, and we want to maintain that feature.
However, large changes in year-over-year stress test
results, particularly those not driven by portfolio changes,
can make it difficult for firms to engage in responsible
capital planning.
Maintaining the dynamism of the supervisory stress test
need not be at odds with mitigating excessive volatility in
supervisory stress test results. We are in the process of
carefully considering how to achieve an appropriate balance of
these two goals in future proposals.
Q.3. The 2008 crisis created financial stress because firms
were not anticipating significant losses from mortgage-backed
securities, which were assumed to be relatively safe assets
until unanticipated losses rapidly materialized over the 2007-
2008 period. Over that period banks were permitted to return
about a hundred billion in capital to shareholders, which later
had to be made up by taxpayers through public capital
injections.
How will a low-volatility stress test effectively require
banks to preserve capital during such sharp turns in the
market?
A.3. Mitigating excessive volatility in loss estimates, and
estimates of poststress capital, need not be synonymous with
maintaining a static stress test that does not take emerging
risks into the economic and financial environment into account.
Indeed, it is essential to the continued success of the
stress test as a supervisory tool that we preserve the dynamism
of the stress test, and we seek to balance this objective with
other supervisory objectives in evaluating future proposals.
The severely adverse scenario used in the Board's annual
stress test reflects a sharp deterioration in macroeconomic and
market conditions, similar to what we experienced during the
2007-2008 period.
Several elements of the Federal Reserve's stress testing
and scenario framework are geared toward capturing shifts in
the economic environment and in firms' risk profiles. These
types of shifts would continue to be captured in the
supervisory stress test results. Specifically, supervisory
models are regularly reestimated with newly available data, and
the Board's scenario design framework allows for the
incorporation of salient risks to the current economic outlook.
Further, the Federal Reserve's supervisory modeling policies
seek to limit reliance on past outcomes, so that supervisory
models can incorporate events or outcomes outside of historical
experience.
Q.4. You also indicated that the Fed would begin to ``disclose
additional detail about supervisory stress tests models and
results . . . allow[ing] firms to benchmark the results of
their own models against those of the supervisory models.''
Won't a lower-volatility stress test in which details of
models and assumptions are widely known result in a system
where stress tests are functionally equivalent to the Basel III
risk-based capital rules? If so, what would be the
justification for having multiple systems of risk-based
capital?
A.4. Maintaining the dynamism of the supervisory stress test--
and therefore its distinction from the Basel III risk-based
capital rules--is one of our key objectives, and need not be at
odds with mitigating excessive volatility in supervisory stress
test results. Supervisory stress test results for a given firm
will continue to change year-over-year, as the scenarios and
firms' portfolio characteristics change. We seek to reduce
potentially excessive changes in year-over-year stress test
results, which can make it difficult for firms to engage in
responsible capital planning.
We believe that the additional model disclosures that we
proposed late last year appropriately increase the degree of
transparency into supervisory models while preserving the
dynamism of the exercise.
In evaluating future proposals, we will continue to
consider how best to achieve an appropriate balance of the
objectives of mitigating excessive volatility in capital
requirements and preserving the dynamism of the stress test
exercise.
Q.5. The Fed is apparently also considering seeking the
public's ``input on scenarios and salient risks facing the
banking system each year,'' providing another opportunity for
interested parties to shape the stress tests. Under the current
framework, the scenarios are determined by the Fed's
economists, with input from the reserve banks.
Have you lost confidence in the ability of these experts to
foresee risks and develop effective stress test scenarios? If
not, what is the value of allowing industry actors to influence
the tests they will receive?
A.5. The stress test provides a forward-looking measurement of
bank capital, a view of common and systemic risks across the
banking sector, and a broader understanding of the health of
the financial system. By helping us ensure that the largest
firms have sufficient capital to absorb losses and continue to
lend in stressful conditions, the stress test helps to reduce
the potential that distress from a single large firm will spill
over to the broader economy. The results are valuable for
markets, analysts, and ultimately, the participating firms.
The Federal Reserve Board's (Board) supervisory stress test
independently assesses the resilience of the financial system
under stress. I believe that our ability to provide an
independent view of capital adequacy enhances the credibility
of the test and of our supervisory program. Our independent
assessment of poststress capital relies on models and scenarios
developed by Federal Reserve staff, which is comprised of a
wide range of experts that drive innovation in their fields.
Across the Federal Reserve System, our diverse workforce
publishes a wide range of economic and policy research and
plays an active role in academic discourse.
