[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
IMPLEMENTING BASEL III:
WHAT'S THE FED'S ENDGAME?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
AND MONETARY POLICY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 14, 2023
__________
Printed for the use of the Committee on Financial Services
Serial No. 118-45
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
54-177 PDF WASHINGTON : 2024
-----------------------------------------------------------------------------------
HOUSE COMMITTEE ON FINANCIAL SERVICES
PATRICK McHENRY, North Carolina, Chairman
FRANK D. LUCAS, Oklahoma MAXINE WATERS, California, Ranking
PETE SESSIONS, Texas Member
BILL POSEY, Florida NYDIA M. VELAZQUEZ, New York
BLAINE LUETKEMEYER, Missouri BRAD SHERMAN, California
BILL HUIZENGA, Michigan GREGORY W. MEEKS, New York
ANN WAGNER, Missouri DAVID SCOTT, Georgia
ANDY BARR, Kentucky STEPHEN F. LYNCH, Massachusetts
ROGER WILLIAMS, Texas AL GREEN, Texas
FRENCH HILL, Arkansas, Vice EMANUEL CLEAVER, Missouri
Chairman JIM A. HIMES, Connecticut
TOM EMMER, Minnesota BILL FOSTER, Illinois
BARRY LOUDERMILK, Georgia JOYCE BEATTY, Ohio
ALEXANDER X. MOONEY, West Virginia JUAN VARGAS, California
WARREN DAVIDSON, Ohio JOSH GOTTHEIMER, New Jersey
JOHN ROSE, Tennessee VICENTE GONZALEZ, Texas
BRYAN STEIL, Wisconsin SEAN CASTEN, Illinois
WILLIAM TIMMONS, South Carolina AYANNA PRESSLEY, Massachusetts
RALPH NORMAN, South Carolina STEVEN HORSFORD, Nevada
DAN MEUSER, Pennsylvania RASHIDA TLAIB, Michigan
SCOTT FITZGERALD, Wisconsin RITCHIE TORRES, New York
ANDREW GARBARINO, New York SYLVIA GARCIA, Texas
YOUNG KIM, California NIKEMA WILLIAMS, Georgia
BYRON DONALDS, Florida WILEY NICKEL, North Carolina
MIKE FLOOD, Nebraska BRITTANY PETTERSEN, Colorado
MIKE LAWLER, New York
ZACH NUNN, Iowa
MONICA DE LA CRUZ, Texas
ERIN HOUCHIN, Indiana
ANDY OGLES, Tennessee
Matt Hoffmann, Staff Director
Subcommittee on Financial Institutions and Monetary Policy
ANDY BARR, Kentucky, Chairman
BILL POSEY, Florida BILL FOSTER, Illinois, Ranking
BLAINE LUETKEMEYER, Missouri Member
ROGER WILLIAMS, Texas NYDIA M. VELAZQUEZ, New York
BARRY LOUDERMILK, Georgia, Vice BRAD SHERMAN, California
Chairman GREGORY W. MEEKS, New York
JOHN ROSE, Tennessee DAVID SCOTT, Georgia
WILLIAM TIMMONS, South Carolina AL GREEN, Texas
RALPH NORMAN, South Carolina JOYCE BEATTY, Ohio
SCOTT FITZGERALD, Wisconsin JUAN VARGAS, California
YOUNG KIM, California SEAN CASTEN, Illinois
BYRON DONALDS, Florida AYANNA PRESSLEY, Massachusetts
MONICA DE LA CRUZ, Texas
ANDY OGLES, Tennessee
C O N T E N T S
----------
Page
Hearing held on:
September 14, 2023........................................... 1
Appendix:
September 14, 2023........................................... 39
WITNESSES
Thursday, September 14, 2023
Baer, Greg, President and CEO, Bank Policy Institute (BPI)....... 5
Broeksmit, Robert D., President and CEO, Mortgage Bankers
Association (MBA).............................................. 6
Olmem, Andrew, Partner, Mayer Brown LLP.......................... 8
Philo, Alexa, Senior Policy Analyst for Banking, Systemic Risk,
Economic Justice & Racial Equity, Americans for Financial
Reform (AFR)................................................... 10
APPENDIX
Prepared statements:
Baer, Greg................................................... 40
Broeksmit, Robert D.......................................... 57
Olmem, Andrew,............................................... 66
Philo, Alexa................................................. 76
Additional Material Submitted for the Record
Baer, Greg:
Written responses to questions for the record from
Representative Barr........................................ 89
Written responses to questions for the record from
Representative Donalds..................................... 90
Written responses to questions for the record from
Representative Waters...................................... 92
Broeksmit, Robert D.:
Written responses to questions for the record from
Representative Barr........................................ 93
Written responses to questions for the record from
Representative Donalds..................................... 106
Written responses to questions for the record from
Representative Waters...................................... 107
Olmem, Andrew:
Written responses to questions for the record from
Representative Donalds..................................... 108
Written responses to questions for the record from
Representative Waters...................................... 110
Philo, Alexa:
Written responses to questions for the record from
Representative Barr........................................ 112
Written responses to questions for the record from
Representative Donalds..................................... 117
Written responses to questions for the record from
Representative Waters...................................... 118
IMPLEMENTING BASEL III:
WHAT'S THE FED'S ENDGAME?
----------
Thursday, September 14, 2023
U.S. House of Representatives,
Subcommittee on Financial Institutions
and Monetary Policy,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:02 a.m., in
room 2128, Rayburn House Office Building, Hon. Andy Barr
[chairman of the subcommittee] presiding.
Members present: Representatives Barr, Posey, Luetkemeyer,
Williams of Texas, Loudermilk, Rose, Timmons, Norman,
Fitzgerald, Kim, De La Cruz, Ogles; Foster, Sherman, Meeks,
Scott, Green, Beatty, Vargas, Casten, and Pressley.
Ex officio present: Representatives McHenry and Waters.
Also present: Representative Himes.
Chairman Barr. The Subcommittee on Financial Institutions
and Monetary Policy will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time.
Today's hearing is entitled, ``Implementing Basel III:
What's the Fed's Endgame?''
I now recognize myself for 4 minutes to give an opening
statement.
Federal banking regulators recently proposed several new
rules to rewrite regulations in the financial system on a
largely partisan basis. The proposed rule that would have the
largest effect is a so-called Basel III Endgame proposal. That
proposal is underdeveloped and misleadingly motivated, and was
written behind closed doors principally by the Fed's Vice Chair
for Supervision as part of his holistic review. That proposal
is being sold partly under the guise of implementing the Basel
Committee on Banking Supervision's recommended Basel III
framework, thereby outsourcing U.S. standards to an opaque
global governance committee in Europe.
But the proposal put forward goes far beyond those
recommendations. It would unfortunately put the U.S. ahead in a
race to a gold-plated top for global capital requirements and
push the U.S. to the bottom for global competitiveness. The
proposal would install arbitrary and extreme increases in
required capitalization for what regulators, Biden
Administration officials, and Fed stress tests have said is an
already resilient, well-capitalized U.S. banking system. The
proposal is partisan, as evidenced by the Fed's and the FDIC's
Board votes and the lack of consensus and unanimity among Fed
Governors and FDIC Directors. Partisan rulemaking by Democrat-
appointed Federal banking regulators is a tacit admission that
they are content surrendering independence of their agencies
for short-term political gain.
The Basel-related capital proposal lacks a convincing
foundation and it is cynical to put it forward as a rationale
for the non-credible evaluation of the March banking
instability authored and engineered solely by the Vice Chair
for Supervision at the Fed. The proposal appears, in many
areas, to simply be arbitrary and capricious. The proposal was
put forward with shockingly little quantitative analysis of
what the impacts would be, and where the unintended
consequences would be felt, and there is no substantive cost-
benefit analysis.
Members of this committee from both sides of the aisle
asked for analysis from the Fed's Vice Chair of Supervision,
yet the request was essentially ignored. The proposal also
presents unexplored threats to capital markets, including
markets for Treasury securities, and no one knows how the
proposal will interact with other recent proposals by the
regulators, with yet more seemingly on the horizon.
In a time of historic inflation, the fastest increases in
interest rates in modern history, and a growing likelihood of a
credit crunch, now is not the time to raise capital levels.
Such action threatens to further constrain credit availability
and put already-sensitive sectors, such as commercial real
estate, in further peril. The proposal would be an effective
repeal by rule-writing of bipartisan congressional intent in
the S. 2155 Tailoring law, a repeal that has been a partisan
goal for some even before the March banking stresses and has
essentially been instructed by President Biden.
The Basel III Endgame proposal is just a start for
Democrat-appointed Federal bank regulators. Since that proposal
was made in July, proposals for long-term debt and resolution
plans have been put forward, which this subcommittee will
consider in our next hearing, and we have heard that even more
is in the pipeline. Yet the regulators in charge will not
directly tell Congress or the American people and possibly even
their fellow board members of their plans.
Federal banking regulation under the Biden Administration
has become unnecessarily divisive and partisan, which itself is
an emerging threat to stability. The divisive, underdeveloped,
and arbitrary Basel III Endgame proposal should be withdrawn
and replaced with a proposal that focuses on addressing
problems that exist and uses adequate input from the private
sector and Congress, as well as robust impact and economic
analysis.
The Chair now recognizes the ranking member of the
subcommittee, the gentleman from Illinois, Mr. Foster, for 4
minutes for an opening statement.
Mr. Foster. Thank you, Chairman Barr, and thank you to our
witnesses for joining us. Today, we will discuss Federal
prudential regulators' joint proposals to implement the final
components of Basel III agreements and modify capital
calculations for U.S. global systemically important banks (G-
SIBs). These proposals modify capital requirements for the
largest U.S. banks with a goal of ensuring that they
appropriately account for the risk of their activities and hold
the necessary assets and reserve to weather periods of
significant stress in the financial system.
The 2008 financial crisis and the subsequent taxpayer-
funded bailout of banks and the long-lasting damage to the
financial health of our country demonstrated the need for
reforms to ensure the safety and soundness of the U.S. banking
system. In the years that followed the financial crisis,
Congress enacted the Dodd-Frank Act, and global regulators
convened to develop what would become the Basel III framework,
many facets of which have already been implemented.
During the passage and implementation of the Dodd-Frank Act
and the initial implementation of phases of Basel III, many
predicted that the higher capital requirements would damage the
competitiveness of the banking industry in the United States.
They predicted that the increased capital requirements,
particularly focused on the largest U.S. banks, would make it
hard for large U.S. banks to remain profitable and to compete
against both their international competitors and against their
smaller competitors in the United States.
In practice, the exact opposite has proven true. These
firms continued to lend at record levels and earned record
profits and outcompeted their foreign competitors in the stable
and growing economy that followed those reforms. But as history
has shown, threats to the financial system are dynamic,
difficult to predict, and constantly evolving. Until recently,
bank failures have been controlled, and have not required bank
regulators to utilize emergency measures to head off systemic
risk and contagion in the banking system. In an age of rapid
financial innovation, internet-driven bank runs, rising
geopolitical tensions, pandemics, and climate change,
regulators and Congress must respect the lessons learned from
the financial crises of our past, while also looking ahead and
adjusting prudential standards as necessary to account for
emerging risks.
The proposals that we are discussing today are necessarily
complex, totaling more than 1,100 pages. The details are
important since they will undoubtedly have effects on the
lending activity, market behavior, and internal operations both
of the large U.S. banks, which will be directly affected, and
the other players in the economy which will have to adapt to a
new equilibrium. Because of that complexity, it is important
that the public have maximum visibility into both the rules
themselves and the quantitative consideration that led to the
final choices made.
For that reason, in July, I joined Chairman Andy Barr in
sending a letter to the Federal Reserve Vice Chair for
Supervision, requiring details of the analysis and supporting
data used to carry out the holistic review of capital
requirements that led to the proposals we are discussing today,
as well as any other supporting data or key assumptions that
have to be made. We must recognize that this is not a purely
quantitative operation. The analyses of bank requirements have
important assumptions that have to be made regarding the
probability of financial failures for a given level of banking
and the cost of those financial failures, although it is
unlikely those will be exactly calculable ever, but it is
important the public see the key assumptions.
The Federal Reserve's response to date has not included
this information we asked for, and I urge them to be more
forthcoming. With that said, I look forward to hearing the
perspectives of our witnesses today, and thank you again, Chair
Barr, for holding this hearing.
