HFSC Hearing on the Fed ‘s Supervision and Regulation with Chair Yellen
House Financial Services Committee
“Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System”
Wednesday, November 4, 2015
Key Topics & Takeaways
- Stress Tests: Chairman Hensarling (R-Texas) asked how market participants can be “convinced” that there is less systemic risk when there is no insight into stress tests. Chair Yellen stated that the Fed does a “great deal” to explain methodologies used through an annual overview that is published and includes detailed information about scenarios and analytic framework.
- SIFI Designation: Rep. Scott (D-Ga.) asked whether the FSOC should communicate clearly and publically the specific risks that designated firms pose, so that they understand why they were designated and the actions they can take to be de-designated. Yellen answered that the FSOC already explains “very clearly” the basis for designation decisions to the firms and that it reconsiders designations every year.
- Living Wills: Yellen explained that the Fed has taken the position that the living will process is new and the expectation was that it would take several rounds and guidance from the regulators to achieve credible plans. She added that the Fed is evaluating the latest round and “will make important decisions” in the coming months.
Witness
- Janet Yellen, Chair, Federal Reserve Board of Governors
Opening Statements
In his opening statement, Chairman Jeb Hensarling (R-Texas) noted that the Dodd-Frank Act requires the Federal Reserve’s Vice Chair of Supervision to testify before Congress twice a year. “Regrettably,” he said, the Fed still has no such vice chair five years later because President Obama has been “either unwilling or unable to follow the law.” Hensarling said Congress can no longer wait to do its job, especially as the Fed has been granted “vast, new sweeping regulatory powers” by Dodd-Frank despite its “contributions” to the last crisis. He commented that the Federal Reserve can now “functionally control every major corner of the financial services sector.’
Hensarling expressed his concern with the Fed’s part in a “shadow regulatory system that is neither transparent nor accountable,” and stated that the Fed cannot be allowed to “shield” its regulatory activities from congressional oversight. He criticized rules introduced since the crisis, calling them a “regulatory tsunami” that has sidelined capital that could otherwise fuel economic growth. Hensarling insisted that the Fed’s lack of transparency and “all-encompassing” regulatory authority leads to a risk that “our central bankers will soon become our central planners.”
Ranking Member Maxine Waters (D-Calif.), in her opening statement, said she was eager to hear about the Federal Reserve’s progress on financial reforms. Specifically, she stated her interest in how the Fed is using the flexibility granted by Dodd-Frank to tailor regulations for firms based on their risk profiles and in how the Fed has bolstered its expertise to regulate systemic non-bank financial institutions.
Waters criticized legislation the Committee has considered that would harm the Fed’s ability to regulate both banks and non-banks, as well as proposals that would undermine the ability of the Financial Stability Oversight Council (FSOC) to identify regulatory gaps. She warned that Congress must be “ever-vigilant” of the threat of another crisis and insisted that it must be mindful of attempts to “defund and defame” Dodd-Frank.
Rep. Randy Neugebauer (R-Texas) noted that the Fed regulates and supervises some of the largest financial institutions in the world, and commented that its rules have “significantly altered capital structures.” He was also critical of the Comprehensive Capital Analysis and Review (CCAR) stress tests for being opaque and lacking meaningful oversight. Neugebauer stated interest in hearing how the Fed sees its different capital and liquidity rules working together and noted that there have already been “unintended consequences” in bond markets.
Testimony
In her testimony, Federal Reserve Chair Janet Yellen said one of the Federal Reserve’s most prominent goals is to promote a strong and resilient financial system that is able to the serve the economy and promote growth. As such, she explained that the Fed works to ensure firms comply with regulations so they can continue to serve customers and businesses in times of stress. She noted that the regulatory approach of the Fed has changed significantly since the crisis, with a new focus on systemic vulnerabilities and interconnectedness, rather than on the soundness of individual institutions.
Comprehensive changes to the regulatory structure, Yellen continued, address risk in two ways: 1) reducing the probability that large institutions will fail by making them more resilient; and 2) limiting the systemic damage that would result if an institution were to fail. She further explained that limiting the systemic damage of a failure is accomplished by the adoption of resolution plans that show how firms can be resolved through bankruptcy and through the Total Loss Absorbing Capacity (TLAC) rule.
Questions and Answers
Hensarling asked how market participants can be “convinced” that there is less systemic risk when there is no insight into stress tests. Yellen stated that the Fed does a “great deal” to explain the methodologies used through an annual overview that is published, noting it includes detailed information about scenarios and analytic framework.
Waters noted the concern that the CCAR stress test is not calibrated and asked if the Fed will commit to additional tailoring for the CCAR. Yellen explained that the Fed does a “great deal” of tailoring to the supervisory approach to ensure they are appropriate for each firm’s size, complexity and systemic risk, and that they are looking at additional ways to tailor the approach, including the CCAR process.
