SBC Hearing on Capital and Liquidity Regulation
Senate Banking Committee
“Bank Capital and Liquidity Regulation Part II: Industry Perspectives”
Thursday, June 23, 2016
Key Topics & Takeaways
- Financial CHOICE Act: Sen. Brown (D-Ohio) discussed Rep. Jeb Hensarling’s (R-Texas) Financial CHOICE Act that was recently proposed, which includes repealing Titles II and VIII of Dodd Frank, and asked if Baer supported such ideas. Baer expressed his support for Title II, arguing that the Orderly Liquidation Authority (OLA) is a “credible” and “sensible” backstop to bankruptcy. He also expressed his support for Title VIII and said it is appropriate to have supervision of financial market utilities.
- CCAR: Sen. Shelby (R-Ala.) referred to Federal Reserve Chairwoman Janet Yellen’s recent testimony at two separate Congressional hearings this week where she noted that the Fed is undertaking “meaningful tailoring” of different risk profiles of banks, to include a possible exemption from the stress tests for regional banks. Abernathy noted his encouragement by Yellen’s testimony and explained that tailoring CCAR and stress tests is an important way to make regulatory tools work more effectively. He continued that the Fed has the authority to make such a decision and that he hopes the Fed will engage Congress, the public and the financial services industry “to ensure it gets [it] right.”
Witnesses
- Rebeca Romero Rainey, Chairman and CEO, Centinel Bank of Taos, on Behalf of the Independent Community Bankers of America
- Wayne A. Abernathy, Executive Vice President, Financial Institutions Policy and Regulatory Affairs, American Bankers Association
- Greg Baer, President, The Clearing House Association, Executive Vice President and General Counsel, The Clearing House Payments Company
- Jennifer Taub, Professor of Law, Vermont Law School
Opening Statements
Senator Richard Shelby, Committee Chairman
In his opening statement, Richard Shelby (R-Ala.) said that regulators often reference previous crises to justify the implementation of further rules without establishing a requisite nexus between rules and their prevention of a crisis. Shelby noted that as a result, the vastly complex regulatory system could increase systemic risk and create a false sense of security. He argued that “regulators should regulate banks but not run them,” and expressed concern that the complexity of capital and liquidity regulations could contribute to the next crisis. Shelby continued by stating his belief that strong capital is essential for a sound banking system and to protect against taxpayer bailouts. However, he claimed that no regulators have engaged in a rigorous economic analysis to determine how regulation will impact funding and liquidity levels when a crisis strikes. He claimed that regulators are “unwilling to stress test their own capital and liquidity rules to see if these rules will result in more or less liquidity in the occurrence of a crisis.” He concluded that it is unknown whether these rules are appropriately tailored to prevent and handle the next crisis.
Senator Sherrod Brown, Ranking Member
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) emphasized his hope to hear from the individuals affected by the previous financial crisis. He explained that Congress put in place a framework for capital and liquidity rules, including stress tests and living wills, to prevent a repeat of economic devastation. Brown claimed that regulators have tailored rules to relieve larger banks when appropriate, and he announced that the Federal Reserve (Fed) and Federal Deposit Insurance Corporation (FDIC) may tailor the rules further as they use an inter-agency regulatory process to review a potential simplification of the capital regime for community banks.
Brown continued by stating that regulators have tailored rules to relieve larger banks when appropriate. He explained that the Fed recently announced plans to alter stress test requirements for banks with over $50 billion in total assets. Brown claimed that other lawmakers want to “dismantle” Dodd-Frank and argued that the financial crisis was caused by “reckless deregulation” that set off a broader economic crisis.
Testimony
Rebeca Romero Rainey, Chairman and CEO, Centinel Bank of Taos, on Behalf of theIndependent Community Bankers of America
In her testimony, Rainey highlighted the compliance costs and difficulties imposed on community banks by the post-crisis financial regulations. Rainey stated that the goal of every local bank is to act as a source of credit for those within the community; however, the one-size-fits-all approach taken by Basel III has ultimately harmed consumers and businesses within the community that community bankers sought to help. Rainey explained that Basel III requires community banks to make tradeoffs in order to do serve their customers, but that credit availability will be reduced and development costs are expected to increase under these rules, especially in rural areas. She stressed that not only does Basel III raise required capital levels, it also makes it harder to meet them. Ultimately, Rainey called for an exemption from Basel III and a return to Basel I for banks with less than $50 billion in assets in order to relieve the economic burden placed on community banks and thus improve credit availability.