Chairman Barr. Thank you to the ranking member. The Chair
now recognizes the Chair of the full Financial Services
Ccommittee, the gentleman from North Carolina, Chairman
McHenry, for 1 minute.
Chairman McHenry. Thanks, Chairman Barr. The Biden-
appointed Federal banking regulators had the opportunity to
learn from the March banking instability. They had the chance
to productively engage with Congress and propose reasonable
changes to regulation to improve safety, soundness, and
stability. Instead, they took advantage of a crisis to justify
their long-held, politically-motivated priorities.
Members of this committee on both sides of the aisle have
asked for the economic analysis to justify the Basel-related
proposals. The Fed's Vice Chair for Supervision has essentially
ignored that request. We need to know how this will impact
inflation, which accelerated in August. What about the Fed's
rate policy, how does it affect that, or credit availability,
how does it affect that or the cost of credit? We need to
answer these questions for the American people whose day-to-day
lives will only get harder if this is implemented. That is why
Committee Republicans sent a letter this week calling on
Biden's regulators to rescind this deeply-flawed proposal. We
need to see the economic analysis, the American people need to
understand the justification, and we need to hold them
accountable. I yield back.
Chairman Barr. The gentleman yields back. The Chair now
recognizes the ranking member of the Full Committee, the
gentlewoman from California, Ranking Member Waters, for 1
minute.
Ms. Waters. Thank you very much. We certainly did receive a
wake-up call this spring with the failures of Silicon Valley
Bank, Signature Bank, and First Republic Bank. It became clear
that we need to improve safety and soundness rules for large
banks, given the systemic risks they can pose. To that end,
regulators propose to strengthen bank capital requirements for
the largest banks to ensure that, among other things, they hold
sufficient capital for unrealized losses in their securities
portfolios.
I am talking about the Federal Reserve, the Federal Deposit
Insurance Corporation, and the Office of the Comptroller of the
Currency. They all are urging us to make sure that we do what
is necessary to ensure the safety and soundness of our banks.
Their proposal would also implement an international agreement
that the United States made with other countries in 2017 that
Mr. Trump's regulators ignored while they prioritized
deregulating big banks that could put our economy at risk. Here
is the bottom line: We need stronger rules, not deregulation,
to avoid future crises.
Chairman Barr. The gentlelady's time has expired.
Ms. Waters. I yield back.
Chairman Barr. Today, we welcome the testimony of Mr. Greg
Baer, the president and chief executive officer of the Bank
Policy Institute; Mr. Robert Broeksmit, the president and CEO
of the Mortgage Bankers Association; Mr. Andrew Olmem, a
partner at Mayer Brown; and Ms. Alexa Philo, a senior policy
analyst for banking, systemic risk, economic justice & racial
equity at Americans for Financial Reform. We thank each of you
for taking the time to be here.
Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. And without objection,
each of your written statements will be made a part of the
record.
Mr. Baer, you are now recognized for 5 minutes for your
oral remarks.
STATEMENT OF GREG BAER, PRESIDENT AND CEO, BANK POLICY
INSTITUTE (BPI)
Mr. Baer. Chairman Barr, Ranking Member Foster, and members
of the subcommittee, thanks for the invitation to testify
today. Congressional attention here is important, given the
stakes for the U.S. economy. It is further warranted because
the agency's proposal would constitute a de facto repeal of
regulatory tailoring legislation that Congress passed on a
bipartisan basis in 2018.
Before getting into the details of the proposal, I would
like to dispel three misunderstandings that have arisen around
it. First, some have suggested that it is a response to the
failure of Silicon Valley Bank and a few others in March 2023.
Those banks failed for two reasons: interest rate risk; and
liquidity risk. The proposed Basel rule has nothing to do with
liquidity risk or interest rate risk. It is about everything
else: credit risk, market risk, operational risk, counterparty
credit risk, and risk on derivative instruments. It is apples
and oranges or apples and refrigerators.
Second, some have suggested that this proposal is needed
because bank capital models understated risk and caused the
global financial crisis. An undisputed fact: No U.S. bank had
adopted the internal models approach to capital assessment by
2008. The global financial crisis occurred on the watch of a
Basel-standardized approach, remarkably, a standardized
approach that this proposal will continue.
Third, some believe that while significantly higher capital
charges will push activity out of the banking system, there is
no problem with that, as nonbanks will pick up the slack. There
are a lot of problems with that. Banks lend at intermediated
lower rates than nonbanks not because they are kinder or
dumber, but rather because their deposit base gives them a
lower cost and more stable source of funding. As a result,
banks are the only reliable lenders during an economic
downturn.
I remember asking a fintech executive in March of 2020 how
her firm had weathered the crisis. Her answer was, ``It was
easy. We just stopped lending.'' Consistent with that, very
recent research from the Bank for International Settlements
found that non-financial firms cut lending by about 50 percent
more than banks in the face of financial shocks.
Turning to the proposal, the second half of the proposal
was a series of formulas setting a risk weight for every bank
loan or exposure, and the first half is a description of those
formulas. What the proposal is oddly lacking is any explanation
for how those risk weights were, in fact, derived. The proposal
contains almost no analysis of the absolute or relative risk of
the underlying assets or exposures. The absence of detailed
historical analysis is incredible, given that the agency
possess a massive database of historical experience and have
easy access to market data. In place of analysis, the agency
simply set the 2017 agreement negotiated by Agency staff in
Basel as a minimum requirement for U.S. banks, but that
agreement is not a treaty, and it carries no legal weight in
this country. Furthermore, it was adopted before the Federal
Reserve began to impose a stress capital charge for many of the
very same risks contained in the Basel agreement.
Most importantly, the proposal ignores reality. Since 2010,
the nation's largest banks have weathered very large
macroeconomic shocks and market turmoil, benefiting from
diversification across both product and geographic lines. In
contrast, the proposed rule implicitly finds that every large
bank in this country is undercapitalized and requires, on
average, 16 percent more capital. The proposed rule is
calibrated at such a high level that it will be difficult to
offer products that the Basel formulas and the Fed stress
testers favor. Thus, and to an unprecedented extent in the
history of this country, the decision of whether you get that
loan and how it will be priced would be shifted from banks and
their loan officers to the formula writers in Basel and the
stress testers at the Federal Reserve.
Lastly, I should note that while the agency frequently
refers to this as an implementation of the Basel agreement, the
clear understanding at the time the Basel agreement was
announced in 2017 was that it would not increase capital for
the covered banks and would probably decrease capital. This is
completely inconsistent with that understanding. If the
proposed rule were adopted, banks operating in the United
States would be the only major banks in the world being
assessed solely based on a standardized approach, would be the
only banks in the world experiencing an explicit stress capital
charge on top of that standardized charge, and would be the
only banks in the world facing a variety of capital add-ons
above the Basel-agreed risk rates. And we don't know why,
particularly for the regional banks, which Congress
specifically said should be exempt from this kind of treatment.
Thank you for your time.
[The prepared statement of Mr. Baer can be found on page 40
of the appendix.]
Chairman Barr. Thank you, Mr. Baer. Mr. Broeksmit, you are
now recognized for 5 minutes to give your oral remarks.
STATEMENT OF ROBERT D. BROEKSMIT, PRESIDENT AND CEO, MORTGAGE
BANKERS ASSOCIATION (MBA)
Mr. Broeksmit. Chairman Barr, Ranking Member Foster, and
members of the subcommittee, my name is Bob Broeksmit, and I
appreciate the opportunity to testify this morning on behalf of
the Mortgage Bankers Association, the national association
representing more than 2,200 member firms in an industry that
employs 390,000 individuals and provides real estate finance-
related services in virtually every community across our
nation. My over 35 years of experience in real estate finance
gives me a unique appreciation for the complexity of the
housing finance system as well as the importance of ensuring
that it works for all participants.
MBA believes that this notice of proposed rulemaking (NPR)
poses unwarranted risks to the U.S. economy, to housing, and
real estate markets, specifically, and contradicts many of the
Biden Administration's policy goals. This includes efforts to
close the racial homeownership and wealth gaps, the provision
of affordable housing, the promotion of competition over
consolidation, and the upcoming unveiling of a final Community
Reinvestment Act rule.
It is still unclear how the NPR interacts with other
regulatory proposals and how these rules collectively could
stunt economic growth and credit access needed to support the
creation of more affordable housing from the largest providers
of capital in the country. It is also unclear what specific
problems the NPR is trying to, solve considering that the
Federal Reserve and the U.S. Treasury have consistently stated
that the banking system is strong. For example, capital ratios
of large banks operating in the U.S. have more than doubled
since the great financial crisis, and more than a decade of
real-life experience has demonstrated that banks have adequate
capital to withstand significant economic shocks. In fact,
recent stress test results confirm that the banking system is
safe and well-capitalized.
The large increases in capital standards will likely stunt
macroeconomic growth and reduce banks' participation as single-
family and commercial multi-family lenders and servicers, and
as providers of warehouse lines and mortgage servicing rights
financing. The proposed changes effectively increase capital
requirements at larger banks by about 15 to 20 percent, large
enough to impact which lines of business banks choose to
withdraw from or support.
The proposal makes significant changes to how banks
calculate their risk-weighted assets and imposes several
additional requirements on banks with assets of $100 billion or
more, including lowering the cap on regional banks' holdings of
mortgage servicing rights to 10 percent of capital less than 5
years after it was raised to 25 percent to encourage more banks
to service mortgages. And under the proposal--get this--every
million dollars of capital an impacted bank allocates to
mortgage lending would translate to at least $7 million less
lending to first-time homebuyers who can't come up with a 20-
percent down payment.
This, in turn, could cause banks to pull back even further
from the mortgage business, making homeownership less
attainable to first-time homebuyers and low- and moderate-
income borrowers with smaller down payments. These borrowers
overwhelmingly rely on low down payments to attain
homeownership, and the proposed capital rule could discourage
bank portfolio lending to these borrowers, driving all low-
down-payment activity to the Government-Sponsored Enterprises
(GSEs) or government-insured and guaranteed programs. As a
result, the proposed requirements could undercut the Community
Reinvestment Act (CRA) and Special Purpose Credit Programs that
leverage portfolio lending as strategies to close the racial
homeownership and wealth gaps.
The failure of the proposal to provide any credit
whatsoever for private mortgage insurance effectively defeats
the purpose of that insurance and significantly increases costs
for homebuyers. A capital regime that recognizes the mitigation
of credit risk provided by private mortgage insurance is not
only far more efficient, but also reduces costs and improves
affordability for first-time and underserved homebuyers who
cannot make a 20-percent down payment. Given ongoing affordable
housing challenges, regulators should be taking steps that
encourage banks to better support real estate finance markets.
This proposal does precisely the opposite, despite near record
low single-family delinquencies and pristine underwriting.
In conclusion, MBA strongly opposes certain provisions of
the proposal that undermine the mortgage market, and takes
exception to the extremely scant economic analysis regarding
how the changes will affect the economy, the single-family
housing market, and the commercial real estate finance markets.
Thank you for the opportunity to testify this morning, and I
look forward to answering your questions.
[The prepared statement of Mr. Broeksmit can be found on
page 57 of the appendix.]
Chairman Barr. Thank you. Mr. Olmem, you are now recognized
for 5 minutes.
STATEMENT OF ANDREW OLMEM, PARTNER, MAYER BROWN LLP
Mr. Olmem. Chairman Barr, Ranking Member Foster, and
members of the subcommittee, thank you for the opportunity to
discuss the recently-proposed Basel III Endgame proposal. My
testimony today is given in my personal capacity and not on
behalf of Mayer Brown or any of its clients.
The Basel III Endgame proposal represents a major shift in
bank regulatory policy. By design, the proposal will have
substantial long-term consequences for American households,
businesses, and the overall economy. Yet, the significance of
the proposal is not only its economic impact. The proposal does
not satisfy well-established, congressionally-prescribed
procedural requirements intended to ensure transparency,
informed decision-making, and accountability.
As if these errors are not enough of a problem, there is a
more fundamental problem with the proposal. It disregards
Congress' mandates governing capital requirements. The
problematic nature of the proposal is particularly
consequential because capital requirements are among the most
important regulations in economic policy. They not only ensure
that the banking system is safe and sound but also influence
the allocation of credit, determining if and on what terms
credit is extended and by whom. Improperly-calibrated capital
requirements can undermine economic growth and potentially
threaten the stability of the financial system. It is therefore
critical that capital requirements are appropriately calibrated
and durable, yet this proposal falls short on both accounts.