Rep. Ruben Hinojosa (D-Texas) noted that he continues to hear from regional banks that they are unduly burdened by regulations, specifically by stress tests. He asked if regulators have enough discretion to appropriately tailor standards, or whether Congress must take action. Yellen answered that the Fed does not have as much ability to tailor stress tests as would be ideal, and that a legislative change to reduce burdens on smaller institutions “could be useful.”
Rep. Steve Stivers (R-Ohio) noted the inspector general (IG) report that showed several problems in the Fed’s own stress test and asked if changes will be made to the CCAR process. Yellen stated that the IG’s findings were related to model validation procedures and that the Fed will be looking into those matters.
Rep. Gwen Moore (D-Wis.) asked how criticism of stress tests has contributed to a “better focus” of Fed oversight. Yellen noted that stress tests are “one of the most significant innovations” in how the Fed supervises and that firms have learned how to manage risks in their organizations. She noted that there has been an improvement in the capital planning processes within firms but that the Fed is conducting reviews to see if changes can be made to make the tests more effective and less burdensome.
Rep. John Carney (D-Del.) asked Yellen what the best way to provide regulatory relief for small and midsize banks would be and asked if the Fed has the authority to “appropriately” tailor the CCAR process for them. Yellen explained that the Fed has “considerable” authority to tailor the CCAR process to fit the “complexity and systemic footprint” of organizations, but that banks over the $50 billion threshold are subject to stress testing and resolution plan requirements under Dodd-Frank that “cannot be completely removed.”
Capital Rule Coordination
Neugebauer noted the different capital regulations, such as the total loss-absorbing capacity (TLAC) requirement, global systemically important bank (G-SIB) surcharge, and CCAR, and asked how the rules fit together. Yellen explained that the rules do fit together and that most requirements are only imposed on the eight U.S. G-SIBs. She continued that the supplementary leverage ratio is a “backup tool” that works in coordination with the risk based capital surcharge, and that TLAC is necessary to resolve a failed firm under bankruptcy or orderly liquidation. Yellen stressed how “valuable” the CCAR process is because it requires firms to meet minimum capital standards and to analyze their own risks, as well as require “rigorous” capital planning processed to ensure there is an adequate amount of capital to survive a “severe stress.”
Interest Rates
Rep. Carolyn Maloney (D-N.Y.) asked if the risks of raising interest rates “a little early” in December outweigh the benefits. Yellen noted that the Federal Open Market Committee (FOMC) indicated at its last meeting that it may be “appropriate” to adjust rates at the next meeting, but that “no decision has been made,” saying it will depend on the economy’s assessment at the time. She continued that the FOMC expects that the economy will continue to grow and that December “would be a possible” time to raise rates. Yellen stressed that if the data and economic outlook justifies a move in interest rates, it will be done at a “gradual and measured pace.”
Rep. Al Green (D-Texas) asked if the global economy should be considered when setting U.S. interest rates. Yellen stated that global economic performance is taken into account because “we’re interconnected.”
Rep. Tom Emmer (R-Minn.) asked if the FOMC would consider negative interest rates, noting that other countries have implemented them. Yellen explained that while the FOMC has not ruled out negative interest rates, as they would spur lending and stimulate spending, there is not currently a need for them.
Cost Benefit Analysis
Rep. Scott Garrett (R-N.J.) asked if the Fed is required to complete a cost benefit analysis each time it creates a regulation. Yellen explained that the Fed follows the rules of the Administrative Procedures Act and asks for public comment on each rule. She continued that there was an analysis completed on the TLAC regulation, but that an analysis is not completed on each rule.
Rep. Blaine Luetkemeyer (R-Mo.) asked whether the systemically important financial institutions (SIFI) designation of insurers was completed with an extensive analysis other than information publicly available. Yellen stated that there was an “extremely detailed” evaluation completed in addition to “detailed interaction” with the companies, where information was gathered outside of what is publicly available.
Rep. David Scott (D-Ga.) asked whether the FSOC should communicate clearly and publically the specific risks that designated firms pose so that they understand why they were designated and the actions they can take to be de-designated. Yellen answered that the FSOC already explains “very clearly” the basis for designation decisions to the firms and that it reconsiders designation every year.
Green asked if Yellen preferrs a “trigger” of a certain dollar amount in the designation of SIFIs or if she would agree with an activities-based designation. Yellen explained that she remains open to the dollar threshold and would only support a “modest increase” in the threshold, adding that even regional organizations would have a significant impact to a portion of the country.
Rep. Emanuel Cleaver (D-Mo.) noted the “panic” from insurance companies due to their SIFI designation. Yellen explained that the Fed is “working very hard” to tailor appropriate rules and understand the nature of the insurance business, by consulting with firms and state insurance commissioners. She continued that there will likely be a notice of proposed rulemaking that allows for public comment when a decision is made, and that while she could not give a date for the proposed rulemaking, “it’s a high priority.”