Yet we recognize that we are not, and cannot be, a monopoly
on insight and wisdom. In the past, the Board has sought and
benefited from multiple and diverse perspectives on elements of
its stress testing program. For example, the Board recently
invited public comment on principles governing stress test
model design and amendments to further clarify the scenario
design framework. Through that process, we received valuable
feedback which we incorporated in the finalized amendments.
We will continue to push the frontier of stress testing,
through our own research and through the insights we gain from
our engagement with the public. We recently announced that we
will host a stress testing conference in July that will be open
to the public. During the conference, we expect that a number
of diverse stakeholders, including academics, public interest
representatives, and financial sector representatives, will
share their thoughts on certain aspects of the stress test
program, including our current approach to scenario design.
Q.6. In the recent stress capital buffer (SCB) proposal, you
shifted the stressed leverage ratio requirement from the
supplemental leverage ratio to the less stringent Tier 1
leverage ratio. In your recent speech you then proposed to
eliminate the stressed leverage ratio requirement altogether.
You justified elimination of this requirement by claiming that
including the leverage ratio in the stress tests made the
operational effect of the leverage ratio more dependent on
modeled risks.
But won't eliminating the stressed leverage ratio
altogether significantly increase the role of risk modeling and
risk weights in the capital system?
Could you please provide information on how many firms
experienced the current stressed leverage ratio requirement to
be their binding or most significant constraint in the stress
test process?
A.6. The Board's notice of public rulemaking entitled
Amendments to the Regulatory Capital, Capital Plan, and Stress
Test Rules \1\ issued in April 2018 sought comment on the
introduction of a stress leverage buffer requirement in
addition to the current capital rule's 4 percent minimum tier 1
leverage ratio requirement. However, the stress buffer concept
would not be extended to the supplementary leverage ratio. Our
analysis indicates that the stressed supplementary leverage
ratio was the binding constraint for one firm based on the
results of the Comprehensive Capital Analysis Review 2018.
---------------------------------------------------------------------------
\1\ https://www.govinfo.gov/content/pkg/FR-2018-04-25/pdf/2018-
08006.pdf
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Leverage ratios are intended to function as a backstop to
traditional risk-based capital requirements. Whether or not
there is an additional stress leverage buffer, global
systemically important banks would continue to remain subject
to the capital rule's enhanced supplementary leverage ratio
standards so leverage capital requirements would continue to
serve as a strong backstop. Board staff are currently reviewing
all comments on the proposal and will carefully consider
whether any changes to the proposed stress leverage buffer
requirement or more generally are appropriate.
Q.7. Your remarks also indicated that you were motivated by the
view that the ``[t]ransparency of the stress test and its
inputs and outputs is key to the credibility of the stress
test.''
Does the Fed have any evidence that firms or the market
aren't taking stress tests seriously under the current regime?
A.7. The Federal Reserve's stress test remains an effective
supervisory tool. We believe it is important to seek public
input and to assess ways to further enhance the test's
effectiveness.
Since the inception of the supervisory stress test, the
Board has gradually increased the breadth of its public
disclosure. By increasing the amount of information about the
assessment that is available to the public, the Board has
invited the public to engage and make an independent evaluation
of the stress test's soundness. Since the supervisory capital
assessment program exercise in 2009, incremental disclosures of
supervisory models and results have benefited banking
organizations and those seeking to understand the resilience of
firms in times of economic stress. The December 2017 proposals
to increase transparency of the supervisory stress test are the
latest incremental step to increase disclosure.
In evaluating each incremental disclosure, the Board
considers how to disclose information about the stress tests in
a manner that appropriately balances the costs and benefits of
transparency. For example, we have not disclosed the full
details of our models, in large part due to the Board's
concerns about convergence of stress testing, which would make
them less effective and would undermine the financial stability
gains we have made. We also seek to guard against the risk of
firms making modifications to their businesses that change the
results of the stress test without changing the risks they
face. This behavior could result in the stress test giving a
misleading picture of the actual vulnerabilities faced by
firms. It could also result in all firms increasing their
holdings of assets that perform better in the supervisory
stress test, which would make the financial system as a whole
less diversified and more vulnerable to shocks.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM RANDAL K. QUARLES
Q.1. Wells Fargo--Wells Fargo Bank admitted to creating more
than 3.5 million accounts without customers' authorization.
Wells Fargo forced hundreds of thousands of automobile loan
customers to pay for unnecessary insurance policies, with the
added expense leading some borrowers to default and lose their
vehicles. Wells Fargo also admitted to charging improper fees
to some mortgage borrowers. Wells Fargo did not offer help to
870 mortgage borrowers that they were entitled; 545 of those
borrowers had their homes taken from them in foreclosure
proceedings. Three of them were from Nevada.