First, the proposal fails to provide the data supporting
its policy choices and prevents an effective notice-and-comment
period. Under the Administrative Procedure Act (APA), notice
and comment is part of the process of formulating the rule. It
is designed to provide an agency with valuable information from
the public about how a rule could operate and its potential
impact so that the agency can then use the information to
improve the rule. That is why it is hard to understand why the
banking agencies omitted the supporting data. The public could
have used the data to provide more-informed comments and
thereby help improve the rule. If the proposal is sound, the
data will support it. If not, the proposal should be changed as
the APA requires.
The proposal also provides inadequate information about its
potential impacts, including on lending to consumers and small
and medium-sized businesses. It also does not discuss whether
it could trigger mergers or change the structure of the banking
industry. The rush to complete this proposal has left key
questions unanswered. It has also left the proposal vulnerable
to legal challenges under the APA.
In addition, the proposal disregards Congress' specific
directive contained in both the Dodd-Frank Act and S. 2155 that
the Federal Reserve tailor capital requirements. The law
clearly states that the Federal Reserve, ``shall differentiate
among companies based on the individual basis by category,
taking into consideration their capital structure, riskiness,
complexity, financial activity, size, and any other risk-based
factors the board deems appropriate.''
Despite that clear language, the proposal embraces uniform
capital requirements for all banking organizations with $100
billion or more in assets, and all but eliminates the
prudential tailoring scheme adopted by the Fed just 4 years
ago. In the entire 1,087-page proposal, tailoring is mentioned
only in a single footnote. A uniform one-size-fits-all
regulation may be easier for banking agencies to implement and
enforce, but Congress recognized that it does not account for
the diversity of business models that are essential to finance
the U.S.'s $23-trillion economy.
That is why Congress enacted tailoring mandates in not one,
but in two statutes in just the last 13 years. If the banking
agencies believe that the tailoring mandates impede their
ability to craft appropriate capital standards, the
constitutionally-prescribed course is to request that Congress
change the statute. Otherwise, tailoring and the APA remain the
law of the land. It is the legal obligation of independent
agencies to follow the statutory mandates established by this
institution, not to selectively choose which to disregard.
Going forward, what should be done to address the serious
problems with the proposal? There is a common-sense solution.
For the Basel II Capital Accord, the banking agencies first
issued an advance notice of proposed rulemaking (ANPR). The
banking agencies should now follow this precedent using a
revised proposal that complies with their statutory mandates.
Proceeding first with an ANPR allows for more time for
thoughtful analysis of the proposal's potential impacts.
Analysis and the law should determine how the Basel Endgame
proceeds. It is something we all should be able to agree upon.
If Congress can help facilitate this prudent shift in approach,
the country will be better for it. Thank you.
[The prepared statement of Mr. Olmem can be found on page
66 of the appendix.]
Chairman Barr. Thank you. Ms. Philo, you are now recognized
for 5 minutes to give your oral remarks.
STATEMENT OF ALEXA PHILO, SENIOR POLICY ANALYST FOR BANKING,
SYSTEMIC RISK, ECONOMIC JUSTICE & RACIAL EQUITY, AMERICANS FOR
FINANCIAL REFORM (AFR)
Ms. Philo. Thank you very much. Good morning. Thank you,
Chairman Barr and Ranking Member Foster, for the opportunity to
testify, and thank you, Chairman McHenry and Ranking Member
Waters.
I am the senior policy analyst on banking and systemic risk
at Americans for Financial Reform (AFR), a coalition-based
organization dedicated to advocating for a financial sector
that serves workers and communities in the real economy, and
for economic and racial justice. Before joining AFR, I worked
at the Fed and in the banking industry on risk frameworks and
regulatory adherence.
I would like to talk about the importance for financial
stability of the agencies following through on the capital
proposals, the large bank proposal, and the Fed's proposed
rulemaking on this systemically important bank surcharge. These
proposals will strengthen banks' ability to withstand stresses
that can otherwise imperil banks' financial viability, and hurt
depositors and customers in the economy. Just 6 months ago, we
were powerfully reminded of how important it is for banks to be
well-capitalized by the failures of Silicon Valley Bank, First
Republic Bank, and Signature Bank, the second, third, and
fourth largest banks to fail in this country. It is notable
that all three were in the asset size band for which regulators
had loosened guardrails in 2019.
We continue to have a dangerous combination of, on the one
hand, undercapitalization of some products, and, on the other
hand, compensation practices that incentivize outsized risk-
taking, which puts all banks at greater risk of succumbing to
contagion like that observed in March 2023. And as we learned,
without the right standards, a bank can look well-capitalized
on paper but still lack a sufficient capital cushion to weather
severe stresses. These capital proposals take very important
steps to address that.
One important feature is that the Basel III Endgame
finishes incorporating lessons from 2008. The megabanks'
internal models fell short in the 2008 crisis. Regulators have
placed limits on their use, but as former FDIC Chair Sheila
Bair notes, the large banks are still relying on internal
models that in some cases understate their risks and allow them
to boost their returns. To address this, the Endgame requires
reduced reliance on internal models, and tells firms to make
the transition to improved, standardized approaches designed to
be more risk-sensitive.
Another important feature incorporates lessons from 2023.
The proposal restores Basel III requirements for banks in the
same asset band as the ones that failed in 2023, removes an
opt-out clause showing unrealized securities losses in
regulatory capital for the same band and the band above it in
total asset size. Without an opt-out clause, banks will need to
be more transparent about the impact of unrealized securities
losses on capital in a high-interest-rate environment. And
supervisors, depositors, and investors will be able to more
clearly appreciate the massive impact the underwater securities
would have on capital. This capital proposal will put a stop to
the opt-out that makes these securities losses less clear.
Now, a main claim of those against the proposals is that
higher capital standards reduce lending. We disagree. As FDIC
Chair Gruenberg noted, and as has been validated in studies,
this is not the case. Equity capital is not locked away from
supporting the real economy. Rather, it is deployed in numerous
ways that benefit the bank, its stakeholders, and the economy.
Also, more-robust capital standards reduce the risk of
financial crises, which research shows are longer and more
damaging than other recessionary periods and have a
disproportionate impact on Black and Latinx, and, I believe,
rural and other underserved communities. The issue is the
bankers and bank lobbyists want lower and lower standards that
make it easier for them to build up excessive risk positions,
and they have compensation that incentivizes it. Lower capital
standards also will enable more stock buybacks and dividends
that also increase compensation.
To sum up, the agencies should move forward on these
proposals. More well-capitalized banks are better able to
provide credit to customers and communities, advancing economic
justice, and helping the economy work for everyone. Thank you
very much for the opportunity to testify today.
[The prepared statement of Ms. Philo can be found on page
76 of the appendix.]
Chairman Barr. Thank you. We will now turn to Member
questions. And the Chair now recognizes himself for 5 minutes
for questioning.
At the outset, let me offer, without objection, a statement
for the record from the Financial Services Forum. Without
objection, that document will be submitted for the record.
Let me start with Mr. Baer. I am very concerned about the
impact on mid-sized and regional banks with the Basel III
Endgame as proposed. Vice Chair Barr's de facto repeal of the
bipartisan S. 2155 undoes tailoring, confirming capital
requirements for all banks above $100 billion, which will
result in a barbell banking system. We will have some community
banks that are exempted from this proposal, and we will have
too-big-to-fail Wall Street banks, but the regional banking
sector is really in the crosshairs here. And this will result,
as I said, in a barbell banking system, and it will eradicate
the diversity that makes the U.S. banking system the envy of
the world.
Mr. Baer, please comment on the proposal's impact on the
regional banking sector?
Mr. Baer. Sure. Thank you. First, I would just note that
regional banks now are actually well-capitalized. Their
challenge currently is actually an earnings challenge,
especially at a time when deposit costs are rising and loan
rates are not, and, of course, this would add a massive cost to
them. If you think about the proposal, under the Basel, they
were supposed to benefit credit because more granular risk
weights would lower their credit charges, but here, the U.S.
regulators have done add-ons, which they like to call, ``gold
plating.'' Regional banks will also see large operational risk
charges, so they definitely come out net losers under this.
And then, more broadly on tailoring, even away from credit
risk, they are subjected to a whole panoply of regulations that
are not really fit for them. That includes detailed reporting
on market risk--and they don't take a lot of market risk--
resolution planning, and the supplementary leverage ratio,
again, things that aren't really important substantively, but
also come with a massive compliance burden. And, of course,
that is one reason Congress enacted S. 2155.
Chairman Barr. Thank you very much.
Mr. Olmem, I was very impressed with your testimony
relating to the Administrative Procedure Act. I suspect that
many lawyers are salivating at the arbitrary and capricious
nature of this rulemaking. It was proposed with no meaningful
public input or quantitative analysis or cost-benefit analysis.
The Fed said it will begin collecting an onerous amount of data
from banks after they release the NPR, and the agencies have
indicated that the provisions in the rule might change over
time as the agencies speak with the public sector. These are
process failures, and they mean that the public does not have
the data on the final proposal to assess during the comment
period to provide meaningful input on the proposal.
Mr. Olmem, can you please touch on these many
administrative law fouls? If the Fed was still molding the
proposal and collecting data, shouldn't they have proposed an
ANPR to allow industry experts to provide input?
Mr. Olmem. Yes, thank you for the question, and just to be
clear, these aren't just technical process problems. These are
statutory violations. The Administrative Procedure Act is a
Federal law enacted by this institution to make sure that when
agencies engage in rulemaking, they have established a process
that allows the public to engage and that requires agencies to
act in an informed basis using the best available data. So, an
agency simply can't decide on its whim to take a particular
action. It has to be reasoned and informed to help make sure
there is good rulemaking in this country.
Chairman Barr. Thank you.
Mr. Broeksmit, I want to talk about commercial real estate.
You talked about residential real estate, so let me talk about
commercial real estate. I am very concerned that we have $1.5
trillion of commercial real estate loans coming due. Many of
them are set at 3.5 percent. They are going to have to
refinance at 7, 7.5, or 8 percent because of higher interest
rates; $5.5 trillion of commercial real estate debt is out
there, and about 50 percent of this is held by commercial
banks. These loans were financed when rates were around zero
percent. We know that financial markets will be affected
immediately by the onslaught of new and onerous regulations. Is
now the time to undermine the ability of banks to lend and to
intermediate in commercial real estate markets?
Mr. Broeksmit. Chairman Barr, we are very concerned about
the same issue, and it goes back to the issue that all three of
us have discussed, about the lack of any economic underpinning
not only to the rule itself, but how it interacts with other
rules. You have another rule that is being made final for the
Community Reinvestment Act that discourages banks from making
multi-family loans for new apartments, for instance, and this
will interact with that in a way that can really slow down our
economy.
Chairman Barr. My time has expired, but I would hope that
some of the political people at the White House would inform
the Fed that they don't want a recession right before an
election. The gentleman from Illinois, Mr. Foster, is now
recognized.
Mr. Foster. Thank you, Mr. Chairman. It seems like the
rubber hits the road here with the risk weighting of assets,
and there are sort of three general approaches. You can just
allow the banks to use their in-house home-brew models, which
are obviously open to gaming. If you suggest standardization
but simple rules, then the objection you get is, oh, it is just
a one-size-fit-all. It fits all. It doesn't really reflect the
idiosyncrasies of our particular bank. And then, if you adopt
standardized but complex things, people say, oh, that is too
long, it is too complex. How do you view the tradeoffs between
those three? Just to get started, do you think that
directionally, it is a good thing to move away from in-house
modeling of these risks? Is there anyone who thinks that it is
a mistake to move away from in-house modeling? Mr. Baer?
Mr. Baer. Yes. By the way, I think that was a terrific
summary of why capital regulation is very difficult. It
actually involves all of the tradeoffs you mentioned and it is
not easy, so while we are critical, we understand this is not a
simple matter. But if you talk about the Basel Accord on credit
risk, the entire purpose of the Basel Accord in 2017 was to
preserve the use of bank models. That was its core, and as
Europe and the U.K. have implemented it, they have continued to
use bank models.
The idea was that you would allow banks to use models, but
then there would be a floor to how low the risk weight could be
produced, and they set that floor at 72.5 percent after a lot
of haggling. So basically, your internal risk models can't show
less than 72.5 percent of what a standardized charge would do.
That seemed like a pretty good compromise.