Rep. Keith Ellison (D-Minn.) conceded that there is a growing consensus the $50 billion threshold is too low and asked Yellen what it should be. Yellen answered that she would support a “modest increase,” but that such a change is not a “must have.”
Rep. Bruce Poliquin (R-Maine) asked about Yellen’s thought process on designating asset managers. Yellen responded that the FSOC is focusing on activities at the moment rather than designating firms.
Poliquin asked if there is a list or set of criteria available that the industry can use to identify the business practices being considered by the FSOC. Yellen said there is a set of criteria that the FSOC “initially issued” but did not know whether it has been updated.
Poliquin then asked if there is a similar list or set of guidelines for how firms can be de-designated. Yellen answered that it would not be appropriate to have a formal list, but that firms understand “very well” why they were designated and what changes would be needed for the designation to be rescinded.
Poliquin suggested that asset managers would benefit from having sets of criteria for what could lead to their designation and what they could then do to be de-designated. Yellen responded that the FSOC has not, to date, designated any asset managers.
Executive Compensation
Rep. Michael Capuano (D-Mass.) noted the importance of the requirement for the Fed to take action regarding executive pay at banks and asked why the Fed has not yet produced such a regulation. Yellen noted that the Fed has produced guidelines on incentive compensation and supervision and that they are “very attentive” to aspects that could lead to excessive risk taking. She noted the challenge the Fed has faced in creating the rule, adding that it is an “important problem and essential to address.”
Capuano asked what the time frame is for the “next generation” of living wills. Yellen noted that the Federal Deposit Insurance Corporation (FDIC) has delivered detailed evaluations to the firms on their living wills with direction on how to improve their resolvability, adding that they have received updated plans and are evaluating with the FDIC.
Moore asked Yellen how the second round of living wills has informed the Fed. Yellen explained that the Fed has “learned a lot” in recognizing the challenge of cross-border issues. She continued that they have been able to provide “detailed guidance” on firms’ shortcomings and explain what the Fed wants to see in this year’s submissions.
Rep. Denny Heck (D-Wash.) noted that a rating agency has indicated that the living will exercise is working and asked Yellen for her forecast of the process. Yellen answered that the regulators have received very detailed living wills that took account of the instructions given to the firms by the Fed and FDIC, and that the Fed is “carefully evaluating” them.
Ellison noted that in the last round of living will submissions, the Federal Reserve chose not to deem them non-credible while the FDIC did. He asked why the Federal Reserve would “give up authority” to force changes at institutions by not deeming plans non-credible. Yellen explained that the Fed took the position that the living will process is new and the expectation was that it would take several rounds and guidance from the regulators to achieve credible plans. She added that the Fed is evaluating the latest round and “will make important decisions” in the coming months.
Emergency Lending Powers
Rep. Bill Huizenga (R-Mich.) said the failure of the Federal Reserve to act on several items has been a point of frustration for many members of Congress. He then specifically expressed concern about the Fed’s failure to implement a final rule for its Section 13(3) emergency lending authority and asked when a final rule would be issued. Yellen answered that she expects the final rule to be issued “by the end of this month.” She added that the Fed regards its emergency lending powers as crucial to providing liquidity in a time of panic, so it wants to be “very careful” about the final rule.
Huizenga noted his proposal that emergency lending must be approved by nine of the 12 presidents of the Federal Reserve banks. Yellen said the current approach, requiring only the approval of five Fed governors, is adequate and that she has concerns with proposals that could restrict the use of the lending powers.
TLAC
Hinojosa noted that the Fed finalized its TLAC proposal last week and highlighted that credit rating agencies may cut the ratings of the largest banks based on the prospect that the federal government is less likely to provide funding to them in times of crisis. Yellen answered that this is recognition by the rating agencies that TLAC can mitigate the too-big-to-fail problem.
Emmer stated that some analyses of the TLAC draft proposal suggest it penalizes firms for having a desirable business model and that the rule could be a tax on deposit funding. Yellen explained that the rule is an “important step” towards ensuring a workable single point of entry strategy, and the analysis that it penalizes firms is a “mischaracterization of the proposal.” She continued that the Fed has conducted a quantitative impact analysis that was part of the published proposal.
Rep. Bill Foster (D-Ill.) commented that he is enthusiastic about the prospects of contingent capital instruments (CoCos), and that it seems to him that CoCos are being implemented for the U.S. subsidiaries of foreign banking organizations but not U.S. firms. He asked if the Federal Reserve would be operating the trigger for the conversion of CoCos. Yellen said the Fed would want subsidiaries to hold enough loss absorbency for the FDIC to recapitalize them.
Foster stated that the CoCo mechanism is superior to unsecured debt because it warns banks when they are on the verge of violating capital requirements, rather than when they are on the verge of insolvency, and that it is politically easier to trigger the conversion to equity than to launch insolvency proceedings. Yellen answered that in the case of a foreign firm, foreign regulators would want to centrally engage in a single-point-of-entry recapitalization, and that the structure proposed by the Fed would make that possible.