Wayne A. Abernathy, Executive Vice President, Financial Institutions Policy and RegulatoryAffairs, American Bankers Association
In his testimony, Abernathy focused on the evolution of capital and liquidity requirements since the financial crisis and the current complexity of such regulations. He called for a cumulative review of the post-crisis financial reforms, and he underscored not only the complexity of the rules but also the challenges facing regulators to enforce them effectively. He argued that increasing regulatory capital is contractionary, and instead called for rules that spur additional funding of economic activity.
Turning to the Leverage Ratio, Abernathy described it as a “risk blind model” that merely hides the riskiness of an institution’s assets until they “explode.” He argued that financial instruments are liquid until they are not, and the Basel regulations are overwhelmingly static in comparison to the dynamic nature of liquidity. In addition, Abernathy described the Net Stable Funding Ratio as lacking a purpose and hypothesized that the structure of the current Liquidity Coverage Ratio (LCR) will only deepen the next recession.
According to Abernathy, American Banking Association representatives from every state have asked that changes be made to the Basel calculations currently in place. Instead of having to undertake an increasingly complex set of calculations to prove compliance with Basel III, Abernathy argues that banks should be presumed to be in compliance with Basel III standards if they hold twice the level of capital as expected by the minimum Basel standard. In addition, to further increase transparency on international negotiations of financial standards, Abernathy called for the publication of an Advanced Notice of Proposed Rulemaking by the U.S. agencies involved before global standards are agreed and implemented domestically.
Greg Baer, President, The Clearing House Association, Executive Vice President and GeneralCounsel, The Clearing House Payments Company
In his testimony, Baer emphasized that while much of the regulation enacted since the financial crisis has proven to be beneficial to both the banks and the broader economy, ongoing regulation on top of Dodd-Frank offers marginal benefits in addition to the already enacted core reforms. The pending capital and liquidity reforms, Baer argued, will hinder economic growth and serve as an obstacle to credit availability for small businesses and low-income consumers. For example, he criticized Basel IV as essentially rewriting many of the same capital rules that have previously been put forth by the Basel Committee.
With regards to the impact these new regulations would have on the availability of credit, Baer stated that many banks will choose to reduce their role as financial intermediaries due to the costs imposed by the new set of capital and liquidity requirements. As a result, he claimed that businesses and consumers would have to turn to alternative lending options during a recession, which he said tend to be both less available and more expensive. Instead of further saddling well-capitalized banks with additional regulation, Baer believed the focus should turn to exploring other sources of risk outside of the banking industry. Baer also cautioned that the current regulatory reforms will hinder banks from providing market liquidity during the next crisis. Instead, he argued, consumers will turn to shadow lending institutions that have fallen largely outside the regulatory perimeter.
Jennifer Taub, Professor of Law, Vermont Law School
In her testimony, Taub claimed that when banks lose, “we all lose.” She explained that financial crises historically share common elements and typically result from the deflation of debt-fueled asset bubbles, and she cautioned that “thinly capitalized banks that hold those assets collapse when depositors or other lenders withdraw their money.” Taub argued that bank profits are at an “all-time high,” and claimed that the timing could not be better to focus now on implementing much higher bank capital requirements.
Taub argued that the Dodd-Frank Act made the financial system safer, but “not safe enough.” She contended that the current 4 percent leverage ratio is too low increasing it to 5 percent for the largest bank holding companies and 6 percent for their insured depositories will still be too low. Taub instead recommended implementing a 15 to 20 percent non-risk-weighted equity capital ratio or higher, and she countered claims that more equity funding for banks would restrict lending and otherwise increase costs to society.
Taub further argued that a healthy capital cushion is necessary but not sufficient and cautioned against giving banks with a 10 percent Leverage Ratio “a free pass” from other crisis prevention and intervention rules, which she claimed was “misguided.” Rather, she argued that banks are larger than they were before the crisis, borrow “excessively” relative to the assets they hold, and remain overly dependent on short-term wholesale funding. Ultimately, Taub maintained that increasing equity capital, alone, would not justify “rolling back” other protections.
