[Senate Hearing 117-330]
[From the U.S. Government Publishing Office]
S. Hrg. 117-330
THE SEMIANNUAL TESTIMONY ON THE FEDERAL
RESERVE'S SUPERVISION AND REGULATION OF
THE FINANCIAL SYSTEM
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HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING HOW THE FEDERAL RESERVE CAN STAND UP FOR WORKERS AND FAMILIES
AND HELP CREATE A BETTER ECONOMY THAT WORKS FOR EVERYONE
__________
MAY 25, 2021
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: https: //www.govinfo.gov /
__________
U.S. GOVERNMENT PUBLISHING OFFICE
48-250 PDF WASHINGTON : 2022
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chairman
JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey RICHARD C. SHELBY, Alabama
JON TESTER, Montana MIKE CRAPO, Idaho
MARK R. WARNER, Virginia TIM SCOTT, South Carolina
ELIZABETH WARREN, Massachusetts MIKE ROUNDS, South Dakota
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
CATHERINE CORTEZ MASTO, Nevada JOHN KENNEDY, Louisiana
TINA SMITH, Minnesota BILL HAGERTY, Tennessee
KYRSTEN SINEMA, Arizona CYNTHIA LUMMIS, Wyoming
JON OSSOFF, Georgia JERRY MORAN, Kansas
RAPHAEL WARNOCK, Georgia KEVIN CRAMER, North Dakota
STEVE DAINES, Montana
Laura Swanson, Staff Director
Brad Grantz, Republican Staff Director
Elisha Tuku, Chief Counsel
Corey Frayer, Senior Professional Staff Member
Dan Sullivan, Republican Chief Counsel
John Crews, Republican Policy Director
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
(ii)
C O N T E N T S
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TUESDAY, MAY 25, 2021
Page
Opening statement of Chairman Brown.............................. 1
Prepared statement....................................... 27
Opening statements, comments, or prepared statements of:
Senator Toomey............................................... 3
Prepared statement....................................... 28
WITNESS
Randal K. Quarles, Vice Chairman for Supervision, Board of
Governors of the Federal Reserve System........................ 5
Prepared statement........................................... 29
Responses to written questions of:
Chairman Brown........................................... 33
Senator Toomey........................................... 35
Senator Cortez Masto..................................... 36
Senator Scott............................................ 43
Senator Rounds........................................... 46
Senator Tillis........................................... 47
(iii)
THE SEMIANNUAL TESTIMONY ON THE FEDERAL RESERVE'S SUPERVISION AND
REGULATION OF THE FINANCIAL SYSTEM
----------
TUESDAY, MAY 25, 2021
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:01 a.m., via Webex, Hon. Sherrod
Brown, Chairman of the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The Senate Committee on Banking, Housing,
and Urban Affairs will come to order.
This hearing is in the virtual format. For those joining
remotely, a few reminders. Once you start speaking, there will
be a slight delay before you are displayed on the screen. To
minimize background noise, please click the mute button.
You should all have one box on your screens labeled
``Clock''. For all Senators, the 5-minute clock still applies
for your questions. At 30 seconds remaining, you will hear a
bell ring to remind you your time has almost expired. It will
ring again when it has expired.
If there is a tech issue, we will move to the next Senator
until it is resolved. To simplify the speaking order process,
Senator Toomey and I have agreed, as at other hearings, to go
by seniority.
A year ago today, we watched for 8 minutes and 46 seconds
as police murdered George Floyd. Across the country, we saw
Americans demand justice for the killings of too many Black and
Brown Americans and an end to systemic racism in our country.
Over the past year, the pandemic has taken half-a-million
American lives, wreaked havoc on small businesses, pushed
families into foreclosure or eviction, and forced millions of
workers--many women and workers of color--out of the workforce.
For most Americans, it has been an arduous, long, difficult
year, a year that revealed what many of us already knew: that
even before the pandemic, our economy was not working for most
people.
I have heard some people, including many of my conservative
colleagues, say that we had the best economy in our lifetime
before the coronavirus hit. Those people need to follow
President Lincoln's admonition to go and out and get their
public opinion baths.
It certainly was not the greatest economy for most people
in Senator Toomey's hometown in Rhode Island or my hometown of
Mansfield, Ohio.
Workers' wages have been flat for decades. Jobs continued
to move overseas. In my hometown, companies like Westinghouse,
Fisher-Body, Tappan Stove, and Mansfield Tire, employing
literally tens of thousands of people, companies like that
closed down, one after another. Those good union, mostly union
jobs disappeared.
They were not replaced by new investment. The ``creative
DEstruction'' the market fundamentalists like to talk about was
not followed by any CONstruction, creative or otherwise.
Yet corporate profits continue to climb; CEO pay has
soared.
Those outcomes are, of course, connected, as we know.
Corporations lay off workers or cut pay and benefits to
juice their stock price. Companies close down factories and
move good-paying union jobs abroad to cut costs. Big banks keep
getting bigger, fueling the concentration of corporate power in
every part of our economy--from agriculture to health care to
manufacturing.
The economy of the past few decades may have looked good
from the big windows of corporate board rooms figuratively or
literally looking down on Wall Street, or from the Dirksen
Senate Office Building.
But the economy has not looked great in a long time when
looking out from the small towns and rural communities that the
big banks have left behind in search of higher profits. And it
has never looked all that great for the Black and Brown
families who lost their homes and wealth in the wake of the
Great Recession, barely getting back on their feet before the
next crisis hit.
When I talk to Ohioans, I hear a constant refrain: People
do not trust banks, especially the biggest banks. They have
been burned by predatory mortgages, high overdraft fees, and
expensive second-chance accounts.
They have watched Wall Street reward themselves despite
scandal after scandal. They remember how Wall Street bounced
back after they wrecked our economy. They know Washington
allowed that destruction to happen, and they certainly remember
that taxpayers were forced to foot the bill.
Tomorrow, for the first time ever, this Committee will
bring the CEOs of the six largest banks in the country to
testify in front of us. Our job is to hold accountable the
institutions that for far too long have had outsized power in
our economy--power that only continues to grow.
Today we will hear testimony from the Federal Reserve's
Vice Chair for Supervision, the person responsible for
supervising these banks.
Mr. Quarles, checking Wall Street's power is supposed to be
your job, too.
It is your responsibility to enforce the law and to hold
banks accountable for misdeeds with meaningful punishments--not
slaps on the wrist, not paltry fines that do not make a dent.
For gargantuan Wall Street firms, a fine is just a minor cost
of doing business.
It is your job to stand up for the people who do not have
corporate lobbyists, who do not make millions of dollars a
year, who do not get bailouts.
But as far as I can tell, you do not view standing up to
Wall Street as part of your job. You have rolled back rule
after rule--rules that are supposed to be a check on the power
of the biggest banks and supposed to ensure they invest in the
real economy, not in themselves.
Instead of investments in job creation and wages and new
technology, they continue to pour so much extra cash into
riskier and riskier bets and buying back more of their own
stock.
Good for them--but not so good for America.
We need, you need, to bring the focus back to the people
who make this country work.
We need, you need, to make sure banks are taking into
account climate risk. We need, and you need, to make sure that
volatile, unregulated cryptocurrencies do not crash the economy
and harm consumers.
We need to make sure workers' wages keep up with the cost
of living: housing, childcare, prescription drugs, all the
expenses that have been rising for decades now.
We need to close the racial wealth gap and income gap that
keeps getting wider and wider and wider.
It is our responsibility to work on solving these
problems--not for the biggest banks, but for the people whom we
serve.
If we want an economy that reflects our values, we cannot
let Wall Street write the rules. We cannot tell the regulators
how to do their jobs, for that matter. Our financial watchdogs
should not be doing favors for the biggest banks.
Vice Chair Quarles, you work for the American people. I
want to hear how you are going to stand up for workers and
families and help create a better economy that works for
everyone.
Senator Toomey.
OPENING STATEMENT OF SENATOR PATRICK J. TOOMEY
Senator Toomey. Thank you, Mr. Chairman, and welcome Vice
Chairman Quarles.
Congress has provided the Fed with a great deal of
independence in order to isolate it from political influence.
However, Congress has also given the Fed narrowly defined
monetary and regulatory missions.
In the regulatory domain, the Fed has the authority to
ensure the safety and soundness of the financial institutions
that it regulates. It does not have the authority to seek out
and address political or theoretical risks in the distant
future.
The Fed's recent actions raise concerns that it is losing
sight of this constraint. Consider its increasing focus on the
supposed risks of global warming to the financial system. In
March, John Cochrane, a distinguished economist at Stanford
University, powerfully argued before this Committee that, and I
quote, ``climate change poses no measurable risk to the
financial system.''
Put simply, neither the warming of the Earth's temperature
nor severe weather events are a threat to the stability of the
financial system. Experience bears this out. In the last 11
years--a time period that included four of the five costliest
hurricanes in U.S. history--we have not found one bank failure
caused by any weather event. In fact, we are not aware of any
bank failure in the modern era due to weather.
Nevertheless, the Fed recently joined the Network of
Central Banks and Supervisors for Greening the Financial
System. The network's stated aim is to use financial regulation
to ``mobilize mainstream finance to support the transition
toward a sustainable economy.'' In other words, to direct
credit away from fossil fuels.
Such actions are not consistent with the Fed's mandate and
authorities. As Chair Powell himself has said, and this is a
quote, ``society's broad response to climate change is for
others to decide--in particular, elected leaders.''
It is my view that if Congress believes current
environmental laws do not adequately address global warming
risks, then changes should be enacted through the legislative
process by those who are accountable to voters--not by
financial regulators who have neither expertise nor
accountability.
This principle extends to other issues as well. I am
troubled that regional Fed banks are focusing on politically
charged issues, like racial justice activism, that are also
outside the Fed's mission and expertise. This week I sent
letters to three regional Federal Reserve Banks about this
behavior and requested information from them.
Instead of seeking to tackle issues that are outside the
Fed's mandate and authorities, the Fed should focus on
supervising the risks within its domain. For example, the Fed's
recent Financial Stability Report highlights several risks that
should be monitored, including high asset prices. However, the
report fails to consider a primary cause of these risks--that
is, the Fed's own excessively accommodative monetary policy.
Our economy experienced a tremendous shock last year, but
it was met with unprecedented monetary and fiscal support. And
the economy is now in full recovery mode. As a result, I do not
understand the justification for the Fed maintaining its policy
of near-zero interest rates and $1.4 trillion in bond purchases
per year, amounting to roughly half of all new Treasury debt
issuance since the beginning of the pandemic. Let us not kid
ourselves: We are effectively monetizing about $1 trillion of
Federal debt per year.
And this is especially troubling because the warning signs
of inflation have been getting louder. We may be seeing asset
bubbles forming already, and history is replete with examples
where the bursting of bubbles led to financial instability. As
President Clinton's Treasury Secretary Larry Summers noted
yesterday, the Fed needs to start, and I quote, ``explicitly
recognizing that overheating, and not excessive slack, is the
predominant near-term risk for the economy.''
I am concerned that the Fed's current approach almost
guarantees that it will be behind the curve if inflation does
become problematic and persistent--for two reasons. First, the
Fed has announced it will allow inflation to run above its 2-
percent target level for some indefinite period. And, second,
the Fed insists that the inflation we are experiencing now is
just transitory. But you can only know something is transitory
when it has come to an end. What if it does not come to an end?
Another side effect of the Fed's asset purchases is the
regulatory implications of such an abundance of reserves in the
banking system. When the Fed purchases Treasurys or agency
securities, the aggregate level of reserves rises
correspondingly. As a result, reserves in the banking system
have risen by over $2 trillion, and bank leverage ratios have
experienced pressure from absorbing these riskless reserves
that the Fed is creating.
Last year, the Fed recognized this problem and issued
temporary relief that allowed banks to accommodate a surge of
reserves. That relief has expired, and there are signs that it
was needed. The Fed recently stated that it will address this
problem on a permanent basis. Mr. Vice Chairman, I hope you
will do so swiftly.
Let me conclude with this: The Fed does not need to exceed
its mandate and authorities to find risks to address. The siren
calls of politically charged endeavors should be ignored, in
order to preserve the credibility and independence of the Fed.
There are plenty of risks within its reach, including those to
which it may be contributing.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey.
I will now introduce today's witness. We will hear from
Federal Reserve Vice Chair for Supervision Randal Quarles on
the Fed's supervision and regulation of banks and financial
firms. The Federal Reserve, as we know, plays a key role in
making sure we have a strong financial system that works for
all Americans.
Vice Chair Quarles, thank you for your service, thank you
for testifying today. You are recognized. Thank you.
STATEMENT OF RANDAL K. QUARLES, VICE CHAIRMAN FOR SUPERVISION,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Quarles. Thank you. Thank you, Chairman Brown, Ranking
Member Toomey, Members of the Committee. Thank you for the
invitation to testify today.
Last May, I came before you to discuss our actions to
maintain a strong banking sector as a source of support for
consumers, households, and businesses. My remarks at that time
came after the onset of sudden and pervasive financial stress.
Early turmoil in overseas markets quickly crossed borders and,
within days, had reached almost every asset class and corner of
the financial system. And a year ago, the full implications of
the COVID event remained unclear, and the costs would continue
to mount.
Today the storm waters are receding. The economy is
beginning a strong recovery to the other side of the COVID
event.
As the Federal Reserve's recent reports detail, banking
organizations have remained an important source of strength in
this recovery. Higher levels of capital and liquidity, better
risk management, and more robust systems let banking
organizations absorb an unprecedented shock, while providing
refuge from market instability, delivering essential public
aid, and working constructively to support borrowers and
communities.
In short, the full set of post-2008 reforms--as refined and
recalibrated by the work of the last 4 years--ensured that this
time would truly be different than the last. Today the U.S.
banking system is actually more liquid and better capitalized
than it was a year ago, but on top of that has over $100
billion in additional loan loss reserves, leaving it well
positioned to weather future shocks.
While a strong recovery is underway, it is not yet
complete. Our role as the policymakers is to support the
financial system and the economy through the end of this
transition back to normal operations. Our challenge, however,
is to do so as circumstances change and the Nation's need for
that support evolves.
Most immediately, we have worked to align our emergency
actions with other relief efforts, as the economic situation
improves, maintaining or extending some of measures, where
appropriate, to preserve household assistance and promote
continued access to credit, and starting the transition back to
our normal activities, our normal supervisory posture, and our
normal rule book.
However, our role and responsibility extend much further
than merely returning to normal. We also have an obligation to
look closely at the last year, to understand how the financial
system came to experience such severe stress, and to identify
and act on any lessons we find.
Any list of lessons must begin with the strong performance
of supervisory stress testing. The stress-testing program not
only prepared banks for a period of prolonged hardship; it also
clarified their health and resilience as the COVID event
progressed. This role affirmed the ways that stress testing has
evolved in recent years, into a more flexible, more transparent
anchor for the Federal Reserve's broader capital program.
For example, while it was sensible, given that this was the
first real-world test of the post-2008 system--for us to impose
temporary capital distribution restrictions beyond those that
are built into the system, we now know that the system works,
especially when supplemented and informed by a real-time
stress-testing regime. In the future, having learned the
lessons of this real-world test, we will be able to rely on the
automatic restrictions of our carefully developed framework
rather than impose ad hoc and roughly improvised limitations.
Other areas, however, are ripe for closer examination.
These include strains in short-term funding markets and the
second destabilizing run on prime money market mutual funds in
roughly a decade: Treasury markets, where last year's selling
pressures overwhelmed dealers' ability or willingness to
intermediate, and changing patterns in the use of financial
services by consumers and businesses. These trends predate the
COVID event, but the past year accelerated them dramatically,
with important implications for financial stability, safety and
soundness, consumer protection, and underserved communities'
access to safe and fair financial services.
In our work to understand each of these trends, we have
valuable and willing partners in our fellow regulators, in
other agencies, and in our colleagues abroad, and we are
committed to keeping Congress closely and actively informed of
our efforts.
This work is critical, but only in service of a more
fundamental goal: a safe, transparent, and efficient approach
to supervision and regulation, which ensures the financial
system can withstand even historic shocks. Those values are of
perennial importance; they continue to be the bedrock of the
Federal Reserve's work, animating two of our highest priorities
for this year: finalizing the postcrisis Basel III reforms and
completing the long-overdue transition away from LIBOR.
The COVID event is not behind us, and the vulnerabilities
it exposed are not gone. But as we now follow the path out from
this event, the Fed is working to ensure the financial system
is resilient enough to support consumers, households, and
businesses, and recommit ourselves to supporting the economy
through the completion of the recovery.