Foster asked for a briefing on the CoCo issue, and Yellen agreed to organize one.
FSOC Reform
Rep. William Lacy Clay (D-Mo.) said H.R. 1309 would remove the Fed’s ability to make safety and soundness decisions and give them to the FSOC. Yellen responded that she would not like to see the FSOC involved in determining appropriate programs for firms put under Fed supervision.
International Coordination
Clay asked if any major nation defers domestic bank safety and soundness decisions to a board of international regulators such as the Financial Stability Board. Yellen stated that she does not know of any such cases and stressed that nothing becomes law in the U.S. unless U.S. regulators deem it appropriate for domestic firms. She continued that international bodies are coordination groups for consultation, but no substitute for domestic rule efforts.
Rep. Robert Pittenger (R-N.C.) commented that federal regulations are having a significant impact on the economy and may drive firms to leave the U.S. Yellen answered that this is why the U.S. participates in international forums, to ensure that other countries are also raising their own financial regulatory standards.
Bank Culture
Clay asked, in light of many reported violations, what the Fed’s role is in improving bank culture. Yellen replied that the Fed is “extremely disturbed by the pattern of violations.” She stated that it has imposed “exceptionally large” fines in addition to barring individuals from working in the industry, and that the Fed fully expects that boards of the firms it supervises put in place rules and attend to questions of bank culture to stop the pattern of violations.
Changes in Supervision Practices
Rep. Stevan Pearce (R-N.M.) asked if the Federal Reserve’s staff ever considers its internal failures. Yellen said this “set of discussions” has been held over many years and has focused on lessons learned, exercises, and discussion of what needs to be done differently. She added that this has been evident in the Fed’s changed process of supervision and focus on the financial system as a whole.
Capital Requirements and Posting Margin
Scott warned it “sends a conflicting message” that U.S. regulators are encouraging more risk management for derivatives transactions yet Basel capital requirements do not recognize the exposure-offsetting nature of segregated customer margin. He said a clearer message must be sent as to how Basel capital requirements interact with the margin requirements.
Tailoring Regulations
Rep. Robert Hurt (R-Va.) said that despite Yellen’s statements that the Fed tailors its rulemaking for smaller institutions, community banks are still disproportionately affected by regulation. He asked whether Yellen agrees that balanced supervision is an important role of the Fed. Yellen said it is “absolutely one of our most important responsibilities.”
Heck expressed his the need for regulatory relief for smaller institutions and urged Yellen to be more proactive in looking for ways to diminish burdens. He then noted that Yellen’s prepared testimony states that the Federal Reserve will provide a report to Congress at the end of the Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) process and asked when the report would be delivered. Yellen replied that the report would be given before the end of 2016.
Vice Chair of Supervision
Hurt asked Yellen if it would be good to have the vice chair of supervision position filled, and whether it would be appropriate for her to press President Obama to fill the position. Yellen answered that she thinks the Fed is carrying out its supervisory work in a “thorough and thoughtful fashion,” but that she would welcome a nomination.
Stivers (R-Ohio) asked if Yellen would be open to Governor Daniel Tarullo accompanying her to hearings on supervision going forward, to which she stated he is “ready to testify” and she has no problem with him joining her.
Supplementary Leverage Ratio
Rep. Randy Hultgren (R-Ill.) asked why the supplementary leverage ratio is applicable regardless of the riskiness of individual exposures. Yellen explained that the supplementary leverage ratio is a “backup ratio” to risk-based capital standards and is required based on the size of a firm’s balance sheet. She continued that the ratio is “unlikely to be a binding ratio” for larger institutions that have SIFI surcharges.
Basel III
Rep. Marlin Stutzman (R-Ind.) asked how Basel III will be more successful than its predecessors. Yellen noted the improvement of capital standards due to the increased demand of quality and quantity on systemically important firms, as well as the backup leverage requirements that “enhance safety and soundness.”
CLOs
Rep. Andy Barr (R-Ky.) stated that too much regulation can be a problem, and commented that the market for collateralized loan obligations (CLOs) faces a contraction that will cause a credit crunch for American companies because of the Fed’s risk retention rules. He questioned whether the Fed believes companies are better served with expensive, short-term financing rather than stable and long-term CLOs. Yellen said the Fed wants stable and long-term options, but that originators must have “skin in the game” when securitizations take place.
Barr added that he has joined a bipartisan group of lawmakers calling for a “qualified CLO” and asked if Yellen would be open to this. Yellen answered that she “can have a look at it.”
Liquidity
Barr noted that Treasury Secretary Lew has denied that post-crisis regulations are causing a liquidity crisis, but that Fed Governor Lael Brainard has said regulation may be a factor. He asked what would lead Yellen to doubt that regulation is impacting liquidity. Yellen answered that “a bunch of different things” need to be studied, and commented on the prevalence of high-frequency trading.
