Senate Banking on Systemic Importance of U .S. BHCs
Senate
Banking Committee
Measuring
the Systemic Importance of U.S. Bank Holding Companies
Thursday, July 23, 2015
Key Topics & Takeaways
-
Arbitrary Threshold:
Chairman Shelby (R-Ala.) expressed concern that the “arbitrary” asset threshold
captures institutions whose failure would not lead to systemic contagion and
imposes a burdensome layer of regulation on financial institutions that lend
largely to small businesses and local communities while spreading too thin
regulatory resources.
-
Modest Alterations:
Ranking Member Brown (D-Ohio) said that Dodd-Frank should only be altered if
Congress can identify “real” problems to the “actual” institutions and take a
“modest” approach toward regulatory alterations.
-
Fed Discretion: Sen.
Warren (D-Mass.) asked if Congress raised the asset threshold but gave the Fed
discretion to impose tougher rules for firms below this level, would it use
this discretion. Barr said he worried about whether the Fed would do so, noting
that Congress thought the Fed had too much discretion the past and reigned it
in with Dodd-Frank.
Panelists
- Professor Robert
DeYoung, Capital Federal Professor in Financial Markets and
Institutions, University of Kansas School of Business
-
Professor Deborah Lucas,
Sloan Distinguished Professor of Finance and Director, MIT Center for Finance
and Policy, Sloan School of Management
-
Professor Jonathan R.
Macey, Sam Harris Professor of Corporate Law, Corporate Finance, and
Securities Law, Yale Law School
-
The Honorable Michael S.
Barr, Roy F. and Jean Humphrey Proffitt Professor of Law, University of
Michigan Law School
Opening Remarks
Chairman
Richard Shelby (R-Ala.), Chairman, Senate Banking Committee
Chairman
Shelby began his remarks noting the importance of designated criteria for
regulatory determinations of systemically important financial institutions
(SIFIs). While a clear, but “imperfect” process exists for non-bank SIFI
designations, he said, no such process exists for banks.
Shelby
expressed concern that the “arbitrary” threshold of $50 billion in total
assets, above which bank holding companies (BHCs) are subject to heightened
regulatory burdens, captures institutions whose failure would not lead to
“systemic contagion” and imposes a burdensome layer of regulation on financial
institutions that lend largely to small businesses and local communities while
spreading too thin regulatory resources.
While
systemic risk has previously been difficult to measure, Shelby said, regulators
now have access to better tools, and noted that even Federal Reserve (Fed)
Chair Janet Yellen expressed support for giving the Fed flexibility on SIFI
designation criteria.
Ranking
Member Sherrod Brown (D-Ohio), Ranking Member, Senate Banking
Committee
Ranking
Member Brown, citing the 2008 financial crisis as a time when financial
institutions “ran wild” and regulators did “little” or “nothing” about it,
noted that the Dodd-Frank reforms have strengthened the economy despite
Republican skepticism. Brown highlighted requirements for capital and liquidity
standards, risk management, and stress testing that will lower the likelihood
and decrease the cost of the failure of a large BHC.
Nonetheless,
he said, the failure of a regional bank will not threaten the entire system
while cautioning that Dodd-Frank should only be altered if Congress can
identify “real” problems to the “actual” institutions and take a “modest”
approach toward regulatory alterations.
Brown
expressed interest in hearing which specific prudential standards are
inappropriate for regional banks and why, and closed by noting the importance
of striking a balance in the Fed’s authority to tailoring its rules to the
institutions and activities that present the most risk.
Panelist Testimony
Professor
Robert DeYoung, Capital Federal Professor in Financial
Markets and Institutions, University of Kansas School of Business
Professor
DeYoung, in his testimony,
noted that while bank size is the most immediate regulatory consideration, by
itself, bank size is neither a “necessary” or “sufficient” indicator of
systemic risk.
DeYoung
expressed that while the proposal in question would re-draw the threshold for
SIFI designation at $500 billion in total assets, the Fed and Financial
Stability Oversight council (FSOC) would still evaluate banks in the $50
billion to $500 billion threshold.
DeYoung
supported using pre-defined weights to determine a quantitative score for
relative systemic importance which applies the same filters to every BHC and
eliminates the role of human discretion in SIFI determinations, as outlined in
an Office of Financial Research (OFR) policy
briefing on the subject.
DeYoung
emphasized the importance of resolvability in SIFI designations, noting that if
a BHC can be resolved without having a contagion effect on other banks either
through bankruptcy or the orderly liquidation authority (OLA), then it should
not be considered systemically important.