I would also note that bank internal models used in the
United States, which is only really the largest banks under
what is called the advanced approaches, are back-tested
constantly. They are back-tested by compliance staff, risk
staff, audit staff, and, most importantly, by Federal
examiners. We have been doing this for quite some time. We have
not seen enforcement actions for gaming or misstating. Research
that one of my colleagues here and another Ph.D. economist did
showed that there is actually no evidence that there are
significant deviations among banks when it comes to modeling
whether a credit is investment grade or not. So, it is odd to
expect some of that----
Mr. Foster. Okay. I would like to spread out the answers a
little bit, because it is my memory that the internal risk
models failed pretty spectacularly back in 2008.
Ms. Philo, do you want to comment on internal risk
modeling?
Ms. Philo. You bet. Internal models have been a primary
focus of the proposal for a reason. There has indeed been
substantial variation, and the variation is a tremendous
challenge to be able to interpret and have a level of
transparency around the models. In modeling, there is something
called assumptions, limitations, and weaknesses. If you have
good oversight, your assumptions will be robust. And yet, I
think for the industry at large, assumptions, limitations, and
weaknesses is something they are all progressing on, and I
think we have to have the appropriate humility. So, I believe
the internal models have been a substantial problem coming out
of the 2008 crisis, and I believe this proposal is essential to
remedy that.
Mr. Foster. Okay. And what about the complexity issue? I
don't think there is any way to write a brief rule here that
really reflects the big variety of bank business models. Do any
of you have any comments on that? Are your objections mainly to
the details of what is in this complex, and you wish this
coefficient were different in that there were better data
behind the coefficient, or do you have problems with the whole
approach of a complex thing that really reacts differently to
different businesses?
Mr. Broeksmit. Ranking Member Foster, I wanted to go back
to your original question about the three ways one could do
this, and I think the Basel III risk weights for mortgages has
that right mix. It is based on loan-to-value, and clearly, a
loan with a bigger down payment is less risky than a loan with
a smaller down payment, and that is what the Basel III
recommendations recommend.
Mr. Foster. That is loan-to-value at origination or----
Mr. Broeksmit. Yes.
Mr. Foster. Okay. Because, obviously, the risk of a half-
paid-off mortgage is a whole lot smaller.
Mr. Broeksmit. Yes, but it is----
Mr. Foster. That is, for example, a complexity that you
could add to this that would reflect the evolving risk of a
mortgage as it gets paid off.
Mr. Broeksmit. Which would lower the capital requirements
as equity improved. Of course, we would be happy if that were a
part of it. What I am saying is that I think they hit the
middle ground, but then the regulators gold-plated it by 20
percentage points, and it is just not warranted.
Mr. Olmem. What I would add there is, this is why there
needs to be more data. As you know, capital requirements are
very complex and there needs to be a very robust process. I
would note also that the Basel II process took several years.
There was an ANPR, and multiple proposals, and my testimony
contains a whole list of all the hearings that this committee
held over the past several years.
Chairman Barr. The gentleman's time has expired. The
gentleman from Florida, Mr. Posey, is now recognized for 5
minutes.
Mr. Posey. Thank you very much, Mr. Chairman.
Mr. Baer, have the Federal Basel III regulators conducted
an impact study?
Mr. Baer. Yes. The discussion of costs and benefits in the
proposal is extremely cursory, contains no data, and does not
include potential overlaps between that rule and other rules,
including, most notably, the Fed's stress test. I think
everyone in academia and regulation understands, contrary to
some other testimony, that there are costs to raising capital.
In fact, the whole reason the regulators want a countercyclical
capital buffer is because they know that when you raise
capital, that diminishes economic activity.
In past crises, the regulators have relaxed capital
standards explicitly to increase growth. The Basel Committee
estimate is that every 1 percentage point increase in capital
requirements reduces annual GDP by 16 basis points, which means
that this proposal would permanently reduce U.S. GDP by $67
billion a year. That is the Basel Committee of which these
regulators are a part.
There is uniform agreement on this in academia. The tough
thing, of course, is trading off that diminishment in GDP with
any reduction in the risk to the banking system and a reduction
in financial stability risk, but this proposal does not do that
weighing at all. It is a benefit-benefit analysis.
Mr. Posey. Okay. So, they did a cost-benefit analysis?
Mr. Baer. There is no rigor whatsoever. I think it is maybe
a couple of paragraphs, maybe a couple of pages, but it
basically says, we thought about it and we believe that the
benefits exceed the cost, but there are no numbers attached to
that.
Mr. Posey. Wow. I was going to ask you for the impacts, and
you have talked about some of the impacts already. After the
dramatic failure of the banks' supervision related to Silicon
Valley Bank, might it be more beneficial to reform the banks'
supervision and promulgate new capital rules, in other words,
for the bank supervisors to clean up their own house first?
Mr. Baer. I think part of it was a failure of supervision
and not incidentally bank management, but again, this was a
liquidity problem, a depositor concentration problem. If you
think about it, you never used to ask, ``Do all my depositors
know each other?'' Well, in Silicon Valley Bank, they were all
on the same text chain. That is not something other banks do.
That is not a difficult problem to solve. I think other banks
have demonstrated that actually their depositors don't know
each other. They are in different industries in different parts
of the country.
I think that should have been the initial focus for how to
fix this. There are some very smart things you can do around
ensuring that banks are prepared to borrow with a discount
window or that the Fed is prepared to lend. There are a whole
series of smart things you could do here to make the system
safer. But the answer to a liquidity crisis at a bank that had
a unique balance sheet is not to say, Truist needs to hold more
capital for its mortgage loans, or JPMorgan needs to hold more
capital for its market making. It doesn't have anything to do
with that. There is nothing holistic about this. This is not a
tailored or a smart response to what happened in March 2023.
Mr. Posey. Thank you very much. I had a couple of other
questions, but you answered them in the context of the other
questions. So, Mr. Chairman, I thank you for the time, and I
yield back.
Chairman Barr. Thank you. The gentleman yields back, and
now the gentlewoman from California, Ms. Waters, is recognized.
Ms. Waters. Thank you very much. I will address my first
question to Ms. Philo. While big banks and Republicans complain
that this proposal to strengthen capital requirements will stop
lending and crush the economy, I think it is very important
that we put their critiques into perspective. To start with,
Ms. Philo, isn't it true that this proposal does not apply to
community banks at all? It only applies to large banks with
more than $100 billion in assets or those with extensive Wall
Street-like trading operations?
Ms. Philo. Correct. Thank you, Ranking Member Waters. It
does not impact community banks, and the preponderance of the
impacts are on the largest banks, those banks which have relied
most on internal models in the past, and also in the realm of
operational risk, where they have had substantial operational
incidents in their past. Community banks are not impacted, and
as we know, community banks are essential for making sure
lending is available through the lifecycle for some of the most
vulnerable communities in our country.
Ms. Waters. Ms. Philo, while we have heard some say capital
was not an issue with the regional bank failures earlier this
year, we had a Republican witness at an earlier hearing affirm
that capital was part of the problem with Silicon Valley Bank's
failure, specifically relating to available-for-sale securities
for regional banks. As I recall it, there was a run on Silicon
Valley Bank, and that run occurred when they had to sell off
their securities portfolio at a big discount and they went to
the market looking for capital, and that is when everything
broke out and investors began to understand. So capital, or the
lack thereof, did play a role in that failure, wouldn't you
say, Ms. Philo?
Ms. Philo. Yes, I believe that a critical factor here was
that you had a certain amount of capital, but there was a lack
of transparency on how the underwater securities would impact
that capital. And investors, when faced with uncertainty and a
lack of transparency, all of a sudden that capital cushion or
that confidence capital cushion really, frankly, may not be
enough, and we certainly learned that in 2008. I think there
are corollaries here in the Silicon Valley Bank context in
terms of how the investors reacted to the level of capital once
they knew about those and were face to face with the realized
losses. Thank you.
Ms. Waters. I asked Margaret Taylor, a partner at Davis
Polk, about this when she testified before the committee in
May. And she responded that, ``I also think that the not
passing through AOCI in capital, which is something that has
been on the books since 2013, should be revisited.'' So going
further, indeed, the Fed found that there was a $1.9-billion
capital shortcome or nearly 2 percent of its capital when
Silicon Valley Bank was able to have their unrealized losses in
their securities portfolio exempted from its capital
requirements.
This is an issue that would be addressed in this proposal.
Fed Vice Chair Barr explained, ``If the bank had already been
required to include those losses in its reported capital, it is
less likely that the market and depositors would have reacted
the same way.'' Furthermore, banks that were required to
reflect unrealized losses on available-for-sale securities in
regulatory capital managed their interest rate risk more
carefully, suggesting that the requirement to include gains and
losses on available-for-sale securities in regulatory capital
leads to stronger risk management as well.
Ms. Philo, we heard testimony from others today that
capital was not an issue with the failure of Silicon Valley
Bank. Do you agree with me that we need to reiterate that
capital clearly was an issue, and that we need to strengthen
capital requirements by our largest banks, given the risk that
they pose?
Ms. Philo. I do. I do believe that capital was an issue,
and it will potentially remain an issue for that band of total
assets. Silicon Valley Bank was a highly-vulnerable firm in
ways that Silicon Valley Bank's board of directors, senior
management, and Federal Reserve's supervisors failed to act on,
and one reason for that was a lack of true transparency around
the precise level of their capital.
Chairman Barr. The gentlelady's time has expired.
Ms. Philo. Thank you.
Chairman Barr. The gentleman from Missouri, the Chair
Emeritus of this subcommittee, and the current Chair of our
National Security Subcommittee, Mr. Luetkemeyer, is now
recognized.
Mr. Luetkemeyer. Thank you, Mr. Chairman. And I thank the
witnesses for being here this morning. We had testimony from
the regulators as well as the bankers involved in the March
banking crisis in a hearing that we had, and it would appear to
me that the regulators are probably as much to blame as the
banks. All of them had business models outside the norm and
were allowed to continue that outside-the-norm business model
by the regulators, who, quite frankly, admitted in front of us
that they didn't do their job.
So now, it looks to me like we have the regulators saying
the old adage of, never let a crisis go to waste. It looks like
we are sitting here now with the regulators, who should be
finding a way to clean up their own act, of now using this as a
way to institute a Basel, which, to me, is something we
shouldn't be concerned about.
Mr. Baer, why is it a good idea to implement Basel III
standards, which are European standards, on our American banks,
on the American banking industry? I see you chuckle, because
you are like me. This is nonsense.
Mr. Baer. There is a notion that there should be
international comity--that is, ``ity,'' not, ``edy''--with
respect to capital standards, so it is not a bad notion to go
off and talk about it and try to get banks more or less around
the world on something for----
Mr. Luetkemeyer. Wouldn't it be a better idea for the
European banks to actually follow our models, because we have
one of the biggest and best financial markets in the world, and
we want to turn it around and use a failed model of the
European banks, which are all bankrupt and government takeovers
basically at this point?
Mr. Baer. I think the worst of this is that the agency
staff, not even at the Board level, went over and negotiated
this, but then have, again, continually added on and
implemented it here in a way that is not fit-for-purpose.
To me, the best example of that is, whether it is
operational risk, market risk, particularly market risk, while
Basel was considering all of this, the Federal Reserve
implemented a global market shock and a stress capital buffer
to cover those risks, then over the years they negotiated in
Basel a second way to cover that. And every other country in
the world, I believe, is going to implement the one in Basel
and we are going to implement both.
In terms of holistic reviews, you can think about Basel as
a good place to start, but that does not relieve the agencies
of the obligation to document the risk weights, to prove--and
maybe things have changed since 2017--where they got the risk
weights, why they think this is appropriate, and then to
consider what else they are doing and how it relates.
Mr. Luetkemeyer. Okay.
Mr. Olmem, it would seem to me that by implementing this,
it would send a message that their stress tests are inadequate
to actually be able to do the job of predicting a problem,
understanding how a situation could be resolved, understanding
how strong a bank may be. If you are going to have to jump up
the capital ratios here, it looks to me like it is a testimony
to the fact that stress tests aren't working. How would you
comment on that?
Mr. Olmem. One of the interesting things about the proposal
is it doesn't reflect all of the other work that has been done
over more than a decade, starting with Dodd-Frank, which I
think at the time was sold as the final chapter in bank
regulation, and yet, since then, we have had a whole series of
additional pile-on regulations. I think a common-sense way to
think about this is, when is enough enough? And the reaction
every time a bank fails, which happens in commerce, capitalism,
is that we go on and have another wholesale revision of capital
requirements.