In February, the Federal Reserve cited those and other
issues when it ordered the bank to halt expansion until it can
prove to regulators that it has systems in place to prevent
consumer abuses.
What issues remain with Wells Fargo leadership's
remediation plan?
Will the Fed object to Wells Fargo capital distribution
plan until a remediation plan has been accepted and the consent
decree released?
Why did the Federal Reserve not use the Comprehensive
Capital Analysis and Review process to object to Wells Fargo's
capital distribution plan?
A.1. Thank you for your question. Please note that I have
recused myself from participating in official matters specific
to Wells Fargo, as detailed in a press release dated December
15, 2017.
Q.2. The most recent news from Wells Fargo--870 mortgage
borrowers not appropriately assisted--more than 500 wrongly
foreclosed on--was reported AFTER the consent order was signed
in February.
Should we expect more problems of unfair, deceptive and
abuse practices harming Wells Fargo's customers in the coming
year? Does the Fed and other banking regulators feel they have
a handle on the harmful practices at Wells Fargo?
A.2. Please see my response to Question 1.
Q.3. Is the asset cap the Fed put in place adequate for
changing Wells Fargo's behavior?
A.3. Please see my response to Question 1.
Q.4. The Supervisory Reports states that that sales practices
and incentive-based compensation is an area of priority. [p.27]
What will the Fed do to change incentive pay and sales
practices at banks?
A.4. As noted in the Federal Reserve Board's (Board) November
2018 Supervision and Regulation Report, the Board conducted
reviews of sales and incentive compensation practices at
certain State member banks with total assets between $10
billion and $50 billion. The reviews identified acceptable
practices. When exceptions were noted, however, findings were
determined to be correctable in the normal course of business.
Through our existing supervisory process, we will continue
to monitor firms' progress towards appropriately balancing
risks concerning sales and related incentive compensation
practices.
Q.5. What is the status of the Incentive-based compensation
rule mandated by the Dodd-Frank Wall Street Reform and Consumer
Protection Act? I would note that this is a mandatory law, not
discretionary.
A.5. In June 2016, the Board, Office of the Comptroller of the
Currency (OCC), the Federal Deposit Insurance Corporation
(FDIC), the Securities and Exchange Commission (SEC), the
National Credit Union Administration (NCUA), and the Federal
Housing Finance Agency (collectively, the agencies), jointly
published and requested comment on a proposed rule under
section 956 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act. This joint effort proposed several requirements
to address incentive compensation arrangements. The agencies
received over 100 comments on the proposed rule. Development of
a final rule on an interagency basis in light of those comments
is now under active work by the agencies.
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.
The Board's supervision focuses on encouraging robust risk
management and governance around incentive compensation
practices rather than prescribing amounts and types of pay and
compensation.
Q.6. Bank Secrecy Act/Anti- Money Laundering--In the Fed's
Supervisory Report released last week, you note that of the
supervisory findings currently outstanding, nearly 20 percent
relate to weaknesses in BSA/AML programs. [p.26]
Can you be more specific about how ``machine-based
learning'' could help banks more easily comply with the Bank
Secrecy Act?
A.6. Some banks are becoming increasingly sophisticated in
their approach to Bank Secrecy Act/Anti- Money Laundering (BSA/
AML) compliance, and machine learning features prominently
among the types of new technology that banks have been
exploring in recent years. Machine learning can have many
different applications, for example, some banks have
experimented with this technology as a way to identify
potentially suspicious patterns in transaction data at a
reduced cost to the institution. While machine learning has the
potential to enhance suspicious activity monitoring and other
BSA/AML compliance processes, the use of this technology is at
an early stage. The Federal Reserve does not advocate a
particular method to comply with the BSA and believes that, as
a general matter, institutions should consider a broad range of
factors when considering new approaches to BSA/AML compliance
such as performance, cost, and security of a particular
technology. Any such processes should be transparent and
reproducible so that banks and examiners understand how the
system meets regulatory requirements. When developing
innovative approaches, banks must continue to meet their BSA/
AML compliance obligations.
Q.7. Are the banking regulators working with FinCEN on future
joint guidance? What would such guidance include? What impact
would the guidance have under the new decision that guidance
does not have the force of law?