Question & Answer
Basel
Shelby noted that the application of global standards on the banking industry can have an “unexpected” impact on community banks and asked how Basel III’s treatment of trust-preferred securities (TRuPS)is negatively impacting community banks. Abernathy replied that global rules do not always “fit” for community banks, and that under Basel III capital rules, banks have to treat TRuPS as if they were losses. He recommended that if a bank as twice the amount of capital than the Basel minimum standard, it should be a good enough indication that the bank is already in compliance with Basel rules.
CCAR
Shelby asked how regulatory requirements drive capital allocation and their impact on small and medium size businesses. Baer explained that the Comprehensive Capital Analysis and Review (CCAR) stress test puts a strain on FICO cut offs for loans which is “displacing” bank judgments and putting additional pressure on loans subject to greater default rates.
Shelby referred to Federal Reserve Chairwoman Janet Yellen’s recent testimony at two separate Congressional hearings this week where she noted that the Fed is undertaking “meaningful tailoring” of different risk profiles of banks, to include a possible exemption of stress tests for regional banks. Abernathy noted his encouragement by Yellen’s testimony and explained that tailoring CCAR and stress tests is an important way to make regulatory tools work more effectively. He continued that the Fed has the authority to make such a decision and that he hopes the Fed will engage Congress, the public and the financial services industry “to ensure it gets [it] right.”
Shadow Banking
Brown asked whether the risk posed by systemically important nonbanks played an important role in the financial crisis and if it is important to have heightened regulations of nonbanks. Rainey replied that all entities should be regulated due to the risk they pose to the financial system. Baer stressed that it is important to recall how much of the financial crisis came from the nonbanking system, while Taub added that concerns about the shadow banking system “aren’t new.”
Brown then asked if bank regulations will force traditional bank activities into the nonbank sector. Taub replied that there is a problem in the shadow banking system that should be looked at, to include possibly reducing leverage at hedge funds, among other things.
Financial CHOICE Act
Brown discussed Rep. Jeb Hensarling’s (R-Texas) Financial CHOICE Act that was recently proposed, which includes repealing Titles II and VIII of Dodd Frank, and asked if Baer supported such ideas. Baer expressed his support for Title II, arguing that the Orderly Liquidation Authority (OLA) is a “credible” and “sensible” backstop to bankruptcy. He also expressed his support for Title VIII and said it is appropriate to have supervision of financial market utilities.
Sen. Elizabeth Warren (D-Mass.) referred to Hensarling’s proposal as the “Big Wet Kiss for Wall Street Act” that assaults the Consumer Financial Protection Bureau (CFPB), and asked what would happen if the CFPB adopted the Securities and Exchange Commission’s (SEC) leadership structure as Hensarling proposes. Taub replied that the CFPB would be “substantially weakened and slowed down.”
Warren then explained that the proposal revoked the authority in Dodd-Frank that allows the CFPB to restrict the authority of using forced arbitration for consumers and asked how consumers will be impacted should this authority be eliminated. Taub replied that consumers would be “deeply harmed” and that forced arbitration takes away the rights of consumers.
Liquidity Coverage Ratio
Sen. Tim Scott (R-S.C.) stated that the LCR discourages banks to accept business deposits and asked if such a concept is at odds with such practices. Abernathy echoed Scott’s concern, stating that one of the fundamental purposes of banking is to accept deposits and arguing that such regulation will make it harder for banks to accept such deposits. He continued that while business deposits may have run in times of stress in Europe, U.S. banks still attracted business deposits during the recession.
Baer noted his “sympathy” for the LCR and that it is “generally a good idea.”
International Implications
Sen. Tom Cotton (R-Ark.) asked if the Fed has accounted for what higher capital requirements will mean for the enforcement of sanctions if the largest institutions are leaving certain markets due to the costs imposed by new regulations. Baer expressed concern that such regulations will “blind” national security and defense officials from spotting wrong doing and terrorist financing.
Cotton then asked if other regulatory agencies who enforce global sanctions are weighing in with the Fed on regulations. Baer and Abernathy agreed that they believe other agencies are having conversations with the Fed on these issues. Abernathy added that such regulations will have an impact on banks of all sizes, both international and domestic.