He
closed noting that the regulator’s job is not to “help out poorly run
institutions” but instead to provide a framework for safe resolution in times
of crisis.
Professor
Deborah Lucas, Sloan Distinguished Professor of Finance and
Director, MIT Center for Finance and Policy, Sloan School of Management
Professor
Lucas began her testimony
noting that, ideally, BHCs should only be SIFI-designated if the financial
stability benefits outweigh the costs, noting, however, that the cost-benefit
tradeoffs are difficult to quantify.
Lucas
cited recent work which suggests that the current threshold for automatic SIFI
designation could be raised “dramatically” without heightening systemic risk
and that size alone is not the best proxy for a BHC’s contribution to systemic
risk.
Other
criteria that could be incorporated to SIFI designation, Lucas said, include:
size, interconnectedness, substitutability, complexity, and
cross-jurisdictional activity. Lucas noted that incorporating these criteria
has challenges, including identifying metrics and determining the importance of
each metrics, data availability, avoiding excessive complexity, and preserving
overall transparency.
Lucas
also identified the exemption of major government run financial institutions,
such as Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA)
as the “most serious deficiency” of the current system and supported the idea
that these institutions should also fall under FSOC’s mandate.
Professor
Jonathan R. Macey, Sam Harris Professor of Corporate Law,
Corporate Finance, and Securities Law, Yale Law School
Professor
Macey, in his testimony,
supported the proposal to increase the automatic threshold for SIFI designation
to $500 billion with Fed oversight over systemic importance below that
threshold for five reasons: the bill 1) would reduce the “distortive” effect of
the current regime; 2) provide better analytics and more “intellectual rigor”
in the designation process; 3) promote “fairness” on the current
arbitrary nature of the process; 4) reduce “pathologies” in banking
regulation that have perpetuated interconnectivity since Dodd-Frank was passed;
and 5) provide positive incentives for banks to be smaller while imposing costs
on some of the “very largest” financial institutions.
Currently,
Macey cautioned, regulators left to their own devices are incentivized to
increase the number of SIFIs, while instead they should be incentivized to
decrease systemic risk by reducing the number of firms that pose such a risk.
The
Honorable Michael S. Barr, Roy F. and Jean Humphrey Proffitt
Professor of Law, University of Michigan Law School
Professor
Barr began his testimony
outlining the damage to the U.S. economy brought on by the 2008 financial
crisis which “demanded” a strong regulatory response after “years of
unconstrained excess.”
In
terms of BHC supervision, Barr noted that enhanced prudential measures,
including risk-based capital requirements, leverage limits, liquidity
requirements, risk management, resolution planning, credit exposure reporting,
concentration limits, and annual stress tests provide a graduated system with
increased stringency dependent on the risk posed to individual firms’ financial
stability. These standards, he maintained, are already at work and the
threshold for heightened standards should not be increased.
The
system, Barr said, does not require automatic SIFI designation; it simply
provides security for firms under the $50 billion threshold to know they are
not subject to the rules. Designating BHCs using a process similar to the
non-bank SIFI designation process, he said, runs counter to the purpose of
non-bank designation and said applying the same process will make the financial
system “weaker” without helping “small, home-town banks.”
Barr
expressed that small banks would benefit from clear safe harbor rules, “plain-language”
versions of rules that apply to them with longer examination cycles and
streamlined reporting requirements.
Question & Answer
Asset
Threshold
Shelby
asked about the benefits of using a multi-factor test to determine if an
institution is systemically important rather than setting a threshold at $50
billion. Lucas said there are examples were larger institutions can operate as
“traditional banks” and thus it does not make sense to apply the same
regulations as other SIFIs. Macey agreed and said a multi-variable approach
would allow firms to modify their operations to reduce systemic risk.
Sen.
Elizabeth Warren (D-Mass.) asked whether, if Congress acted
to raise the threshold but give the Fed discretion to impose tougher rules for
firms below this level, the Fed would use this discretion. Barr said he worried
about whether the Fed would do so, noting that Congress thought the Fed had too
much discretion in the past and reined it in with Dodd-Frank.
Sen.
Michael Crapo (R-Idaho) noted that Fed Chair Yellen would be open to a “modest”
increase in the designation threshold because for some banks, the costs of
compliance do not exceed the benefits of added regulation and asked if the
panel agreed. DeYoung said banks should conduct stress tests “without being
asked” and noted that FDIC Vice Chair Thomas Hoenig suggested that small banks
without off-balance sheet activity should be exempt from Basel III capital
requirements. Lucas said it is important to leave room for discretion but
that it would also be appropriate to raise the asset threshold.