Thank you, and I look forward to your questions.
Chairman Brown. Thank you very much, Mr. Vice Chair. I
appreciate your comments.
After George Floyd's funeral, Chair Powell acknowledged,
``This tragic event put a spotlight on the pain of racial
injustice in this country.'' He went on to say, ``There is no
place in the Federal Reserve for racism, and there should be no
place for it in our society.''
Do you agree with that statement, Vice Chair Quarles?
Mr. Quarles. Wholeheartedly.
Chairman Brown. Thank you.
When we say ``systemic racism,'' we mean all the decisions
people and institutions make that hold people in communities of
color back. You have issued rules that make it easier for the
biggest banks to make risky bets instead of investing in the
real economy. You failed to take action against banks for
lending discrimination. Don't these decisions contribute to
systemic racism?
Mr. Quarles. Well, I am not sure what instances you are
referring to that we failed to take action on lending
violations. We are quite aggressive in pursuing fair lending
violations and other sorts of discriminatory behavior in the
banking industry.
Chairman Brown. Well, read the history of the Fed, read the
history of housing discrimination, and we see this Federal
Reserve, with you as Vice Chair, have not really stepped up. It
is not just a moral issue. It is an economic one. According to
the San Francisco Fed study, our economy has lost $70 trillion
over the past 30 years because of racial inequities. We will
continue to hold back our economic growth and competitiveness
if we do not unleash all of America's potential.
Let me move somewhere else. You said that banks are in
strong financial conditions, more liquid, better capitalized
than a year ago, with $100 billion in loan loss reserves. Is
that correct?
Mr. Quarles. That is correct.
Chairman Brown. Thank you. To me, it is why it is even more
troubling that banks are fighting the $4 billion debt relief
plan to Black and Brown farmers who, as you know, in your
understanding of history of the Fed and history of the banking
system and the financial system, those farmers have struggled
to get loans and Government grants, for generations were
systemically denied USDA loans that should have been granted.
Banks are going to get back every penny of money they lent plus
20 percent on top of that. These USDA loans are guaranteed at
95 percent, yet banks are still fighting this. The only
explanation I can come up with is that they will block anything
that might cut into their profits even a cent.
Let me ask a second question. As big banks vie for
competition and then close local branches, many rural
communities are left 30, 40, 50 miles from a place to deposit a
check or to get a small business loan. The Fed is responsible
for approving bank mergers and consolidations, which have led
to banking deserts across the country.
Do you agree the Fed has contributed to the loss of banks
in rural areas?
Mr. Quarles. No, actually, I do not. When we look at bank
mergers, among the factors that we take into account, that we
are required by statute to take into account and do so
seriously, is the convenience and needs of the communities that
are served by the merging institutions. And the closing of
branches, where those are going to be closed, the plans for
that are very carefully reviewed by us.
Chairman Brown. Well, for the last decade, part of that
time, right after you left the Bush administration and in your
time with the Trump administration at the Fed, from 2019 we
have lost 5,600 bank branches. Twenty percent of branch
closings since 2010 have been the only branch in its census
tract. The Fed's job is to make sure we have a strong banking
system. That includes access--it includes the strength of local
communities. It includes access to banking services. And we
know if there is not a bank in the neighborhood, so often these
are mostly low-income areas, both rural and urban, we know
where people turn. They are much more likely to turn to an
unregulated, high-interest-charging financial service entity.
My time has expired. Senator Toomey, you are recognized.
Senator Toomey. Thank you, Mr. Chairman.
As I mentioned in my opening statement, there are a number
of troubling signs that the Fed is attempting to get into the
business of environmental policy. As you know, Mr. Quarles, the
Fed's regulatory role is to ensure the safety and soundness of
the financial institutions that it regulates. Let me ask you a
simple question. I think this is probably a yes-or-no answer.
Are you aware of any banks that failed due to Superstorm Sandy,
Hurricane Andrew, the California wildfires, or any other recent
weather event?
Mr. Quarles. No.
Senator Toomey. I am not either, and you can go back quite
a ways, and it is hard to find. We have not been able to find
it yet. So it is pretty clear to me that neither the warming of
the Earth's temperature, which is occurring, nor severe weather
events pose a threat to the stability of the financial system.
As Larry Summers said last week, there seems to be an
overemphasis of certain risks like climate change by central
banks, and here is a quote attributable to Larry Summers. He
said, and I quote, ``in order to be relevant to something that
is on political leaders' minds.''
So my concern is this will ultimately come at the expense
of monitoring the real risks, and the Fed should not be wasting
time and resources on what is ultimately a political effort.
Let me move on to money market reforms. This past March,
you said that the Financial Stability Board will be outlining
proposals for further money market reforms. You made a
reference to that in your opening statement. Presumably, the
impetus for these reforms is market disruptions we saw last
spring. Of course, as you know, many markets were disrupted.
Even the Treasury market was disrupted, the repo market was
disrupted. And it seems very likely that a factor that made
things worse for money market funds was the presence of a 30-
percent liquid asset threshold that triggered these mandatory
fees and gates. These regulations, of course, were meant to
prevent runs, but ultimately it looks at those the had the
opposite of their intended effect.
My question for you is: If we are going to propose any new
regulations, shouldn't we first make sure we fix any flaws in
the existing ones?
Mr. Quarles. I do think that the existing regulatory
framework has to be something that is looked at, and we are
including that in the overall broad review of the issues that
led to the money market fund issues last March.
Senator Toomey. All right. Good.
As you know, this week I sent letters to three regional Fed
banks inquiring about what I see as a troubling veer into
social policy topics. In particular, some of the banks have
appeared to engage in an activity that I think can fairly be
characterized as advocacy with respect to systemic racism,
which is a very controversial idea that somehow American laws
and institutions, including, I presume, the Federal Reserve,
are inherently racist in their design. A big concern here is
whether the Fed banks are operating well beyond their statutory
mandate.
Would you agree that if regional Fed banks engage in
partisan advocacy masquerading as research, that advocacy would
harm the Fed's credibility and its trustworthiness as an
independent and nonpartisan entity?
Mr. Quarles. So let me say two things with response to
that. The short answer is yes. At the Fed we have a narrow
mandate. We have been given significant autonomy to pursue that
mandate, and I think that that is important. But that means
that we should stay within the lanes of that narrow mandate.
I do think that within that mandate, research into breaking
down the effects of some of the large aggregate economic
numbers, whether by geography, whether by different
demographies, can be appropriate. But it should not cross the
line into advocacy. It should be analysis.
Senator Toomey. Thanks. Last question: As you know, the
Fed's QE has put capital pressure on banks, and you addressed
that with a temporary measure, and I know you have indicated
that there will be something more coming through. So you
anticipate more permanent changes in the regulatory regime to
recognize this capital pressure?
Mr. Quarles. Well, we are looking at that now. I think our
best estimate is that as the level of reserves in the system
grows over the course of this year, we will see some of that
pressure. There are a variety of ways one could address it. We
are exploring them all. We have not decided whether it will
ultimately be necessary or what we have to propose, but we are
looking closely at it.
Senator Toomey. I hope you will. I will finish up, Mr.
Chairman, but, Mr. Quarles, I do think the Fed is imposing this
through its unusual activity, which is continuing inexplicably
to me. So I do hope you will look to remediate that. Thank you.
Chairman Brown. Thank you, Senator Toomey.
Senator Menendez from New Jersey is recognized for 5
minutes.
Senator Menendez. Thank you, Mr. Chairman. I was very happy
to see Acting Comptroller Hsu announce the OCC was revising the
ill-advised Trump era Community Reinvestment Act rule. After
last week's OCC announcement, I hope to see a joint interagency
CRA rulemaking by all three bank regulators. This is an
important civil rights law that should not be enforced in a
piecemeal fashion.
So, Vice Chair Quarles, have conversations begun among the
agencies on how the Federal Reserve, the FDIC, and the OCC
might align their regulatory efforts around the CRA?
Mr. Quarles. We have throughout the CRA process. As you
know, it has been the Fed's position and desire that we would
end the process with a joint rulemaking. We have each shared
the comments we have received on our separate processes, the
OCC's rule, our Advance Notice of Proposed Rulemaking. We are
all aware of the input that has come from that, and it remains
our objective to see a joint rule.
Senator Menendez. I appreciate it is your objective. The
question is: Since there is a change at the OCC--I understand
what you did before. The question is: Are you engaged now in an
effort with the OCC to align yourselves?
Mr. Quarles. Well, we are certainly talking with them, and
obviously, the position of the OCC has changed and, therefore,
our continuing engagement I think is likely to result in the
objective we have always had. But we do continue to talk with
them.
Senator Menendez. Well, let me reiterate how critical it is
for all three banking regulators to get to the same page when
it comes to the CRA. It is especially important, having seen
the disproportionate impact this pandemic has had on minority-
owned businesses and communities. I have a sense that some of
my colleagues would think that none of you have any role to
play in terms of dealing with the great inequities in our
society. I totally disagree with that. And certainly when you
have oversight over the Community Reinvestment Act, this is a
key tool to try to deal with some of the issues that we face
today for which the CRA was originally created. So I hope you
will all get together and adopt a unified rule that strengthens
the original intent of the CRA, which has never mattered more.
Let me ask you, this month marks 10 years since the
deadline for finalizing the incentive-based compensation
rulemaking, the rule to ban practices that reward senior bank
executives for irresponsible risk taking. In those 10 years, we
experienced the London whale, the Wells Fargo fake account
scandal, and most recently Credit Suisse involvement with
Archegos Capital Management. All three instances of corporate
malfeasance or mismanagement were tied to executive pay
incentives in one way or another.
So was the Federal Reserve forced to take some regulatory
action to the London whale and the Wells Fargo fake account
scandal?
Mr. Quarles. I guess two things I would say. Well, the
London whale was before my time, and I am recused from the
details of Wells. So those specific questions, I am not sure
that I can answer, but I can certainly say----
Senator Menendez. It is a simple question. It is not
something that you have to recuse yourself. It is an
acknowledgment of what the Reserve did, whether you were
involved in it or not. My understanding is that there were
regulatory actions, and so if there were, do you take my word
for the moment--because my time is limited. Wouldn't it be more
effective oversight to help prevent these types of scandals
from taking place in the first place?
Mr. Quarles. We do in our supervisory engagement with the
firms; that is an important element of it, their compensation
arrangements, their incentive compensation practices. As you
know, the incentive compensation rule is a joint agency rule
that requires complicated joint agency negotiation, but the Fed
does closely supervise compensation practices.
Senator Menendez. Ten years. Ten years. I do not care how
complicated the matter is. It does not take 10 years for great
minds to get together to think about what is an appropriate way
to deal with excessive compensation. I think preventing
scandals and resultant consumer harm is more effective. The
Federal Reserve along with other regulators have a tool in
their arsenal to help curb this type of risky and irresponsible
behavior. And yet after 10 years, the incentive-based
compensation rule remains unfinished. That is unacceptable, and
I will be pressing each of the regulators that come before us.
It is about time to get this done.
Chairman Brown. Thank you, Senator Menendez.
Senator Hagerty from Tennessee is recognized for 5 minutes.
Senator Hagerty. Chairman Brown, thank you, Ranking Member
Toomey, thank you for holding this hearing. Vice Chairman
Quarles, it is great to see you again, and I appreciate your
testimony today.
Vice Chairman Quarles, like my colleagues, I am concerned
about the Fed's potential mission creep into regulating social
policies. I was pleased with the strength that our financial
sector has shown as we have navigated this pandemic. I feel
that we have done very well. I was pleased with the Financial
Stability Report that talks about the balances in loss
mitigation programs in our largest banks being reduced. I think
that is a sign of strength right now. And I really am concerned
about increasing, you know, with unnecessary regulations new
burdens on imposing social policies that we really are at a
point in our recovery we should not be impeding banks'
potential to return to prepandemic levels. I am sure you share
those concerns.
Vice Chairman Quarles, you gave a speech at the end of last
year where you talked about your thoughts on the evolution of
bank supervision. In the speech, you noted that your goals at
the Fed are to make our regulatory framework more efficient,
more consistent, simpler, more predictable. And certainly
driving all of that is a fundamental principle of regulation,
making it more transparent.
You also noted that it is even harder for the Fed--and I
agree with those principles completely. You also noted that it
is even harder for the Fed to do that beyond the regulatory
framework when you get to firm-specific supervision. I agree
with that as well.
Last week--I would like to ask you about this--President
Biden issued an Executive order. That Executive order
encouraged financial regulators to detail their plans to
incorporate climate-related financial risk into their
regulatory and supervisory practices. Vice Chairman, how will
this directive, which is well outside the Fed's mandate, how
does this directive square against the principles that I think
you so clearly articulated in terms of efficiency, confidence
building, simplicity, and transparency in our regulatory and
supervisory framework?
Mr. Quarles. Well, I would say two things in response to
that. First, I do think that it is appropriate and, indeed,
incumbent on us as Federal regulators to look at potential
risks--climate change is a potential risk--and to come up with
a data-driven analytical framework around that to guide our
engagement with the banks and to ensure that the system is
resilient to what we determine to be actual risks arising from
it. We are in the early stages of doing that. We have developed
a process at the Fed for establishing such a framework. I think
that, as I say, it is not only appropriate; it is incumbent on
us.
Also true is that our job is ensuring the resilience of the
financial system, not advancing a particular view of climate
policy. That is for the Congress, perhaps other agencies. It is
not the job of the Fed or other financial regulators, and so we
should remain focused on that approach to our climate change
analysis as opposed to something broader.
Senator Hagerty. Well, I echo Ranking Member Toomey's view
that weather has historically not been a driving force in
resilience for the banking system, and I do not believe this is
a high priority that the Fed should be wasting resources on.
I would like to turn my questions to the next area, which
is asset valuations, Vice Chairman Quarles. The recent
Stability Report talked about asset valuations and acknowledged
the fact that assets are high. We have talked about asset
bubbles before. What it failed to mention was the impact of
inflation, yet inflation, we just hit a 13-year high in terms
of inflation. And I am quite concerned about the inflation that
we are seeing in our system. I think it is being driven by
excessive amounts of Government stimulus spending. We have got
supply chain dislocations that are lending to this. We have got
pent-up demand that lends itself to this. But we have a real
concern about inflation. At the same time we have a tremendous
amount of liquidity pumped into the banking system.
I want to understand your perspective on what the potential
impact of all this liquidity and inflationary pressure is on
the banking system today.
Mr. Quarles. Well, it remains my view and the general Fed
view that these pressures are most likely to be transitory. As
you note, the most recent monthly inflation number was the
highest since 2009, but after 2009 we did not experience
durably high inflation, and I think it is still most likely
that that will be the case here.
If we are wrong--and, of course, we could be wrong--I think
we have the tools to address inflation before it becomes kind
of a permanent part of the framework.
Senator Hagerty. Thank you, Mr. Chairman.
Chairman Brown. Thank you.
Senator Tester of Montana is recognized for 5 minutes.
Senator Tester. Thank you, Chairman Brown, and I want to
thank you, Vice Chair Quarles, for the work that you and your
team have done at the Fed during this crisis. And I want to
thank you for your collaboration and your work to truly keep
the Fed independent. So thank you for that.
Look, there are many challenges we face through this
pandemic and the economic implications that have resulted from
this. There are also many challenges that existed before the
pandemic that continue to remain. I have been concerned about
small businesses and families in rural communities having
access to capital and credit. We have talked about it before.
And there is also a lack of affordable accessible housing
across the country, and that problem has only gotten worse
during this pandemic.
I am also concerned that there may be new or growing
problems that are not getting the focus that they merit while
we deal with this current crisis. This is something that we
have visited about before and I think it is important to
consider on an ongoing basis, and I am sure it is something
that you do in this role as Vice Chairman.
So are there trends that you are seeing or problems that
you are concerned about that we really should be focused on?
Mr. Quarles. It is a broad question, so let me try not to
filibuster away the rest of your time with a 5-minute answer.
But let me focus on two things.
I do think that in our recent Financial Stability Report,
you know, we looked at some of the financial issues that I
think it is good for us to be focused on now. I do not put the
financial stability risks as extremely high at the moment. I
think they are moderate. But questions about asset valuation
and the potential implications of that to the financial system
are important.
One area where I am particularly focused both domestically
and also in my international work as Chair of the FSB is on the
regulatory framework for nonbank finance where I think we saw
that there could be some improvements in that regulatory
framework that would make the system more resilient for the
next time it faces a shock like March of 2020.