A.7. In December 2018, the Federal Reserve Board (Board) issued
a joint statement with the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation, the
National Credit Union Administration, and the Financial Crimes
Enforcement Network that encourages depository institutions to
explore innovative approaches to meet their BSA/AML compliance
obligations and to further strengthen the financial system
against illicit financial activity. \1\ The statement
recognizes that new technologies may help banks to more
efficiently identify and report money laundering, terrorist
financing, and other illicit financial activity.
---------------------------------------------------------------------------
\1\ See https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20181203a.htm.
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While the statement encourages banks to explore new ways of
using their existing tools or adopting new technologies to meet
their BSA/AML compliance obligations, the statement is not
itself binding and expressly recognizes that some financial
institutions may not have the means or ability to innovate. In
addition, the statement makes clear that the Federal Reserve
will not penalize banks that maintain effective anti- money
laundering programs but choose not to pursue innovative
approaches.
Q.8. Merger and Acquisition Risk--In the Fed's Supervisory
Report released last week, you note that upcoming Regional
Banking Organizations Supervisory Priorities include merger and
acquisition risks. A number of banking experts said that
reducing the capital requirements and other rules for banks
above $50 billion would lead to more bank mergers.
Do you expect to see more bank mergers this year and next
year than the past few years? Can you estimate the number of
bank mergers you expect in 2019?
A.8. When reviewing a bank holding company application or
notice that requires approval, the Federal Reserve considers
the financial and managerial resources of the applicant, the
future prospects of both the applicant and the firm to be
acquired, financial stability factors, the convenience and
needs of the community to be served, the potential public
benefits, the competitive effects of the proposal, the
applicant's compliance with laws and regulations, and the
applicant's ability to make available to the Federal Reserve
information deemed necessary to ensure compliance with
applicable law.
Once a merger or application has been approved, we follow
merger and acquisition (M&A) activity within the regional
banking portfolio \2\ chiefly to assess operational risk as the
acquirers integrate the new operations into their consolidated
organization.
---------------------------------------------------------------------------
\2\ For supervisory purposes, the Federal Reserve generally
defines regional banking organizations as those with total assets
between $10 billion and $100 billion.
---------------------------------------------------------------------------
We continue to see significant M&A activity within the
portfolio, and indeed the regional banking portfolio has grown
as banking companies under $10 billion in assets accelerate
their growth across that size threshold by performing
acquisitions.
We do expect M&A activity within the regional banking
portfolio to continue, but any estimate of the projected level
of this activity would be pure speculation, as it will depend
on many different market factors.
Q.9. How much of merger activity is due to changes from S. 2155
and bank regulator actions to reduce some rules?
A.9. The Economic Growth, Regulatory Relief, and Consumer
Protection Act (EGRRCPA), enacted in May 2018, raised the asset
threshold at which certain prudential standards apply from $50
billion to $100 billion. The new law also changed the asset
threshold for a small bank holding company from $1 billion to
$3 billion. Anecdotal evidence suggests that the former
thresholds may have provided a merger disincentive to banks to
grow beyond that point. At this time, the Federal Reserve does
not have any specific evidence to indicate that merger activity
has materially increased due to changes from EGRRCPA.
Q.10. Since you note risks to regional banks arising from
mergers and acquisitions, what are those risks?
A.10. As noted in my response to 5(a), when reviewing a bank
holding company application or notice that requires approval,
the Federal Reserve considers the financial and managerial
resources of the applicant, the future prospects of both the
applicant and the firm to be acquired, financial stability
factors, the convenience and needs of the community to be
served, the potential public benefits, the competitive effects
of the proposal, the applicant's compliance with laws and
regulations, and the applicant's ability to make available to
the Federal Reserve information deemed necessary to ensure
compliance with applicable law.
Once a merger or application has been approved, we follow
M&A activity within the regional banking portfolio chiefly to
assess operational risk as the acquirers integrate the new
operations into their consolidated organization. Operational
risks during integration can involve almost any aspect of
running a bank, but the one that gives the greatest supervisory
concern is compatibility of information technology systems. The
acquiring bank needs to ensure that the transition is smooth
across all balance sheet and income statement accounts, that
customers are not inconvenienced or exposed to errors as the
accounts are integrated, and that management information
systems (MIS) used for internal reporting--MIS that generates
metrics on credit, liquidity, and market risks for example--
accurately capture the new consolidated entity.
Q.11. Liquidity Coverage Ratio/Stress Tests--Banks are required
to retain enough assets they can easily convert to cash to
cover 30 days of expenses. You recommend reducing this cash
cushion for all but the largest banks by revisions to the
Liquidity Coverage Ratio. You say the reduction is minimal.
