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Senate Banking Committee Hearing with Prudential Regulators

Senate Banking Committee 

“Oversight of Financial Regulators”

Wednesday, May 15, 2019

Key Takeaways

  • Regulatory Recalibration: Chairman Mike Crapo (R-Idaho) said that the regulators should work on simplifying the Volcker Rule by eliminating the proposed accounting prong and revising the covered funds definition, as well as harmonize margin requirements for inter-affiliate swaps. Crapo also said that regulations applied to the U.S. operations of foreign banks are tailored to the risk profile of the relevant institution, noting that existing home country regulations that apply should be considered.
  • Leveraged Lending: Sen. Pat Toomey (R-Pa.) noted that a large majority of leveraged loans are not on the balance sheet, and instead the assets are held by end users who are not leveraged themselves, to which Quarles agreed, adding that most holders of CLOs are not runnable institutions, which enhances financial stability. Quarles continued that while “domestically we have a good handle on this,” more information is needed globally, and that the FSB is working on that to see where the international exposure is.
  • Foreign Banks: Toomey pointed out the “substantial role” foreign banking organizations (FBOs) have in the American banking system and his concern that an un-level playing field is being created through different regulatory regimes that could “diminish” competition, to which Quarles agreed. Quarles continued that national treatment must be considered when constructing regulatory positions and that the FBO proposals are similar to the domestic tailoring proposals with a few differences, to include looking only at the international holding company (IHC) or consolidated U.S. operations when configuring the base size (and that they will consider comments otherwise).  

Witnesses

Opening Remarks

Chairman Mike Crapo (R-Idaho), Senate Banking Committee

In his opening statement, Crapo noted that since S. 2155 became law, each of the regulatory agencies has been working on implementation, noting that other recent proposals warrant further attention, such as the Community Bank Leverage Ratio. He continued that the regulators should work on simplifying the Volcker Rule by eliminating the proposed accounting prong and revising the covered funds definition, as well as harmonize margin requirements for inter-affiliate swaps. Crapo noted that regulations applied to the U.S. operations of foreign banks are tailored to the risk profile of the relevant institution, adding that existing home country regulations that apply should be considered. He continued that in a recent Senate Banking Committee hearing they discussed whether guidance has been enforced as rules and encouraged the regulators to adhere to the Congressional Review Act and submit all rules for congressional review.

Ranking Member Sherrod Brown (D-Ohio), Senate Banking Committee

In his opening statement, Brown stated that based on the rules regulators have “torn up” the last few years, it “makes you wonder if they want to go through another financial crisis.” He continued that while the outlook is “great for banks” and the wealthiest Americans, millions of families are struggling to get by and “the last thing they need is another crisis.” Brown criticized President Trump for his stance on bankruptcy and financial crises, adding that the administration “seems more concerned with making it easier for Wall Street firms to do what they please,” which could lead to the next crisis.

Witnesses

The Honorable Joseph M. Otting, Comptroller of the Currency, OCC

In his testimony, Otting noted that S. 2155 reduced the regulatory burden for small and mid-size banks while continuing to safeguard the financial system, adding that the OCC has made “significant progress” implementing features of the law. He continued that the OCC is working with the Consumer Financial Protection Bureau (CFPB) on the consumer protection pieces from S. 2155, and that in December 2018 they issued final rules to expand the 18-month examination cycle, reducing the burden on community banks. Otting noted that the OCC is working with the other regulators to implement pending provisions and that most of them will be complete in the third quarter this year, with “all to be done by year-end.” He specifically spoke about easing rules for reporting requirements, narrowing the Volcker Rule to expand banks engaged in riskier activities, and finalizing changes on certain aspects for company-run stress tests and capital/liquidity requirements. Otting added that other issues the OCC is focused on include the Community Reinvestment Act (CRA), Bank Secrecy Act (BSA), and promoting small dollar ticket lending.