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House Financial Services Committee
“Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System”
Wednesday, November 4, 2015
Key Topics & Takeaways
- Stress Tests: Chairman Hensarling (R-Texas) asked how market participants can be “convinced” that there is less systemic risk when there is no insight into stress tests. Chair Yellen stated that the Fed does a “great deal” to explain methodologies used through an annual overview that is published and includes detailed information about scenarios and analytic framework.
- SIFI Designation: Rep. Scott (D-Ga.) asked whether the FSOC should communicate clearly and publically the specific risks that designated firms pose, so that they understand why they were designated and the actions they can take to be de-designated. Yellen answered that the FSOC already explains “very clearly” the basis for designation decisions to the firms and that it reconsiders designations every year.
- Living Wills: Yellen explained that the Fed has taken the position that the living will process is new and the expectation was that it would take several rounds and guidance from the regulators to achieve credible plans. She added that the Fed is evaluating the latest round and “will make important decisions” in the coming months.
Witness
- Janet Yellen, Chair, Federal Reserve Board of Governors
Opening Statements
In his opening statement, Chairman Jeb Hensarling (R-Texas) noted that the Dodd-Frank Act requires the Federal Reserve’s Vice Chair of Supervision to testify before Congress twice a year. “Regrettably,” he said, the Fed still has no such vice chair five years later because President Obama has been “either unwilling or unable to follow the law.” Hensarling said Congress can no longer wait to do its job, especially as the Fed has been granted “vast, new sweeping regulatory powers” by Dodd-Frank despite its “contributions” to the last crisis. He commented that the Federal Reserve can now “functionally control every major corner of the financial services sector.’
Hensarling expressed his concern with the Fed’s part in a “shadow regulatory system that is neither transparent nor accountable,” and stated that the Fed cannot be allowed to “shield” its regulatory activities from congressional oversight. He criticized rules introduced since the crisis, calling them a “regulatory tsunami” that has sidelined capital that could otherwise fuel economic growth. Hensarling insisted that the Fed’s lack of transparency and “all-encompassing” regulatory authority leads to a risk that “our central bankers will soon become our central planners.”
Ranking Member Maxine Waters (D-Calif.), in her opening statement, said she was eager to hear about the Federal Reserve’s progress on financial reforms. Specifically, she stated her interest in how the Fed is using the flexibility granted by Dodd-Frank to tailor regulations for firms based on their risk profiles and in how the Fed has bolstered its expertise to regulate systemic non-bank financial institutions.
Waters criticized legislation the Committee has considered that would harm the Fed’s ability to regulate both banks and non-banks, as well as proposals that would undermine the ability of the Financial Stability Oversight Council (FSOC) to identify regulatory gaps. She warned that Congress must be “ever-vigilant” of the threat of another crisis and insisted that it must be mindful of attempts to “defund and defame” Dodd-Frank.
Rep. Randy Neugebauer (R-Texas) noted that the Fed regulates and supervises some of the largest financial institutions in the world, and commented that its rules have “significantly altered capital structures.” He was also critical of the Comprehensive Capital Analysis and Review (CCAR) stress tests for being opaque and lacking meaningful oversight. Neugebauer stated interest in hearing how the Fed sees its different capital and liquidity rules working together and noted that there have already been “unintended consequences” in bond markets.
Testimony
In her testimony, Federal Reserve Chair Janet Yellen said one of the Federal Reserve’s most prominent goals is to promote a strong and resilient financial system that is able to the serve the economy and promote growth. As such, she explained that the Fed works to ensure firms comply with regulations so they can continue to serve customers and businesses in times of stress. She noted that the regulatory approach of the Fed has changed significantly since the crisis, with a new focus on systemic vulnerabilities and interconnectedness, rather than on the soundness of individual institutions.
Comprehensive changes to the regulatory structure, Yellen continued, address risk in two ways: 1) reducing the probability that large institutions will fail by making them more resilient; and 2) limiting the systemic damage that would result if an institution were to fail. She further explained that limiting the systemic damage of a failure is accomplished by the adoption of resolution plans that show how firms can be resolved through bankruptcy and through the Total Loss Absorbing Capacity (TLAC) rule.
Questions and Answers
Hensarling asked how market participants can be “convinced” that there is less systemic risk when there is no insight into stress tests. Yellen stated that the Fed does a “great deal” to explain the methodologies used through an annual overview that is published, noting it includes detailed information about scenarios and analytic framework.
Waters noted the concern that the CCAR stress test is not calibrated and asked if the Fed will commit to additional tailoring for the CCAR. Yellen explained that the Fed does a “great deal” of tailoring to the supervisory approach to ensure they are appropriate for each firm’s size, complexity and systemic risk, and that they are looking at additional ways to tailor the approach, including the CCAR process.