Others say it is large and significant. Your Federal Reserve
colleague, Governor Lael Brainard says it ``weakens the buffers
that are core to the resilience of our system.''
How will you know if your analysis is wrong? How will you
know if banks have less capital than prudent based on these
regulatory changes you propose?
A.11. The Board's liquidity framework for large banking
organizations has two general components: standardized
measures, such as those included in the liquidity coverage
ratio rule or net stable funding ratio proposed rule, and firm-
specific measures, such as liquidity risk management
requirements and internal liquidity stress testing
requirements.
The recent proposals to further tailor prudential standards
would reduce or remove standardized liquidity requirements for
some firms, but they would retain the firm-specific measures
for all firms with $100 billion or more in total assets. As a
result, the proposals would continue to require these firms to
meet liquidity risk management standards, conduct internal
liquidity stress tests, and hold a buffer of highly liquid
assets sufficient to meet projected 30-day stressed cash flow
needs under internal stress scenarios. The proposals would also
require these firms to maintain regulatory reporting of key
liquidity data, which facilitates the Board's supervision of
liquidity-related risks. In addition, the Board will continue
to assess the safety and soundness of firms in the normal
course of supervision.
Taken together, these firm-specific standards and data
reporting requirements will allow supervisors to continue to
achieve regulatory objectives while improving upon the
simplicity, transparency, and efficiency of the regime. In this
manner, the proposals build on the Board's existing practice of
tailoring regulatory requirements based on the size,
complexity, and overall risk profile of banking organizations.
Q.12. If banks or their trade associations start taking the
Federal Reserve to court due to their differences in how the
tailoring worked, a stress test result or a cost-benefit
analysis they do not agree with, will you feel your analysis
was wrong?
A.12. The Board takes seriously the importance in the
rulemaking process of seeking comment from the public,
carefully considering those comments, and assessing the costs
and benefits of its rulemaking efforts. The Board believes
strongly that public comment and cost-benefit analysis can
enlighten our regulatory actions and inform the implementation
of our statutory responsibilities. In addition to seeking
public comment on its proposals, the Board often collects
impact information directly from parties that may be affected.
Under the Board's current practice, consideration of costs and
benefits occurs at each stage of the regulatory or policymaking
process. Recent examples of the publication of quantitative
analyses in connection with its rulemakings include the global
systemically important bank (G-SIB) surcharge rule, the single-
counterparty credit limit rule, and the long-term debt rule.
The Board has established processes that allow institutions
to respond to and appeal certain types of administrative
actions, such as stress test results. In addition, the
Administrative Procedure Act (APA) provides for judicial review
of final regulations issued by the Board. Affected firms have
the legal right to challenge the actions of any administrative
agency under the APA, including whether the agency has engaged
in reasoned decision making. Although the Board strives to
robustly support all of its supervisory and regulatory actions,
these appeal and judicial review processes help to ensure fair
and effective implementation of our statutory responsibilities,
consistent with applicable administrative requirements.
Q.13. This isn't just one weakening of buffers. There are
numerous reductions at from several rulemakings that I think
collectively have a material effect in weakening safeguards.
Are you concerned that this ``death by a thousand cuts'' will
result in much less of a capital cushion for banks that may
find themselves in trouble in the future?
A.13. Reforms implemented since the financial crisis have
resulted in substantial gains in the resiliency of large
banking organizations and the financial system as a whole. The
proposals issued in October 2018 and April 2019, seek to tailor
the Board's prudential requirements for certain U.S. banking
organizations and foreign banking organizations in accordance
with the risk profiles of these firms while still maintaining
the core reforms and gains made over the past decade.
For liquidity standards, the proposals would continue to
ensure that firms with the most significant risk profiles are
subject to the most stringent liquidity requirements. For
example, all U.S. G-SIBs and firms with very substantial size
or cross-jurisdictional activity would be subject to the full
liquidity coverage ratio and proposed net stable funding ratio
requirements. The proposals would also require any firm with a
high reliance on unstable short-term wholesale funding to meet
the full requirements. This distinction would reflect these
firms' elevated vulnerability to liquidity risk, and help to
reduce the risk of asset fire sales that could transmit
distress to other market participants and destabilize the
system.
As noted in my response to question 6(a), all firms with
assets greater than $100 billion will continue to be subject to
firm-specific liquidity requirements. As a result, these firms
will still be required to conduct internal stress tests and
hold liquidity buffers sufficient to meet projected 30-day net
stressed cash-flow needs.