The Honorable Randal K. Quarles, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System

In his testimony, Quarles noted the many innovative changes there have been since the first stress test report was released a decade ago and discussed many of the steps the Fed has taken to improve the regulatory framework. He explained that the Fed has tailored the oversight of financial institutions to ensure regulations match the character of the firm, particularly those with $100-250 billion in assets, noting that the tailoring proposal for domestic firms was proposed last year and that prudential requirements for U.S. operations of foreign banking organizations (FBOs) were proposed recently. Quarles continued that during the last six months, the Fed has taken steps to consolidate the role stress testing takes, transitioning firms that are less complex to an extended testing cycle due to posing lower risk, as well as publishing new details of the methodology and models, increasing the transparency of the tests. He added that the Fed continues to engage with global regulatory counterparts through the Financial Stability Board (FSB) that he chairs for the next three years.

The Honorable Jelena McWilliams, Chairman, FDIC

In her testimony, McWilliams explained the “critical” oversight role the FDIC has over the banks, leading to financial stability and consumer protections, noting that such oversight is based on a firm’s business model and risk profile. She continued that there have been numerous actions taken to appropriately address risks to the financial system and gave an update on progress the FDIC has made in implementing S. 2155, to include: an interagency proposal to allow reduced reporting requirements in the first and third calendar quarters for certain institutions, an interagency interim final rule to treat certain municipal obligations as high-quality liquid assets for purposes of calculating the liquidity coverage ratio, two interagency proposals tailoring capital and liquidity requirements according to risk-based categories, and an interagency proposal to amend the supplemental leverage ratio for custodial banking organizations. Regarding the Volcker Rule, McWilliams explained that after reviewing 151 comment letters on “Volcker 2.0,” the regulator agencies are working toward revisions to the rule to “provide more clarity, certainty, and objectivity to market participants.”

The Honorable Rodney Hood, Chairman, NCUA

In his testimony, Hood explained that he is working with NCUA senior leadership, the Office of Minority and Women Inclusion (OMWI), and the Office of Credit Union Resources and Expansion to ensure that the NCUA is doing “everything they can” to work with small- and low-income designated credit unions. He continued that the NCUA has awarded over $2 million in grants to credit unions that allows them to develop new products and services, recover from natural disasters, and help underserved communities. Hood explained that next week he is presenting a new federal credit union charter that will serve the Native American community, providing “much needed services” to individuals and businesses in this area. He stressed that wherever the NCUA can “better the system,” they are trying to do so. Hood noted that while the credit union system is strong, he is focused on cybersecurity risks and intends to deploy the resources necessary to protect credit unions against cyber-attacks.

Q&A

Activities-Based Approach

Sens. Crapo and Tina Smith (D-Minn.) spoke about a recent letter sent from former Fed members referencing the proposal for an activities-based approach to stability regulation. In response to a question from Smith regarding the estimate that such a revised approach would take six or more years, Quarles replied that their estimate was “highly dependent on contingent assumptions,” noting that the former regulators do not have experience with an activities-based approach and that he does not agree it will take that long.

Leveraged Lending

Brown questioned leveraged lending and previous statements by Quarles regarding their impact on financial stability, noting that many financial experts and regulators agree that leveraged lending is a “serious concern.” Quarles replied that there has been “careful analysis” on whether a repricing of that asset class would have an impact on the financial system and that the result leads him to believe it would not. However, he noted that in recent banking exams, leveraged lending underwriting practices were reviewed and areas were identified where improvements “would be appropriate.” Quarles continued that the FSB is looking at the collateralized loan obligation (CLO) structure on a global basis to see where most of the leveraged loans are held, noting the importance of understanding this.

Sen. Pat Toomey (R-Pa.) noted that a large majority of leveraged loans are not on the balance sheet, and instead the assets are held by end users who are not leveraged themselves, to which Quarles agreed, adding that most holders of CLOs are not runnable institutions, which enhances financial stability. Quarles continued that while “domestically we have a good handle on this,” more information is needed globally, and that the FSB is working on that to see where the international exposure is.