Resolvability
When
asked by Shelby how resolvability relates to systemic risk, DeYoung said these
two concepts are often equated. He said that if a firm can be resolved and have
its assets easily valued by the market than it should not be considered a SIFI.
Brown
asked if it is good thing that banks have: 1) more capital and liquidity; 2)
less leverage; 3) strong risk management; and 4) resolvability, to which Barr
said yes.
Brown
asked how well the Fed tailors its rules for banks over $50 billion, and what
the threshold should be below which an institution should be considered a
community bank. Barr said he has been impressed with the Fed’s ability to
tailor its rules and suggested that banks under $10 billion are considered to
be community banks.
Sen.
Pat Toomey (R-Pa.) stated that regulations are reducing liquidity across
markets, have “saddled” medium banks with costs, and have restricted lending.
He then asked if any one failure of a bank under $50 billion would have an
impact on the economy. Barr said that if multiple smaller banks failed then
there could be an impact.
Risk
Correlation
Toomey
then asked if there is a correlation of risk created by regulations as
businesses are driven to similar risk profiles, which increases the risk that
multiple failures will occur. Macey said this is a “huge risk,” and that
firms tend to move activities to the most profitable unregulated areas which
can pose systemic problems.
Impact
on Lending
Toomey
asked if the liquidity coverage ratio (LCR) is restricting lending. DeYoung
said he is concerned that the LCR and the net stable funding ratio (NSFR) will reduce
the capacity of banks to lend and that the effects of having binding
constraints on capital and liquidity are not yet known.
Fed
Rule Tailoring
Sen.
Tom Cotton (R-Ark.) said that having regulations tailored to individual firms
leads to more bureaucracy and arbitrary discretion. Macey agreed and said this
“bespoke regulation” is not consistent with the rule of law.
Sen.
Heidi Heitkamp (D-N.D.) asked what the Fed is getting right, and offered
support to giving it the authority to balance its rules and streamline them for
smaller firms. Barr said a tailored approach “makes a lot of sense” and that
stress testing helps with risk management, capital planning, and organizational
structure.
For
more information on this meeting and to view an archived webcast, please click here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Capital/Resolution Authority/SIFIs,Hearing Summaries Agency:Senate Banking Committee,Publish Year:2015
Senate
Banking Committee
Measuring
the Systemic Importance of U.S. Bank Holding Companies
Thursday, July 23, 2015
Key Topics & Takeaways
-
Arbitrary Threshold:
Chairman Shelby (R-Ala.) expressed concern that the “arbitrary” asset threshold
captures institutions whose failure would not lead to systemic contagion and
imposes a burdensome layer of regulation on financial institutions that lend
largely to small businesses and local communities while spreading too thin
regulatory resources. -
Modest Alterations:
Ranking Member Brown (D-Ohio) said that Dodd-Frank should only be altered if
Congress can identify “real” problems to the “actual” institutions and take a
“modest” approach toward regulatory alterations. -
Fed Discretion: Sen.
Warren (D-Mass.) asked if Congress raised the asset threshold but gave the Fed
discretion to impose tougher rules for firms below this level, would it use
this discretion. Barr said he worried about whether the Fed would do so, noting
that Congress thought the Fed had too much discretion the past and reigned it
in with Dodd-Frank.
Panelists
- Professor Robert
DeYoung, Capital Federal Professor in Financial Markets and
Institutions, University of Kansas School of Business
-
Professor Deborah Lucas,
Sloan Distinguished Professor of Finance and Director, MIT Center for Finance
and Policy, Sloan School of Management -
Professor Jonathan R.
Macey, Sam Harris Professor of Corporate Law, Corporate Finance, and
Securities Law, Yale Law School -
The Honorable Michael S.
Barr, Roy F. and Jean Humphrey Proffitt Professor of Law, University of
Michigan Law School
Opening Remarks
Chairman
Richard Shelby (R-Ala.), Chairman, Senate Banking Committee
Chairman
Shelby began his remarks noting the importance of designated criteria for
regulatory determinations of systemically important financial institutions
(SIFIs). While a clear, but “imperfect” process exists for non-bank SIFI
designations, he said, no such process exists for banks.
Shelby
expressed concern that the “arbitrary” threshold of $50 billion in total
assets, above which bank holding companies (BHCs) are subject to heightened
regulatory burdens, captures institutions whose failure would not lead to
“systemic contagion” and imposes a burdensome layer of regulation on financial
institutions that lend largely to small businesses and local communities while
spreading too thin regulatory resources.