Rep. Ruben Hinojosa (D-Texas) noted that he continues to hear from regional banks that they are unduly burdened by regulations, specifically by stress tests. He asked if regulators have enough discretion to appropriately tailor standards, or whether Congress must take action. Yellen answered that the Fed does not have as much ability to tailor stress tests as would be ideal, and that a legislative change to reduce burdens on smaller institutions “could be useful.”
Rep. Steve Stivers (R-Ohio) noted the inspector general (IG) report that showed several problems in the Fed’s own stress test and asked if changes will be made to the CCAR process. Yellen stated that the IG’s findings were related to model validation procedures and that the Fed will be looking into those matters.
Rep. Gwen Moore (D-Wis.) asked how criticism of stress tests has contributed to a “better focus” of Fed oversight. Yellen noted that stress tests are “one of the most significant innovations” in how the Fed supervises and that firms have learned how to manage risks in their organizations. She noted that there has been an improvement in the capital planning processes within firms but that the Fed is conducting reviews to see if changes can be made to make the tests more effective and less burdensome.
Rep. John Carney (D-Del.) asked Yellen what the best way to provide regulatory relief for small and midsize banks would be and asked if the Fed has the authority to “appropriately” tailor the CCAR process for them. Yellen explained that the Fed has “considerable” authority to tailor the CCAR process to fit the “complexity and systemic footprint” of organizations, but that banks over the $50 billion threshold are subject to stress testing and resolution plan requirements under Dodd-Frank that “cannot be completely removed.”
Capital Rule Coordination
Neugebauer noted the different capital regulations, such as the total loss-absorbing capacity (TLAC) requirement, global systemically important bank (G-SIB) surcharge, and CCAR, and asked how the rules fit together. Yellen explained that the rules do fit together and that most requirements are only imposed on the eight U.S. G-SIBs. She continued that the supplementary leverage ratio is a “backup tool” that works in coordination with the risk based capital surcharge, and that TLAC is necessary to resolve a failed firm under bankruptcy or orderly liquidation. Yellen stressed how “valuable” the CCAR process is because it requires firms to meet minimum capital standards and to analyze their own risks, as well as require “rigorous” capital planning processed to ensure there is an adequate amount of capital to survive a “severe stress.”
Interest Rates
Rep. Carolyn Maloney (D-N.Y.) asked if the risks of raising interest rates “a little early” in December outweigh the benefits. Yellen noted that the Federal Open Market Committee (FOMC) indicated at its last meeting that it may be “appropriate” to adjust rates at the next meeting, but that “no decision has been made,” saying it will depend on the economy’s assessment at the time. She continued that the FOMC expects that the economy will continue to grow and that December “would be a possible” time to raise rates. Yellen stressed that if the data and economic outlook justifies a move in interest rates, it will be done at a “gradual and measured pace.”
Rep. Al Green (D-Texas) asked if the global economy should be considered when setting U.S. interest rates. Yellen stated that global economic performance is taken into account because “we’re interconnected.”
Rep. Tom Emmer (R-Minn.) asked if the FOMC would consider negative interest rates, noting that other countries have implemented them. Yellen explained that while the FOMC has not ruled out negative interest rates, as they would spur lending and stimulate spending, there is not currently a need for them.
Cost Benefit Analysis
Rep. Scott Garrett (R-N.J.) asked if the Fed is required to complete a cost benefit analysis each time it creates a regulation. Yellen explained that the Fed follows the rules of the Administrative Procedures Act and asks for public comment on each rule. She continued that there was an analysis completed on the TLAC regulation, but that an analysis is not completed on each rule.
Rep. Blaine Luetkemeyer (R-Mo.) asked whether the systemically important financial institutions (SIFI) designation of insurers was completed with an extensive analysis other than information publicly available. Yellen stated that there was an “extremely detailed” evaluation completed in addition to “detailed interaction” with the companies, where information was gathered outside of what is publicly available.
Rep. David Scott (D-Ga.) asked whether the FSOC should communicate clearly and publically the specific risks that designated firms pose so that they understand why they were designated and the actions they can take to be de-designated. Yellen answered that the FSOC already explains “very clearly” the basis for designation decisions to the firms and that it reconsiders designation every year.
Green asked if Yellen preferrs a “trigger” of a certain dollar amount in the designation of SIFIs or if she would agree with an activities-based designation. Yellen explained that she remains open to the dollar threshold and would only support a “modest increase” in the threshold, adding that even regional organizations would have a significant impact to a portion of the country.
Rep. Emanuel Cleaver (D-Mo.) noted the “panic” from insurance companies due to their SIFI designation. Yellen explained that the Fed is “working very hard” to tailor appropriate rules and understand the nature of the insurance business, by consulting with firms and state insurance commissioners. She continued that there will likely be a notice of proposed rulemaking that allows for public comment when a decision is made, and that while she could not give a date for the proposed rulemaking, “it’s a high priority.”