Mr. Luetkemeyer. You mentioned the tailoring situation, and
we discussed it, the chairman discussed it. It would appear to
me that if we are going to basically repeal S. 2155 and replace
it with this one-size-fits-all, that the small banks are going
to be the losers in this. Would you comment on that?
Mr. Olmem. I think that is one of the big concerns here, is
that there is a remarkable diversity of institutions that are
covered by this and you are going to have a one-size-fits-all
approach to regulating them, and that over time, the risks will
converge in business models because that is easier to regulate.
And losing that diversity in business models really does
undermine the vitality of our banking system.
Mr. Luetkemeyer. Thank you for that.
Mr. Broeksmit, you made a comment that for every million
dollars worth of capital increase, we lose $7 million of
lending ability, and I think Mr. Barr mentioned that this is
going to cost $67 billion in GDP per year. Do you have a cost
of what it would be for the home mortgage market, what the cost
is going to be to the consumers, to the banks, and to the
lenders?
Mr. Broeksmit. The cost to consumers is that there will be
fewer sources of mortgage financing and that mortgage servicing
rights, which this proposal caps at 10 percent instead of 25
percent, will go down in value. And that affects the price of
every loan regardless of whether it is made by a bank covered
by this proposal or anyone.
Mr. Luetkemeyer. And that is going to really hurt the low-
and moderate-income folks because of the increased cost of a
loan.
Mr. Broeksmit. That is correct.
Chairman Barr. The gentleman's time has expired. The
gentleman from California, Mr. Sherman, is recognized.
Mr. Sherman. Mr. Baer is right to point out that increasing
capital is not free. It does reduce economic activity, but
having capital standards that are too low is very expensive.
Just this year, we saw three banks go under. This was not a
matter of just a liquidity problem. These banks were bankrupt,
and the proof is the FDIC sold them for a negative $30 billion.
So, the market looked at their assets and liabilities and said
they were vastly underwater. The cost to our system is not just
the $30 billion that will be recovered, in effect, from
depositors over coming years, but the lack of confidence,
particularly in regional and community banks, that are still
impacting our economy and will for years to come.
Banks face two types of risks, credit risk and interest
rate risk, the risk that the borrower won't pay or the risk
that the borrower will pay, but at a interest rate that is too
low given the economic conditions at the time and the bank's
cost of capital.
In the last war, France relied on fixed fortifications, and
we saw Blitzkrieg. 2008 was about credit risk, so now, we have
Basel III. But 2023 was about interest rate risk, and while Mr.
Barr says Basel III does nothing, he is only mostly right. It
does way too little with regard to interest rate risk. And
there is this myth, and I fear Jay Powell buys into it, that if
interest rates go up, the banks will be fine because, although
the loans they have made and their portfolios have declined in
value, their depositors will be lazy and stupid and leave the
money in low-interest bank accounts. And I don't think that a
financial system based on the idea that depositors will be lazy
and stupid over the long term is a sound basis for regulating
banks.
One thing that needs to be pointed out is that when you
focus on credit risk, you take money away from local business
loans and the construction loans that we need to build more
apartment buildings because the rents are too high. When you
fail to focus on interest rate risk, you incentivize the banks
putting their money in 10-year Treasuries, and 30-year
Treasuries. Apple can borrow all the money it needs, so a
system that underrates the risk of lending money to Apple on a
fixed rate, 20- to 30-year basis, and overstates the risk of
making loans to people building apartment buildings, and
building small businesses in my district, is a perverse system.
Now, we do something under Basel III in the available-for-
sale securities. If they go down in value, that portion of the
interest rate risk is captured. But what about those that are
supposed to be held for maturity and what about just the basic
loan portfolio that is in securities? Basel III is helpful in
saying, we are not going to rely on the bank's own internal
modeling, but that is only as good as the new modeling that the
regulator's come up with, and let's see what they do.
I am particularly interested, Ms. Philo, in the fact that
the risk weight capitals on tax equity investments, where the
bank buys the tax credit from the project developer, will
increase from 100 percent to 400 percent for many banks. Tax
equity investments can help low-income housing. That won't be
affected, but under this rule, clean energy tax equity
investments would face a four-fold increase under the proposal.
Ms. Philo, what effect could that have on our ability to
meet the standards of the Inflation Reduction Act and meet our
requirements under climate change treaties?
Ms. Philo. I do appreciate where you are coming from.
Different risks have different weights, and we are relying on
the regulators in this process to make sure that they align. I
think this is one area where we may wish to see more of that.
And may I say that----
Mr. Sherman. On behalf of polar bears everywhere, yes. I
want to go on to one other question.
Mr. Broeksmit, I am told that we are going to have no
credit for mortgage insurance. Does that make any sense?
Mr. Broeksmit. Nonsense. It makes no sense at all. We
should encourage banks to use other sources of loss-absorbing
capital in our marketplace, and this gives no credit for
private mortgage insurance.
Mr. Sherman. Thank you.
Chairman Barr. The gentleman's time has expired. The
gentleman from Texas, Mr. Williams, who is also the Chair of
the House Small Business Committee, is now recognized.
Mr. Williams of Texas. Thank you, Mr. Chairman. As we have
discussed at length today, the Federal Reserve unveiled the
Basel III Endgame proposal that changes capital requirements
for financial institutions. Multiple regulators, including Fed
Chairman Powell, have come before this committee and testified
that our banking system is already well-capitalized and
resilient. This proposal is using the bank failures from
earlier this year as a weak justification for this partisan
rewrite of bank capital regulations without considering their
impact. These proposed changes will dramatically affect the
banking community, and there is a legitimate concern that Basel
revisions will have a broad impact on small businesses' ability
to access reliable credit and increase businesses' overall
borrowing costs. Over the past year, we have seen a 2-percent
drop in large banks' lending to small businesses. Should
regulators move forward with the Basel proposal, that number
will continue to increase.
Mr. Baer, could you elaborate on how the Basel III proposal
will impact bank lending and the cost of credit for borrowers,
and what does this mean for small businesses trying to obtain a
loan? I am a small business owner. I managed to inherit.
Mr. Baer. Sure. Thank you. First, I would say it is already
having an effect. If you listen to earnings calls this quarter,
you hear about banks already, particularly regional banks,
talking about risk-weighted asset optimization, which means
basically shedding the assets that have the higher risk
weights. There is already a credit crunch beginning in this
country. One oddity of the proposal is, there is basically a
100-percent risk weight for corporate loans. There is a
possibility of a 65-percent risk weight to the extent that the
bank's internal process rates those as investment grade. There
is then a requirement in the Basel Accord that those also have
to be listed on a securities exchange in order to get the lower
risk weight.
Europe and, I believe the U.K., did not adopt that. Our
research shows that it is an entirely spurious requirement,
that if you look at the actual data--and we have a lot of
historical data on this--internally-rated investment grade
loans do just as well, whether the company is listed or not.
So, there is really no basis for that. But more importantly, we
also have data through the advanced approaches on what the
appropriate risk weight really is, and it is more like 38
percent for corporate loans, and closer to 30 percent for
investment grade. This proposal has us debating between 65 and
100 percent, but the real answer is probably closer to 35
percent. It is just another example of where there was not data
in this proposal to justify the risk weights that were agreed
to at Basel, and another example of where they have taken the
Basel Accord and implemented it in a way that is uniquely harsh
on American businesses.
Mr. Williams of Texas. Okay. Thank you. The Biden
Administration is out of control. Government spending has led
to record-high inflation, and increased interest rates which
have made it extremely hard for Americans to buy a home. Now,
under this Administration, U.S. mortgage rates have shot up
above 7 percent, the highest they have been in 22 years. The
Basel III proposal will worsen mortgage markets and reduce
mortgage availability. Banks will be forced to be more cautious
when extending credit, making the dream of homeownership for
many families more and more distant.
So, Mr. Broeksmit, can you elaborate on the effects that
Basel III will have on the mortgage market, and will we see
heightened consequences in an already-struggling market out
there?
Mr. Broeksmit. Yes, we will. And the reason is that if
these increased capital requirements go into effect, banks will
make fewer mortgage loans and/or they will raise the price at
which they are able to make those loans because they still have
to return an appropriate level of return on capital to their
shareholders, so there will be fewer loans available--less
choice at a higher cost. And the servicing aspect of this will
also raise prices on consumers because the mortgage servicing
value is an integral part of how every mortgage is priced, not
just mortgages made by these banks.
Mr. Williams of Texas. My last question is, Federal
regulators have made U.S. banking standards much more stringent
than the standards European regulators are imposing on European
banks, and we have heard this. The U.S. should not be
pressured, let alone forced by our own regulators to constrain
American banks. This proposal is creating an unlevel playing
field with financial institutions and constraining U.S. G-SIBs.
The gap between U.S. and European capital levels will continue
to grow, and the consequences of these decisions will drive
adverse and unwelcome challenges to market access and
availability of credit.
So in the time I have left, Mr. Olmem, can you expand on if
the Basel standards will create a competitive advantage for
European banks, and what will the effects of the European
advantage be on the American public and U.S. competitiveness on
the world stage?
Mr. Olmem. Thank you for the question, and that is
certainly one of the key questions that is left unanswered by
this proposal. There is no real discussion of that competitive
difference or study. I would just note from kind of a
geopolitical interest that U.S. banks provide a really valuable
role in the global financial system, and having them be active
participants around the globe is good for the world's economy.
This proposal does contain a series of charges that will make
it more costly for them to be active in those markets, and I
think that the long-term implications require further study.
Mr. Williams of Texas. Thank you. I yield back.
Chairman Barr. The gentleman from New York, Mr. Meeks, who
is also the ranking member of the House Foreign Affairs
Committee, is now recognized.
Mr. Meeks. Thank you, Mr. Chairman. Let me pick up somewhat
where my colleague just left off. I am very concerned about
homeownership, and I know from talking to the NAACP and the
National Urban League that they were very excited about the
Special Purpose Credit Programs (SPCPs).
Mr. Broeksmit, could you provide more background on what
the Special Purpose Credit Programs are, and will this be
affected at all by the Basel III Endgame?
Mr. Broeksmit. It is good to see you, Mr. Meeks, and I
would be happy to elaborate on this. The Special Purpose Credit
Programs permit lenders to craft programs that make it easier
for groups that have historically been disadvantaged in the
home buying and home financing process to get loans. They can
be based on majority-minority areas or they can be based on the
characteristics of the individual borrower. Many banks have
been very innovative in using SPCPs to tailor programs geared
toward reducing the racial homeownership gap, which in turn
reduces the racial wealth gap.
This proposal increases the amount of capital that banks
would have to retain on loans with less than 20 percent down,
very significantly, like, by 40 percent. And that is where my
earlier comment came in about for every million dollars in
capital that a bank allocates to mortgages, they could make $7
million less in mortgages with that amount of capital. So, the
availability of those programs will go down and/or the rates
will go up.
Mr. Meeks. Thank you. And as indicated, I am also the
ranking member also on the House Foreign Affairs Committee, and
I do understand that the intent of the Basel III Endgame was to
improve the comparability of the capital levels across
institutions and jurisdictions, which makes sense to me because
I believe in that mission, and I know how important the cross-
Atlantic harmonization is, especially because of how
interconnectedness. And I think that is the reason why, in
response to some how interconnected European economies are with
the United States, whether we like it or not, what happens
here, affects Europe, and what happens in Europe, affects here,
so there needs to be that interconnectedness. The goal is
harmonization to the degree that it would be possible.
Now, I am told by some that our nation's proposed
implementation of Basel III goes in a different direction than
that of Europe. Is that correct, Mr. Baer?
Mr. Baer. Yes, Congressman, I couldn't agree more. Again,
starting from the place that when the agreement was announced
in 2017, the expectation was that capital wouldn't go up in
this country. It is going to go up 16 percent. Well, no, I
guess that wouldn't be starting. The idea on credit risk was to
retain internal models subject to an output floor or some
parameters. This will be the only country I am aware of that is
eliminating those, and again, the biggest difference is these
other nations are not having a stress capital charge on top of
this to cover many of the same risks. And we also in this
country still have gold-plated, which is again a political
parlance for higher G-SIB surcharges. Although they call it a
G-SIB surcharge, it is really a capital markets surcharge
because that is what all the components add up to.