While
systemic risk has previously been difficult to measure, Shelby said, regulators
now have access to better tools, and noted that even Federal Reserve (Fed)
Chair Janet Yellen expressed support for giving the Fed flexibility on SIFI
designation criteria.
Ranking
Member Sherrod Brown (D-Ohio), Ranking Member, Senate Banking
Committee
Ranking
Member Brown, citing the 2008 financial crisis as a time when financial
institutions “ran wild” and regulators did “little” or “nothing” about it,
noted that the Dodd-Frank reforms have strengthened the economy despite
Republican skepticism. Brown highlighted requirements for capital and liquidity
standards, risk management, and stress testing that will lower the likelihood
and decrease the cost of the failure of a large BHC.
Nonetheless,
he said, the failure of a regional bank will not threaten the entire system
while cautioning that Dodd-Frank should only be altered if Congress can
identify “real” problems to the “actual” institutions and take a “modest”
approach toward regulatory alterations.
Brown
expressed interest in hearing which specific prudential standards are
inappropriate for regional banks and why, and closed by noting the importance
of striking a balance in the Fed’s authority to tailoring its rules to the
institutions and activities that present the most risk.
Panelist Testimony
Professor
Robert DeYoung, Capital Federal Professor in Financial
Markets and Institutions, University of Kansas School of Business
Professor
DeYoung, in his testimony,
noted that while bank size is the most immediate regulatory consideration, by
itself, bank size is neither a “necessary” or “sufficient” indicator of
systemic risk.
DeYoung
expressed that while the proposal in question would re-draw the threshold for
SIFI designation at $500 billion in total assets, the Fed and Financial
Stability Oversight council (FSOC) would still evaluate banks in the $50
billion to $500 billion threshold.
DeYoung
supported using pre-defined weights to determine a quantitative score for
relative systemic importance which applies the same filters to every BHC and
eliminates the role of human discretion in SIFI determinations, as outlined in
an Office of Financial Research (OFR) policy
briefing on the subject.
DeYoung
emphasized the importance of resolvability in SIFI designations, noting that if
a BHC can be resolved without having a contagion effect on other banks either
through bankruptcy or the orderly liquidation authority (OLA), then it should
not be considered systemically important.
He
closed noting that the regulator’s job is not to “help out poorly run
institutions” but instead to provide a framework for safe resolution in times
of crisis.
Professor
Deborah Lucas, Sloan Distinguished Professor of Finance and
Director, MIT Center for Finance and Policy, Sloan School of Management
Professor
Lucas began her testimony
noting that, ideally, BHCs should only be SIFI-designated if the financial
stability benefits outweigh the costs, noting, however, that the cost-benefit
tradeoffs are difficult to quantify.
Lucas
cited recent work which suggests that the current threshold for automatic SIFI
designation could be raised “dramatically” without heightening systemic risk
and that size alone is not the best proxy for a BHC’s contribution to systemic
risk.
Other
criteria that could be incorporated to SIFI designation, Lucas said, include:
size, interconnectedness, substitutability, complexity, and
cross-jurisdictional activity. Lucas noted that incorporating these criteria
has challenges, including identifying metrics and determining the importance of
each metrics, data availability, avoiding excessive complexity, and preserving
overall transparency.
Lucas
also identified the exemption of major government run financial institutions,
such as Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA)
as the “most serious deficiency” of the current system and supported the idea
that these institutions should also fall under FSOC’s mandate.
Professor
Jonathan R. Macey, Sam Harris Professor of Corporate Law,
Corporate Finance, and Securities Law, Yale Law School
Professor
Macey, in his testimony,
supported the proposal to increase the automatic threshold for SIFI designation
to $500 billion with Fed oversight over systemic importance below that
threshold for five reasons: the bill 1) would reduce the “distortive” effect of
the current regime; 2) provide better analytics and more “intellectual rigor”
in the designation process; 3) promote “fairness” on the current
arbitrary nature of the process; 4) reduce “pathologies” in banking
regulation that have perpetuated interconnectivity since Dodd-Frank was passed;
and 5) provide positive incentives for banks to be smaller while imposing costs
on some of the “very largest” financial institutions.
Currently,
Macey cautioned, regulators left to their own devices are incentivized to
increase the number of SIFIs, while instead they should be incentivized to
decrease systemic risk by reducing the number of firms that pose such a risk.