Further, with respect to capital, the proposals do not
modify capital requirements of the largest, most systemically
important banking organizations (U.S. G-SIBs and banks either
that are very large or have substantial cross-jurisdictional
activity). The proposals may result in an adjustment of capital
requirements for smaller, less-systemic firms, although the
impact on capital levels for these firms could vary under
different economic and market conditions. The proposals also
would also lower these firms' compliance costs. As a result,
the proposed requirements would reduce costs appropriately for
those firms that have a limited impact on the financial system
as a whole, relative to firms with more significant systemic
footprints.
Q.14. While you praise transparency in regulation, some warn
that providing the textbook prior to the test or describing
rigorous requirements for regulation allows banks to skirt the
law in areas not yet covered. For example, there was probably
little oversight of cryptocurrencies yet they have become a
huge problem with Initial Coin Offering frauds. How will your
focus on transparency avoid giving banks the option to make an
argument that they not be tested or held accountable for
something not clearly defined in the rules?
A.14. Issuing clear regulations is fundamental to the
legitimacy of democratically accountable institutions and is
central to the Federal Reserve's mission; regulated firms have
a right to know the specific requirements that apply to them.
While the Board is aware that prescriptive regulation may not
capture all potentially harmful activity undertaken by
regulated firms, the Board's comprehensive supervisory regime
is designed to identify such activity before it poses harm to a
firm or to financial stability, and the Board also relies on
its general safety and soundness authority \3\ to address such
activity.
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\3\ 12 CFR part 208, subpart J, appendix D-1.
Q.15. Standard & Poor's and Moody's stated that weakening bank
requirements is a credit negative for bank bond investors. An
S&P report said ``the Fed's proposals are incrementally
negative for bank creditors.'' Moody's report stated that the
``reduced frequency of capital and liquidity stress testing
could lead to more relaxed oversight and afford banks greater
leeway in managing their capital and liquidity stress testing
could lead to more relaxed oversight and afford banks greater
leeway in managing their capital and liquidity, as well as
reduce transparency and comparability, since fewer firms will
participate in the public supervisory stress test.'' Do you
concur with two of the Credit Rating Agencies that your
proposals--reducing or recalibrating capital requirements and
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stress tests--are ``credit negative''? Why or why not?
A.15. The proposed adjustments to the Board's capital and
liquidity requirements are designed to efficiently tailor
prudential standards to the risks of large banking
organizations while ensuring that firms maintain sufficient
resources and risk management practices to be resilient under a
range of economic conditions. They are intended to maintain and
support the postcrisis increases in resiliency.
In regard to capital and liquidity requirements, including
capital and liquidity stress testing requirements, the Board is
focused on reducing the complexity of the requirements in a way
that does not materially lower the aggregate amount of total
loss absorbing capacity maintained by banking organizations
supervised by the Board. In addition, the Board is focused on
tailoring the capital and liquidity prudential standards so
that they are more reflective of the variety of business models
and risk profiles observed across the industry, in a manner
consistent with the requirements of EGRRCPA.
Any adjustments to the Board's regulatory requirements will
be coupled with the Board's continued commitment to strong
supervision, and expectation that financial institutions manage
their risks and maintain sufficient capital and liquidity to
continue operations under stressed conditions.
Q.16. Community Reinvestment Act and Regulatory Coordination--
In your response to my questions for the record last Spring,
you neglected to answer one of my questions.
Which, if any recommendation from the Treasury Department
or Comptroller Otting do you disagree with regarding the
Community Reinvestment Act?
A.16. Recommendations offered by the Treasury Department and
Comptroller Otting on opportunities to modernize the Community
Reinvestment Act (CRA) regulations have contributed to valuable
analysis and dialogue among the agencies, as well as input from
the public. As I have stated previously, I support the goal of
improving the current supervisory and regulatory framework for
CRA based on feedback from industry and community stakeholders.
We are reviewing the information the OCC has received in
response to its advanced notice of proposed rulemaking on the
CRA, as well as information gathered through the Federal
Reserve's listening sessions at many of the Federal Reserve
Banks around the country to determine whether there are steps
we might take as regulators to come closer to both the letter
and intent of the statute. That review is ongoing, and our
evaluation of any particular proposal or element of a proposal
will depend on a full analysis of the available information
upon completion of that review.
Q.17. As the Vice Chair of Supervision at the Fed, can you
explain why there appears to be less interagency coordination,
and more controversial proposals being advanced, since you took
over the Supervisory role at the Fed? What is the potential for
reducing public confidence and certainty in the regulatory
actions you and others are attempting to take quickly and
unilaterally?