Rep. Keith Ellison (D-Minn.) conceded that there is a growing consensus the $50 billion threshold is too low and asked Yellen what it should be. Yellen answered that she would support a “modest increase,” but that such a change is not a “must have.”
Rep. Bruce Poliquin (R-Maine) asked about Yellen’s thought process on designating asset managers. Yellen responded that the FSOC is focusing on activities at the moment rather than designating firms.
Poliquin asked if there is a list or set of criteria available that the industry can use to identify the business practices being considered by the FSOC. Yellen said there is a set of criteria that the FSOC “initially issued” but did not know whether it has been updated.
Poliquin then asked if there is a similar list or set of guidelines for how firms can be de-designated. Yellen answered that it would not be appropriate to have a formal list, but that firms understand “very well” why they were designated and what changes would be needed for the designation to be rescinded.
Poliquin suggested that asset managers would benefit from having sets of criteria for what could lead to their designation and what they could then do to be de-designated. Yellen responded that the FSOC has not, to date, designated any asset managers.
Executive Compensation
Rep. Michael Capuano (D-Mass.) noted the importance of the requirement for the Fed to take action regarding executive pay at banks and asked why the Fed has not yet produced such a regulation. Yellen noted that the Fed has produced guidelines on incentive compensation and supervision and that they are “very attentive” to aspects that could lead to excessive risk taking. She noted the challenge the Fed has faced in creating the rule, adding that it is an “important problem and essential to address.”
Capuano asked what the time frame is for the “next generation” of living wills. Yellen noted that the Federal Deposit Insurance Corporation (FDIC) has delivered detailed evaluations to the firms on their living wills with direction on how to improve their resolvability, adding that they have received updated plans and are evaluating with the FDIC.
Moore asked Yellen how the second round of living wills has informed the Fed. Yellen explained that the Fed has “learned a lot” in recognizing the challenge of cross-border issues. She continued that they have been able to provide “detailed guidance” on firms’ shortcomings and explain what the Fed wants to see in this year’s submissions.
Rep. Denny Heck (D-Wash.) noted that a rating agency has indicated that the living will exercise is working and asked Yellen for her forecast of the process. Yellen answered that the regulators have received very detailed living wills that took account of the instructions given to the firms by the Fed and FDIC, and that the Fed is “carefully evaluating” them.
Ellison noted that in the last round of living will submissions, the Federal Reserve chose not to deem them non-credible while the FDIC did. He asked why the Federal Reserve would “give up authority” to force changes at institutions by not deeming plans non-credible. Yellen explained that the Fed took the position that the living will process is new and the expectation was that it would take several rounds and guidance from the regulators to achieve credible plans. She added that the Fed is evaluating the latest round and “will make important decisions” in the coming months.
Emergency Lending Powers
Rep. Bill Huizenga (R-Mich.) said the failure of the Federal Reserve to act on several items has been a point of frustration for many members of Congress. He then specifically expressed concern about the Fed’s failure to implement a final rule for its Section 13(3) emergency lending authority and asked when a final rule would be issued. Yellen answered that she expects the final rule to be issued “by the end of this month.” She added that the Fed regards its emergency lending powers as crucial to providing liquidity in a time of panic, so it wants to be “very careful” about the final rule.
Huizenga noted his proposal that emergency lending must be approved by nine of the 12 presidents of the Federal Reserve banks. Yellen said the current approach, requiring only the approval of five Fed governors, is adequate and that she has concerns with proposals that could restrict the use of the lending powers.
TLAC
Hinojosa noted that the Fed finalized its TLAC proposal last week and highlighted that credit rating agencies may cut the ratings of the largest banks based on the prospect that the federal government is less likely to provide funding to them in times of crisis. Yellen answered that this is recognition by the rating agencies that TLAC can mitigate the too-big-to-fail problem.
Emmer stated that some analyses of the TLAC draft proposal suggest it penalizes firms for having a desirable business model and that the rule could be a tax on deposit funding. Yellen explained that the rule is an “important step” towards ensuring a workable single point of entry strategy, and the analysis that it penalizes firms is a “mischaracterization of the proposal.” She continued that the Fed has conducted a quantitative impact analysis that was part of the published proposal.
Rep. Bill Foster (D-Ill.) commented that he is enthusiastic about the prospects of contingent capital instruments (CoCos), and that it seems to him that CoCos are being implemented for the U.S. subsidiaries of foreign banking organizations but not U.S. firms. He asked if the Federal Reserve would be operating the trigger for the conversion of CoCos. Yellen said the Fed would want subsidiaries to hold enough loss absorbency for the FDIC to recapitalize them.
Foster stated that the CoCo mechanism is superior to unsecured debt because it warns banks when they are on the verge of violating capital requirements, rather than when they are on the verge of insolvency, and that it is politically easier to trigger the conversion to equity than to launch insolvency proceedings. Yellen answered that in the case of a foreign firm, foreign regulators would want to centrally engage in a single-point-of-entry recapitalization, and that the structure proposed by the Fed would make that possible.