So, this will be the only country that has not only the
higher market risk capital in the Basel proposal but also a
separate surcharge that covers many of the same risks. We just
put out some research on this in the last couple of months, and
we are deviating significantly from what was agreed and how it
has been implemented in both Europe and the U.K., and we are
deviating every time upward.
Mr. Meeks. And that affects competitiveness?
Mr. Baer. It certainly affects competitiveness, not in
every area--U.S. mortgage lenders don't compete with French
mortgage lenders. The competitiveness is more around capital
markets. The bigger problem is that we are just wrong that our
calibration is too high. And whether we are competing with a
European or a Japanese or a British bank, it just means that
U.S. businesses and homeowners are going to pay more for credit
than they ought to, and that more of what has traditionally
been a banking business will leak out to the non-bank sector,
where, again, people will pay more and where the government is
going to have to intervene more frequently because they are not
equipped and motivated to continue lending in crisis. That is
the real concern.
Mr. Meeks. Okay. I only have 15 seconds left, so no one
could answer my question. But I will just say I have concerns
also to see whether or not the Basel III Endgame would affect
money going to Minority Depository Institutions (MDIs) and
Community Development Financial Institutions (CDFIs), another
issue which is very important to me. I am out of time, so I
yield back.
Chairman Barr. Thank you, Mr. Meeks. The gentleman from
Tennessee, Mr. Rose, is now recognized.
Mr. Rose. Thank you, Chairman Barr, and thank you to our
witnesses for taking the time to be with us today.
Mr. Olmem, the Basel proposal is expected to increase the
risk-weighted assets for banks' capital markets activities by
75 percent, meaning that banks will have a significantly higher
capital charge for critical capital markets activities that
they conduct. One such activity that could be adversely
impacted, in my opinion, is securitization. Do you have any
concerns that Basel could negatively impact securitization in
our economy and our capital markets?
Mr. Olmem. Yes, thank you for that question. That is a
particular area actually where the U.S. proposals differ
significantly from the European, and there is not a factual
foundation to understand why the calculations involved there
have changed. I would also just note generally about the
economic analysis around the capital risk is that in the
proposal itself, it says that the impact on liquidity of the
proposal is an area that requires further research. That is the
extent of the economic analysis that is contained in the
proposal.
Mr. Rose. Thank you. I appreciate that. And, Mr. Olmem,
Federal Reserve Governor Michelle Bowman has expressed concerns
about the rolling back of regulatory tailoring provisions in
the proposed rule, stating that, ``Collapsing capital
categories II, III, and IV into a single prudential category
may call into question whether the Federal Reserve is complying
with the statutory requirements to tailor prudential
requirements for large firms.'' Are you worried that the lack
of tailoring will drive consolidation among regional banks to
achieve the scale needed for compliance?
Mr. Olmem. I think this is a serious issue, again, that has
not been addressed, and it is a common-sense question that one
would ask when one would put together a proposal like this. But
again, there is no thorough analysis of that issue in the
proposal.
Mr. Rose. I agree. And, Mr. Olmem, do you feel that the
lack of differentiation in capital rules across such a wide
range of banks is appropriate?
Mr. Olmem. Yes. And more importantly, this institution has
passed, again, in 2 separate bills over the last 13 years,
legislation saying that tailoring is important. And that is
what is so striking to see, an independent agency whose charge
is not to create, but to implement the policy that this
institution and this committee devises. Instead, here you have
a clear example of where the institution is disregarding a
clear directive from Congress.
Mr. Rose. Thank you. Mr. Broeksmit, home affordability is
such a present problem due to various decisions, in my opinion,
by this Administration. This new proposal seems like it would
make it even more difficult to purchase a home, particularly
for first-time homebuyers and borrowers who haven't yet saved
up 20 percent for a down payment and are trying to get a
conventional loan. Do you think this proposal will make home
affordability worse, and if so, how?
Mr. Broeksmit. Thank you, Representative Rose, and thank
you for your leadership on the trigger lead issue, which we
appreciate very much. Yes, as I have mentioned before, I do
think that this will make mortgages even less affordable at a
time when mortgage rates are at a generational high and when
the supply of homes is very low, and, therefore, home prices
keep on marching upward, so it is exactly the wrong time to do
this. And there is no evidence that the additional capital
requirements in this proposal have anything to do with the
underlying risk of the loans themselves. And that is what the
regulator should be focused on, and there is no evidence at all
that they have done that.
Mr. Rose. And what do you say to the regulators to fix
these unforeseen albeit obvious downstream issues from this
proposal?
Mr. Broeksmit. The Basel III standards, which vary by loan-
to-value, meaning that you are allowed to hold less capital
against a loan where the borrower made a higher down payment,
are sensible. The additional 20 percentage points that the
regulators are putting on top of them are nonsensical, so on
the mortgage side, if you simply went with the Basel III rules,
you would have a much better result.
Mr. Rose. And, Mr. Baer, it will take all the time, but I
will let you answer this for the record. The Basel III Endgame
proposal seems as if it could negatively impact the housing
market in an already difficult time, and, frankly, make
commercial banking's incentive to stay in residential lending
even less desirable. If your members start shrinking their
residential lending businesses, what does that do to this
housing market and to the GSEs? And I am sorry, we are out of
time, so I will have to let you answer that in writing for the
record. I yield back.
Chairman Barr. The time has expired. The gentleman can
answer that for the record.
The gentleman from Georgia, Mr. Scott, is now recognized.
Mr. Scott. Thank you, Mr. Chairman.
Mr. Baer, let me start with you. You will recall that prior
to the 2008 financial crisis, our nation's largest banks were
overly relying on their own models for credit risk, and these
models failed to predict the magnitude of credit losses during
the collapse. And this is why our Financial Services Committee
put strong capital requirements into Dodd-Frank to strengthen
the banking industry's ability to withstand stresses and
shocks.
Since then, our banking system has successfully navigated
very difficult periods, including the recent 2020 COVID
economic shock. But now, I am very concerned with the
unintended economic consequences of this proposed rule and its
potential impact on our banking institutions as they engage in
critical market activities. And there was considerable dissent
and opposition for releasing the notice of rulemaking,
including from Fed Chair Powell himself.
On June 17th, Chairman Powell raised concerns that the
costs of higher capital could diminish banks' roles as
financial intermediaries and liquidity providers in critical
markets. Chairman Powell voiced concerns with the scope of the
proposal. He said, ``exceeding what is required by Basel, while
also exceeding what we know of our plans for the implementation
by other large jurisdictions,'' and he specifically referenced
the EU and the U.K., and Chairman Powell went on to note that,
``The need to strengthen supervision for firms with assets
between $100 billion and $260 billion by tailoring these rules
to reflect the size and risk of these institutions.''
This proposed rule eliminates tailoring rules under Section
165 of Dodd-Frank, which requires that the Federal Reserve,
``shall differentiate among companies on an individual basis or
by category.'' My question to you, Mr. Baer, is why is it
important to consider things like risks and size and business
models and complexities of individual institutions, and what do
you have to say in reference to my good friend, Chairman
Powell's, opposition to this rule?
Mr. Baer. It is a great question, and I appreciate it. I am
not sure he opposed it. I would characterize it as expressing
misgivings, but he can speak for himself on that. You can think
about the proposal as a whole or in parts. As a whole, it is
raising capital requirements by 16 percent and effectively
finding that every large bank in this country is
undercapitalized, and there is no evidence for that. At the
component levels, it also raises individual concerns, which I
think the Chair and other Governors raised, like, why are we
raising market risk capital by 75 percent when that is an
area--again, completely away from Silicon Valley Bank--where
banks are continuing to lower risk and still earn good returns?
We have not talked at all about operational risk. If this
thing was implemented, 30 percent of the risk-weighted assets
held by banks would be operational risk assets. Those are
phantom assets. They are not assets; they are just assets
created to produce a capital charge. They are supposed to be
about cyber attacks, but they are really about litigation
judgments. But the notion that 30 percent of the capital being
held by U.S. banks would be for a future fine that one of these
same regulators might impose upon them seems distinctly odd,
particularly when you realize how much that is going to cost
borrowers. So right now, you pay a judgment that costs your
shareholders, but in the future, it is going to cost all your
customers because you are going to have to capitalize that.
Mr. Scott. Thank you.
Mr. Baer. It's wildly disproportionate. That is true for
all banks. But certainly, for the regional banks, they are
really in a tough fight right now. They do not need this layer
of burden on top of the other challenges they are facing.
Chairman Barr. The gentleman's time has expired.
Mr. Scott. Thank you very much.
Chairman Barr. I would let you go a little longer because
that was good testimony. The gentleman from South Carolina, Mr.
Timmons, is now recognized.
Mr. Timmons. Thank you, Mr. Chairman, and I want to thank
all of the witnesses for being here today. I feel like we are
watching the same show over and over again but somehow expect
it to end differently. Everyone wants a prosperous economy. I
think we can all agree to that. We want it to be stable, and we
want to be well-prepared to navigate the inevitably turbulent
waters. They are well-intentioned policies, but they have no
basis in the real world, and ultimately do more harm than good,
and it happens again and again. This happened pre-2008, again
in 2023 with Silicon Valley Bank and Signature Bank, and here
we are again pushing overly burdensome reforms that will again
do more harm than good.
We are going to highlight the last three examples. Let's go
back to pre-2008. Democrats strongly encouraged banks to loan
money to people regardless of their credit scores or ability to
repay those loans. Doing so would be allegedly discriminatory.
The Financial Crisis Inquiry Commission, which was appointed by
Congress to determine the causes of the subprime mortgage
crisis, found that Federal housing policy either was primarily
the cause of or, at the very least, was a substantial
contributing factor to the crisis.
Mr. Olmem, you were on the Hill during that time. Would you
agree that Federal housing policy was a substantial
contributing factor to that housing crisis?
Mr. Olmem. Yes, and I think all studies back up that
conclusion.
Mr. Timmons. Okay. And this resulted in millions of
Americans suffering severe hardship. People lost their jobs.
People lost their houses. They couldn't buy houses they had
been planning to buy. Let's go to Silicon Valley Bank and
Signature Bank. Mr. Olmem, do you agree that Congress spending
$7 trillion resulted in inflation, which then resulted in an
increase in interest rates?
Mr. Olmem. That's a little bit outside my area of
expertise, but I think most economists would say that it had
something to do with it.
Mr. Timmons. Okay. And I just want to point out that if you
were saving up for a $300,000 house in my district, you were
expecting to pay around $1,100 or $1,200 a month in a mortgage
payment. Now, because of interest rates going up, because my
colleagues across the aisle spent $5 trillion ostensibly
because of COVID, that same mortgage is about $2,400 or $2,500
a month. So, they have essentially denied the dream of
homeownership to the very people that they are allegedly trying
to help.
And here we are now discussing proposals to harden the
economy, to make it more capable of overcoming turbulent
economic waters to solve a problem that was created by policies
in Washington. They spent trillions of dollars, they caused
inflation to go up, interest rates rose, and Silicon Valley
Bank and Signature Bank failed.
Mr. Olmem, would you agree that but for interest rates more
than doubling, would Silicon Valley Bank and Signature Bank
have failed?
Mr. Olmem. It is always difficult to do the counterfactual,
but it is clear that the sharp increase in interest rates was a
driving factor in the failure of those institutions----
Mr. Timmons. They grew too fast, and they had to park some
money somewhere, and they parked it somewhere that didn't work
because they got upside down with their Treasuries. So now,
they are proposing structural changes to harden the financial
system of the United States because the policies that we pushed
out--I keep saying, ``we'', but I was against all of these--
that they pushed out caused the problem, so now they are going
to solve it. So, policies that were pushed out by Democrats
created the problem, and we need to have these new policies
that will further impede Americans' ability to get mortgages,
and will further impede the economy's ability to grow.
Mr. Olmem, do you agree that if all of Basel III is
actually fully implemented, it will be harder for Americans to
get a loan, or will it be easier?
Mr. Olmem. First of all, that is one of the reasons why
this process is so problematic is we don't really know, and the
agencies are moving forward in an uninformed manner. They have
not gone off and done that data to answer those basic
questions. Now, I think you have heard from the testimony
today, based on what we do know, that the high probability is
yes.
Mr. Timmons. I think we have seen this show again and
again, and before the Democrats spent trillions of dollars,
President Obama's Treasury Secretary, Larry Summers, said,
``This is going to cause inflation.'' And here we are today
saying that these proposed changes to our financial system will
make it harder for Americans to get mortgages, will make it
harder for the U.S. economy to grow, and we need to stop
causing problems. The Federal Government needs to get out of
the way.