A.17. The Board consults and coordinates on a regular basis
with its fellow bank regulatory agencies on a wide range of
matters affecting depository institutions and their affiliates.
This consultation and coordination facilitates a more cohesive
regulatory framework, which is intended to promote the safety
and soundness of the banking system in the most efficient and
least burdensome way possible. The Board also consults
regularly with the SEC, Consumer Financial Protection Bureau
(CFPB), Commodity Futures Trading Commission (CFTC), OCC, FDIC,
NCUA, and Treasury Department, in areas where regulatory
responsibilities overlap. Coordination and cooperation with
other agencies occurs at staff levels as well as through senior
officers and members of the Board. In addition, the Board
participates in the Federal Financial Institutions Examination
Council (FFIEC) and in the Financial Stability Oversight
Council, both of which facilitate interagency consultation and
cooperation. These many avenues of consultation at multiple
levels increase the coordination and consistency of regulation
across a banking industry that has multiple regulators and
charters.
Many of the proposals and final rules issued by the Board
in recent months have been issued in coordination with other
agencies. Recent examples of proposed or final rules issued in
coordination with the OCC and FDIC include amending the
definition of high-quality liquid assets under the agencies'
liquidity rules; expanding eligibility for an extended
examination cycle for insured banks and branches of foreign
banks; raising the threshold for residential real estate
transactions requiring an appraisal; and tailoring of liquidity
and capital requirements for large banking organizations. Other
recent examples of proposals issued in coordination with the
FDIC and OCC include a proposal to establish a community bank
leverage ratio, a proposal to streamline reporting requirements
for small institutions, and a proposal to exclude community
banks from the Volcker rule. The agencies continue to work
together to implement other provisions of S. 2155 and on other
matters of common interest.
Q.18. Labor Market/Housing Market--The U.S. has seen consistent
positive private sector job growth now for more than 100
consecutive months. To what extent are these gains sustainable?
What risks to the labor market do you see on the horizon?
A.18. As you noted, private sector payrolls have increased
every month since the spring of 2010. The labor market remains
strong, and I expect the expansion to continue, with further
positive job gains.
As always, there are risks to the outlook, and admittedly,
recessions are hard to foresee. But many studies demonstrate
that economic expansions do not end simply because they have
persisted for a long time. Rather, some shock or collection of
shocks occurs that is sufficient to push the economy into
recession. At present, the banking system is well capitalized
and highly liquid, and the Federal Reserve is committed to do
everything we can to sustain the ongoing expansion. The Federal
Reserve's recently inaugurated Financial Stability Report
discussed risks and the resilience of our financial system in
some detail. Other risks to the outlook could come from abroad,
in the form of a material downturn to some of our trading
partners or from the effects of Government policies, including
trade policy and Brexit.
While such downside risks are present, as reported recently
in the Summary of Economic Projections, most Federal Reserve
policymakers view the risks around our projections as balanced.
Most importantly, policy is not on a preset course, and we will
respond to changes in the economic outlook as warranted.
Q.19. More than half of renters pay more than \1/3\ of their
income for rent. Nearly half of Americans cannot handle a $400
emergency. What are your concerns about the housing market
where prices are high and supply--both rental and home
ownership--is inadequate in many communities? What should
Federal policy makers do to increase the supply of affordable
homes?
A.19. A healthy labor market is one of the most important
factors helping families afford their housing costs. Our labor
market is currently quite strong overall. The unemployment rate
is at its lowest level in many decades, and the strong job
market has encouraged more people to seek and hold jobs.
According to aggregate statistics, however, house prices and
rents have been rising well above the growth rate of aggregate
disposable household income. Moreover, aggregate statistics can
mask important differences across regions of the country. This
is especially the case with housing markets, which have
distinct geographic and local features. While an improving
labor market has produced some easing in the share of
households that are cost-burdened, the share of cost-burdened
households remains elevated relative to the period before the
financial crisis, and I share your concern over what this means
for the households affected.
Housing costs have been rising because of increasing costs
of labor and materials and, importantly, the availability and
cost of land for residential construction, which are in turn
influenced by local conditions and regulation. The Federal
Reserve tracks conditions in the housing market and has noted
the challenges of adding directly to the supply of affordable
housing. Each of the regional Federal Reserve Banks has an
active, well-staffed community development function--one of the
great benefits of the Federal Reserve's structure. We get
important and timely information on the state of local economic
and financial conditions, including those affecting low- and
moderate-income, as well as other underserved, communities. Our
community development staff at the Board and several Reserve
Banks have conducted research to better understand housing
affordability challenges, recognizing the importance of
sufficient affordable housing to a community's economic
vitality. We also conduct and disseminate research on policy
and practice solutions. Increasingly we have been exploring the
challenges of supplying affordable rental housing and the role
of local land use and zoning policies.