The
Honorable Michael S. Barr, Roy F. and Jean Humphrey Proffitt
Professor of Law, University of Michigan Law School
Professor
Barr began his testimony
outlining the damage to the U.S. economy brought on by the 2008 financial
crisis which “demanded” a strong regulatory response after “years of
unconstrained excess.”
In
terms of BHC supervision, Barr noted that enhanced prudential measures,
including risk-based capital requirements, leverage limits, liquidity
requirements, risk management, resolution planning, credit exposure reporting,
concentration limits, and annual stress tests provide a graduated system with
increased stringency dependent on the risk posed to individual firms’ financial
stability. These standards, he maintained, are already at work and the
threshold for heightened standards should not be increased.
The
system, Barr said, does not require automatic SIFI designation; it simply
provides security for firms under the $50 billion threshold to know they are
not subject to the rules. Designating BHCs using a process similar to the
non-bank SIFI designation process, he said, runs counter to the purpose of
non-bank designation and said applying the same process will make the financial
system “weaker” without helping “small, home-town banks.”
Barr
expressed that small banks would benefit from clear safe harbor rules, “plain-language”
versions of rules that apply to them with longer examination cycles and
streamlined reporting requirements.
Question & Answer
Asset
Threshold
Shelby
asked about the benefits of using a multi-factor test to determine if an
institution is systemically important rather than setting a threshold at $50
billion. Lucas said there are examples were larger institutions can operate as
“traditional banks” and thus it does not make sense to apply the same
regulations as other SIFIs. Macey agreed and said a multi-variable approach
would allow firms to modify their operations to reduce systemic risk.
Sen.
Elizabeth Warren (D-Mass.) asked whether, if Congress acted
to raise the threshold but give the Fed discretion to impose tougher rules for
firms below this level, the Fed would use this discretion. Barr said he worried
about whether the Fed would do so, noting that Congress thought the Fed had too
much discretion in the past and reined it in with Dodd-Frank.
Sen.
Michael Crapo (R-Idaho) noted that Fed Chair Yellen would be open to a “modest”
increase in the designation threshold because for some banks, the costs of
compliance do not exceed the benefits of added regulation and asked if the
panel agreed. DeYoung said banks should conduct stress tests “without being
asked” and noted that FDIC Vice Chair Thomas Hoenig suggested that small banks
without off-balance sheet activity should be exempt from Basel III capital
requirements. Lucas said it is important to leave room for discretion but
that it would also be appropriate to raise the asset threshold.
Resolvability
When
asked by Shelby how resolvability relates to systemic risk, DeYoung said these
two concepts are often equated. He said that if a firm can be resolved and have
its assets easily valued by the market than it should not be considered a SIFI.
Brown
asked if it is good thing that banks have: 1) more capital and liquidity; 2)
less leverage; 3) strong risk management; and 4) resolvability, to which Barr
said yes.
Brown
asked how well the Fed tailors its rules for banks over $50 billion, and what
the threshold should be below which an institution should be considered a
community bank. Barr said he has been impressed with the Fed’s ability to
tailor its rules and suggested that banks under $10 billion are considered to
be community banks.
Sen.
Pat Toomey (R-Pa.) stated that regulations are reducing liquidity across
markets, have “saddled” medium banks with costs, and have restricted lending.
He then asked if any one failure of a bank under $50 billion would have an
impact on the economy. Barr said that if multiple smaller banks failed then
there could be an impact.
Risk
Correlation
Toomey
then asked if there is a correlation of risk created by regulations as
businesses are driven to similar risk profiles, which increases the risk that
multiple failures will occur. Macey said this is a “huge risk,” and that
firms tend to move activities to the most profitable unregulated areas which
can pose systemic problems.
Impact
on Lending
Toomey
asked if the liquidity coverage ratio (LCR) is restricting lending. DeYoung
said he is concerned that the LCR and the net stable funding ratio (NSFR) will reduce
the capacity of banks to lend and that the effects of having binding
constraints on capital and liquidity are not yet known.
Fed
Rule Tailoring
Sen.
Tom Cotton (R-Ark.) said that having regulations tailored to individual firms
leads to more bureaucracy and arbitrary discretion. Macey agreed and said this
“bespoke regulation” is not consistent with the rule of law.
Sen.
Heidi Heitkamp (D-N.D.) asked what the Fed is getting right, and offered
support to giving it the authority to balance its rules and streamline them for
smaller firms. Barr said a tailored approach “makes a lot of sense” and that
stress testing helps with risk management, capital planning, and organizational
structure.
For
more information on this meeting and to view an archived webcast, please click here.