With that, Mr. Chairman, I yield back.
Chairman Barr. The gentleman yields back. The gentleman
from Illinois, Mr. Casten, is now recognized.
Mr. Casten. Thank you, Mr. Chairman. I would like to follow
up in a little more detail on the comments Mr. Sherman raised
about tax equity markets, and I know it is familiar for some of
my colleagues. This is where somebody who does something that
entitles them to Federal tax incentives but doesn't have
taxable income, finds a partner, typically a bank, who has
taxable income, and they essentially buy the tax credit by
buying a minority of the equity in the project in exchange for
the preponderance of the tax attributes.
Under the current rules, bank capital that is spent on tax
equity only has a 100-percent risk weighting unless it is more
than 10 percent of bank capital, at which point it takes on a
400-percent risk weighting. The proposed rules in Basel would
essentially take off the 10-percent cap, oddly and perhaps
accidentally, except for tax equity on low-income housing. I
want to park that for a moment. But what that means
practically, particularly in light of the Inflation Reduction
Act, which was primarily a tax incentive bill, is that here we
have this huge investment, tons of investments of private
capital, and every bank in this space is going to see a 400-
percent increase in their capital requirements if they are
providing tax equity.
Mr. Baer, I see you nodding your head on this, so let me
start with you. But first, Mr. Chairman, I would like unanimous
consent to introduce a letter from the American Council on
Renewable Energy, dated August 22nd, to the White House, into
the record.
Chairman Barr. Without objection, it is so ordered.
Mr. Casten. This letter says that annual tax equity
investments in the clean energy sector could shrink by 80
percent to 90 percent, and many banks could exit the renewable
tax equity market entirely if this is implemented.
Mr. Baer, do you agree with that statement? What are you
seeing from your members as far as these tax equity
consequences?
Mr. Baer. Thanks. First, I will just say that was a better
summary of the issue than I could have done, so I am glad you
did it for me. No, we have talked to banks. They would
absolutely exit this market if their risk weight went from 100
to 400 percent, and the problem is even broader, which is we
don't know why they decided to go from 100 to 400 percent. They
obviously left it at 100 percent for low-income housing tax
credits, okay, but why not these? Why not others?
Mr. Casten. Let me stay on that because you are
anticipating my next question. I don't understand that logic.
Let's first just back up. Do you believe that the risk profile
of bank capital that is in tax equity investments for low-
income housing tax equity is substantially different than the
risk profile for other bank capital that is in tax equity
investments?
Mr. Baer. Yes, our understanding is that the loss
experience, which, again, is what should drive capital rules,
not the political favorability of the loss experience, with
both of these has been very good and does not justify a 400-
percent risk weight, which is 4 times what you would have for
basically a corporate loan. So, I don't believe that there is
evidence that the loss rates on this are higher than any
corporate loan you would make.
Mr. Casten. Okay.
Mr. Baer. Certainly, there is nothing in the proposal which
demonstrates that.
Mr. Casten. Yes. In Basel III, I think they refer to the
low-income housing investments as community development
investments, not subject to the 400-percent tax.
Mr. Baer. Correct.
Mr. Casten. Would you have any objection to just saying,
well, let's just say that these tax equity investments in
renewable energy are also community development investments?
They preponderantly do help local communities after all.
Mr. Baer. What I would say is that the Basel agreement is
not a treaty that the Senate ratified or that this Congress
passed as a law, so you can do whatever you want. You don't
need to sidestep the vernacular of the Basel Accord. You can do
whatever you think is the right thing to do based on the risk
and the cost.
Mr. Casten. Yes, I am inclined to agree, and I am just
speculating. I am not sure this wasn't an oversight on their
part. The U.S does some weird things to incentivize behaviors
through the Tax Code that other governments don't do, and I
could forgive European regulators for not necessarily
appreciating all this, but I would hope that we can fix this in
some other fashion.
I hope maybe some of our colleagues could work with us
because we did really pass the biggest clean energy bill ever
passed by any government in history anywhere. We are really
seeing these huge investments coming in. We do really have to
leave a better planet for our children than the one we
inherited from our parents. We have the tools to do it, and we
shouldn't handicap it because of what, I agree with you, is no
difference in the fundamental risk. And to be clear, I think it
is important for our banks to be well-capitalized, but on this
narrow point, if we agree that the risk profile isn't
different, then let's not cut off our nose to spite our face.
Thank you all, and I am out of time. I yield back.
Chairman Barr. The gentleman yields back. The gentlewoman
from California, Mrs. Kim, is now recognized.
Mrs. Kim. Thank you, Mr. Chairman. We are all in agreement
that Silicon Valley Bank's collapse was largely due to the
failure of its leadership to manage the historical rate hike
not seen in a couple of decades. And on top of the bank's
mismanagement, the Fed's own review blames its supervisors for
failing to act in a timely manner, and in my home State of
California, we are still dealing with the ripple effects of the
Silicon Valley Bank failure. So instead of venturing into new
capital requirements that will increase financing costs for
small businesses and first-time homebuyers, Federal financial
regulators should follow their own reports and address their
mishaps and supervisory breakdowns.
Mr. Baer, Silicon Valley Bank purchased long-term debt to
the point where it had breached its interest rate risk limits
on and off since 2017. In your point of view, who is
responsible for allowing the limit breach to happen, and who
bears the responsibility for giving Silicon Valley Bank a break
for breaching these limits?
Mr. Baer. Sure. Thank you. It is an important question.
Clearly, the primary responsibility lies with the management of
the bank, and secondary, I think, would be the examiners who
tolerated the breaches.
Mrs. Kim. Would you say it is the San Francisco Fed?
Mr. Baer. Yes, I believe that is correct.
Mrs. Kim. Yes. Do you know if the San Francisco Fed was the
only Reserve Bank allowing their member banks to purchase long-
term T-bills?
Mr. Baer. It was more the duration than the nature of the
instrument. So if you think about what was really happening, it
was a perfect storm in the sense that all banks around the
country, as a result of COVID and stimulus programs, got in
massive amounts of deposits. Usually, when you are getting in
lots of deposits, you are also having a lot of loan demand, so
you take those deposits, and you make loans. There was no loan
demand, again because of a lot of programs and the state of the
economy, so they had tons of deposits, and they needed to put
them somewhere, so they bought securities.
The smarter banks, most of the banks, the banks really
probably in all the other Reserve districts said, well, you
know what? We are going to buy securities, but we are going to
buy short-dated instruments because interest rates could rise,
right? And a lot of the banks, and I talked to them, when they
had their earnings calls, they got grief from analysts,
investors, saying, why are you earning such a low yield? And
what they responded responsibly was, I am managing my interest
rate risk and I want to keep my duration short because rates
could rise.
Silicon Valley Bank and some other banks, not many, took a
very different tack and they said, no, we are going to stretch
for the yield. We are going to buy longer-dated instruments,
and that is what ended up dooming them when there was a run.
Again, if there had not been a run, they would never have had
to realize the unrealized losses, but there was, and there was
not a good way to monetize those securities.
Mrs. Kim. Simply put, Silicon Valley Bank's collapse is
being used as a red herring to increase capital requirements.
Federal financial regulators have the tools, but they decided
not to use them. According to a recent 10,000 Small Businesses
survey, 70 percent of small businesses reported it was
difficult to access capital.
I want to ask you another question, Mr. Baer. Several
groups wrote a letter to the Fed, the OCC, and the FDIC asking
these three agencies to delay the Community Reinvestment Act
(CRA) rules until after the capital rules are finalized. So, if
Federal agencies proceed with their timelines, can you describe
how these layers of new regulations could impact access to
capital for small businesses and financing for consumers?
Mr. Baer. I think this is a classic example of what a
holistic review would look like in the sense that the CRA
proposal is in some ways similar to this in that it is
incredibly detailed and effectively a form of credit
allocation, but it assumes where banks will make certain
investments and how easy those investments are to make. Of
course, that is now driven by a subsequent proposal on capital
of over 1,000 pages, and I will confess, we have not even
mapped out this CRA credit for this, how reasonable a business
is that to be in now. I think a lot of this would be in the
mortgage market. So for certain types of loans, is CRA
incentivizing something that the Basel proposal is
disincentivizing? I don't know yet, but I would love a chance
to think about it and then comment on the CRA thing----
Mrs. Kim. Let's move on, because I know my time is coming
to an end quickly. But I also want to echo the comments that we
heard from my colleagues about the proposal that will make it
even harder for lenders to offer loans to buyers who do not put
down the 20-percent down payment. We are talking about low-
income families, veterans, as much of the Americans of all
different backgrounds to buy a home to live their American
Dream. So, can you talk about what type of homeowners will be
pushed out of the market?
Mr. Broeksmit. Yes, I agree with you that first-time
homebuyers who do not have generational wealth and don't have
the ability to make a 20-percent down payment, will be affected
most by this. And that is the very area where banks are being
creative in loans on their balance sheet, and they should be
encouraged instead of having massive surcharges to the capital
they have to allocate on those loans.
Mrs. Kim. Thank you.
Chairman Barr. The gentlelady's time has expired. The
gentlewoman from Massachusetts, Ms. Pressley, is now
recognized.
Ms. Pressley. Thank you. Earlier this year, we witnessed
three of the largest bank failures in U.S. history, a direct
consequence of Republican deregulation in 2018, which weakened
bank regulations by exempting banks like Silicon Valley Bank
from enhanced stress testing and stringent capital
requirements. As has been proven, the Republicans' opposition
to regulation comes at the expense of economic stability for
working families. And now, they are doubling down on their
prior mistakes, despite the harm that we saw just a few months
ago ripple across our economy, especially in my district, the
Massachusetts 7th.
When Silicon Valley Bank collapsed, small businesses in my
district couldn't accept payments, affordable housing
development was slowed, it was suddenly in jeopardy, and tech
companies couldn't make payroll.
Ms. Philo, when banks lack sufficient capital, who bears
the brunt of the cost when there is a financial crisis?
Ms. Philo. Thank you very much, Congresswoman Pressley.
Research shows that financial crises are extremely costly and
have a disproportionate impact on Black and Brown communities,
Black and Latinx communities and businesses, and rural and
other underserved communities. The 2008 crisis cost $2.6
trillion, and the set of capital reforms in these proposals are
really essential to prevent that large-scale boom and bust of
financial cycles that we found ourselves historically and that
hurt all Americans and businesses, but disproportionately
reduced the wealth and the access to credit for communities of
color, rural, and other underserved communities and businesses.
Thank you.
Ms. Pressley. No, thank you. And adding insult to injury,
and we have seen this happen time and time again, Silicon
Valley Bank's CEO was paid millions of dollars, ostensibly for
being incompetent, and rewarded for the harm that they caused.
And every time banking regulators try to increase capital
requirements, we hear this misleading corporate rhetoric like
that of Jamie Dimon, who said that these proposed capital
requirements are bad for America. And I am really quite tired
of it, so let's set the record straight here today.
Ms. Philo, isn't it true that better-capitalized banks are
able to lend more even during periods of stress?
Ms. Philo. Thank you very much. Yes, a bank can use capital
to make more loans. Many bank executives and the bank lobby
claim that increased capital requirements will undermine credit
availability. We strongly disagree that increased capital
requirements will undermine credit availability. Indeed, well-
capitalized and secure banks are essential to providing credit
to businesses, families, and communities.
A 2020 World Bank report summarized several studies which
found that well-capitalized banks in the U.S. had higher loan
growth than nearby banks with fewer capital reserves, that
well-capitalized, large U.S. banks had higher loan originations
and liquidity, and that better-capitalized international banks
had lower funding costs that enabled them to increase lending.
I recognize there are studies that say a lot of different
things, but I found this to be credible, and I appreciate the
time.
Ms. Pressley. And similarly, some banks believe that this
rule will slow down the U.S. economy, but do you believe that
this will be the case given that implementation will be gradual
and occur over years?
Ms. Philo. I have recognized the question, and yet I do
believe that these proposals will not slow down the economy.
The proposals make the long implementation and the gradual
phase-in explicit, and I believe that is the intention there to
mitigate those impacts. So, I do not believe that that will be
an overarching issue.