Foster asked for a briefing on the CoCo issue, and Yellen agreed to organize one.
FSOC Reform
Rep. William Lacy Clay (D-Mo.) said H.R. 1309 would remove the Fed’s ability to make safety and soundness decisions and give them to the FSOC. Yellen responded that she would not like to see the FSOC involved in determining appropriate programs for firms put under Fed supervision.
International Coordination
Clay asked if any major nation defers domestic bank safety and soundness decisions to a board of international regulators such as the Financial Stability Board. Yellen stated that she does not know of any such cases and stressed that nothing becomes law in the U.S. unless U.S. regulators deem it appropriate for domestic firms. She continued that international bodies are coordination groups for consultation, but no substitute for domestic rule efforts.
Rep. Robert Pittenger (R-N.C.) commented that federal regulations are having a significant impact on the economy and may drive firms to leave the U.S. Yellen answered that this is why the U.S. participates in international forums, to ensure that other countries are also raising their own financial regulatory standards.
Bank Culture
Clay asked, in light of many reported violations, what the Fed’s role is in improving bank culture. Yellen replied that the Fed is “extremely disturbed by the pattern of violations.” She stated that it has imposed “exceptionally large” fines in addition to barring individuals from working in the industry, and that the Fed fully expects that boards of the firms it supervises put in place rules and attend to questions of bank culture to stop the pattern of violations.
Changes in Supervision Practices
Rep. Stevan Pearce (R-N.M.) asked if the Federal Reserve’s staff ever considers its internal failures. Yellen said this “set of discussions” has been held over many years and has focused on lessons learned, exercises, and discussion of what needs to be done differently. She added that this has been evident in the Fed’s changed process of supervision and focus on the financial system as a whole.
Capital Requirements and Posting Margin
Scott warned it “sends a conflicting message” that U.S. regulators are encouraging more risk management for derivatives transactions yet Basel capital requirements do not recognize the exposure-offsetting nature of segregated customer margin. He said a clearer message must be sent as to how Basel capital requirements interact with the margin requirements.
Tailoring Regulations
Rep. Robert Hurt (R-Va.) said that despite Yellen’s statements that the Fed tailors its rulemaking for smaller institutions, community banks are still disproportionately affected by regulation. He asked whether Yellen agrees that balanced supervision is an important role of the Fed. Yellen said it is “absolutely one of our most important responsibilities.”
Heck expressed his the need for regulatory relief for smaller institutions and urged Yellen to be more proactive in looking for ways to diminish burdens. He then noted that Yellen’s prepared testimony states that the Federal Reserve will provide a report to Congress at the end of the Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) process and asked when the report would be delivered. Yellen replied that the report would be given before the end of 2016.
Vice Chair of Supervision
Hurt asked Yellen if it would be good to have the vice chair of supervision position filled, and whether it would be appropriate for her to press President Obama to fill the position. Yellen answered that she thinks the Fed is carrying out its supervisory work in a “thorough and thoughtful fashion,” but that she would welcome a nomination.
Stivers (R-Ohio) asked if Yellen would be open to Governor Daniel Tarullo accompanying her to hearings on supervision going forward, to which she stated he is “ready to testify” and she has no problem with him joining her.
Supplementary Leverage Ratio
Rep. Randy Hultgren (R-Ill.) asked why the supplementary leverage ratio is applicable regardless of the riskiness of individual exposures. Yellen explained that the supplementary leverage ratio is a “backup ratio” to risk-based capital standards and is required based on the size of a firm’s balance sheet. She continued that the ratio is “unlikely to be a binding ratio” for larger institutions that have SIFI surcharges.
Basel III
Rep. Marlin Stutzman (R-Ind.) asked how Basel III will be more successful than its predecessors. Yellen noted the improvement of capital standards due to the increased demand of quality and quantity on systemically important firms, as well as the backup leverage requirements that “enhance safety and soundness.”
CLOs
Rep. Andy Barr (R-Ky.) stated that too much regulation can be a problem, and commented that the market for collateralized loan obligations (CLOs) faces a contraction that will cause a credit crunch for American companies because of the Fed’s risk retention rules. He questioned whether the Fed believes companies are better served with expensive, short-term financing rather than stable and long-term CLOs. Yellen said the Fed wants stable and long-term options, but that originators must have “skin in the game” when securitizations take place.
Barr added that he has joined a bipartisan group of lawmakers calling for a “qualified CLO” and asked if Yellen would be open to this. Yellen answered that she “can have a look at it.”
Liquidity
Barr noted that Treasury Secretary Lew has denied that post-crisis regulations are causing a liquidity crisis, but that Fed Governor Lael Brainard has said regulation may be a factor. He asked what would lead Yellen to doubt that regulation is impacting liquidity. Yellen answered that “a bunch of different things” need to be studied, and commented on the prevalence of high-frequency trading.
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