Senator Tester. I appreciate that. So as the communities
and institutions that you regulate recover from the pandemic
and the economic crisis, like many of the challenges we face
now, how to address the recovery may look in different in rural
community, frontier communities, than it does in more urban or
suburban communities. So in your role, are you seeing
differences in how different communities are recovering from
this pandemic?
Mr. Quarles. We are. There clearly are geographic
differences. There are differences between urban and rural. To
some extent, there are inevitably going to be--as you come out
of an event like this, you know, there are differences in the
speed of policy change, and that results in differences in
geography. There are differences in--you know, some industries
are concentrated in a particular geography, and they have
greater supply problems than other industries.
It continues to be our expectation that over the course of
the year, that will tend to even out, but there are clearly
differences at the current moment.
Senator Tester. OK. So are there things that we should be
doing to help recovery overall? But dovetailing off the last
question, too, are there things we should be doing to reduce
the disparities between communities in their recovery? So both
those questions: overall globally, and is there something we
should be doing different in other communities?
Mr. Quarles. Yeah, I would say from the point of view of
the Federal Reserve, you know, I think our use of our tools to
address this is if we ensure that the recovery proceeds as
smoothly as possible, we will get to the other side of it and
that evening out faster. I think our tools do not lend
themselves particularly well to, again, geographically or
demographically targeted solutions, and that our job is best
performed in ensuring that the overall economy is moving in the
right direction as fast as possible.
Other more targeted solutions are the realm of Congress,
and I would not presume to tell you what you should or should
not do there.
Senator Tester. We always appreciate your input. Anyway,
thank you very much.
Thank you, Mr. Chairman. Thank you, Vice Chair.
Chairman Brown. Thanks, Senator Tester.
Senator Tillis of North Carolina is recognized for 5
minutes.
Senator Tillis. Thank you, Mr. Chair, and thank you, Chair
Quarles, for being here today. And thank you for your time over
the years. I find you to be highly accessible, and I appreciate
the time we spent talking just this week.
I want to get back to something that we discussed, and it
relates to the MRAs and MRIAs that the Fed supervisors send to
financial institutions. Those are matters requiring attention
really reflecting potential issues supervisors find.
I understand a lot of that information is designated as
``confidential supervisory information.'' What I believe that
means is that when they receive an MRA or MRIA, they are really
prohibited from disclosing that information to anyone,
including their elected representatives. I see a problem with
that. For all intents and purposes, that puts a Fed supervisor
in a judge, jury, and executioner role, and I think that the
supervisory decisions can limit a company's dividend, their
business decisions, their hiring decisions, and pretty much any
business action. Even if they disagree, they do not really have
any recourse. That seems problematic to me. I know you are a
lawyer, and I am not, but it seems like this is pretty
foundational.
I guess the question that I have is why the Fed would need
to self-impose this requirement and why is it that the banking
institution does not have the flexibility to share information
that may be in a confidential supervisory letter, but to share
that information and advocate in instances where they disagree
with the supervisory position. And, more importantly, where in
the law does the Fed have this authority to impose this
restriction on financial institutions?
Mr. Quarles. So I think there are a number of fair points
there. First, you know, the due process guardrails around our
supervisory activities I think are important. As you know, I
have made that a theme of mine at the Federal Reserve that we
need to think more carefully than we have in the past about how
to impose those. Transparency is important in supervision as
well as in respect to work with regulation.
Now, the Federal Reserve Act and other banking statutes do
acknowledge, they have historically acknowledged, that there
can be concerns with the disclosure of supervisory information,
even by the affected firm, which can lead to contagion to other
firms. It can be misunderstood. It can cause, you know, a
perception that there are greater problems at a firm than there
are, depending on how a particular action may have been worded,
understood between the supervisor and the firm, and perhaps
susceptible to misinterpretation.
So we have historically been cautious about the release of
individual firms' supervisory information, including by those
firms. But we are trying to become more transparent about it.
In the supervisory report that we delivered to you today or
have delivered in the past, we discuss sort of in the aggregate
MRAs, MRIAs, what they deal with, the number of them. So we are
trying to increase transparency around that to allow this sort
of discussion and engagement without crossing the line into,
you know, potential risk to individual firms from disclosure of
their CSI.
Senator Tillis. But wouldn't it make sense that if there
was a potential risk to an individual firm, they themselves
would not want to disclose that and work with the Fed? I am
talking more about issues that an institution may disagree
with. It seems like right now they have a gag order on even
talking about that. And I do not really see anything that
provides them with due process, mainly because I do believe in
the judge, jury, executioner sort of context that they are
operating in now.
So what could we do to put meat on the bones of the concept
of transparency when all the control is in the control of the
Fed or the Fed supervisors?
Mr. Quarles. So I think, you know, I do not have an answer
for that today. That is something that I have given thought to.
These are practices that have attained for decades, really.
They have become more important in recent decades with the
expansion of the supervisory activities, and, you know, I think
that we should be paying more attention to it at the Fed as to
how to square that circle.
Senator Tillis. Thank you. I look forward to continuing to
keep an intense focus on this. And I also want to thank you for
a lot of the regulatory reform that you did to kind of ease the
burden on the industry. I believe that you have played a very
important role in doing that, and I wanted to thank you
publicly for it.
Thank you, Mr. Chair.
Chairman Brown. Thank you, Senator Tillis.
Senator Warner from Virginia is recognized for 5 minutes.
And, Senator Warner, I am going to go slip into the Finance
Committee as you do, and if you would next either call on
Senator Lummis, if she is there, or Senator Cortez Masto if
there is no Republican here. If you would do that, thank you.
Senator Warner [presiding]. Thank you, Mr. Chairman.
Vice Chairman Quarles, it is great to see you again. I want
to raise a couple subjects that I know we have talked about in
the past. One is we know over the last year with COVID we have
seen disparate economic effects. Particularly communities of
color have been hard hit; particularly women-owned businesses
have been hard hit. One of the things that we have talked about
in the past is a relatively small piece of the financing
sector, but one I think that has great potential to grow is
CDFIs, community development financial institutions. I worked
with folks on this Committee, including Senator Crapo last
year, and we got a $12 billion commitment to both do grants and
Tier 1 capital into these CDFIs. I am happy to see Treasury
rolling that out. The Fed also obviously has a role here in
terms--and I know Senator Brown raised this in terms of CRA
activities.
We also saw during the pandemic that the Federal Reserve's
Paycheck Protection Program Liquidity Facility helped produce
some liquidity relief to CDFIs. I would like you to speak to
that and, you know, on a going-forward basis how we can not
only help CDFIs but also even community banks that may be
trying to lend into some of these disadvantaged communities
that has been tough to do in the past.
Mr. Quarles. Certainly. Thanks, Senator. Well, we do have a
very active program with respect to CDFIs as well as MDIs. We
are working with the Treasury in the Emergency Capital
Investment Program. That provides capital directly to CDFIs as
well as MDIs. The Fed as well as the OCC and the FDIC released
a rule in connection with that program to help implement the
assistance by giving regulatory capital treatment for
instruments that are issued under the program. We have provided
a set of frequently asked questions on our website so that
CDFIs can be better aware of how to take advantage of it. We
host regular Ask the Regulator sessions.
Senator Warner. I know you are kind of going through the--I
hope we can keep working on this, and, again, a topic that I
will not ask you to comment on today, but I try to keep
familiarizing my colleagues with--you know, we have been
working on, I think, a very interesting proposal that for
first-generation homebuyers--and, again, that would help people
across all demographic backgrounds--a mortgage product that
would include an interest rate subsidy that would have the
homeowner in a sense pay the same normal amount they pay on a
30-year mortgage, but they would actually be obtaining a 20-
year mortgage. The ability of wealth building literally doubles
if you have a 20-year mortgage versus a 30-year mortgage. And
when we are looking at a wealth gap that is basically 10:1
between Black and White families, 7:1 between Latino families
and White families, if we can build more equity on a quicker
basis for homebuyers, I would ask my colleagues to trust me on
the math on this. More to come. But I do want to keep raising
this and, again, hope we can get broad, bipartisan support as
we get more details.
I apologize about my little commercial there. I know we
have discussed this, and I think you are intrigued on how we
can do something that would not drive up the cost of the real
estate or drive up the pricing when we have such short supply,
but actually might address some of the wealth gap issues.
In my last 50 seconds, I just want to raise the issue of
cryptocurrencies. I mean, we have seen the EU come forward with
a fairly broad-based report on crypto. I see some value in
distributed ledge, but the volatility amongst some of these
entities concern me. I see some of the illicit use from my role
on the Intel Committee.
Can you speak to this? What else do we need to give you and
the other regulators to get this under some semblance of order?
Mr. Quarles. Well, we, along with the OCC and the FDIC, are
engaged right now in what we are calling a sprint in seeking to
pull together views on exactly that, on a common regulatory
framework, the capital treatment, the operational treatment.
And in the course of that, if there are gaps in the regulatory
framework, we will also make those known.
Senator Warner. I look forward to continue working with
you. I think we do need to get a structure here.
I do not know whether I am--calling a Republican colleague,
is Senator Lummis or Senator Rounds here? If not, I am going
to----
Senator Lummis. Lummis is here.
Senator Warner. OK. Senator Lummis, please.
Senator Lummis. Thanks, Senator Warner. And welcome to the
Committee, Mr. Quarles. I am delighted that you would join us
today.
There have been concerns in Europe that Basel III's net
stable funding ratio requirement might cause changes or
adjustments for certain commodity markets, including gold. My
question is: Do you see any concerns in the United States about
this? And how can we ensure the July 1 deadline makes a smooth
implementation date?
Mr. Quarles. So I would say that we have not seen evidence
currently of that phenomenon in the United States as we
approach implementation of the NSFR. Now, we have provided a
long runway toward implementation of the NSFR. We had a very
comprehensive comment process in the United States. We took
account of many of those comments in implementing our final
rule, and we provided a lot of advance notice to firms as to
how to prepare for it.
So I do think that we have done a fair bit to ensure that
that transition is smooth.
Senator Lummis. Thank you. I am going to switch over to the
project that Wyoming has done to complete its regulations and
bank examination manual for digital assets. It covers issues
like digital asset volatility risk, money laundering and
sanctions requirements, custody, digital asset receivership,
and capital standards.
Can you provide an update on the FFIEC and Federal
Reserve's work toward the creation of a supervisory framework
for bank digital asset activities?
Mr. Quarles. The OCC, the FDIC, and the Fed are working
together, again, in what we have been calling a ``sprint,'' so
over a relatively concentrated period of time to pull together
all of our work in digital assets and to have a joint view, a
joint framework for their regulation and supervision practices
with regard to them.
We are in the middle of that or actually in the early
stages of the sprint, so it would be premature for me to tell
you where that is going to turn out. But this is something that
is a high priority not only as a matter of importance but as a
matter of chronology, and we expect to be able to give at least
some results from that soon.
Senator Lummis. Well, while you are doing that, I want to
refer you to the work that Wyoming has done. The Wyoming
Division of Banking has done this securities examination
manual. It has done this special purpose depository institution
custody and fiduciary examination manual. It has done the SPDI
Bank Secrecy Act anti-money laundering, asset control
examination manual. It has done this risk examination manual.
It has done the BSA/AML FEC compliance for these. It has done
the examinations manual. It has done the information security
for SPDIs. It has done the payment system risk compliance here.
We have got 771 pages of ways to assist you in understanding
all of the hard work that Wyoming has done to provide a
template for your good work. So I just want to point out that
you have a good road map in front of you for future reference.
Mr. Quarles. I appreciate that, and I hope that when we are
done, we have something that is nearly so comprehensive.
[Laughter.]
Senator Lummis. Wonderful. Thanks.
Could you comment on the positive role of community banks
in providing credit during the pandemic, especially
facilitating the Paycheck Protection Program and especially in
rural States like Wyoming?
Mr. Quarles. Community banks were essential in the PPP
program. They were a critical part of the distribution
mechanism, in part because of their broad reach into their
communities and their sort of deep knowledge of particular
customers. I think it would have been difficult for the PPP
program to have worked without the participation of the
community banks.
Senator Lummis. Thank you, Mr. Chairman. You have hit the
5-minute nail on the head. I appreciate your appearing before
the Committee today, and I yield back.
Senator Warren. All right. I think that means that I am up
next, so I will go ahead and get started.
Last month, a hedge fund called ``Archegos'' imploded after
making some very risky bets, and some of our biggest banks had
loaned Archegos the money to make those bets, even though the
hedge fund was managed by a guy who had already been charged
with insider trading and banned by regulators from handling
clients' money.
Now, those banks suffered $10 billion--that is billion--in
losses as Archegos collapsed with more than half the losses
hitting one bank in particular--Credit Suisse.
So, Vice Chair Quarles, your job at the Fed is to oversee
the safety and soundness of our banks, and last year you made
the decision that Credit Suisse and a few other big foreign
banks no longer should be required to participate in a Fed
program that was designed to oversee the riskiest banks, the
Large Institution Supervision Coordinating Committee, or LISCC.
Is that right?
Mr. Quarles. Yes, although it did not change the intensity
with which----
Senator Warren. So you are the one who said we are not
going to do that. So at the time you justified dropping these
banks from increased supervision on the ground that these
banks--and I have it here--``have significantly shrunk their
U.S. footprint, and their U.S. operations are much less risky
than they used to be.'' Your time, of course, was impeccable on
this. Just a few months later, Archegos blew up and resulted in
billions of dollars of losses to Credit Suisse.
So now, Vice Chair Quarles, before you told the banks like
Credit Suisse that they did not need extra scrutiny from
regulators, before that, did you see any warning signs that
these banks had some deficiencies in their risk management?
Mr. Quarles. Well, the losses that you are referring to,
the great bulk of the Archegos losses occurred outside the
United States. State-funded----
Senator Warren. Are you saying that losses outside the
United States can affect operations inside the United States by
these large multinationals? Surely not.
Mr. Quarles. But we do not supervise their operations
outside the United States, so their operations within the
United States have shrunk exactly as I said.
Senator Warren. So you are going to stick with your
original play. You know, in 2019, back when Credit Suisse was
subjected to the Fed's stress test, the Fed ``identified
weaknesses in the assumptions used by the firm to project
stress trading losses that raised concerns about the firm's
capital adequacy and capital planning process.'' In plain
English, the Fed said that Credit Suisse's models just were not
realistic.
So I want to put the timeline together here. In 2019,
Credit Suisse fails a test because it cannot accurately project
its trading losses. In 2020, you, Mr. Quarles, decide that
Credit Suisse should be subject to weaker supervision. And in
2021, a headline shows up in the Wall Street Journal that
reads, ``Credit Suisse had surprise $20 billion exposure to
Archegos investments.''
So let me ask this: Mr. Quarles, do you now agree that you
made the wrong decision to weaken supervision for a bank like
Credit Suisse?
Mr. Quarles. Senator, we did not weaken the supervision of
a bank like Credit Suisse. The civil servants who are
supervising Credit Suisse and a large bank and foreign bank
operations----
Senator Warren. Wait, you took out of the program----
Mr. Quarles. ----would take issue with you----
Senator Warren. I am sorry. You cannot just say----
Mr. Quarles. ----LISCC supervisors.
Senator Warren. You took out of a program that was designed
to have it enhance supervision, say you did not need the
enhanced supervision. That is what you said at the time,
because their footprint in the United States had shrunk.
Mr. Quarles. I did not say it was supervision, ma'am. I
said it was more appropriate to supervise them with other
foreign banks of the same size footprint in the United States,
which is what we do. Other foreign banks with similar prime
brokerage operations that have long been supervised outside of
LISCC because their footprint in the United States is smaller.
These banks are now smaller. The losses that you are referring
to did not occur in the United States----
Senator Warren. I have to say that----
Mr. Quarles. ----we would not have been able to pick them
up in LISCC or otherwise.
Senator Warren. ----I am stunned by your argument that you
want to say that there was no warning sign from the fact that
$10 billion in losses could have affected what Credit Suisse
was doing here in the United States. Look, we dodged a bullet
with the Archegos collapse this time. But what slipped through
the net by regulators to contain these losses when things go
wrong was relatively small to what could have slipped through.
It could have been an even bigger failure, and that is because
instead of protecting the system, you spent your time at the
Fed cutting holes in the safety net anytime you could. Your
term as Chair is up in 5 months, and our financial system will
be safer when you are gone. I urge President Biden to fill your
role with someone who will actually keep our financial system
safe.