Ms. Pressley. Thank you. The benefits of higher capital
requirements are clear. They will enhance bank resilience and
secure more stable lending in our economy. We have seen three
bank failures this year, and this rule is necessary to
strengthen our financial system so that it can weather future
crises. The American people are paying close attention.
Republicans continue to oppose common-sense regulations in our
banking industry. We know who will suffer and we know exactly
whom to hold accountable. Thank you. I yield back.
Mr. Fitzgerald. [presiding]. The gentlelady yields back.
Chairman Barr has allowed me to sit in as Chair briefly, so I
am going to recognize myself for 5 minutes.
Thank you all for being here today. The interagency
proposed rule for implementation of the Basel III regulatory
framework would add up to 20 percentage points to
internationally agreed-upon Basel III risk weights for
mortgages. I don't want to be redundant; I know that we have
kind of explored this area many times this morning.
I was fortunate enough on the break that we just had to
meet with Wisconsin REALTORS and Wisconsin bankers back to back
in some roundtables, and I thought the conversation was
actually fascinating. There is obviously an issue that has
emerged in this economy, which is, adults 25- to 35-years-old
have been completely frozen out of the market for the most
part, and some of this came from feedback we were getting from
some of the REALTORS. Some of them also happen to be mortgage
brokers.
I was wondering, first of all, Mr. Broeksmit, can you talk
a little bit about this issue related to credit scores for
consumers and this whole group of adults in that age range who
have no credit score, which is what we are being told at this
point, or if they end up being in a situation where they are a
married couple, where one may have a credit score and the other
one doesn't, so they are making changes and going through all
these gyrations to try and put themselves in a place where they
could qualify for a mortgage so they are first-time homebuyers?
Mr. Broeksmit. One of the things about credit scoring that
is frustrating is that most credit scores don't give credit for
your rental payment history. There is nothing more predictive
of your future ability to make a housing payment than how you
are paying it today, whether it is an apartment or whether it
is a home. So, there are efforts underway to get landlords to
report that payment history to the credit bureaus, and there
are also workarounds, although they are cumbersome, as I am
sure your constituents told you, so that you can get credit for
that rental experience. For instance, if you can get 12 monthly
bank statements and it shows that amount going out about the
same time every month, that is a big consideration in
underwriting. So, there are some steps underway to ameliorate
that for credit scoring.
Mr. Fitzgerald. Yes. Also related to small business, as
they continue to see credit lines, there are these unused
portions of credit that are out there. And some banks right now
have this discretion to simply cancel those credit lines and
then try and reissue. I am wondering if you wanted to comment
on that because it is kind of a confusing part of, once again,
what most small businesses in America are looking at as they
try and capitalize some of these new projects or purchases.
Mr. Broeksmit. If I understand this voluminous proposal
correctly, banks would be required to hold capital on the
maximum amount that could be drawn rather than the amount that
is outstanding. That could have a really chilling effect on the
sort of small business credit you mentioned, and also home
equity lines of credit, where consumers take that out and use
it as they need it because they only pay interest if they use
it. And then, if the banks are forced to hold capital against
the whole line, it would make it much more expensive.
Mr. Fitzgerald. Yes. Approximately 70 percent of small
businesses right now in America are saying they are having a
very difficult time accessing credit, which is up considerably
from where it was even a year ago. What effect do you think it
would have on the FICO scores for small business owners as
well, which I know is part of the mix right now as you talk to
many of the banks kind of across the country?
Mr. Broeksmit. I think the main effect is that the cost
would go up and the availability would diminish. If the
business owner or the consumer makes timely payments on that
credit, I think the credit score will be okay. It is really
more a question of the availability and the cost.
Mr. Fitzgerald. Yes.
Mr. Baer, you talked about the credit crunch, I think is
the way you described it before. If you see some of the banks
kind of tighten up on not only the credit scores and the way
they are evaluated, but if, in fact, they have to add more
capital, which most of them and everyone that I have spoken to
has said it is absolutely ridiculous that they would have to
add capital at this point, it would make it much more
difficult, which is kind of what I am hearing here this morning
being reported back from the witnesses. Do you think that there
would be a breaking point at which we see either changes in
inventory when it comes to single-family homes or small
businesses that are starting to either relocate or are unable
to expand after the pandemic that had such a devastating
effect? What do you see kind of across-the-board as to what
that landscape would look like?
Mr. Baer. Sure. It is obviously complex, but basically, if
your required capital ratio goes up, you have a choice. You can
increase the numerator, raise capital, retain earnings, or you
can decrease the denominator, and that means getting out of the
types of loans that are attracting the highest risk weights or
the types of assets, and a lot of that are loans and
particularly small business loans.
Mr. Fitzgerald. Very good. Thank you. I yield back. Next,
we are going to recognize Mr. Green from Texas for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. And I thank the ranking
member, and I thank the witnesses for appearing today. I would
like to further introduce the witnesses by way of observation.
It appears to me that we have but one female on this panel of
witnesses. If you are a female, would you kindly extend your
hand so that I may validate?
[Hand raised.]
Mr. Green. Only one hand. Thank you. My vision is good.
That appears to be Ms. Philo. Is that correct, ma'am?
Ms. Philo. Yes, sir.
Mr. Green. My observation also indicates to me that all of
the persons appear to be what I would call Anglo, we commonly
in this country refer to people as White. I really don't like
the term, to be quite honest, but if you have documented
yourself, perhaps on the Census, as something other than White,
would you extend a hand into the air?
[No response.]
Mr. Green. Let the record reflect that we have none of the
persons who have documented themselves as someone other than a
White person. I am doing this, friends, because I happen to
believe that there are people of color who can do what you do,
but I could be wrong.
So let me pick on you, Mr. Olmem. You have a storied
career, by the way. I compliment you, sir, and your firm has
done an outstanding job. I see that on November 17, 2022, 53
lawyers made partner and counsel. And of that 53--this is
fantastic--55 percent of those promoted were female. That is
fantastic. Your firm is doing a great job. I compliment you.
Let the world know that I have said it.
Mr. Olmem. Thank you.
Mr. Green. And the greatest number of promotions were in
banking and finance. Outstanding, and I have one other comment
about you. I am just absolutely impressed with your
credentials. One other comment. The American Lawyer named you
as one of their 2021 trailblazers, recognizing individuals who
are agents of change in the legal industry. Agent of change, a
trailblazer. Are there women of color who can do what you do,
sir?
Mr. Olmem. Certainly.
Mr. Green. And are there women of color who can do what you
do--my vision is not as good as I would like for it to be--but,
Mr. Baer?
Mr. Baer. Yes, I would agree, Congressman.
Mr. Green. And our final witness, would you agree that
there are women of color who can do this?
Mr. Broeksmit. I would, and, in fact, the immediate past
Chair of the Mortgage Bankers Association was just such a woman
of color and she did a great job.
Mr. Green. Thank you. I want to compliment all of you, but
I must tell you I am a little bit disappointed that we have not
arrived. We are not there yet because for some reason, there
are no people of color on this panel, and it is not your fault,
so please, it is not personal as it relates to you. There has
to be someone who will point these things out. If no one points
them out, 50 years from now, we will still have panels that are
all White with no people of color. It appears that on my watch,
I am that person.
I would ask this: Do you think that we should continue to
have all-White panels in a country where we have other persons
who are capable, competent, and qualified, and happen to be of
color? If you think so, extend your hand. I will make it easy
for you, extend your hand.
[No response.]
Mr. Green. Let the record reflect that no hands have gone
up. By the way, it was the Democrats that produced the one
person who happens to be a female, so I compliment my
Democratic colleagues and my Democratic ranking member for
doing this. It is a bit late for you to answer this question,
but, Ms. Philo, I would have asked you, and perhaps you will
answer for the record, about this internal modeling that takes
place. And I want you to please explain for the record how this
complicates----
Mr. Fitzgerald. The gentlemen's time has expired. I will
allow the witness to answer the question.
Mr. Green. No, I am asking her for the record how this
complicates the job of those who have to monitor banking.
And, Mr. Chairman, I would like to put in the record the
article that I referenced related to Mr. Olmem's law firm,
Mayer Brown, which has an outstanding record. I thank you, and
I yield back.
Mr. Fitzgerald. Without objection, it is so ordered.
And the gentleman's time has expired. We now recognize the
gentleman from Georgia, Mr. Loudermilk, for 5 minutes.
Mr. Loudermilk. Thank you, Mr. Chairman. Thank you all for
being here. I am here batting at the bottom of the order,
partially because I have been spending about the last 50
minutes with constituents from Georgia, one of our largest
counties' chambers of commerce. And interestingly enough, there
was a lot of discussion regarding this matter right here and a
lot of concern about the U.S. and the government in general,
especially the financial services sector, adopting
international standards versus those that are designed and
catered directly toward the U.S. industry.
But I appreciate you all being here today. And in addition
to the multitude of procedural material and sovereignty
concerns that my colleagues and I have raised in letters,
hearings, and discussions with regulators, I want to make it
clear to the public that the Basel III proposed rule isn't some
obscure regulation that only affects big banks. My colleagues
and I are concerned that the 1,087-page Basel III proposed rule
could tangibly increase the cost of capital, affecting
businesses and homeowners nationwide.
You have mostly answered a lot of the major concerns that I
had, so I am not going to go through a lot of those, especially
when it affects the mortgages and mortgage servicing rights
(MSRs).
Mr. Broeksmit, just kind of encapsulating everything based
on the answers you have given to several of these questions, do
you agree that borrowers would notice the effects of the Basel
III NPRs treatment of MSRs?
Mr. Broeksmit. I do, and, in fact, in 2011, just before the
Basel agreements were put into place, banks serviced 91 percent
of home mortgages. They now service 47 percent. If you make it
even less attractive, they will service less.
Mr. Loudermilk. What will be the alternative? Is it just,
we would see an impact in the real estate market? Are there
alternative places to borrow money?
Mr. Broeksmit. To be clear, there are plenty of other good
players who service mortgages, and independent mortgage bankers
do a great job servicing loans. But from the consumer's
perspective, the more sources of demand and sources of capital
for mortgage servicing, the more valuable the asset. The more
valuable the asset, the lower the mortgage rate, because the
servicing value is an integral part of mortgage pricing.
Mr. Loudermilk. It sounds like maybe competition tends to
lower costs and prices.
Mr. Broeksmit. Competition and choices for consumers, yes.
Mr. Loudermilk. Exactly. I have shared with other people
that back when I served in the Air Force and the military, I
was involved in intelligence, and the Soviet Union was our
adversary. And one defector during that time ended up coming to
the United States, someone from the Soviet military. And at the
first grocery store in the U.S. he went to, he was so amazed
with the selection and the choices he had that he thought it
was a setup by the CIA, and he said, ``Who needs 12 different
types of raisin bran?'' And so again, choice is a part of our
economy.
Last question for you on this: Does the proposed rule
contemplate the consumer confusion this would cause anywhere in
the 1,087 pages? Have they addressed the confusion that this
would bring?
Mr. Broeksmit. In addition to all of the other things they
have not addressed to justify this rule, that is one of them.
Mr. Loudermilk. Okay. Thank you for that.
Turning to Mr. Olmem, was there broad consensus among the
regulators on the NPR?
Mr. Olmem. No, there wasn't. In fact, there was, I think, a
record number of dissents at the Board for a proposal, at least
in recent memory, and there were two dissents at the FDIC.
Mr. Loudermilk. Okay. And this is probably the last
question I have time for: What should Congress take away from
the reservations that several key banking regulators have
expressed with the NPR? What should our reaction be? What
should we do?
Mr. Olmem. That there needs to be significantly more
congressional oversight and involvement in this process, and to
remember that policy on capital regulation is really set here
at Congress, and Congress needs to make sure that the
regulators are following what Congress has already set out in
the Federal law.
Mr. Loudermilk. Do you see this as being partisan, given
that even people within this Administration have expressed
concerns?
Mr. Olmem. It shouldn't be. Historically, capital
regulation, if you go back, those statutes, for the most part,
with kind of Dodd-Frank being the one exception, have been
passed with significant bipartisan majorities. So it shouldn't
be, and that is the danger.
Mr. Loudermilk. Okay. Thank you, Mr. Chairman. With that, I
yield back the 1 second that I had left.
Mr. Fitzgerald. The gentleman yields back. I would like to
thank our witnesses for their testimony today.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned.
[Whereupon, at 12:02 p.m., the hearing was adjourned.]
A P P E N D I X
September 14, 2023
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
[all]