Foreign Banks

Toomey pointed out the “substantial role” FBOs have in the American banking system and his concern that an un-level playing field is being created through different regulatory regimes that could “diminish” competition, to which Quarles agreed. Quarles continued that national treatment must be considered when constructing regulatory positions and that the FBO proposals are similar to the domestic tailoring proposals with a few differences, to include looking only at the international holding company (IHC) or consolidated U.S. operations when configuring the base size (and that they will consider comments otherwise).

Brown claimed that during the debate over S. 2155, it was stated that only the treatment of domestic banks would be changed, not FBOs, but then the Fed proposed a framework for FBOs similar to the domestic proposal. Quarles stated that the FBO proposal does have differences, explaining that the liquidity requirements on U.S. operations for FBOs are “almost four percent higher by estimates.”

Bank Secrecy Act (BSA) and Anti-Money Laundering (AML)

Sen. Martha McSally (R-Ariz.) stated that many banks are having to close due to rigorous BSA/AML implementation and that regulations should be tailored for smaller businesses. Otting replied that the regulators meet monthly and staff meet weekly on this and other issues, adding that later this year the agencies plan to re-introduce the examination manual, moving toward a risk-based approach, but would not give an exact timeline. Quarles echoed Otting’s comments, adding that they are also working with the Financial Crimes Enforcement Network (FinCEN) to “reduce the burden associated with it.”

Guidance and Regulation

Sen. Thom Tillis (R-N.C.) stated that the FDIC has done a “great job” looking at guidance and removing ones that do not make sense or should have gone through the Administrative Procedures Act (APA) and asked if guidance should be able to supersede law. Hood replied that the NCUA is looking at guidance to ensure none of it is being misinterpreted as rules. McWilliams noted that the FDIC “retired” close to 68 percent of their guidance letters. Quarles noted that the Fed has made it clear that guidance is not supposed to be used for enforcement actions and that it is imperative regulators “think carefully about where we are drawing the line” when it comes to what can be accomplished through supervision and what can be done through regulation. Otting echoed Quarles’ comments, adding that the OCC has conducted training on what guidance is and will see “limited guidance being issued in the future.” Tillis also said he would submit a follow up question on the inter-affiliate margin exemption issue.

Impact of S. 2155

Crapo noted that due to S. 2155 and other regulatory activities there has been strong performance in the financial sector, but that the other side of the aisle claims the law is only benefitting the wealthy. Quarles replied that “a dynamic economy benefits everyone,” citing labor market and unemployment statistics. McWilliams added that small businesses have been able to access credit and consumers have been able to refinance mortgages at better rates. Hood noted that due to the law, low- and moderate-income consumers can now get loans.

Sen. Jerry Moran (R-Kan.) questioned whether S. 2155 is having as big of an impact on small businesses and rural America as Congress expected when drafting the law and asked for an update on other regulations stemming from the law. Otting replied that most regulations should be released by September, with only a few being proposed in the fourth quarter, adding that the regulators meet monthly about these pending issues.

Community Reinvestment Act (CRA)

Sens. Brown, Smith, Catherine Cortez Masto (D-Nev.), and Robert Menendez (D-N.J.) asked about the CRA, to which Otting replied the OCC has been receiving feedback over the last 15 months, with over 1,000 people speaking with them about it and over 1,500 comment letters received. He continued that they are focusing on what qualifies for CRA, how to measure CRA, and where growth has been. Quarles and McWilliams added that they are working to ensure the civil rights community has input and that they are meeting with other consumer groups as well.

Current Expected Credit Loss (CECL)

Sen. Doug Jones (D-Ala.) noted his concern about the unintended consequences of the CECL model being considered by the Financial Accounting Standards Board (FASB). Quarles replied that he has received a “broad range of estimates” regarding the potential impact of CECL, which is why a phased-in implementation has been proposed so that the effects of the change can be seen over time. McWilliams added that this is the “number one” question she receives from community banks, noting that she has met with FASB to discuss concerns with implementation and that the FDIC is working with banks so they understand how to comply.

For more information on this hearing, click here.