Thank you.
Chairman Brown [presiding]. Thank you, Senator Warren.
Senator Van Hollen from Maryland is recognized for 5
minutes.
Senator Van Hollen. Thank you, Mr. Chairman, and thank you,
Vice Chairman Quarles.
Let me start by associating myself with the comments of
Senator Mark Warner with respect to CDFIs and MDIs, and I know
this is something the Chairman and many of us have been working
on.
I also want to commend the Fed for moving forward on the
real-time payment system. I thought it was too late in getting
started, but I am glad you are all working to try to make up
for some lost time. I see that a pilot program will be launched
later this year and that the full rollout date is now schedule
for 2023.
Two questions on other issues. First, on the issue of
central bank digital currencies, I am glad to see the Fed
moving forward with issuing a report on central bank digital
currencies that will include public input and that the Fed
hopes to play a ``leading role in the evolution of
international standards.'' I do not think we can afford to have
the United States fall too far behind on this measure,
especially given China's moving ahead with their own pilot
program. I recognize that there are lots of issues. Can you
tell us more about where we are in researching and developing--
can you tell me whether or not the Fed would have existing
authority to launch a pilot program if it so chose? Or do you
believe you need congressional authority to do that?
Mr. Quarles. Well, so as you have noted, we are beginning a
process--Chair Powell announced it last week--of doing a very
deep and comprehensive study of sort of the potential of the
issues around central bank digital currencies in the United
States. As you noted, there are a host of issues.
I think it would be--I think ultimately what that study
will lead us to is to a conclusion as to whether a CBDC is
appropriate for the United States. I think, you know, that is
very much an open question currently.
As to whether we have the authority to implement a pilot
program or to implement a CBDC, I think that depends on how the
structure of the CBDC is--on how we structure it. There are
certain structures that we could perhaps do under current
authority, but most of the types of CBDC that are discussed
would require additional legislative authority to actually use.
We are engaged in a pilot of sorts of testing out the
technology around CBDC with MIT. Currently the Boston Fed and
MIT are working on this technology pilot. But a broader pilot
and certainly a CBDC itself is most likely to require
additional legislative authority.
Senator Van Hollen. Well, I would appreciate it if you or
your colleagues can get back to me on exactly what additional
authority you would need to do a more expansive pilot program
or move forward with the full decision.
Let me ask you about the issue of the Fed's efforts to take
into account the risks of climate change. I was glad to see the
Fed recently created the new Supervision Climate Committee to
strengthen its capacity to identify and assess financial risks
from climate change and a Financial Stability Climate Committee
as well.
Mr. Quarles, when can we expect to see the Fed's framework
on climate change or any recommendations, reports, or
deliverables that will be the product of these two committees?
Mr. Quarles. Well, I cannot give you a timeline today on,
you know, when we will have a sort of publicly available
framework for comment. I can certainly commit that we will be
very engaged in that process of getting public input, getting
input from Congress on our thoughts, and that it is important
that we develop a framework promptly and one that is based on
data and our own experience.
Senator Van Hollen. Well, Senator Schatz and I and some
others are moving to introduce the Climate Change Financial
Risk Act, which we introduced last Congress. We will be
reintroducing it to establish a group of scientists and
economists to look at these issues and hopefully inform your
decisions.
You agree that the standardization on climate risk data
will be important from a supervisory perspective, in other
words, to develop clear standards so that we can compare apples
to apples in this conversation?
Mr. Quarles. Yes, I do.
Senator Van Hollen. Well, thank you, and I do look forward
to hearing from you with respect to a little better idea of
when we can expect those recommendations from those two
reports. Thank you.
Thank you, Chairman Brown.
Chairman Brown. Thank you, Senator Van Hollen.
Senator Cortez Masto from Nevada is recognized for 5
minutes.
Senator Cortez Masto. Thank you, Mr. Chair. Vice Chairman
Quarles, welcome. It is great to see you again.
Let me start with an issue around the unbanked population.
So the latest FDIC report shows that 6.3 percent of the
population in Nevada is unbanked, and as the Federal Government
continues to allocate assistance from the American Rescue Plan,
such as child tax credits, what steps can the Federal Reserve
take to ensure that more individuals have access to bank
accounts and financial services in order to receive this
assistance?
Mr. Quarles. So I think that, you know, as you have noted,
COVID has shown some of the specific ways, has highlighted some
of the specific ways in which the unbanked are disadvantaged.
And we do participate in a number of efforts to try to increase
the number of citizens with bank accounts. We include that in
our CRA evaluations of banks as to whether the efforts that
they are taking to ensure that all the members of their
communities have access to bank accounts at those institutions.
And we participate in something called ``BankOn'', which is a
program with the banks to promote access to standardized, very
low cost transaction accounts for all Americans, particularly
those who are unbanked.
Senator Cortez Masto. Thank you. Vice Chair Quarles, in
your testimony you call for, and I quote, ``further review . .
. of changing patterns in the use of financial services, by
consumers and businesses; and a changing relationship between
banks and their nonbank partners.''
Can you further elaborate on that? Are you talking about
what I have heard earlier in conversation about fintech or
cryptocurrencies or the unbanked? What are you thinking there?
Because you are right, the consumers and businesses are going
to be driving this, and I am curious what the Fed's review
looks like in this space.
Mr. Quarles. Yes, well, the short answer is all of the
above. You know, technology, a variety of forms, whether that
is partnerships between banks and fintech firms where the
fintech firms provide consumer interface principally and the
banks provide the plumbing, or in some cases fintech firms are
seeking to operate without banking partners and what the
potential implications for that are. In some cases, they are
able to operate more cheaply. Perhaps that can be a tool to
address inclusion. But it raises issues for how we think about
the supervision of those firms.
There are other aspects of technology where you have got
sort of very large tech firms that are increasingly providing
services to the banking industry and how do we supervise the
operational and potential financial stability risks associated
with those relationships when historically our traditional
focus has been on the banks. We have the authority under
something called the ``Bank Service Company Act'' to examine
these third-party firms, and we need to work through a
framework as to exactly how we would do that more robustly as
these relationships grow.
Senator Cortez Masto. Well, thank you, and it is a big
task, and I understand that you talked about ensuring the
stability, safety, and soundness of the market as well. I get
that. To what extent do you bring in consumer protection? Is
that part of what you are looking at as well as the Fed to
ensure from the business and consumer perspective that there
are protections in place?
Mr. Quarles. Very much so. As we look at issues like the
use of artificial intelligence, either by banks or by fintechs,
you know, assuring that these various technologies do not
exacerbate risks to the consumers, that they are being operated
with that in mind, is something that we are very focused on.
Senator Cortez Masto. And then, briefly--I have got about
40 seconds left--how is the Federal Reserve considering stress
testing to assess how prepared individual firms and the overall
system are to respond to and recover from systemic cyberevents?
Mr. Quarles. So we do run tabletops, and we do not really
run what we would call ``stress tests'' there to determine
capital charges associated with potential cyberevent risk. But
we do--you know, we are very heavily engaged with the firms on
their cyberexposure.
Senator Cortez Masto. Thank you. Thank you for being here
today.
Chairman Brown. Thank you, Senator Cortez Masto.
I am not sure if Senator Moran is available? Then Senator
Ossoff from Georgia is recognized for 5 minutes.
Senator Ossoff. Thank you, Mr. Chairman, and thank you, Mr.
Quarles, for your service and for your testimony today.
What do you assess to be the most significant risks to
macroeconomic and financial stability and growth over the next
2 to 4 years?
Mr. Quarles. So I would begin by saying that I think that
the overall risks to stability, to financial stability, are
only moderate. I do not think that we are in an era of
especially large risks to financial stability currently. I
think that the COVID event has highlighted that, at least to my
mind, the particularly risks lie largely in the improvements
that can be made to the regulatory framework around nonbank
financial institutions and the potential exposure of nonbanks
in the financial sector to be a source of instability. Again, I
do not think that risk is large currently, but I think that
that is certainly what I am focused on, particularly in my
international work.
Senator Ossoff. At what corners of capital markets and the
financial services industry do you think regulators lack
sufficient visibility to make informed decisions about risk and
whether their authorities are sufficient?
Mr. Quarles. So that is a good question. Do we need
additional data? Obviously, most of our data certainly at the
Federal Reserve comes from our supervision of the banking
system. For the most part, I would say that our supervision of
risks in the nonbanking system, the information that we get
from the banking system's relationship with the nonbanks has
been adequate for us to be able to judge risks in the nonbank
sector. But, obviously, we do not get that information directly
from those firms, and there are cases where there are data gaps
from the nonbanking sector as to the exact state of the risks
that they face.
Senator Ossoff. Thank you. As the Federal Reserve
contemplates its posture moving forward with respect to
interest rates and quantitative easing, how is labor force
participation, the predictable disruption to labor markets that
has resulted from this pandemic and which persists today, and
the dynamics in labor markets unique to this shock and this
moment, how does that affect your and your colleagues' reading
of the strength of the labor market, the unemployment rate as
you contemplate potential changes to your posture targeting
unemployment, price stability, and fulfilling your mandate?
Mr. Quarles. So as you know, we revised our monetary policy
framework particularly in how we think about these labor market
issues, labor market strength measures, relative to when we
think it is appropriate to begin withdrawing accommodation and
to say that we really need to see the data coming through on
improved employment numbers before we would--you know, before
we think it is--we will wait to see that data, whereas in the
past we might have said based on our projections, we expect to
see that data. And in order to remain ahead of the curve, we
will act now even before the actual employment figures improve
to where we think they are going to be in, say, a year.
Our experience over the course of the last decade has shown
that when we had that slower reaction function, when we allowed
employment to improve, to continue to improve past what would
have been our traditional measures of a level of unemployment
that would have accelerated inflation, that we did not get
inflation, and we had significantly improved employment
outcomes. I am a person who believes that we should listen to
the data, we should believe it, and so we will wait to see that
actual data before making some of the moves that we would have
made sooner in the past.
Senator Ossoff. Thank you, Mr. Quarles. I have got just 20
seconds left, but if you could please comment on the financial
situation of households in the lower quintile in terms of
wealth and income, what do you think are the structural
impediments to improvement in the financial condition of low-
wealth and low-income households? And how much progress have we
made over the last few months, please?
Mr. Quarles. Well, I think the principal impediment is an
improved economy, and I think our job at the Fed is to continue
to provide support for a rapid recovery of the economy, which
will help all demographies.
Senator Ossoff. Thank you, Mr. Quarles.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Ossoff.
Senator Warnock we believe is on his way. Senator Moran's
office is still on the screen. Let me run through and make sure
anybody that might want to ask questions and has not yet, on
the Republican side, Senators Shelby, Crapo, Scott, Rounds,
Kenney, Moran, Cramer, and Daines. And on the Democratic side,
Senators Reed, Smith, Sinema, Warnock. And Senator Moran has
just returned. Senator Moran, you are recognized--your camera
just went off. Senator Moran, you are recognized for 5 minutes
if you can stay and do that.
Randal, as you know, this is a little different time to do
these hearings this way.
Senator Moran, you are recognized for 5 minutes.
Senator Moran. Yes, I am on. Chairman, thank you very much.
Mr. Quarles, thank you for your presence today and your service
on the Federal Reserve Board of Governors.
I want to talk about Basel III. You stated that
implementation of the so-called Basel III end game is a
priority item for rulemaking proposal for public comment
expected later this year. Would you provide the Committee with
your perspective on how best to maintain the tailoring rules
recently implemented?
Mr. Quarles. Well, tailoring the regulatory framework will
remain a principle that we have in mind as we come out with
proposals to implement the final pieces of Basel III, of which
the most important are the capital charge for operational risk
and what we call the ``fundamental review of the trading book''
or a capital charge for trading risk.
For the most part, I do not think those--you know, I think
those rules will in many cases tailor themselves. They are
addressed principally to larger firms, but we will certainly
have in mind the principles of tailoring that we have used in
our regulatory work over the last 4 years, and that we used in
implementing S. 2155.
Senator Moran. Mr. Quarles, let me see if I can build on
that. Despite some objections that the Fed has been gutting
Dodd-Frank and putting financial stability at risk with the
recalibrating of its regulations and supervisory framework
during the past few years, over the past year the banking
system has proved to not only be incredibly resilient but one
of the primary sources of strength in the U.S. economy. Would
you expand on why right-sizing of regulations proved effective
over the past year and how we should go further in those
efforts? And I am really talking about response to COVID and
the challenges of our economy. We have come through this pretty
well in that sense, and what are the lessons learned, and what
do we need to be doing in the future?
Mr. Quarles. Yes, well, I think the lessons learned in the
most fundamental sense are that we did have a strong banking
system, that we had a banking system that was able to support
the real economy. It served as a source of support for the real
economy; that the measures that were taken both post the
financial crisis and improving capital and liquidity, and to
make that framework more efficient over the course of the last
3\1/2\ years, both worked together to create a strong
regulatory environment for that to attain.
Senator Moran. Thank you very much.
Mr. Chairman, thank you for the opportunity to question.
Chairman Brown. Seeing no one else ready to testify, w will
close the hearing. Thank you, Vice Chair Quarles, for being
here today and providing testimony.
For Senators who wish to submit questions for the record--
ah, Senator Warnock is on. Senator Warnock from Georgia is
recognized for 5 minutes. Ready or not.
Can you hear? Senator Warnock, you are recognized for 5
minutes.
Senator Warnock. Hello. Can you hear me now?
Chairman Brown. There we go. Yes, we can hear you
perfectly. Thank you.
Senator Warnock. Great. Thank you, Chairman Brown. And, Mr.
Quarles, thank you so very much for being with us.
The Community Reinvestment Act addresses how banks must
meet the credit and capital needs of the communities they
serve. Congress, of course, passed the CRA, as you know, in
1977 in response to real problems, like redlining, a practice
by which banks discriminated against prospective customers
based primarily on where they lived or their racial/ethnic
background rather than their actual creditworthiness.
So the CRA not only addresses a harmful legacy of
discrimination in lending, but also racism and bias in our
current lending system that harms communities and blocks
wealth-building opportunities. So I was happy to hear about
last week's decision by the OCC to halt implementation and
reconsider its controversial CRA rulemaking, which started
under the previous Administration. This proposed rule would
have watered down this important civil rights era legislation
and harmed many working-class communities.
Vice Chair Quarles, the Fed also has oversight authority
over the CRA and was notably absent from last year's
rulemaking. Do you believe a joint CRA rulemaking with the Fed,
OCC, and FDIC is important to ensure we do not leave our most
vulnerable communities behind?
Mr. Quarles. Yes, Senator, I think it is both important and
desirable and achievable for our three agencies to have a joint
rule and approach on the CRA.
Senator Warnock. So will you commit to working with the OCC
and the FDIC to issue a joint CRA rulemaking?
Mr. Quarles. So we are certainly working with them to do
that. That has long been our stated goal. You know, we are
regularly talking with them. As you know, Senator, the Fed put
out its own Advance Notice of Proposed Rulemaking with our own
sort of CRA improvement framework. We are sharing the
information that we have gained from that process with the OCC.
The OCC is sharing the comments that they got during their
process with us. The three agencies are engaged in joint
discussions. It does remain very much our objective, and as I
say, I think it is achievable for us to have a joint rule.
Senator Warnock. I agree, and I think it is much more
important for us to get the reform right than to do it quickly,
and so I am hopeful that you will gather feedback from broad
and diverse stakeholders to make sure that we get a joint rule
and make sure that we get the CRA reform right.
Thank you, Mr. Chairman. I am going to defy Baptist
preacher gravity and close with 2 minutes left.
Chairman Brown. Well, no Baptist preacher I have ever
listened to. Thank you, Senator Warnock.
Thank you to the witness, and, Senator Warnock, just for
your information, we will follow up with you on that CRA. That
is really important. We have been talking to all three
regulators, and Senator Warnock is right on exactly where we
want to go on that. So thank you.
Thank you, Mr. Quarles, for being here today and providing
testimony.
For Senators who wish to submit questions for the record,
those questions are due 1 week from today, Tuesday, June 1st.
Vice Chair Quarles, based on the change made to our
Committee rules, you have 45 days to respond to any questions.
Thank you again.
With that, the hearing is adjourned.
[Whereupon, at 11:30 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN SHERROD BROWN
A year ago today, we watched for 8 minutes and 46 seconds as police
murdered George Floyd, and across the country, we saw Americans demand
justice for the killings of too many Black and Brown Americans and an
end to systemic racism in our country.