For more information on this hearing, please click here.
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Senate Banking Committee
“Bank Capital and Liquidity Regulation Part II: Industry Perspectives”
Thursday, June 23, 2016
Key Topics & Takeaways
- Financial CHOICE Act: Sen. Brown (D-Ohio) discussed Rep. Jeb Hensarling’s (R-Texas) Financial CHOICE Act that was recently proposed, which includes repealing Titles II and VIII of Dodd Frank, and asked if Baer supported such ideas. Baer expressed his support for Title II, arguing that the Orderly Liquidation Authority (OLA) is a “credible” and “sensible” backstop to bankruptcy. He also expressed his support for Title VIII and said it is appropriate to have supervision of financial market utilities.
- CCAR: Sen. Shelby (R-Ala.) referred to Federal Reserve Chairwoman Janet Yellen’s recent testimony at two separate Congressional hearings this week where she noted that the Fed is undertaking “meaningful tailoring” of different risk profiles of banks, to include a possible exemption from the stress tests for regional banks. Abernathy noted his encouragement by Yellen’s testimony and explained that tailoring CCAR and stress tests is an important way to make regulatory tools work more effectively. He continued that the Fed has the authority to make such a decision and that he hopes the Fed will engage Congress, the public and the financial services industry “to ensure it gets [it] right.”
Witnesses
- Rebeca Romero Rainey, Chairman and CEO, Centinel Bank of Taos, on Behalf of the Independent Community Bankers of America
- Wayne A. Abernathy, Executive Vice President, Financial Institutions Policy and Regulatory Affairs, American Bankers Association
- Greg Baer, President, The Clearing House Association, Executive Vice President and General Counsel, The Clearing House Payments Company
- Jennifer Taub, Professor of Law, Vermont Law School
Opening Statements
Senator Richard Shelby, Committee Chairman
In his opening statement, Richard Shelby (R-Ala.) said that regulators often reference previous crises to justify the implementation of further rules without establishing a requisite nexus between rules and their prevention of a crisis. Shelby noted that as a result, the vastly complex regulatory system could increase systemic risk and create a false sense of security. He argued that “regulators should regulate banks but not run them,” and expressed concern that the complexity of capital and liquidity regulations could contribute to the next crisis. Shelby continued by stating his belief that strong capital is essential for a sound banking system and to protect against taxpayer bailouts. However, he claimed that no regulators have engaged in a rigorous economic analysis to determine how regulation will impact funding and liquidity levels when a crisis strikes. He claimed that regulators are “unwilling to stress test their own capital and liquidity rules to see if these rules will result in more or less liquidity in the occurrence of a crisis.” He concluded that it is unknown whether these rules are appropriately tailored to prevent and handle the next crisis.
Senator Sherrod Brown, Ranking Member
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) emphasized his hope to hear from the individuals affected by the previous financial crisis. He explained that Congress put in place a framework for capital and liquidity rules, including stress tests and living wills, to prevent a repeat of economic devastation. Brown claimed that regulators have tailored rules to relieve larger banks when appropriate, and he announced that the Federal Reserve (Fed) and Federal Deposit Insurance Corporation (FDIC) may tailor the rules further as they use an inter-agency regulatory process to review a potential simplification of the capital regime for community banks.
Brown continued by stating that regulators have tailored rules to relieve larger banks when appropriate. He explained that the Fed recently announced plans to alter stress test requirements for banks with over $50 billion in total assets. Brown claimed that other lawmakers want to “dismantle” Dodd-Frank and argued that the financial crisis was caused by “reckless deregulation” that set off a broader economic crisis.
Testimony
Rebeca Romero Rainey, Chairman and CEO, Centinel Bank of Taos, on Behalf of theIndependent Community Bankers of America
In her testimony, Rainey highlighted the compliance costs and difficulties imposed on community banks by the post-crisis financial regulations. Rainey stated that the goal of every local bank is to act as a source of credit for those within the community; however, the one-size-fits-all approach taken by Basel III has ultimately harmed consumers and businesses within the community that community bankers sought to help. Rainey explained that Basel III requires community banks to make tradeoffs in order to do serve their customers, but that credit availability will be reduced and development costs are expected to increase under these rules, especially in rural areas. She stressed that not only does Basel III raise required capital levels, it also makes it harder to meet them. Ultimately, Rainey called for an exemption from Basel III and a return to Basel I for banks with less than $50 billion in assets in order to relieve the economic burden placed on community banks and thus improve credit availability.