Q.20. Banks Hoarding Interest Income as the Fed Raises Rates--
Since the Fed began raising interest rates, banks have seen a
significant jump in net interest income and charged consumers
more for loans, all while keeping the interest rate paid on
customer deposits relatively flat. Why are depositors not
getting higher interest rates?
A.20. Banks' profits are partly determined by the difference in
interest expense they must pay on deposits and other
liabilities and the interest they earn on their assets,
including loans. Interest rates on bank deposits are determined
by private markets, as are the interest rates on loans, bonds,
and other financial savings and investment products. A
significant share of banks' funding comes from customer
deposits, for which banks must compete with other banks and
nonbanks, such as money market mutual funds. Banks must also
compete with other banks, nonbanks, and markets when setting
lending rates for borrowers. Historically, we have seen that
banks do not raise the rates they offer on customer deposits as
much or as quickly as interest rates on other bank products,
such as loans, when the Federal Reserve raises its policy rate.
Moreover, the rate paid by banks on their deposit accounts does
not tend to rise as much or as quickly as the yields savers
earn on alternative savings investments, such as money-market
mutual funds.
Of note, average advertised deposit rates are often an
incomplete indicator of how banks attract and retain customer
deposits. Presently, the range of rates offered by banks is
wide, and many banks temporarily offer promotional rates. In
addition, banks may use alternative methods to compete for
deposits vis-a-vis other banks and money market mutual funds.
Such alternative methods of compensating depositors include
cash incentives, special rates that are not broadly advertised,
and special offers on other services. We continue to study
these trends and the ways in which changes in monetary policy
transmit to the broader economy.
Q.21. Cannabis Banking--As more States begin to legalize
marijuana, it becomes imperative that Congress act on offering
financial services for cannabis and cannabis affiliated
businesses. In its first year of legalization, the State of
Nevada collected $69.8 million in tax revenue from cannabis
alone--this figure indicates that there is not an insignificant
amount of cash that is floating around our financial system.
Are you able to discuss whether, if any, how a lack of
financial services for cannabis businesses impacts our monetary
system?
A.21. We understand that cannabis business may largely be
conducted via cash transactions. Although the volume (and the
attendant risk) of cash transactions may be large for any
individual business, the scale of these businesses relative to
the scale of the United States economy is quite small. As such,
any additional cash activity from these businesses does not
appear to be having any impact on the Federal Reserve's ability
to provide currency and coin nor on its ability to conduct
monetary policy.
Q.22. Could you discuss the regulatory burden that this
prohibition places on federally chartered banks?
A.22. Federal law makes it a Federal crime to possess, grow, or
distribute marijuana, and prohibits an entity from knowingly
engaging in a monetary transaction in criminally derived
property. \4\ Therefore, financial transactions that are
related to marijuana are defined as money laundering under
Federal law, even those related to operations that are licensed
or approved under State law. The conflict between Federal and
State law has created challenges for marijuana-related
businesses and banks.
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\4\ See the Controlled Substances Act and 18 U.S.C. 1957.
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In 2014, the Financial Crimes Enforcement Network (FinCEN)
issued guidance to ``clarify how financial institutions can
provide services to marijuana-related businesses (MRBs)
consistent with their Bank Secrecy Act (BSA) obligations.'' \5\
Similar to other BSA guidance, a reference to the 2014 FinCEN
guidance was incorporated into the FFIEC BSA/AML Examination
Manual. If there are legislative changes or if FinCEN repeals
or revises its guidance, the Board, along with the other FFIEC
agencies, will evaluate whether additional steps would be
appropriate.
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\5\ https://www.fincen.gov/sites/default/files/shared/FIN-2014-
G0011.pdf
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Examiners assess whether the bank management has
implemented controls that are commensurate with the bank's
risks, and when those risks involve MRBs as customers,
examiners assess if the bank is complying with FinCEN's 2014
marijuana guidance, including its suspicious activity report
filing requirements. In general, examiners determine if the
bank's controls are commensurate with the risks posed by its
products, services, and customers. As a general matter, the
decision to open, close, or decline a particular account or
relationship is made by a depository institution, without
involvement by its supervisor.
[all]