And over the past year, the pandemic has taken half-a-million
American lives, wreaked havoc on small businesses, pushed families into
foreclosure or eviction, and forced millions of workers--many women and
workers of color--out of the workforce.
For most Americans, it's been a very long and difficult year. A
year that revealed what many of us already knew--that even before the
pandemic, our economy wasn't working for most people.
I've heard some people, including many of my conservative
colleagues, say that we had the best economy in our lifetime before the
coronavirus hit. Those people need to follow Pres. Lincoln's admonition
to get their public opinion baths.
It certainly wasn't the greatest economy for most people in Senator
Toomey's hometown in Rhode Island, or my hometown of Mansfield.
Workers' wages have been flat for decades. Jobs continued to move
overseas. In my hometown, companies like Westinghouse, Fisher-Body,
Tappan Stove, Mansfield Tire closed down, one after another, and
thousands of good union jobs disappeared.
And they weren't replaced by new investment--the ``creative
DEstruction'' the market fundamentalists like to talk about wasn't
followed by any CONstruction, creative or otherwise.
Yet corporate profits continue to climb and CEO pay has soared.
Those outcomes are of course connected.
Corporations lay off workers or cut pay and benefits to juice their
stock price. Companies close down factories and move good-paying union
jobs abroad to cut costs. Big banks keep getting bigger, fueling the
concentration of corporate power in every part of our economy--from
agriculture to health care to manufacturing.
The economy of the past few decades may have looked good from the
big windows of corporate board rooms looking down on Wall Street--or
from the Dirksen Senate Office Building.
But the economy hasn't looked great in a long time when looking out
from the small towns and rural communities that the big banks have left
behind in search of higher profits. It's never looked all that great
for the Black and Brown families who lost their homes and wealth in the
wake of the Great Recession, barely getting back on their feet before
the next crisis hit.
When I talk to Ohioans, I hear a constant refrain: people don't
trust banks, especially the biggest banks. They've been burned by
predatory mortgages, high overdraft fees, and expensive second chance
accounts.
They've watched Wall Street reward themselves, despite scandal
after scandal. They remember how Wall Street bounced back after they
wrecked our economy. They know Washington allowed that destruction to
happen. And they certainly remember that taxpayers were forced to foot
the bill.
Tomorrow, for the first time ever, we will bring the CEOs of the
six largest banks in the country to testify before this Committee. Our
job is to hold accountable the institutions that for too long have had
outsized power in our economy--power that only continues to grow.
Today, we'll hear testimony from the Federal Reserve's Vice Chair
for Supervision--the person responsible for supervising those banks.
Mr. Quarles, checking Wall Street's power is supposed to be your
job too.
It's your responsibility to enforce the law and to hold banks
accountable for their misdeeds with meaningful punishments--not slaps
on the wrist. Not paltry fines that don't make a dent--for gargantuan
Wall Street firms, a fine is just the cost of doing business.
It's your job to stand up for the people who don't have corporate
lobbyists, who don't make millions of dollars a year, and who don't get
bailouts.
But as far as I can tell, you don't view standing up to Wall Street
as part of your job. You have rolled back rule after rule--rules that
are supposed to be a check on the power of the biggest banks, and
supposed to ensure they invest in the real economy--not themselves.
Instead of investments in job creation and wages and new
technology, they continue to pour all their extra cash into riskier and
riskier bets, and buying back more of their own stock.
Good for them--but not so good for America.
We need--and you need--to bring the focus back to the people who
make this country work.
We need--and you need--to make sure banks are taking into account
climate risk. We need--and you need--to make sure that volatile,
unregulated cryptocurrencies don't crash the economy and harm
consumers.
We need to make sure workers' wages keep up with the cost of
living--housing, childcare, prescription drugs, all the expenses that
have been rising for decades now.
We need to close the racial wealth and income gap that keeps
getting wider and wider.
It's our responsibility to work on solving these problems--not for
the biggest banks, but for the people we serve.
If we want an economy that reflects our values, we can't let Wall
Street write the rules--or tell the regulators how to do to their jobs,
for that matter. Our financial watchdogs shouldn't be doing favors for
the biggest banks.
You work for the American people, and I want to hear how you are
going to stand up for workers and families and help create a better
economy that works for everyone.
______
PREPARED STATEMENT OF SENATOR PATRICK J. TOOMEY
Thank you, Mr. Chairman.
Congress has provided the Fed with a great deal of independence to
isolate it from political influence. However, Congress also gave the
Fed narrowly-defined monetary and regulatory missions.
In the regulatory domain, the Fed has the authority to ensure the
safety and soundness of the financial institutions that it regulates.
But it doesn't have the authority to seek out and address political or
theoretical risks in the distant future.
The Fed's recent actions raise concerns that it's losing sight of
this constraint. Consider its increasing focus on the supposed risks of
global warming to the financial system. In March, John Cochrane, a
distinguished economist at Stanford, powerfully argued before this
Committee that ``climate change poses no measurable risk to the
financial system.''
Put simply, neither the warming of the Earth's temperature nor
severe weather events are a threat to the stability of the financial
system. Experience bears this out. In the last 11 years--a time period
that included four of the five costliest hurricanes in U.S. history--we
haven't found one bank failure caused by any weather event. In fact,
we're not aware of any bank failure in the modern era due to weather.
Nevertheless, the Fed recently joined the Network of Central Banks
and Supervisors for Greening the Financial System. The network's stated
aim is to use financial regulation to ``mobilize mainstream finance to
support the transition toward a sustainable economy.'' In other words,
to direct credit away from the fossil fuel sector.
Such actions are inconsistent with the Fed's mandate and
authorities. As Chair Powell himself has said, ``society's broad
response to climate change is for others to decide--in particular,
elected leaders.''
If Congress believes current environmental laws don't adequately
address global warming risks, changes should be enacted through the
legislative process by those accountable to voters--not by financial
regulators who have neither expertise nor accountability.
This principle extends to other issues as well. I'm troubled that
regional Fed banks are focusing on politically charged issues, like
racial justice activism, that are outside the Fed's mission and
expertise. This week I sent letters to three regional Federal Reserve
Banks about this behavior and requested information from them.
Instead of seeking to tackle issues that are outside the Fed's
mandate and authorities, the Fed should focus on supervising the risks
within its domain. For example, the Fed's recent Financial Stability
Report highlights several risks that should be monitored--such as high
asset prices. However, the report fails to consider a primary cause of
these risks: the Fed's own excessively accommodative monetary policy.
Our economy experienced a significant shock last year, but it was
met with unprecedented monetary and fiscal support. And the economy is
now in full recovery mode. As a result, I don't understand the
justification for the Fed maintaining its policy of near-zero interest
rates and $1.4 trillion in bond purchases per year, amounting to
roughly half of new Treasury debt issuance since the beginning of the
pandemic. Let's not kid ourselves: we are effectively monetizing about
$1 trillion of Federal debt per year.
This is especially troubling because the warning signs of inflation
are getting louder. We may be seeing asset bubbles forming already, and
history is replete with examples where the bursting of bubbles led to
financial instability. As President Clinton's Treasury Secretary Larry
Summers noted yesterday, the Fed needs to start ``explicitly
recognizing that overheating, and not excessive slack, is the
predominant near-term risk for the economy.''
I'm concerned that the Fed's current approach almost guarantees
that it will be behind the curve if inflation becomes problematic and
persistent--for two reasons. First, the Fed has announced it will allow
inflation to run above its 2 percent target level. Second, the Fed
insists that the inflation we're experiencing now is transitory. But
you can only know something is transitory when it comes to an end. What
if it does not come to end?
Another side effect of the Fed's asset purchases is the regulatory
implications of such an abundance of reserves in the banking system.
When the Fed purchases Treasuries or agency securities, the aggregate
level of reserves rises correspondingly. As a result, reserves in the
banking system have risen by over $2 trillion dollars and bank leverage
ratios have experienced pressure from absorbing these riskless reserves
that the Fed is creating.
Last year, the Fed recognized this problem and issued temporary
relief that allowed banks to accommodate a surge of reserves. That
relief has expired and there are signs that it was needed. The Fed
recently stated that it will address this problem on a permanent basis.
I urge you to do so swiftly.
Let me conclude with this: the Fed doesn't need to exceed its
mandate and authorities to find risks to address. The siren calls of
politically charged endeavors should be ignored, in order to preserve
the credibility and independence of the Fed. There are plenty of risks
within its reach, including those to which it may be contributing.
______
PREPARED STATEMENT OF RANDAL K. QUARLES
Vice Chairman for Supervision, Board of Governors of the Federal
Reserve System
May 25, 2021
Chairman Brown, Ranking Member Toomey, Members of the Committee,
thank you for the invitation to testify today. Last May, my colleagues
and I came before you--in a virtual format for the first time--
discussing our actions to maintain a strong banking sector as a source
of support for consumers, households, and businesses. I'd like to thank
the Committee for its flexibility and its commitment to ongoing, open
dialogue, especially in the course of such a challenging year.
My remarks 1 year ago came after the onset of sudden and pervasive
financial stress. \1\ Early turmoil in overseas financial markets
quickly crossed borders and, within days, had reached almost every
asset class and corner of the financial system. From the beginning, the
causes of this strain were clear, rooted in the policy measures taken
to address the outbreak of COVID-19. But at that time, the full
implications of the COVID event remained unclear, and the costs would
continue to mount.
---------------------------------------------------------------------------
\1\ Randal K. Quarles, ``Supervision and Regulation Report''
(testimony before the Committee on Banking, Housing, and Urban Affairs,
U.S. Senate, Washington, DC, May 12, 2020), https://
www.federalreserve.gov/newsevents/testimony/quarles20200512a.htm.
---------------------------------------------------------------------------
The American economy and banking sector then remained at the edge
of the storm, with one wave of stress behind us and others yet to come.
Today, the storm waters are receding. The economy is beginning a strong
recovery, which owes much to an extraordinary, coordinated, and
sustained campaign of support, by both Congress and the Federal
Reserve, that helped clear a path to the other side of the COVID event.
As the Federal Reserve's recent reports detail, banking
organizations have remained an important source of strength in this
recovery. \2\ Entering the COVID event, the banking system was
fortified by over 10 years of work to improve safety and soundness,
from both regulators and the banks themselves. Higher levels of capital
and liquidity, better risk management, and more robust systems let them
absorb an unprecedented shock--while providing refuge from market
instability, delivering essential public aid, and working
constructively to support borrowers and communities. \3\ In short, the
full set of post-2008 reforms--as refined and recalibrated by the work
of the last 4 years--ensured that this time would truly be different
than the last. Today, the U.S. banking system is actually more liquid
and better capitalized than it was a year ago, with over $100 billion
in additional loan loss reserves, leaving it well-positioned to weather
future shocks.
---------------------------------------------------------------------------
\2\ Board of Governors of the Federal Reserve System, Supervision
and Regulation Report, April 2021 (Washington: Board of Governors,
April 2021), https://www.federalreserve.gov/publications/files/202104-
supervision-and-regulation-report.pdf; Board of Governors of the
Federal Reserve System, Financial Stability Report, May 2021
(Washington: Board of Governors, May 2021), https://
www.federalreserve.gov/publications/files/financial-stability-report-
20210506.pdf. The Supervision and Regulation Report accompanies this
testimony.
\3\ See Randal K. Quarles, ``Remarks at the Hoover Institution''
(speech at the Hoover Institution, Stanford, CA (via webcast), October
14, 2020), https://www.federalreserve.gov/newsevents/speech/
quarles20201014a.htm.
---------------------------------------------------------------------------
While a strong recovery is underway, it is not yet complete. \4\
Some households and businesses are still vulnerable, even as we enter
this last stretch of the return to normal. Our role, as policymakers,
is to support the financial system and the economy through the end of
this transition back to normal operations. Our challenge, however, is
to do so as circumstances change and the nation's need for that support
evolves. \5\
---------------------------------------------------------------------------
\4\ See, e.g., Jerome H. Powell, ``Getting Back to a Strong Labor
Market'' (speech at the Economic Club of New York (via webcast),
February 10, 2021), https://www.federalreserve.gov/newsevents/speech/
powell20210210a.htm.
\5\ See Jerome H. Powell, ``Community Development'' (speech at the
``2021 Just Economy Conference'' sponsored by the National Community
Reinvestment Coalition, Washington, DC (via webcast), May 3, 2021),
https://www.federalreserve.gov/newsevents/speech/powell20210503a.htm
(``Lives and livelihoods have been affected in ways that vary from
person to person, family to family, and community to community'').
---------------------------------------------------------------------------
Most immediately, we have worked to align our emergency actions
with other relief efforts, as the economic situation improves. Last
spring, the Federal Reserve adopted a set of extraordinary and mostly
temporary measures to ease the strain in financial markets and ensure
banks could support communities and meet customer needs. \6\ In the
last 6 months, we have maintained or extended some of those measures,
where appropriate, to preserve household assistance and promote
continued access to credit. \7\
---------------------------------------------------------------------------
\6\ For a catalogue of these actions, see ``Supervisory and
Regulatory Actions in Response to COVID-19'', Board of Governors of the
Federal Reserve System, last updated March 15, 2021, https://
www.federalreserve.gov/supervisory-regulatory-action-response-covid-
19.htm.
\7\ See, e.g., Board of Governors of the Federal Reserve System,
``Federal Reserve Board Announces It Will Extend Its Paycheck
Protection Program Liquidity Facility, or PPPLF, by Three Months to
June 30, 2021'', news release, March 8, 2021, https://
www.federalreserve.gov/newsevents/pressreleases/monetary20210308a.htm;
Board of Governors of the Federal Reserve System, ``Federal Reserve
Board Announces the Second Extension of a Rule To Bolster the
Effectiveness of the Small Business Administration's Paycheck
Protection Program (PPP)'', news release, February 9, 2021, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20210209a.htm;
Board of Governors of the Federal Reserve System, ``Federal Reserve
Announces the Extension of Its Temporary U.S. Dollar Liquidity Swap
Lines and the Temporary Repurchase Agreement Facility for Foreign and
International Monetary Authorities (FIMA Repo Facility) Through
September 30, 2021'', news release, December 16, 2020, https://
www.federalreserve.gov/newsevents/pressreleases/monetary20201216c.htm;
Board of Governors of the Federal Reserve System, Federal Deposit
Insurance Corporation, and Office of the Comptroller of the Currency,
``Agencies Provide Temporary Relief to Community Banking
Organizations'', news release, November 20, 2020, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20201120a.htm.
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We also began the transition back to our normal activities, our
normal supervisory posture, and our normal rulebook. We closed 12 of
our 13 emergency lending facilities; let temporary changes to our
leverage rules expire as planned; and announced plans to transition
large banks back to our regular capital regulation program, calibrating
dividend and share repurchase restrictions to the results of the
upcoming supervisory stress tests. \8\
---------------------------------------------------------------------------
\8\ Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, and Office of the Comptroller of the
Currency, ``Temporary Supplementary Leverage Ratio Changes To Expire as
Scheduled'', news release, March 19, 2021, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20210319b.htm;
Board of Governors of the Federal Reserve System, ``Federal Reserve
Board Announces That the Temporary Change to Its Supplementary Leverage
Ratio (SLR) for Bank Holding Companies Will Expire as Scheduled on
March 31'', news release, March 19, 2021, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20210319a.htm;
Board of Governors of the Federal Reserve System, ``Federal Reserve
Announces Temporary and Additional Restrictions on Bank Holding Company
Dividends and Share Repurchases Currently in Place Will End for Most
Firms After June 30, Based on Results From Upcoming Stress Test'', news
release, March 25, 2021, https://www.federalreserve.gov/newsevents/
pressreleases/bcreg20210325a.htm.
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These are important near-term steps, and they are part of any
responsible transition out of our emergency posture. However, our role
and our responsibility extend much further than merely returning to
normal. We also have an obligation to look closely at the last year, to
understand how the financial system came to experience such severe
stress, and to identify and act on any lessons we find. The COVID event
was a unique shock, but it was also the first real-world test of the
regulatory and supervisory regime established after the 2008 financial
crisis. As such, it gives us a chance to examine that regime's
strengths and shortcomings, and to position it well for future
challenges.
Any list of lessons must begin with the strong performance of
supervisory stress testing. \9\ The stress-testing program not only
prepared banks for a period of prolonged hardship; it also clarified
their health and resilience as the COVID event progressed. This role
was a return to the original purpose of stress testing and a
confirmation of its earliest use during the 2008 financial crisis. It
also, however, affirmed the ways that stress testing has evolved in
recent years, into a more flexible, more transparent anchor for the
Federal Reserve's broader capital program.