Wayne A. Abernathy, Executive Vice President, Financial Institutions Policy and RegulatoryAffairs, American Bankers Association
In his testimony, Abernathy focused on the evolution of capital and liquidity requirements since the financial crisis and the current complexity of such regulations. He called for a cumulative review of the post-crisis financial reforms, and he underscored not only the complexity of the rules but also the challenges facing regulators to enforce them effectively. He argued that increasing regulatory capital is contractionary, and instead called for rules that spur additional funding of economic activity.
Turning to the Leverage Ratio, Abernathy described it as a “risk blind model” that merely hides the riskiness of an institution’s assets until they “explode.” He argued that financial instruments are liquid until they are not, and the Basel regulations are overwhelmingly static in comparison to the dynamic nature of liquidity. In addition, Abernathy described the Net Stable Funding Ratio as lacking a purpose and hypothesized that the structure of the current Liquidity Coverage Ratio (LCR) will only deepen the next recession.
According to Abernathy, American Banking Association representatives from every state have asked that changes be made to the Basel calculations currently in place. Instead of having to undertake an increasingly complex set of calculations to prove compliance with Basel III, Abernathy argues that banks should be presumed to be in compliance with Basel III standards if they hold twice the level of capital as expected by the minimum Basel standard. In addition, to further increase transparency on international negotiations of financial standards, Abernathy called for the publication of an Advanced Notice of Proposed Rulemaking by the U.S. agencies involved before global standards are agreed and implemented domestically.
Greg Baer, President, The Clearing House Association, Executive Vice President and GeneralCounsel, The Clearing House Payments Company
In his testimony, Baer emphasized that while much of the regulation enacted since the financial crisis has proven to be beneficial to both the banks and the broader economy, ongoing regulation on top of Dodd-Frank offers marginal benefits in addition to the already enacted core reforms. The pending capital and liquidity reforms, Baer argued, will hinder economic growth and serve as an obstacle to credit availability for small businesses and low-income consumers. For example, he criticized Basel IV as essentially rewriting many of the same capital rules that have previously been put forth by the Basel Committee.
With regards to the impact these new regulations would have on the availability of credit, Baer stated that many banks will choose to reduce their role as financial intermediaries due to the costs imposed by the new set of capital and liquidity requirements. As a result, he claimed that businesses and consumers would have to turn to alternative lending options during a recession, which he said tend to be both less available and more expensive. Instead of further saddling well-capitalized banks with additional regulation, Baer believed the focus should turn to exploring other sources of risk outside of the banking industry. Baer also cautioned that the current regulatory reforms will hinder banks from providing market liquidity during the next crisis. Instead, he argued, consumers will turn to shadow lending institutions that have fallen largely outside the regulatory perimeter.
Jennifer Taub, Professor of Law, Vermont Law School
In her testimony, Taub claimed that when banks lose, “we all lose.” She explained that financial crises historically share common elements and typically result from the deflation of debt-fueled asset bubbles, and she cautioned that “thinly capitalized banks that hold those assets collapse when depositors or other lenders withdraw their money.” Taub argued that bank profits are at an “all-time high,” and claimed that the timing could not be better to focus now on implementing much higher bank capital requirements.
Taub argued that the Dodd-Frank Act made the financial system safer, but “not safe enough.” She contended that the current 4 percent leverage ratio is too low increasing it to 5 percent for the largest bank holding companies and 6 percent for their insured depositories will still be too low. Taub instead recommended implementing a 15 to 20 percent non-risk-weighted equity capital ratio or higher, and she countered claims that more equity funding for banks would restrict lending and otherwise increase costs to society.
Taub further argued that a healthy capital cushion is necessary but not sufficient and cautioned against giving banks with a 10 percent Leverage Ratio “a free pass” from other crisis prevention and intervention rules, which she claimed was “misguided.” Rather, she argued that banks are larger than they were before the crisis, borrow “excessively” relative to the assets they hold, and remain overly dependent on short-term wholesale funding. Ultimately, Taub maintained that increasing equity capital, alone, would not justify “rolling back” other protections.