---------------------------------------------------------------------------
\9\ Randal K. Quarles, ``Themistocles and the Mathematicians: The
Role of Stress Testing'' (speech at the Federal Reserve Bank of
Atlanta, Atlanta, GA (via webcast), February 25, 2021), https://
www.federalreserve.gov/newsevents/speech/quarles20210225a.htm; see,
also, Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Announces Results From Second Round of Bank Stress Tests
Will Be Released Friday, December 18, at 4:30 p.m. EST'', news release,
December 4, 2020, https://www.federalreserve.gov/newsevents/
pressreleases/bcreg20201204a.htm.
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For example, while it was prudent--given that this was the first
real-world test of the post-2008 system--for us to impose temporary
capital distribution restrictions beyond those that form part of that
system, we now know that our framework works. We can have particular
confidence in the framework when it is supplemented and informed by a
real-time stress testing regime. In the future, having learned the
lessons of this test, we will be able to rely on the automatic
restrictions of our carefully developed framework when the stress test
tells us the system will be resilient, rather than impose ad hoc and
roughly improvised limitations.
Other areas, however, are ripe for closer examination, both
domestically and internationally. These include the strains in short-
term funding markets, and the second destabilizing run on prime money
market mutual funds in roughly a decade, which required significant
public intervention to address. \10\ Despite some efforts after the
2008 crisis to enhance the resiliency of these investment vehicles, the
basic model of a seemingly stable-value fund, backed by assets the
value and liquidity of which varies, remained vulnerable. Work is
ongoing both domestically and at the Financial Stability Board on how
to better address these vulnerabilities.
---------------------------------------------------------------------------
\10\ Randal K. Quarles, ``The FSB in 2021: Addressing Financial
Stability Challenges in an Age of Interconnectedness, Innovation, and
Change'' (speech at the Peterson Institute for International Economics,
Washington, DC (via webcast), March 30, 2021), https://
www.federalreserve.gov/newsevents/speech/quarles20210330a.htm.
---------------------------------------------------------------------------
Areas for further examination also include Treasury markets, where
last year's selling pressures overwhelmed dealers' willingness or
ability to intermediate, and which continue to be a focus for the
Board, the Department of the Treasury, and other regulators. \11\ Among
other measures, we are reviewing the design and calibration of the
supplementary leverage ratio, which was originally gauged for a
financial system with far lower levels of cash reserves and a much
smaller Treasury market. \12\
---------------------------------------------------------------------------
\11\ Randal K. Quarles, ``What Happened? What Have We Learned From
It? Lessons From COVID-19 Stress on the Financial System'' (speech at
the Institute of International Finance, Washington, DC (via webcast),
October 15, 2020), https://www.federalreserve.gov/newsevents/speech/
quarles20201015a.htm.
\12\ See n. 8, Board of Governors of the Federal Reserve System,
news release, March 19, 2021.
---------------------------------------------------------------------------
Finally, these areas for further review include a rapidly changing
set of customer practices; changing patterns in the use of financial
services, by consumers and businesses; and a changing relationship
between banks and their nonbank partners. These trends predate the
COVID event, but the past year accelerated them dramatically, with
important implications for financial stability, safety and soundness,
consumer protection, and underserved communities' access to safe and
fair financial services. The Federal Reserve is working to understand
and address this changing landscape in a number of ways--from the use
of artificial intelligence, to the evolving need for operational
resiliency, to the growing risk of disruptive shocks from cybersecurity
failures. \13\
---------------------------------------------------------------------------
\13\ Board of Governors of the Federal Reserve System, Consumer
Financial Protection Bureau, Federal Deposit Insurance Corporation,
National Credit Union Administration, and Office of the Comptroller of
the Currency, ``Agencies Seek Wide Range of Views on Financial
Institutions' Use of Artificial Intelligence'', news release, March 29,
2021, https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20210329a.htm; Board of Governors of the Federal Reserve System,
SR letter 20-24: ``Interagency Paper on Sound Practices To Strengthen
Operational Resilience'', November 2, 2020, https://
www.federalreserve.gov/supervisionreg/srletters/SR2024.htm; see also
``Jerome Powell: Full 2021 60 Minutes Interview Transcript'', 60
Minutes Overtime, April 11, 2021, https://www.cbsnews.com/news/jerome-
powell-full-2021-60-minutes-interview-transcript/.
---------------------------------------------------------------------------
We are not alone in our work to understand these post-COVID-event
lessons. We have valuable and willing partners in our fellow
regulators, in other agencies across Government, and in our colleagues
abroad. We continue to participate actively in relevant work at the
Financial Stability Board and other international forums, since
financial risks do not respect the jurisdictional lines between
agencies or countries. And we are committed to keeping Congress closely
and actively informed of our efforts, mindful of the effect these
trends may have on our core mandate.
This work is critical, but only in service of a more fundamental
goal: a safe, transparent, and efficient approach to supervision and
regulation, which ensures the financial system is strong and stable
enough to withstand even historic shocks. \14\ Those values are of
perennial importance, and they continue to be the bedrock of the
Federal Reserve's work. \15\ They also animate two of our highest
priorities for this year: to finalize the postcrisis Basel III reforms
and to complete the long-overdue transition away from LIBOR. On the
former, we remain committed to implementing Basel III for our
internationally active banking organizations in a full, timely, and
consistent manner, with a rulemaking proposal for public comment later
this year. For LIBOR, by contrast, the time for comment, speculation,
and delay has long since passed. Continued use of LIBOR in new
contracts after 2021 would create safety and soundness risks, and we
will examine bank practices accordingly. \16\
---------------------------------------------------------------------------
\14\ Randal K. Quarles, ``The Eye of Providence: Thoughts on the
Evolution of Bank Supervision'' (speech at the Federal Reserve Board,
Harvard Law School, and Wharton School Conference: Bank Supervision:
Past, Present, and Future (via webcast), December 11, 2020), https://
www.federalreserve.gov/newsevents/speech/quarles20201211a.htm.
\15\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Adopts Final Rule Outlining and Confirming the Use of
Supervisory Guidance for Regulated Institutions'', news release, March
31, 2021, https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20210331a.htm; Board of Governors of the Federal Reserve System,
``Federal Reserve Board Publishes Frequently Asked Questions (FAQs)
Comprising Existing Legal Interpretations Related to a Number of the
Board's Longstanding Regulations'', news release, March 31, 2021,
https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20210331b.htm; Board of Governors of the Federal Reserve System,
``Federal Reserve Publishes Latest Version of Its Supervision and
Regulation Report'', news release, November 6, 2020, https://
www.federalreserve.gov/newsevents/pressreleases/bcreg20201106a.htm.
\16\ Randal K. Quarles, ``Keynote Remarks'' (speech at ``The SOFR
Symposium: The Final Year'', an event hosted by the Alternative
Reference Rates Committee, New York, NY (via webcast), March 22, 2021),
https://www.federalreserve.gov/newsevents/speech/quarles20210322a.htm;
see also Mark Van Der Weide, ``The End of LIBOR: Transitioning to an
Alternative Interest Rate Calculation for Mortgages, Student Loans,
Business Borrowing, and Other Financial Products'' (testimony before
the Subcommittee on Investor Protection, Entrepreneurship, and Capital
Markets, Committee on Financial Services, U.S. House of
Representatives, Washington, DC, April 15, 2021), https://
www.federalreserve.gov/newsevents/testimony/vanderweide20210415a.htm.
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The COVID event is not behind us, and the vulnerabilities it
exposed are not gone. As we continue to recover, the ``vast influence
of accident'' can only grow, with consequences that can
disproportionately fall on the most vulnerable. \17\ However, we can do
more than just wait and hope that the path out of the COVID event is
smooth. We can work to ensure the financial system is resilient enough
to support consumers, households, and businesses, and we can recommit
ourselves to supporting the economy through the completion of the
recovery. The work we undertake to learn the lessons of the past year
is a critical step in upholding that commitment.
---------------------------------------------------------------------------
\17\ Thucydides, The History of the Peloponnesian War, translated
by Richard Crawley, at Ch. 3, https://www.gutenberg.org/files/7142/
7142-h/7142-h.htm.
---------------------------------------------------------------------------
Thank you. I look forward to your questions.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
FROM RANDAL K. QUARLES
Q.1. We see more and more severe weather events in Ohio and in
all of my colleagues' States--from flooding to ice storms to
catastrophic hurricanes. Taking these risks into consideration
is something individual banks have done for a long time. How is
the Fed supervising banks for climate risk on a system-wide
basis? When can we expect the Fed to include climate risks in
the big bank stress tests? The Fed should not wait several
years to incorporate these risks--which could destroy trillions
of dollars in assets--when the climate crisis is already here.
A.1. We expect supervised firms to manage effectively and
mitigate all material risks they face, including those risks
posed by climate change. With respect to climate-related risks,
we are undertaking a broad work plan of analysis and public
engagement. We are actively engaging with large financial
institutions to strengthen our understanding of how they
currently assess climate risks and incorporate the physical and
transition risks from climate change into their risk management
frameworks. We are also engaging with a wide range of
stakeholders to ensure a broad range of diverse perspectives.
This engagement and our ongoing analytical work will inform
our assessment of our supervisory program. As with all
supervisory undertakings, we will tailor our approach and
resources to focus on firms that face the most risk.
Climate scenario analysis is one of many tools that can be
used to better understand the range of potential climate-
related risks to the financial sector. Climate scenario
analysis, which is distinct from regulatory stress tests, is a
tool to explore how climate risks could evolve under a range of
plausible scenarios. In contrast, regulatory stress tests are
used to assess capital adequacy under specific shocks in the
short term and have specific consequences for capital and
supervisory ratings. We are building our understanding of
climate scenario analysis by engaging with financial
institutions, academics, and foreign central banks, and other
institutions to better understand scenario design.
We are taking a careful, thoughtful, and transparent
approach to our work regarding climate related risks, and we
will engage with Congress and the public along the way.
Q.2. During your testimony, you indicated that the Federal
Reserve carefully reviews branch closures as part of its merger
analysis. How many branches of banks involved in a merger or
consolidation since June 1, 2011, have closed? How many of such
closures have occurred in rural, minority, or low-moderate
income areas? Please describe all instances in which the
Federal Reserve bas denied a bank merger application because of
concerns related to branch closures.
A.2. This response provides the requested data on the number of
branch closures associated with banks that were involved in a
merger or consolidation since June 1, 2011. The response also
discusses certain limitations in the available data that do not
enable an inference of causation to be established between
branch closures since 2011 and M&A activity.
From 2011 to 2020, there was a net loss of 5,605 branches
for banks that were involved in an M&A transaction over that
period. \1\ During this time period, the total net loss of
branches that were located in counties that possessed one or
more of the characteristics of being low-and moderate-income
(LMI), \2\ majority-minority, \3\ or nonmetropolitan \4\ was
2,453. \5\
---------------------------------------------------------------------------
\1\ ``Branch'' means full-service, brick and mortar retail bank
branches.
\2\ LMI counties are defined as counties with median family income
less than 80 percent of national median family income for that year.
\3\ Majority-minority counties are defined as counties in which
less than half of the population is non-Hispanic White.
\4\ Nonmetropolitan counties are defined as any county that is not
part of a Metropolitan Statistical Area (MSA). An MSA is defined as an
area with at least one urbanized area that has a population of at least
50,000 and comprises the central county or counties containing the
core, plus adjacent outlying counties having a high degree of social or
economic integration with the central county as measured by commuting
data.
\5\ These branches often possess multiple characteristics, and the
total number of closed branches in LMI counties was 1,254 out of 2,453
total branches; the total number of closed branches in majority-
minority counties was 1,062 out of 2,453 total branches; and the total
number of closed branches in nonmetropolitan counties was 1,144 out of
2,453 total branches.
---------------------------------------------------------------------------
The limitations of the data do not enable an inference of
causation to be established between all of the net branch
closures and M&A activity, because closures captured in these
figures may have occurred for reasons unrelated to M&A
activity. For example, the figures provided above include all
of the branch openings and closings of the banks and savings
associations involved in an M&A transaction (including at the
holding company level) that occurred after the date of the
institution's first instance of M&A activity in the period
between 2011 to 2020. As an important caveat, the figures do
not account for proximity in time between branch activity to
the first associated M&A activity. Consequently, it would be
difficult to associate some of an institution's branch closures
with its M&A activity if those closures occurred well after the
M&A transaction.
In addition, the data do not account for the geographic
relationship between the branch activity and the M&A activity.
The branch networks of an acquirer and target institution may
only partially overlap or not overlap at all. It would be
difficult to causally associate some of an institution's branch
closures with the institution's M&A activity if such closures
occurred outside the geographic area where the acquirer's and
target's branch networks overlapped.
Moreover, branch consolidations resulting from M&A activity
are reflected in the data as branch closures. In M&A
transactions, the acquiring and target institutions may have
branches that are located a short distance from one another in
areas where the institutions have overlapping operations.
Although the combined organization may consolidate nearby
branches into a single branch to enhance operating efficiency,
consolidation of this type generally would not limit customers'
access to the bank's branches.
From 2011 to 2020, there was a net loss of 12,098 branches
among all banks and savings associations nationwide. Although
bank consolidation may be a factor in the overall decline,
other factors have also contributed to this trend. These
factors may include, for example, the rise in online and mobile
banking products and services, increased competition from
internet banks and nonbank fintech companies, changing customer
preferences, increased branch operational costs, and, most
recently, the COVID event.
Between 2011 and present, the Board has not denied any M&A
proposals due to concerns related to branch closures. The Board
denies few M&A proposals overall because it has set clear
standards about what M&A transactions it will approve. As a
consequence of that transparency, bank holding companies and
banks generally do not propose M&A transactions that would not
meet the Board's standards. \6\ In addition, some applicants
choose to withdraw proposals prior to the Board's
consideration. Approximately 12 percent of the merger
applications submitted to the Federal Reserve from 2006 through
2020 were withdrawn.
---------------------------------------------------------------------------
\6\ The Board has released publicly its approach to applications
that may not satisfy statutory requirements for approval or that
otherwise raise supervisory or regulatory concerns. This is reflected
in the Board's Supervision and Regulation (SR) letter 14-2;Consumer
Affairs (CA) letter 14-1: ``Enhancing Transparency in the Federal
Reserve's Applications Process'', https://www.federalreserve.gov/
supervisionreg/srletters/sr1402.htm.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM RANDAL K. QUARLES
Q.1. In your testimony before the Banking Committee you argued
that Federal regulators should analyze potential climate-
related risks and develop a ``data-driven analytical
framework'' to guide your engagement with banks. You further
noted that the Federal Reserve is in the ``early stages'' of
doing that. Following your testimony, Acting Comptroller of the
Currency Michael Hsu made comments on June 2, 2021, that appear
to prejudge the outcome of this analysis. \1\ He argued that
regulators will ``eventually'' be required to incorporate
climate-related risks into bank capital rules because
``exposure is exposure and you have to risk manage and
capitalize for that.'' \2\ Do you believe that changes to the
bank capital framework are an appropriate way to address
climate-related risks?
---------------------------------------------------------------------------
\1\ Pete Schroeder, Climate change risks will affect U.S. bank
capital in long-run--official, Reuters (Jun. 2, 2021), https://
www.reuters.com/article/usa-regulator-banks/climate-change-risks-will-
affect-us-bank-capital-in-long-run-official-idUSL2N2NJ2Y7.
\2\ Id.
A.1. Congress has given the Federal Reserve narrow but
important mandates around monetary policy, financial stability,
and supervision of financial firms, and we would consider the
potential effects of climate change only to the extent they
would affect the achievement of our statutory mandates. With
respect to climate-related risks, we are undertaking a broad
work plan of analysis and public engagement. We are actively
engaging with large financial institutions to strengthen our
understanding of how they currently assess climate risks and
incorporate the physical and transition risks from climate
change into their risk management frameworks. We are also
engaging with a wide range of stakeholders to ensure a broad
range of diverse perspectives.