Question & Answer
Basel
Shelby noted that the application of global standards on the banking industry can have an “unexpected” impact on community banks and asked how Basel III’s treatment of trust-preferred securities (TRuPS)is negatively impacting community banks. Abernathy replied that global rules do not always “fit” for community banks, and that under Basel III capital rules, banks have to treat TRuPS as if they were losses. He recommended that if a bank as twice the amount of capital than the Basel minimum standard, it should be a good enough indication that the bank is already in compliance with Basel rules.
CCAR
Shelby asked how regulatory requirements drive capital allocation and their impact on small and medium size businesses. Baer explained that the Comprehensive Capital Analysis and Review (CCAR) stress test puts a strain on FICO cut offs for loans which is “displacing” bank judgments and putting additional pressure on loans subject to greater default rates.
Shelby referred to Federal Reserve Chairwoman Janet Yellen’s recent testimony at two separate Congressional hearings this week where she noted that the Fed is undertaking “meaningful tailoring” of different risk profiles of banks, to include a possible exemption of stress tests for regional banks. Abernathy noted his encouragement by Yellen’s testimony and explained that tailoring CCAR and stress tests is an important way to make regulatory tools work more effectively. He continued that the Fed has the authority to make such a decision and that he hopes the Fed will engage Congress, the public and the financial services industry “to ensure it gets [it] right.”
Shadow Banking
Brown asked whether the risk posed by systemically important nonbanks played an important role in the financial crisis and if it is important to have heightened regulations of nonbanks. Rainey replied that all entities should be regulated due to the risk they pose to the financial system. Baer stressed that it is important to recall how much of the financial crisis came from the nonbanking system, while Taub added that concerns about the shadow banking system “aren’t new.”
Brown then asked if bank regulations will force traditional bank activities into the nonbank sector. Taub replied that there is a problem in the shadow banking system that should be looked at, to include possibly reducing leverage at hedge funds, among other things.
Financial CHOICE Act
Brown discussed Rep. Jeb Hensarling’s (R-Texas) Financial CHOICE Act that was recently proposed, which includes repealing Titles II and VIII of Dodd Frank, and asked if Baer supported such ideas. Baer expressed his support for Title II, arguing that the Orderly Liquidation Authority (OLA) is a “credible” and “sensible” backstop to bankruptcy. He also expressed his support for Title VIII and said it is appropriate to have supervision of financial market utilities.
Sen. Elizabeth Warren (D-Mass.) referred to Hensarling’s proposal as the “Big Wet Kiss for Wall Street Act” that assaults the Consumer Financial Protection Bureau (CFPB), and asked what would happen if the CFPB adopted the Securities and Exchange Commission’s (SEC) leadership structure as Hensarling proposes. Taub replied that the CFPB would be “substantially weakened and slowed down.”
Warren then explained that the proposal revoked the authority in Dodd-Frank that allows the CFPB to restrict the authority of using forced arbitration for consumers and asked how consumers will be impacted should this authority be eliminated. Taub replied that consumers would be “deeply harmed” and that forced arbitration takes away the rights of consumers.
Liquidity Coverage Ratio
Sen. Tim Scott (R-S.C.) stated that the LCR discourages banks to accept business deposits and asked if such a concept is at odds with such practices. Abernathy echoed Scott’s concern, stating that one of the fundamental purposes of banking is to accept deposits and arguing that such regulation will make it harder for banks to accept such deposits. He continued that while business deposits may have run in times of stress in Europe, U.S. banks still attracted business deposits during the recession.
Baer noted his “sympathy” for the LCR and that it is “generally a good idea.”
International Implications
Sen. Tom Cotton (R-Ark.) asked if the Fed has accounted for what higher capital requirements will mean for the enforcement of sanctions if the largest institutions are leaving certain markets due to the costs imposed by new regulations. Baer expressed concern that such regulations will “blind” national security and defense officials from spotting wrong doing and terrorist financing.
Cotton then asked if other regulatory agencies who enforce global sanctions are weighing in with the Fed on regulations. Baer and Abernathy agreed that they believe other agencies are having conversations with the Fed on these issues. Abernathy added that such regulations will have an impact on banks of all sizes, both international and domestic.
For more information on this hearing, please click here.