Given that we are in the early stages of this work, we do
not yet have a considered view about what actions might be
appropriate from the Federal Reserve to address potential
financial and economic risks of climate change once we have a
more analytical understanding of that possibility. I would note
that the Bank of England (BoE), which is considered among the
most active global regulators in applying climate risk analysis
to bank supervision, is running an analysis of its bank and
insurance system's climate exposures that it is calling a
stress test and which will be complete in the spring of 2022,
yet even the BoE has been quite clear that this test will not
be used to set capital standards. We are taking a careful,
thoughtful, and transparent approach to this work, and we will
engage with Congress and the public along the way.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM RANDAL K. QUARLES
Q.1. Suspicious Activity Reports--Last year, a New York Times
article stated that major banks had filed Suspicious Activity
Reports (SARs) that showed major financial institutions had
helped suspected terrorists, drug dealers, and corrupt foreign
officials move trillions of dollars around the world. \1\
---------------------------------------------------------------------------
\1\ https://www.nytimes.com/2020/09/20/business/fincen-banks-
suspicious-activity-reports-buzzfeed.html
---------------------------------------------------------------------------
The article reported multiple examples of major financial
institutions failing to take proactive action regarding
customers on whom they have filed SARs and/or against whom they
have suspicions of illegal activity. How big of a concern is
this for the Fed?
A.1. We are committed to a strong anti-money laundering (AML)
regime. The Federal Reserve expects banks operating in the
United States to have an effective AML program as required by
the Bank Secrecy Act (BSA) and appropriate measures in place to
identify and report suspicious activity to law enforcement.
The Federal Reserve has taken action, and will continue to
take action, to address BSA/AML deficiencies within its
supervised institutions where warranted. Within the last
several years, we have imposed enforcement actions against
firms for failing to understand and mitigate the money
laundering and terrorist financing risks associated with
certain global business lines, activities, and customers.
While U.S. banks are neither required nor in an appropriate
position to determine whether a crime has been committed, they
are required to identify and report suspicious activity to
FinCEN consistent with the relevant suspicious activity
reporting regulations.
Banks are required to file SARs in a wide range of
circumstances. U.S. banks are obligated to screen all
transactions for suspicious activity, even those for which the
bank does not have a direct customer relationship with the
originator of the transaction, such as in the case of foreign
correspondent banking.
Q.2. What steps is the Federal Reserve instituting to ensure
that financial institutions comply with the Anti-Money
Laundering Act of 2020?
A.2. We are committed to ensuring that our supervised entities
comply with BSA/AML laws and regulations. The Federal Reserve
is working closely with the U.S. Department of the Treasury,
FinCEN, and the other Federal and State banking supervisors to
provide meaningful consultation and support for effective,
appropriately tailored implementation of the AML Act reforms.
In addition, the Federal Reserve and other Federal and State
banking supervisors are collaborating through the Federal
Financial Institutions Examination Council's BSA/AML Working
Group to update our supervisory approach, as necessary, to
incorporate AML Act reforms.
Q.3. Archegos Capital Management--In the May 2020 Financial
Stability Report, \2\ the Federal Reserve warned about the high
level of ``business-sector debt.'' Since then the implosion of
the Archegos Capital Management resulted in a $10 billion loss
to Credit Suisse and Morgan Stanley.
---------------------------------------------------------------------------
\2\ https://www.federalreserve.gov/publications/files/financial-
stability-report-20200515.pdf. P. 33.
---------------------------------------------------------------------------
How will the Federal Reserve adjust its stress tests for
large financial institutions to ensure that banks can
accurately project major trading losses for their private fund
clients?
Will the Federal Reserve include hypothetical scenarios
based on overleveraged private fund clients in its annual bank
stress tests?
A.3. The Federal Reserve's supervisory stress test incorporates
global market shock and counterparty default components to
assess the risks of firms with significant trading activities.
In the June 2020 and December 2020 supervisory stress tests,
the Federal Reserve projected trading and counterparty losses
of $83.2 billion and $95.1 billion, respectively, under the
severely adverse scenario for the 13 firms with significant
trading activities. These amounts are far larger than the total
global losses stemming from Archegos, the great bulk of which
were incurred by foreign banks outside the United States and
nearly 100 times larger than the minor portion of Archegos
losses that fell within the Federal Reserve's regulator
perimeter.
Consistent with the Federal Reserve Board's Policy
Statement on the Scenario Design Framework for Stress Testing
(Scenario Design Framework), we consider emerging and ongoing
areas of financial market vulnerability in the development of
the global market shock component. For example, over the last
few years the global market shock component has emphasized
heightened stress to highly leveraged markets. We will continue
to develop our supervisory stress test scenarios according to
the Scenario Design Framework, ensuring that salient risks are
captured.
As part of our capital plan assessment, we review the
assumptions and methodologies used by firms to project revenues
and losses under a range of stressful conditions, including an
internal stress scenario that is reflective of a firm's unique
risk exposures and business activities. This assessment helps
to highlight key weaknesses in a firm's internal processes that
can result in additional supervisory scrutiny.
Q.4. Cyber Risks--Federal Reserve Bank of Cleveland President
Loretta Mester urged further development and use of stress
testing to assess the financial system's resilience to cyber
risks.
How can an institution ensure that the data it backed up
has not already been altered?
A.4. In today's data driven marketplace, data integrity is
extremely important for any financial institution's operations
and decision making. We recently published interagency guidance
that outlines sound practices for strengthening operational
resilience. The guidance contains a number of practices that
seek to ensure the effectiveness of processes and controls to
protect the confidentiality, integrity, availability, and
overall security of the firm's data and information systems.
One such practice is for firms to establish controls to
safeguard the integrity and availability of critical data
against the impact of destructive malware, including
ransomware, or other similar threats. Recovery from such
incidents may include use of protocols for secure, immutable,
off-line storage of critical data. In addition, we point
institutions to National Institute of Standards and Technology
(NIST) resources such as: NIST Special Publication 1800-11-Data
Integrity Recovering from Ransomware and Other Destructive
Events \1\ and the NIST draft white paper, Securing Data
Integrity Against Ransomware Attacks: Using the NIST
Cybersecurity Framework and NIST Cybersecurity Practice Guides
\2\ for more detailed information.
---------------------------------------------------------------------------
\1\ See NIST Cybersecurity Practice Guide SP 1800-11, ``Data
Integrity: Recovering from Ransomware and Other Destructive Events''.
\2\ See the NIST draft white paper, ``Securing Data Integrity
Against Ransomware Attacks: Using the NIST Cybersecurity Framework and
NIST Cybersecurity Practice Guides''.
Q.5. We see more cybercriminals target small businesses,
leading to a loss of revenue, jobs and in some cases, putting
some out of business.
How should financial institutions consider the impact of
cybercrime when they lend to small businesses?
A.5. There are several potential risks that may limit or render
a small business incapable of fulfilling the terms of its loan
agreement with its lender, including cybercrime. As part of
their underwriting, lenders should consider how the small
business's ability to repay could be affected for a variety of
risks including cyberincidents. The level of cyberpreparedness
and hygiene of a small business could be considered as factors
in underwriting together with other risks that could affect the
borrower's ability to repay.
As banks themselves become more aware of cyber risks, they
could provide a useful channel for increasing awareness among
their customers, especially small businesses, to heightened
resilience and the need to have appropriate safeguards to
manage these risks.
Q.6. Expanding on Your Testimony--In your testimony, you call
for ``further review of changing patterns in the use of
financial services, by consumers and businesses; and a changing
relationship between banks and their nonbank partners.''
Besides greater online banking, what changing patterns has
the Federal Reserve noticed in the usage patterns of customers
of financial services companies?
A.6. Customers' use of digital financial services--banking,
payments, investment, insurance, lending, and financial
planning--increased substantially in the years preceding the
COVID event and continued to accelerate during the last year.
Customers are starting to use online channels for a range of
financial activities that span beyond checking account
balances, including financial transactions such as making
payments, seeking loans, or investing money. For example,
according to the 2020 edition of McKinsey's annual Digital
Payments Consumer Survey, \3\ more than three-quarters of
Americans use some form of digital payment, such as browser-
based and in-app online purchases, in-store checkout using a
mobile phone and/or Quick Response code, and person-to-person
payments. In some cases, consumers are gaining access to these
services through their banks; in other cases, through nonbank
fintech companies.
---------------------------------------------------------------------------
\3\ See 2020 McKinsey Digital Payments Consumer Survey.
---------------------------------------------------------------------------
In addition, consumers are increasingly getting customer
service through digital channels. A number of banks have
leveraged new technologies such as artificial intelligence (AI)
to enable 24x7 chat-bots, which can answer basic customer
service questions.
Consumer surveys such as the 2019 E&Y Global FinTech
Adoption Survey \4\ and the 2019 PwC Global Fintech Report \5\
show shifting customer preferences with respect to the use of
online financial services. Price, ease of setup, user
experience, and access to innovative products are all important
factors for consumers using new fintech services.
---------------------------------------------------------------------------
\4\ See 2019 E&Y Global FinTech Adoption Survey.
\5\ See 2019 PwC Global Fintech Report.
---------------------------------------------------------------------------
Businesses are also seeking to leverage advances in
financial technology for services such as lending, payments
technology, fraud detection, and data processing services. For
example, the 2020 Federal Reserve Small Business Credit Survey
\6\ found that 20 percent of small businesses had used an
online (nonbank) lender for funding in the past 5 years.
Medium/high-credit-risk applicants were more inclined to apply
to online lenders and were more than twice as likely as other
applicants to state that denials by other lenders drove their
application decisions. They also had the greatest chance of
success at online lenders, with 77 percent getting approved in
comparison to a 40 percent approval rate at a large bank.
---------------------------------------------------------------------------
\6\ See 2020 Federal Reserve Small Business Credit Survey.
Q.7. What concerns do you have about the commercial real estate
market? If remote work increases substantially, do you expect
to see any risk to the financial system due to outstanding
---------------------------------------------------------------------------
commercial real estate loans?
A.7. As noted in the May 2021 Financial Stability Report (FSR),
disruptions caused by the COVID event continue to make it
difficult to assess valuations in the commercial real estate
(CRE) sector. Since late 2020, CRE price indexes based on
transactions recovered from their decline early last year,
suggesting elevated pressures. Further, capitalization rates,
which measure annual income relative to prices of commercial
properties, have continued to tick down. Yet, other measures
suggest market participants perceive values as having fallen
over the past year.
For example, an index of the prices of CRE properties
administered by real estate investment trusts (REITs), which
supplements observed transactions with appraisal information,
remains below pre-COVID levels. \7\ Similarly, stock prices of
REITs that invest in harder-hit commercial property sectors
have increased since November but generally remain below their
pre-COVID levels.
---------------------------------------------------------------------------
\7\ The Green Street price index remained below its pre-COVID
level in February. This index is appraisal based, using both sales and
nonsales information to track prices of properties managed by REITs.
---------------------------------------------------------------------------
Other indicators continue to show strains in CRE markets.
Vacancy rates continue to increase and rent growth has declined
further. Additionally, delinquency rates on commercial
mortgage-backed securities (CMBS), which usually contain
riskier loans, remain elevated. Delinquency rates for CRE loans
secured by COVID-affected properties, such as hotels and retail
properties, also rose during the second half of 2020. Finally,
the January 2021 Senior Loan Officer Opinion Survey on Bank
Lending Practices \8\ indicated that banks, on net, reported
weaker demand for most CRE loans and tighter lending standards
in the fourth quarter of 2020.
---------------------------------------------------------------------------
\8\ https://www.federalreserve.gov/data/sloos/sloos-202101.htm
---------------------------------------------------------------------------
It is too early to determine the long-term trends arising
from a prolonged work from home environment such as has been
experienced during the COVID event. The Federal Reserve will
continue to monitor the CRE market as these trends materialize.
Q.8. Your testimony notes that these changes have ``important
implications for financial stability, safety and soundness,
consumer protection, and underserved communities' access to
safe and fair financial services.''
What are the implications for consumer protection and
underserved communities' access to safe and fair financial
services you wish to bring to the attention of Congress, the
banking sector, the markets and the public?
A.8. As noted in my response to Question 4, customers' use of
digital financial services--banking, payments, investment,
insurance, lending, and financial planning--increased
substantially in the years preceding the COVID event and
continued to accelerate during the COVID event. The Federal
Reserve strongly supports responsible innovation and recognizes
the benefits it can offer to financial institutions,
businesses, and consumers, as seen by the vital role innovative
technology played in enabling the economy and financial
services throughout the course of the last year.
We also realize that innovation can lead to new and
unforeseen risks. In the financial arena, we have seen through
the years that many innovations, while beneficial, brought new
ways to introduce familiar problems, such as leverage, maturity
transformation, inadequate risk management, and too-big-to-fail
issues to manifest.
The combination of rapid changes in technology, the rise of
large technology firms, and the fact that oversight of these
entities and their financial activities may be limited and
dispersed across many different regulatory bodies provide a
real challenge--particularly to the financial system--as
society attempts to promote responsible innovation.
The Federal Reserve is focused on ensuring its oversight
takes into account technological innovation, particularly for
our supervised institutions. Much fintech development is
happening in the nonbank sector and the Federal Reserve does
not have direct supervisory authority over nonbank fintechs.
However, we continue to monitor developments to assess their
potential impact on the banking sector and on financial
stability. We also regularly discuss these topics with the
other agencies. In March 2021, along with the other Federal
financial regulatory agencies, we jointly issued an interagency
request for information on risk management of AI in financial
services. \9\ As nonbank fintechs partner with banking
organizations we supervise, we carefully review those
partnerships to ensure they do not raise risks to banks' safety
and soundness and comply with consumer protection requirements,
including fair lending laws and regulations that prohibit
illegal discrimination.
---------------------------------------------------------------------------
\9\ See Federal Reserve Board, Press Releases, ``Agencies Seek
Wide Range of Views on Financial Institutions' Use of Artificial
Intelligence'', March 29, 2021, https://www.federalreserve.gov/
newsevents/pressreleases/bcreg20210329a.htm.
---------------------------------------------------------------------------
The Federal Reserve's robust fair lending supervisory and
enforcement program reflects our commitment to promoting fair
lending and identifying unlawful discrimination in the
institutions we supervise. We examine for fair lending risk at
every consumer compliance exam, and a bank's fintech activities
are assessed within the fair lending review, commensurate with
the level of risk. In studying the benefits and challenges of
fintech, we look at the potential risks of amplifying bias and
inequitable outcomes. It is important that we understand how
complex data interactions may skew the outcomes of algorithms
in ways that undermine fairness and transparency.
Q.9. In your testimony, you note the use of artificial
intelligence (AI) specifically.
What concerns does the Federal Reserve have regarding AI?
A.9. The Federal Reserve supports responsible innovation by
financial institutions. With appropriate governance, risk
management, and compliance management, financial institutions'
use of AI has the potential to offer improved efficiency,
enhanced performance, and cost reduction for financial
institutions, as well as benefits to consumers and businesses.
At the same time, the use of AI presents a variety of
risks. Many of the potential risks associated with using AI are
not unique to AI. For instance, the use of AI could result in
operational vulnerabilities, such as internal process or
control breakdowns, cyberthreats, information technology
lapses, risks associated with the use of third parties, and
model risk, all of which could affect a financial institution's
safety and soundness. However, AI may present particular risk
management challenges to financial institutions, such as those
in the areas of explainability, data usage, and dynamic
updating. The use of AI can also create or heighten consumer
protection risks, such as risks of unlawful discrimination,
unfair, deceptive, or abusive acts or practices under the Dodd-
Frank Wall Street Reform and Consumer Protection Act, unfair or
deceptive acts or practices under the Federal Trade Commission
Act, or privacy concerns.
The Federal Reserve, in coordination with our fellow
Federal banking agencies, has taken a variety of steps to
assess the benefits and risks associated with AI. These steps
have included outreach to a wide range of external parties,
including banks, consumer groups, vendors, and others to hear a
range of perspectives on how the technology is being used and
particular risk management challenges that banks face in using
the technology. Among other efforts, the agencies hosted an Ask
the Regulators session for bankers in December 2020, and the
Federal Reserve hosted a 2-day academic symposium on AI in
January 2021.
Further, in March 2021, in collaboration with the Office of
the Comptroller of the Currency, Federal Deposit Insurance
Corporation, Consumer Financial Protection Bureau, and National
Credit Union Administration, the Federal Reserve published a
Request for Information (RFI) to explore whether additional
supervisory clarity is needed to facilitate the responsible use
of AI. The RFI explores the benefits and risks noted above in
more detail. The agencies are seeking feedback from a wide
range of stakeholders, including financial services firms,
technology companies, consumer advocates, civil rights groups,
merchants, and other businesses, and the public to inform any
future policy steps in this area. The agencies intend to
continue working together on further activities related to AI.
Q.10. How will the Federal Reserve ensure that AI does not lead
to discrimination in financial services?
A.10. Discrimination has no place in a fair and transparent
marketplace. Discriminatory practices can close off
opportunities and limit consumers' ability to improve their
economic circumstances, including through access to home
ownership and education. The Fair Housing Act (FHA) and Equal
Credit Opportunity Act (ECOA) were enacted to help ensure
consumers are treated fairly when offered financial products
and services. The Federal Reserve supervises the institutions
it oversees for compliance with these laws to ensure that banks
do not discriminate on the basis of race, color, national
origin, sex, religion, marital status, familial status, age,
handicap/disability, receipt of public assistance, and the good
faith exercise of rights under the Consumer Credit Protection
Act (collectively, the ``prohibited bases'').
The Federal Reserve's fair lending supervisory program
reflects our commitment to promoting financial inclusion and
ensuring that the financial institutions under our jurisdiction
fully comply with applicable Federal consumer protection laws
and regulations. In studying the benefits and challenges of
fintech, including AI, we look at the potential risks of
introducing or amplifying bias. It is important that we
understand how complex data interactions may skew the outcomes
of algorithms in ways that undermine fairness and transparency.
We review the use of fintech, including AI, in consumer lending
as part of our supervisory program, including evaluating
whether banks' use of AI creates consumer protection risks.
In addition to our supervisory work, we proactively support
financial institutions in their efforts to guard against fair
lending risks through outreach efforts that promote sound
compliance management practices and programs, including with
respect to the use of AI. Outreach efforts include Consumer
Compliance Outlook, a widely subscribed Federal Reserve System
publication focused on consumer compliance issues which has
included several focus pieces on the use of technology in
banking, its companion webinar series, Outlook Live, as well as
the Consumer Compliance Supervision Bulletin, which had an
issue dedicated to fintech. We continue to engage with public
stakeholders and to study the benefits and challenges of
fintech, including potential risks of amplifying bias and
inequitable outcomes. We hosted a public symposium dedicated to
leading academics discussing AI and bias and held an
interagency ``Ask the Regulator'' webinar on banks' use of AI
in December 2020.
The March 2021 interagency RFI on AI includes a section
dedicated to fair lending, seeking input on techniques
available to facilitate or evaluate the compliance of AI-based
credit determination approaches with fair lending laws; the
risks that AI can be biased and/or result in discrimination on
prohibited bases and how to reduce any such risks; how existing
principles and practices aid or inhibit evaluations of AI-based
credit determination approaches for compliance with fair
lending laws; and challenges financial institutions may face
when applying internal model risk management principles and
practices to the development, validation, or use of fair
lending risk assessment models based on AI.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCOTT
FROM RANDAL K. QUARLES
Q.1. I want to address your work with the International
Association of Insurance Supervisors and the current monitoring
period of the Insurance Capital Standard.
While these terms might not mean much to the average South
Carolinian, a bad outcome will mean that the average South
Carolinian will have their access to retirement products and
insurance services severely restricted. Recognition of O.S.
insurance capital standards as outcome-comparable to the ICS is
the ultimate and measurable goal here.
In speaking on this topic to the National Association of
Insurance Commissioners, you stated that if differences between
international insurance markets were significant, ``a one-size-
fits-all methodology could produce unintended consequences,
send false signals to regulators or capital markets, and
ultimately be destabilizing.'' Europeans do not have a need for
private-sector retirement products. Or private health
insurance. Our markets are radically different. A one-size-
fits-all approach to capital regulation will be a disaster.
Vice Chair Quarles, you are one of the most powerful
international regulatory voices in the world. You have
extensive relationships with the key financial regulatory
personnel--around the globe. I strongly urge you to commit to
using all necessary political capital to have the O.S. system
of insurance regulation formally deemed as equivalent at the
IAIS before your tenure at the Federal Reserve comes to a
close.
Is the Federal Reserve prepared to vote in favor of the
time-tested O.S. system of insurance regulation and deem group
capital measurement standards as preferable and outcome
comparable to the ICS? Perhaps better said, are you going to
stand up for both my constituent policyholders and American
insurers?
A.1. Yes, the Federal Reserve is committed to standing up for
U.S policy holders and insurers.
While it is important to note that none of the standards
set by the International Association of Insurance Supervisors
(IAIS) have binding effect on the United States, we believe
that it is in our national interest to engage in the
international insurance standards-development process so that
it produces standards that protect the U.S. market and U.S.
consumers when foreign insurers operate here through their U.S.
subsidiaries and that are appropriate for U.S. companies
operating abroad in a similar fashion.
The Federal Reserve advocates for the U.S. approach to
insurance regulation at the IAIS. To assess the adequacy of
group capital, U.S. regulators have proposed aggregating
existing legal entity capital requirements, referred to as the
Aggregation Method (AM). The Federal Reserve Board (Board)
proposed a similar approach, termed the Building Block Approach
(BBA), for depository institution holding companies
significantly engaged in insurance activities. The National
Association of Insurance Commissioners and the States have
proposed a similar approach, the Group Capital Calculation
(GCC). The Federal Reserve will continue to advocate for the AM
to be deemed an outcome-equivalent approach for implementation
of the Insurance Capital Standard.
Q.2. I am very interested in the promulgation of the final rule
applying capital standards to insurance companies that own
banks. I am concerned that the proposed rule would impose a
separate ``Collins Amendment'' calculation on certain insurance
companies, based solely on their business structure. I do not
believe this separate calculation to be statutorily required
and it runs directly counter to the sole reason Congress
enacted a--law in 2014--to prevent banking capital standards
from being imposed on insurance companies. Will you commit to
resolving this issue to better reflect the will of Congress in
the final rule?
A.2. As part of the Board's notice ofproposed rulemaking
regarding capital requirements for depository institution
holding companies that are significantly engaged in insurance
activities (proposal), the Board proposed to establish a
section 171 calculation to comply with section 171 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act), which, in part, requires the Board to establish
minimum risk-based capital requirements for depository
institution holding companies on a consolidated basis. The
proposed section 171 calculation would satisfy the requirement
in section 171 of the Dodd-Frank Act to establish a minimum
risk-based capital requirement on a consolidated basis for
depository institution holding companies, while excluding from
this calculation State-regulated insurers to the full extent
permitted by the Insurance Capital Standards Clarification Act
of 2014 (the Clarification Act).
The Board invited public comment on all aspects of the
proposal, including the section 171 calculation. Several
comments suggested that the Building Block Approach (BBA) would
comply with the statutory requirements without an additional
calculation because the BBA's minimum requirement would not be
less than the generally applicable capital requirement.
Consistent with the Administrative Procedure Act, the Board
will consider the comments on the proposal, the requirements of
section 171 of the Dodd-Frank Act (as amended by the
Clarification Act), and other provisions of law, before making
a final rule. The Board continues to consider whether the
proposed section 171 calculation is necessary in order to
ensure that minimum risk-based capital requirements for
depository institution holding companies that are significantly
engaged in insurance activities are established on a
consolidated basis.
Q.3. In recent weeks, you stated: ``Today, the U.S. banking
system is actually more liquid and better capitalized than it
was a year ago, with over $100 billion in additional loan loss
reserves, leaving it well-positioned to weather future
shocks,'' and ``[t[he stress testing program not only prepared
banks for a period of prolonged hardship; it also clarified
their health and resilience as the COVID event progressed.''
How do you reconcile these statements with the fact that
the Federal Reserve is planning to propose Basel III
finalization rules this year that will potentially drive a
large increase in bank capital requirements?
A.3. As I have often stated, the levels of loss absorbing
capital in the banking system that have largely prevailed
throughout my term at the Federal Reserve, are generally
appropriate. Strengthened by a decade of improvements in
capital, liquidity, and risk management, banks have continued
to be a source of strength during the past year. As we work to
implement the Basel III reforms in the United States, we will
aim to maintain these levels of overall strength in our bank
capital requirements.
Q.4. As the Federal Reserve works to complete its economic
analysis to support further Basel III implementation, will the
Fed commit to completing an analysis of the proposed revisions
on all categories of subject banking organizations, including,
for example, IHCs, which have been left out of some prior
quantitative impact studies that focused only on domestic bank
holding companies?
A.4. As a general matter, economic impact analyses associated
with proposed rulemakings focus on the banking organizations to
which a given proposal would apply. Under the current capital
framework, the Basel-based advanced approaches apply to
Category I organizations (U.S. global systemically important
firms) and Category II organizations (firms of global scale
with more than $700 billion in assets or more than $75 billion
in cross-jurisdictional activity). This is consistent with the
approach the Federal banking agencies described in the 2019
tailoring rule that is, applying requirements that reflect
agreements reached by the Basel Committee is appropriate for
the risk profiles of banking organizations in these two
categories. As of 2021, no intermediate holding company (IHC)
exceeds the relevant thresholds to qualify as a Category I or
II organization and therefore no IHC is currently subject to
the advanced approaches framework. While all IHCs are currently
classified as Category III or below, some IHCs could rise to
Category II status in the future depending on their activities
in the United States. As we develop the proposal to implement
the outstanding Basel III capital reforms in the United States,
including determining the proposed scope of application, our
related analysis would incorporate any firms that would be in
scope.
Q.5. And finally, how does the Federal Reserve intend to
release the economic impact analysis to ensure transparency of
impact across all categories of institutions?
A.5. Consistent with our general practice, we would include a
discussion of economic impact of the proposed rule to implement
the outstanding Basel III reforms in the United States in the
Federal Register.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
FROM RANDAL K. QUARLES
Q.1. As a follow-up to your exchange with Senator Warren on the
Large Institution Supervision Coordinating Committee (LISCC),
would any changes made to LISCC designations over your term
have prevented what happened at Archegos?
A.1. The Archegos-related exposures that ultimately led to
substantial losses in the non-U.S. operations of certain non-
U.S. banks were largely established while the U.S. operations
of those banks were supervised as part of the LISCC portfolio
at the Federal Reserve, so the change of supervisory portfolio
was not a factor in the practices that led to the losses. Nor
was the Archegos incident an example of a failure of Federal
Reserve supervision, whether LISCC or non-LISCC: the great bulk
of the losses associated with Archegos occurred in non-U.S.
banks, in activities outside the U.S. bank regulatory perimeter
that are supervised by authorities other than the Federal
Reserve. Only a small portion of the Archegos-related losses
fell within the Federal Reserve's jurisdiction, and in our
annual stress tests of the U.S. banking system we regularly
ensure the ability of the U.S. system to withstand capital
market activity losses that are as much as 100 times as large
as the Archegos losses in the United States, and indeed nearly
9 times as large as the aggregate Archegos losses in the entire
global banking system.
Finally, the realignment of certain banks from the LISCC
supervisory portfolio to our Large and Foreign Banking
Organization (LFBO) portfolio will not make future such
incidents any more likely. LFBO supervision is not ``weaker''
supervision; it is supervision of firms in a manner that allows
the comparison of firms with similar risks to each other. The
realigned banks have reduced the size of their U.S. operations
dramatically, so the U.S. risks of those operations are now
more similar to those of similarly sized foreign banks that
have already long been supervised in our LFBO portfolio than
they are to the U.S. global systemically important banks
(GSIBs) that now constitute our LISCC portfolio.
More specifically, the Federal Reserve Board (Board) sorts
firms into supervisory portfolios based on considerations
outlined in the Board's tailoring rule and consistent with the
Economic Growth, Regulatory Relief and Consumer Protection Act
of 2018. Specifically, the Board applies regulatory standards
to firms on the basis of size, cross-jurisdictional activity,
nonbank assets, weighted short-term wholesale funding, and off-
balance-sheet assets.
The Federal Reserve supervises the intermediate holding
companies of foreign banking organizations under the Large
Foreign Banking Organization portfolio with other large and
complex firms that are not U.S. GSIBs and subjects them to
standards of supervision and regulation commensurate with their
risk. The goal of these stringent standards across supervisory
portfolios is to require these firms to hold sufficient capital
and liquidity. No matter the supervisory portfolio, supervisory
focus is directed to drivers of risk for individual firms to
ensure that effective systems are in place such that risks like
those resulting from the Archegos default are identified in a
timely manner and appropriately analyzed and mitigated such
that associated losses are nonsystemic if they do occur.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TILLIS
FROM RANDAL K. QUARLES
Q.1. In recent testimony before the House Financial Services
Committee, who stated that the Fed's supervisory stance was not
materially deficient and that a ``bulk'' of the losses related
to Archegos occurred outside the United States, and thus, did
not present a material risk to the U.S. economy. You also said
any regulatory proposals in response would be premature and
this ``remains largely a risk management issue.'' Given your
remarks and the fact that both LISCC and non-LISCC firms, which
are subject to the same heightened capital and liquidity
requirements, had exposure to Archegos, is it a leap to suggest
that placing all of the recently removed firms back into LISCC
would have prevented the losses from occurring?
A.1. The Archegos-related exposures that ultimately led to
substantial losses in the non-U.S. operations of certain non-
U.S. banks were largely established while the U.S. operations
of those banks were supervised as part of the LISCC portfolio
at the Federal Reserve, so the change of supervisory portfolio
was not a factor in the practices that led to the losses. Nor
was the Archegos incident an example of a failure of Federal
Reserve supervision, whether LISCC or non-LISCC: the great bulk
of the losses associated with Archegos occurred in non-U.S.
banks, in activities outside the U.S. bank regulatory perimeter
that are supervised by authorities other than the Federal
Reserve. Only a small portion of the Archegos-related losses
fell within the Federal Reserve's jurisdiction, and in our
annual stress tests of the U.S. banking system we regularly
ensure the ability of the U.S. system to withstand capital
market activity losses that are as much as 100 times as large
as the Archegos losses in the United States, and indeed nearly
9 times as large as the aggregate Archegos losses in the entire
global banking system.
Finally, the realignment of certain banks from the LISCC
supervisory portfolio to our Large and Foreign Banking
Organization (LFBO) portfolio will not make future such
incidents any more likely. LFBO supervision is not ``weaker''
supervision; it is supervision of firms in a manner that allows
the comparison of firms with similar risks to each other. The
realigned banks have reduced the size of their U.S. operations
dramatically, so the U.S. risks of those operations are now
more similar to those of similarly sized foreign banks that
have already long been supervised in our LFBO portfolio than
they are to the U.S. global systemically important banks
(GSIBs) that now constitute our LISCC portfolio.
More specifically, the Federal Reserve Board (Board) sorts
firms into supervisory portfolios based on considerations
outlined in the Board's tailoring rule and consistent with the
Economic Growth, Regulatory Relief and Consumer Protection Act
of 2018. Specifically, the Board applies regulatory standards
to firms on the basis of size, cross-jurisdictional activity,
nonbank assets, weighted short-term wholesale funding, and off-
balance-sheet assets. The Federal Reserve supervises the
intermediate holding companies of foreign banking organizations
under the Large Foreign Banking Organization portfolio with
other large and complex firms that are not U.S. GSIBs and
subjects them to standards of supervision and regulation
commensurate with their risk. The goal of these stringent
standards across supervisory portfolios is to require these
firms to hold sufficient capital and liquidity. No matter the
supervisory portfolio, supervisory focus is directed to drivers
of risk for individual firms to ensure that effective systems
are in place such that risks like those resulting from the
Archegos default are identified in a timely manner and
appropriately analyzed and mitigated such that associated
losses are nonsystemic if they do occur.
Q.2. Thank you for your letter to update me last week on the
Board staff efforts to analyze and consider different
approaches to update Regulation T to make additional OTC
securities margin eligible. I appreciate the desire that any
amendments to Reg T would be ``straightforward to implement''
and ``cover a meaningful set of OTC stocks that are liquid but
not already margin-eligible.'' As you know, these rules have
not been updated since 1999, when Nasdaq was the primary
electronic market for OTC securities. Since then, there have
been significant developments in the OTC marketplace, including
Nasdaq becoming an exchange over 14 years ago, and the many
improvements made since then to increase transparency,
liquidity, and information in OTC securities. An update on the
margin eligibility for OTC securities is long overdue. Can you
give me a timeframe for when I can expect to see a proposal
from the Fed on this issue?
A.2. Board staff are continuing to explore avenues for
increasing the universe of equity securities eligible as
collateral for securities trading at broker-dealers. Board
staff are consulting with industry representatives and other
regulators in an attempt to develop a meaningful standard for
assessing the creditworthiness, as collateral, of stocks not
traded on a U.S. securities exchange. These consultations
involve a number of details and issues that are not in our
control and I thus cannot yet give a definitive timetable for
when this effort will be complete. We remain however actively
engaged in the matter.
[all]